CTA Case No. 4250 (Decision)

REPUBLIC OF THE PHILIPPINES COURT OF TAX APPEALS QUEZON CITY CYANAMID PHILIPPINES, INC., Petitioner, - versus - C.T.A. CASE NO. 42SO COMMISS IONER OF I NTERNAL REVENUE, Respondent. M- - - ---M D E C :t B :t 0 N This is an appeal by petitioner, Cyana�id Philippines, Inc., from a decision of respondent Commissioner of Internal Revenue imposing a 25~ undue accumulation of profits busines s needs of petitioner for the taMable year 1981 involving the amount of P3,774,8G7.50, i nc lusive of intere st. Section 25(a ) of the National Revenue Code <NIRC) imposes an additional t aM upon a corporation formed or vailed of for the purpose of preventing the imposition of the taM upon its shareholders or the shareholders of any other corporati on through the �adiulll of per11itting its gains and profits to 278

DECISION CTA CASE NOS. 4250 - 2- accumulate instead of being divided or di~tributed. On the other hand, Section 25(c ) NIRC provides that the fact that earnings or profits of a corporation are permitted to accumulate beyond the reasonc!kble nee d~ of the bltsiness shall be determinative of the purpose to avoid the tax on shareholders unless the corporation shall prove the contrary by a clear preponderance of evidence. Petitioner Cyanamid Philippines , Inc. is a wholly-owned of American Cyanamid Company, a co rporat ion orqanized and existing under and by v:i.rt1..11t of the laws of the State of Maine, U. !:3. A. lt il!l enqa~ed in the manufacture of pharm.aceutical prod1..1cts and chemicals, wholesaler of imported finis hed qoods~ importer and an indentor. (p. 171' BIR Rec., and admitted in "Memorll\\ndllm for Respo nde nt", CTA Records p. 138). On Janllc!kry 30, 1985 after respondent's examin er conducted an examination of petitioner's books of account s and other accounting records, respondent Co mmis sioner of Internal Revenue issued assessment notices both numbered 32-05048-001889-81 to petitioner demanding payments of P119,817.00 a~ deficiency income tax for 1981 and P3,774,867.50 as 25')(. s�.1rtax for improper acc1..1mulation of earnings for the taxable year 1981 computed a~ follows:

DECISION CTA CASE NOB. 4250 - 3- Ntt Rtttlntd Earning1�btg. PH51 2801587,00 Addt Ntt profit during tht yttr Pl4170S1370.00 L1111 Ineo11 TaM ptid Alount tubJtCt under Ste. 2S -'� '"�"4.00 p 9, ~. 926.00 TaM due thtrton --~ Addr lnttrtlt fro� p 2~ 385, 232. 00 4/16/SH/16/BS TAX Dtl H taLECTlll.E On M rc:h 7, 1983, peti tioner protestl!d said eo, Oetobe ~ 1987. Hence, thi5 ppeal. During th� pende ncy of the e~ �, however , both gre d to com prom is the 1981 deficiency IA!Ui nt of P119, 817. 00. Petition l!n" paid the of P26, 577. 00 s COIIIprolliSit The re aining is ue wh ther or not petitioner is liable for the 25~ accumulated earnings tax in the tax year 1981. The pertin ent provisions of Sect ion 25 NIRC, the law �.mder which res pondent assess ed the corresponding 25~ tax for unreasonabl e accumulation of surplus for the fisca l year 1981, r~tads as follows� 11 SEC. 25. AdditiOn!'l tax on corporations improperly aceu�ulating profit 1 or surplus. <a> I �pos it ion of Tax - If any corporation except banks, insurance co11panies, or personal holding co�pan i es, whether � do11est ic or foreign, is forMed or availed of for the purpose of preventing the imposition of tax upon its shareholders or members or th e shareholders or members of another 28l

DECISION CTA CASE NOS. 42SO - 4- corporation, through the Mediu� of permitting its gains and profits to accumulate inst ead of being dividttd or distributed, there is levied and assessttd against such corporation, for each taxable year, a t a x equal to twenty-five per centum of the �.mdistrib�.tted pOt''tion of its accumulated profits or surplus which shall be in addition to the tcl\\x iMposed by Section 24, and shall be computed, collected and paid in the same manner and subject to the same provisions of law, including penalties, as that tax. " XXX XXX XXX "(c) Evidence detet"' minative of ~rposeL - the fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the b�.tsiness shall be detet"'�inative of the purpose to avoid the tax upon its shareholders or members unless the corporation, by clear preponderance of the evidence, shall prove the contrary." A prerequisite to the imposition of the tax is that the corporation be formed or avai 1ed of for the purpose of avoiding inCOIWe tax on its shareholders, or on the shareholders of any other corporation by permitting the earnings and profits of the corporation to accu!Wt..llate instead of dividing them among or distributing theM to the shareholders. If the failure to pay dividends is due to so111e other cause, s�.Jch as the use of the undistributed earnings and pt"'ofi ts for the reasonable needs of the business, such purpose does not fall within the interdiction of the statute. 28?

DECISION CTA CASE NOS. 42~0 - 5- Chapter 3 9, p . 44, P~.!t ~-t.~_Q_ S ec. 21, Revenue R�gulations No. 2; Manila Wine Merchants, Inc. v. Co��issioner of Internal Revenue, No. L-26145, February 20, 1984, 127 SC RA 483). In as much as "Q.!J.LQOse_" involves a state of mind or intent, it is always necessary to look at the surrounding circums tances and the attendant facts on a case by c a se ba sis to deter�ine whether the non-distribution of earnings and profits was to permit the shareholder s to avoid inco�e ta~ or if such was for some 1eg it i mate purpose, such as, its use for the reasonable needs of the bt.nines<s. In this regard, although the of the ta~payer, officers and s tockholders is entitled to� some weight, generally, the issue is to be resolved in the light of the surrounding circumstances, including the interests of those in control of their actual conduct. <Merten<s, Law of Federal Inco�e Taxation, Vol. 7, Chapter 39, p. 45). Respondent submits the following findings and analysis allegedly determinative of petitioner's accumulation of profits or earnings for the ta~able year i nvo 1ved as being beyond the needs of its business: <E~aminer's Memorandum; E~h. 2-A, pp. 169 BIR Records.>

DECISION CTA CASE NOS. 4250 - 6- "A . That the cor�poration, while declaring stock and cas h dividends in 1 '~80, did no t o r fa iled to de c lare a ny durin q the ye ar undet~ review, permitting t he ac c �.1 mulation of profits instead of b ei n~ divided o r distt�ibuted to taxable shareholders; " "B. The fina ncial position of the company as of Novembel'" 30 , 1'381: Assets werl! P52,316,680. 00 ~J h ile liabilities amountl!d to P22,2 12,063.00 6r a ratio of 2.5 to 1; 11 "C. That the corporation had considerable liql\id funds consisting of Cash, Receivables, Inventories and even its sales for the perio d ~ould adequately provid e the no rmal needs of the business ... Petitioner contends that i t did not declal'"e dividends fot~ the yeat" 1'381 in ot"der to use the accumulated earninqs as working capital reserve to meet its "reasonable business needs". The law permits a stock corporation to set aside a portion of its retained earnigs fot" specified purposes.1 , In the case at bat", howevet", p e titioner's purpose for accumulating its earnings does not fall within the ambit of any of these specified purposes. Sec. 43 par. 2 Corporation Code of the Philippines - Stock corporations are prohibited fro� retaining surplus profits in excess of one hundred <100~) of their paid-in capital stock, except: (1) when justified by definite corporation expansion projects or prograas approved by the board of directors or; (2) when the corporation is prohibited under any loan agreeaent with any financial institution or creditor, whether ~ocal or foreign, fro1 declaring dividends without it s/his consent, and such consent has not yet been secured ; or ; (3) when it can be dearly shown that such retentions is necessary under special circuastances obtaining in the corporation, such as when there is need for special reserve for probable contingencies. In) 2R4

DECISION CTA CASE NOS. 4250 - 7- More comp llinq is the findinq t hat there was no need for petitionet~ to set aside a portion of its re t ained ear inqs As workinq capital reserve as it claims sine it ha d co n sidet~a ble liq1.1id funds. r view of petit i onet~' s financial statement (p a;n~ ticllla r ly the Balance Sheet , p. 127, r v als that the coporati on had l iql.li d f �.mds c on5istinq of cash, accoi..\nts receivable , inventory and even its s ales for th~ period is adequate to meet the normal needs of the business. This can be determined by compt..\tinq the c1.1n~ nt Asset to liability ra tio of curr nt rli!\tio ... current assets c1.1r rent liabilities P47 , 052 ,S35.00 P21 , 275,544.00 The signific nee of this ratio is to serve as a primary test of a company's so lvency to Meet current obligations from current assets as a going concern or of adequacy of working c apital. Petitioner in this case failed to prove the imm diacy of its need for the accumu lation of

DECISION CTA CASE NOS. 4250 - 8- earning~, h r11=e the ce�Jiilul ation was not for t h ct r asonable ne d of th bus1ne5s and thus, the surt x h ould then appl Y� <Th � Man i la Win � Meretumta, lm:.. , v�. Th� Co��is�ioner of Intctrnal Revenu~, GR. No. L -26145, February ao, 1984, 127 We fur-ther' r J c::t p tit i oner ' s a""gument t hat "the aeoumul _ted earnings tax does not apply to a p�Jbl icl y - he ld corporati on" citing Amet"'ican jurisprudenc to support its posi tion . The reference finds no app l ication in the case at bar because under S ec:: ion 25 of th NIRC , as amende d by Sect itH'l 5 of P. D. No. 137'a (dated Sept ember 17, 1980), the exc:: pt io n~ to the aceum1.1lated earnings tax are expressly numerat d, to wit: Bank, non- bank financi 1 int rmediaries , corporati ons organized primarily, nd uthorized by the Central Bank of the Philippines to hold shares of st ock of banks, insurance comp nies, or personal holding compani e s , whether domestic or f orei gn . Th e law on the matter i s clear and spec ific. no need to resort to a ppl ieabl e eases decided by the American Fed era l Cour ts for guidancct and enlightenmctnt as to whether the provision of Se c tion 25 of the NI RC shou l d apply t o pet i ti on er.

DECISION CTR CASE NOB. 4250 - 9- Equally cl ear and s p ec i f ic are the provisions of E. 0. 41 parti c ular ly with respe c t to effectivity and c o ve t"a q e. It appears that petitioner availed of the tax amnesty under E.O. 41 Ltnder File No. 32A- F - 00045 5-41B as cEn"tified and confirmed by respondent throu qh its Tax Amnesty Implementation Office on Octobet" 6, 198'7. The availment of the tax amnesty under E.O. 41 as amended is sufficient basis, in appropriate cases, for the cancellation of the assessMent issL1ed after August 2 1 , 1 ~-3 86 <Hevenue Memorand�.1m Ordet" No. 4-87>. Sa id availment does not result in cancellation of assessments issued before August 21, 1'386 as petitioner seeks to do in the case at bar. Therefore, the assessments in this case, issued on January 3 0, 1985 despite petitioner's availment of the ta x a mn est y under E.O. 41 as amended, still sub!>ist. Based on the foreqoinq, we find the petitioner 1 iabl e fot" the payment of the 41.fore111ent i oned 25'}(. surtax on undue accumulation of surplus in the amount of P3,774,86'7.50 inclusive of interest. Petitioner was unable to prove its non-liability by a cleil.r preponderance of evidence. WHEREFORE petitioner Phi 1 ippines, �Inc., is ordered to pay respondent Co��isaioner of 2~7

I, DECISION - CTA CASE NOS. 42SO - 10 - I nternal the of P3, 774, 867.50 represent ing 25~ surtaK on i�pro per a ccu�ulation o f profit� fo r 1981, plus 10~ sureh rge a nd 20~ annua l i n tere t f ro � January 30, 1985 to Januar y 30, 198 7 . Cost s a gain st petitioner. SO ORDERED. WE CONCURt <ev ..~~~ ERNESTO D. ACOSTA A!uociate Judg e CE RT I F I CAT I 0 N I he r eby c e rtify that t his decision wa s reached after due consultation a mong the ~embers of the Court of TaK App ea l s in accordance with Section 13, Article VII I of the Constituti on. Pr e s iding Judgtt Court of Ta~ Appeals