CTA Case No. 4400 (Decision)

~ �- � . ; I REPUBLIC OF THE PHIL.IPPINES COURT OF TAX APPEALS UUEZON CITY HAWfH IAN - PHILIPPINE COMPANY, Petitioner, - versus - C.T.A. CASE NO. 4400 ., HE COMMISSIONER OF IN-rERNAL REVENUE, Respondent . X- - - - - - - - - - - - - - - - - - ~ )( D E c :r :r N T hi~ is an asses s ment case for alleged deficiency income tax for the years 1983 and 1985 in the respective amounts of P2,591,348.80 and P2,026, 235.28, or a total . amount of P4,617,584.08. Both assessments arose from disallowed .deductions of management fees paid to Pet1t1oner's managing agent during said years. Petitioner is a domestic corporation engaged in the ' proce s sing of sugar and its by-product, molasses. On March ,�:.:;J;�.;:.�_, 1989, Petitioner received a letter of demand together with the respective Assessment Notice � Nos. 00591-89 and 00592-89 under respective Assessment Nos. 06B-56-6-000205-83/89 and OGB-56-7-000194- 85/89 assessing Petitioner for alleged deficiency income taxes computed as follows: ~

------ ----....-- .-----� DECISION - C. T. A. CASE NO. 4400 - - "�:-J DEF ICIENCY INCOME TAXES A~srssarnt Noticr No. 00591 -89 06B-56�-6-()QQ205��6J/89 Nrt incoar prr rrturn P~, 451, 001 . 00 Add: DisaJl~nc~s prr invrstigation ~.627, 408.00 Managnrnt Frrs P':J,078,409.00 Net incoae per investigation &revie" - o- Less: EKelpttons P':J,076, 409. 00 Net taKablr tnco1e Incoar taK due thereon PJ,t67,44J.OO Less: TaK paid per return 1,547, 850. 00 Deficiency taK due Pl 1619159J.OO Add: 20J annual interest fro� ~- 16-8~ 971,755.80 to J-1-89 (60J laK.I TOUt. ~T Ill� AND Ol.LECI lBLE PC,:m,Jtts.ao Assessaent Notice No. 005'12-89 068-56-7-000194-85/89 Net incoae prr return CP 889, 769.00 I Add: Disallowances per investigation 4,548,JJJ.OO Manageaent Fees P3,658,561t.OO Net incou per investigation &review -o - Less: EKelptions PJ,658,56~.00 Nrt taKable incoae lncoar taK dur thrrron P1 127J, 9'37.00 .. Le~s: TaK pa id. prr rrturn -o- Deficiency taK dur Pl,27J, 9'37.00 Add: 20~ annua l interest froa ~ - 16-86 to J-1-89 (.59145531 752,238.28 TOTJl. AIO.ttT OlE AND aLLECfll!lE P2, ~.235. 28 .r-" <E xh. 4, BIR Recol"'ds, p; ��� 285)

- DECISION - C.T.A. CASE NO. 4400 - 3- On April 5, 1989, Petitioner, through its managing agent duly Respondent's above-mentioned assessments <Exh. CN, SIR Records, pp. 289-294>. 'Notwithstanding Petitioner's letter of protest and its subsequent letters reiterating such protest (Exhs. C0- 2 and CS>, � Respondent, thr01,.1gh his agent Warrants of Garnishment dated September 7, 1989 to the Bank of the Philippine Islands .and the Philippine Commercial Industrial Bank on October 9,� 1989 and to the Far East Bank and Trust Company on October 10, 1989 <Exhs. CP, CQ and CR, BIR Records, pp. 320- 326). In a letter dated October 17, 1989 filed on even date with the Collection Enforcement Division, Petitioner � requested Respondent to lift the warrants issued against it <Exh. CT, BIR Records, pp. 347-359>. On October 26, 1989, Petitioner reiterated its request to Respondent that the warrants of garnishment be lifted and offered the amount of P1,500,000.00 to be held in escrow in a bank pending the res~lution of the assessments in question. .. Subject to the .offered escro~, Respondent lifted the warrants of garnishment <Exh. cu, BIR Records, pp. 361-362>. Considering the issuance and service of warrants of garnishment as .P" disputed Respondent~s denial on the assessments, Petitioner filed this appeal.

- DECISION - C.T .A. CASE NO. 4400 4- The basic issue to be resolved i n the cas e at bar is: whether or not t he disal lowance by the Respond ent of the mana gement fees due to it s managing ~gent , Jardine Davie s , Jnc. as deduction by Petitioner fo r income tax s s, e ptn~po on the gro und that such mana gemen t fees a ~ e disguised div idends, was proper. In ju stify ing the disallowance of the management fees fro m Petitioner's gross income , Re~pon dent i nvok e d t he "doctr in e of p iercing the ve il of cor porilt!? entity" inasmo..tch as "J ardin e Davies, lnc~, own s 88" of the t otal s toc ks of the Hawai ian-Ph ilippin e Co mpany, " (M em orandt..lm letter of th e Revenue Enforcem ent Officers, dated Jan uar y . 1a, 1989, Exh . 1' BlR Reco rds, pp. 264-266) . Th t..ts, following the doctrine laid down i n the cas e of Yutivo Sons Hardware, Co. v s~ Court of Tax Appeals, G. R ~ No. L -13203, January 28, 1961 ' 1 SCRA 160, Rt>s pondent disregarded the separate corporate personality of the Petitioner and it s managing agent, Jardine Davies, lnc., thus, the disal lowance of the manag&ment by Petitioner to the 1at t e t~ <see Answer, C. T . A. .. Rec ords, P� 38). Th e pertin ent pbrt ion of th e sai d Me�orandum Letter is hereby quoted, thus: JUSTIFICATION FOR THE DISALLOWANCE AND COMMENIS .,. > Hawaiian-Philippine Co�pany subsidiary of Jardine Davies Inc., a

----� DECISION - C.T.A. CASE NO. 44 00 - 5- corporation with offic~s at No. 222, Bu~ndia Av~ ., Makati , Me tt~o Manila, P h ilippin~s . Th~ Jardin e Davi~s. Inc., owns 88~ of th~ total st ocks of th~ Hawaiia n- Phi lippin~ Company. <A xero x copy of th~ li st of stockholders is hereto attach~d . ) On March 20, 198 1, the Hawaiian-Philipp ine Company entered into an agreement between Jardine Davies, Inc., wherein, in acco rdanc~ wi th the terms th er ~of, the Jardine Davies , I nc. will manage the operati ons of the Hawaiian-Philippine Company. (A cop y of t he management agreement is als o h ereto attached.) Mr. E rwin G. Vo rster, a stockhold er and a memb ~r of the Board o f Dir~ctors of the Hawa iian-Philippine Company, who is also th~ Presid ~nt of th e Jardine Davies, Inc., sign~d t h e co nt ra ct in b~h.;:~lf of Jardine Davies, Inc. In a Supre me Court d~cision in the case of Yut i vo S ons Hat~dwat~e Co., vs. CTA, et al., <SCRA lbOJ, the Court disregard the corp o r a t e personality of South~rn Motors, Inc. and taxed them by consolidating the incom~ of Southern 1'11otors , Inc. with Yutivo Sons Hat~dware Co., on the theory that both corporation w~r~ owned by the same family. We the undersign~d so hold that, in the same manner as the Court disregard the corporate pers onalit1es o f Yut1vo Sons Hardware Co. and Sout hern Motors Inc.� because th~y w~r~ owned by the s ame family, th~ execution th~reo f of a managem ent contract between Hawai ian-Ph ili ppine Com pany and Jardine Davi~s Inc., which is ~8~ con trolled, is but a cov~r up to justify their d~ duction of ~anag~m~nt fees from th~ gross incom e of Hawaiian-Philippin~ Compan y. In ~ ff ~ct, th~ manag~m~nt f~~s th~r~of ar~ consid~r~d disguised dividends and are unallowable d~ductions from its gross incom~. Th e answ~r to the qu~stion: Was the R~spond~nt cprrect in disregarding the separate corporate ~ntity of th~ P~tition~t~ and .its managi,.Pg ag~nt, Jardine Davies,

- DECISION - C.T.A. CASE NO. 4400 - 6- I n c. , t h e t~ e f ore , i s t h e k e y de t e t~ mi nan t i n th e resolution of the issue in this case. And We answer in the negative. The doc trine of corporate entity has been recognized repeatedly in . income tax cases. In fact, the incomt:> tax law could not be administered effectively unless this doctrine were freely recognized. "lt is one of substanc e and vitality and that the disregard of the doctrine is the excepti on � instead of the rule" <Ayer vs. Co��issioner, 100 F2d B50 LCCR 1st, 1939)). 1-lnd "the exception to l to sham the gen eral e t~ul is 1 i mit ed transactions and situations involving transactions or that lack a b 1.1s i ness purpose and formalit y " <lngle Coal Corp., vs. U.S., 127 F S upp 753). "The me r e fact that the taxpayer owned all the stock in the corporation is not sufficient to establish the existence o f e1<cepti onal circumstances und er which a co urt might be justified in disregarding the corporate entity" <Benedict A. Kausal, Jr~ ., TC Memo 1956-28'3 ). In the case at bar, Respondent's only justification for disallowing the management fees as prope r deduction was that "the Jar-dine Davies, Inc., owns 88" of the total stocks of the Hawaiian-Philippine Company" <E~<h. 1-C, BIR Recor~ds, p. 271). On th i !"~ �Pbas is a lone, We af'e not prepared to disregard the doctrine of corporate entity.

DECISION - C.T.A. CASE NO. 4400 - 7- It may be admitted that there were al ready cases wherein this Court and the Supreme Court have pi erced the veil of corporate entity but it is ass ured that a multitude of factors have been cons idered in arriving at a conclusion that a taxpayer and its subsidi ary mu st be regarded as one taxable entity. We WOl.lld l:i ke to owne t~ship and control "i!> not s\.tffic ient to establi sh the existence of exceptio nal c i t"cum stances under which a court might be just ifi ed in disregarding the coPporate entity" <Benedict A. Kausal, Jr., sup't.,a). lhe case of Yutivo Sons Hardware Co. v s. Court of Tax Appeals, 1 SC RA 160 used by the Respondent to supp ort her case simply cannot be applied to the case at bar as the facts are entirely different. In a form of summary, the High Court in arriving to its conclusion that Yutivo and Southern Motors should be regarded as one taxable entity, thus held: Brief ly stated, Yutivo financed principally, if not wholly, the bus iness of SM and actually extend ed all the credit to the latter not only in the form of starting capital but also in the form of credits extended for the cars and vehicles allegedly sold by Yutivo to SM as well as adv�ances � or 1oans for the e xpense s of the latter when the capi tal had been exhausted. Thus, the increases in the capital stock were made in advances or " Guat~ antee " pay111ents by Yutivo . and credit ed in favor of SM. The funds ~f SM were all �erged in the cash fund of .�Yut i vo. At all times Yutivo thru officers and directors co��on to it and SM, exercised full control � over the cash

.... DECISION - C.T.A . CASE NO. 4 4 00 - 8- funds, policies, expenditures a nd obl igations of th e l at t er. South er n Motors being but a mere instrumenta l ity or adjunct o f Yutiv o, the tourt of Tax Appeal s corr ectl y di sr egarded t h e techni cal de fense of se parate c orporate entit y in order t o a rrive at th e tr~e tax liabili ty of Yutivo. I In fine, the High Court co nsid ered South e r n Mo tors as a mere shell c orporation used as a bus in ess cond uit b y Yut i vo~ Obvious l y, t he same is not tru e in t h e case a t bar. Pursuant t o its management contract with P e titioner , ma n a g emen t f ee s a r e pa id for ser vice s a ctually rend e red by Jardine Da vie s , Inc. A~ t estified by wi tness Lutg arda Sa maniego, Su ga r Mark eting and Administ rati ve Consultant of Jardine Da vies , lnc. , she s tat ed thus : Q. Mrs � . Witn e s s, wh o takes cha r~ge, if an y, of t he activities of HP Co . outside of S ilay City ? R. J ar dine Davies, Inc., befo re Theo H. Dav ies, its managing agent s for Hawaiian-Phi lipp i ne Company. And anything that is out of t he da y- to- day operation s are handled by them. Q. What ar e the s e operations of HP Co . in Manila? A. The marketing of its ma i n pr o duct, sugar and mol asses, that i s handled by Jard i ne Dav ies. Th ey handle corporate relati ons , tax and legal,... syste,n; the y h a ndle the investments and money management; they handle purchasing for Ha wa i ian -

DECISION - C.T.A. CASE , NO. 4400 ~) - 9- Philippine Company for it~ms that are not locally available in Bacolod; they take care of all the foreign � exchange requirements; they represent Hawaiian-Philippine Company in various offices in Manila. Q. And how did this relationship between Jardine Davies and Hawaiian- Philippines arise? A. It arose from a management contract, management agreement, whil:'h stat~ted as early as 1948 with Theo H. Davies. And then, when it became Jardine Davies, the same management agreement is enforced. XXX XXX XXX Q. Mrs. Witness, how did Jardine Davies perform this general management services ? A. Jardine .Davies, through the president, the senior vice- president of Natural Resources Division, now Sugar Division, the senior vice-president for Treasury and Finance, the senior vice-president for Corporate Relations, Legal and Tax, they set the policies and the annual planning sessions, goal� to be achieved and targets to be attained, the officers conduct plant visits regularly, .. the manager of the mill, the the administrative manager of mill, the factory manager are usually called to Manila from time to time to settle various concerns and to set their plans . They talk about capital expenditur!?..,.... projects; they talk abo11.1t financial matters, and pet~sonnel. ,

�- ,� DECISION - C.T.A. CASE NO. 4400 - 10 - <T. S. N. p. 9 - 10; 11-12, Hearing of February 18, 1991> And these manage ment fees were subjected to contractor's tax and reported as part of income of Jardine Davies, 1 nc. Q. And what re muneration, if any, did Jardi n ~ Davies receive for these management services ? A. ih ey receive this in the of management fees. Q. And how does Jardine Davies treat these management fees? A. Well, these management fees we re, during the time in question, subie~ted to contractor ' s tax and reported as part o f in c om e of Jardine Davies. Currently, it is reported as part of the income of Jardine Davies, Incorporated and was subject to the ~alue Added iax. <E mphasis supplied; T. S. N. p. 39 , Hearing of Apri'l 23, 1'3'3 1> Clearly, the business dealings between the .Petitioner and its managing agent, Jardine Davies, Inc., are at 1 ength. We find nothing to conclude that their business dealings are unusual or irr~gular. At this juncture, it should be stated that the intention to minimize taxes, when used in the context of convincing _.1""' fraud, must be proved to e"ist by clear and eviden~e amounting to more than mere preponderance, and

- .... DECISION - C.T.A . CASE NO. 4400� - 11 - cannot be justified by a mere speculat ion. This is <Vitelli \ because fraud is neve r lightly to be pres umed. and S ons vs. U.S., 250 u. s. 355; Duffin vs. Lucas , 55 F<2d) 78G ; Hudd vs. CoaM. , 43 F<2d> 509; see also Sa l ter, Fraud Under Federal Law, pp. 301-302, citing numerous auth orities ; Arroyo vs . Granada, t al., 18 P h i 1 . 484) �. is never imputed and the court s never s 1stain findings of fraud up on circumstances which, at the mo~t, create only suspici on. <Haygood Lu.ber a nd Mining Co. v s . Co��issioner, 178 F<2d> 769; 1 00 F <2d > 507>. WHEREF UHE, in all the foreg oing discus sions, We so I� believe that it was not proper on the part of the Respondent to disallow the manag ement fees as deduction from the Petitioner's gross income. ACCORDINGLY, Responde nt is hereby ORDERED to CANCEL the a ssess ments in question for being null an d void. Res pondent is likewise ORDERED to LIFT the amo un t of P1,5oo,ooo. oo held i n escrow in her favor, which amount served as guarantee for payment of the defi ciency income ta xes SO ORDERED.

DECISION - - 12 - C.T.A. CASE NO . 4400 WE CONCUft: ~0--~ ERNESTO D. ACOSTA ~ Presiding Jud ge f., { CERTIFIC AT IO N I hereby c e rtify that this decision was reached after due consultation amo ng the member s of the Court of Tax Appeals in accordance with Secti on 13 Article VIII of the Constitution. ~--.~CV-~ ERNESTD D. ACOSTA Presiding Judge .. P "