CTA Case No. 1349 (Decision)

I REPUBLIC Oli' 'fHE !'HILI:PPINES COU11T 0 F 'r1L'\ A? i'l!;AI,S � QUEZON CITY �II MODESTO �T. li1LORES , as .\� Co-Administrator of the Testata Estate of the i':.. late Mary McDonald Bachrach , Petitioner versus / JOSE B. LINGAD, in his capacity as Conunissionet� of Internal Revenue, Respondent . X ~ �- - ~ - - - - - ~ - - X DE CI S I 0 N 'r 12, 1963, the sllin of 'id673,576 .. 81 as deficiency in- come tax for the pe,.r:Lod covering January 1, 1960 to uguat 7, 1960 ~nd interests, from the testate es- tate of the late Mary !'1cDonald Bachrach. Not satisfied with the assessment, Hodesto .tt., Flores, as co-administrator of the above testate estate 1 appealed to this Court. Mary McDonald Bachrach was the widow of the late Emil Bachrach, who bequeathed to her the usufruct of certain properti.es, among which were shares of stock in the Bachrach Motor o., Inc., Cdnsolidated Mines, Inco, People's Bank and Trust Co. and the 1-leralco. The bequest was valued at 731 ,lt4\2.19 in accordance with the American Tropical Experience Table (Sec. 9, N ~I. rt .C & ). l-1ary M. Bach- 386

DECISION - CASE NO. 134-9 I' 2 rach paid inheritance tax in the amount of ~247,- 062.41 based on said v~luation. .. On August 7 , 1960, Ha.ry 1. Bachrach died. The administrate~ of her estate filed an income tax return for Mary N. Bachrach ' for the period from January 1, 1960 to August 7, 1960 and another one for her estate for the remaining period of 1960. The bulk of the deceased's properties consisted of shares of stock of the Bachrach Motor ~o., Inc. (hereinafter referred to as old Bachrach Motor Go.). Thia company was a domes.t!ic corporation organ. .7P .. o. . May 28, 1910 for a t 1m of fifty (50 ) years, expiring on May 28, 1960. It imported, manufactured and dealt in cars, trucks and spare parts, and engaged in land transportation. It had an original authorized capital of ~ 150,ooo.oo, divided into 1,5uu shares with par value of it1 0.00 each ( See Exhibit A, 11 11 petitioner's exhibits, p. 2). Out of this authorized capital stock, the following were subs cribed and paid for as of the date of the incorporation: ln~~.tl2~1:SA ~Q.t" ~ N~h Q;( oha~~Hi MQll!lt Qf CL S SYQ~~r1b~g & ~~lg ln 1. E.M. Bachrach 519 it 1,900. 00 2 . J. H. Sifert 1 100.00 'l � Scott 1 1uu. u ""� ~: 1 1UU.v0 H. B. Hacje 1 100.00 5. D. 1. li leming \ The authorized capital stock was increased to 649, 00o.oo, . 1,5oo,ooo.oo, and finally to ~ 5,uoo,oou.oo (See Exhibits 11 C,.1 11D, 11 11E," petit:toner's exhibits, pp. 20, 25, 30). The shares issued and outstanding 3~

. ( DECISION - CASE NO. 1 34-9 3 J' as of May 28, 1960 amounted to �1,993,4-0o.oc in the names of the following& Names No. of A.moun:!; ' � Shar.es 1 . Mary M. Bachrach 13,236.3 �1,323,6)0.00 2. Estate of Em 1 Bachra h 6,683.7 668,370.00 Neil Hankins ~: H. M. Levine 2.(J 200.00 5. Elmer Madsen 200.00 6. Joseph Kaplin 2.0 7. .Pedro Cayetano 2.0 200.00 .8. Leogardo Velilla 2.0 9� Modesto Flores 2.0 200.00 2 .0 200.00 200.00 2.0 200 ,00 In the course of its operation, the old Bach- rach Motor Co. declared stock dividends. The stock dividends in December 1957 amounted to 6% of the earned surplus account or ~98,ooo.co; in May 1960, 15% or . it260,ooo.oo (See pp. 26Lt-265, t.s.n.; Ex- hibit 11EE, 11 p. 197, petitioner's e.xhi bits). Before the expiration of the franchisal life of the old Bachrach Motor Go., two corporations, the Bachrach Motor Co. (hereof referred to as new Bach- rach 1-lotor Co.) and the Bachrach Transportation Go., !nco, were organized to carry on its businesses. The assets and liabilities of the old Ba chrach 1otor <.;o. pertain:tng to its business as importer, manufacturer and dealer in cars, trucks and spare parts were trans- ferred to the new Bachrach Motor <.;o., aod those per- taininr. to its land transportation business were transfez\red to the Bachrach 'l'ransportation Co., Inc. In consideration of these transfers of assets and liabilities, the stoc�~olders o the old Bachrach Motor ~o. received shares of' stock in the two ne\JJ ...orpora- tions in proportion to their stoc�~oldings in the ; 388

I DECISION - r~ � C SE i 0 . 1349 I _,., ' ol d corporation. j At the time of the transfer of a~sets and lio- \. ) bi lities . of the ol d Bachra ch Mo tor Co ., the esta te of E.. Bachrach ovmed 33 .. 33% of the ca'Pita l stock issued and outstanding of the corporation and the r es t were in t he name s of '�1ar y Ba chr ach and nomina l stochl1olders . I t was ascertained that the shares of stock of the nor.1inal stockho lder s were all endorsed in blank and were in the possession of the adminis- tra t or of the esta t:e of ,1ary Bachrach . The book value of Mary's holdings at t he time of t he t r ansfer was �2 , 043,486.02. 'I'he followi ng tabulr. tion shows the stock.hol dings in t he old and new cor por ations , to wit : Name No . of Shar es No . of Shares �rotal in ol d corp. in the t\-JO new corporati ons ---------------------------------~Bl-1~C ---B~'fC~~----------- 12 ." Ma r y Bachr a h 13, 236. 3 9, /'tl5. 6 3, 250 .. 7 13,236 . 3 ,stat e of E. 5, 040.4 1, 643 .3 6' 6830 '7 Bachra ch 6 , 683 . 7 ~: Neil Hankins 2 1 1 2 H. 11 . Levine 5. Elmer l adsen 2 1 1 2 2 1 1 2 6. Modesto T. Flor es '1 2 2 1 2 7. Joseph Y.aplin 2 1 1 �-- 8. L. L. Vel ill a 2 1 1 2 9. Pedro Cayetano _ 1 1 19,9~ Tot a l 19,93 A ver ifi cati on of t1e income tax return of the decease_d f or the period fr om Jannary 1 to August 7, 1960 showed� t hat the following proceeds received by Mary Bachi'ach were 'repor ted , not as part o her tax- 38 9

DECISION CASE NO . 1349 5 I' able income, but as usufructt Bachrach Motors, Inc. ~ 1 0,250 . 00 Consolidated Mines , Inc. People's Bank & Trust Co . 2,00 0 . 00 Meralco l.J- , 4.1.1-0 . 00 .. To t a 1 :!Is%~~:! (See Exhibit 11W, " P� 155 , petitioner 's exhibits . ) The s e proceeds, respondent claims , a re in excess of the usufructuary benefi t s received by l'lary 1�1. Bachrach which, for transfer tax purpos es, had been valued at 73 1,442. 19. Accordingly , they are taxable as income of the bequest or usufruct. On February 12, 1963, respondent assessed the estate of Hary 1. Bachrach for deficiency income tax cov ering the period January 1 to August 7, 1960 and interest in the amount of �673 ,576.81, after credit- ing the claim for refund of the estate i n the sum of ~6,359.00 ( See Exhibit ''6, 11 pp . 191, 193 , BIR rec .). There being allegedly no way of determining how much of the issued and outstanding sha r es were cash subscriptions or capital paid in, respondent con- sidered the difference between the book value ( ft 2 7043 ,436 o02 ) of the shares in the old Bachrach Motor Co. at the t i me of t he exchange and the original authorized capital (�150,ooo.co) of said corporation as liquidating s tock dividends, 50% of vlhi ch are taxable\ as capital gains. 'l'he liquidating dividends pertaining to the 33 . 33% interest of Emil Bachra ch were taken up by respondent as income of Mary M. Bach- ra ch. 39. 0

r� DECISION - CASE NO. 1349 ,. 6 From t his assessment, Modesto f . ~lares , the co-adnlinis trator of the testat e estate of Hary Ba ch- rach, appealed to this Court. .. As cor!ectly stated by responaent, the issues involved in the instant case are: 1. Did the exchange of shares of s tock result in a taxable gain to the t axpa yer'( 2. If i n the a fflrma t :l ve , ~vhn t 1r1as the cos t basis of the shares of stock in the old Ba chrach Motor Co � ., Inc. �; 3. Is the sum of r-!107,848.26 r epr esenting the usufruct received from the estate of E. ti .. Bachre1ch taxable as income? The controversy hinges on vJh{:: ther !'lary H ~ Bach- rach realized taxable income as stochl1older of the I old Bachrach Hotor Company upon acquisition of the \.,) shares of stock of the new Ba chrach Motor Co . and Bachrach Transportation Co. , t hrough exchange of share for share vJith the old Bachrach Ho tor Gompan~r � It is pe titioner's theory that there was no such corporate liquidation as to give rise to taxable li- quidating dividends. He argues t hat, although what tbok place between the old corporation ar~ the two ne\i corpor ations was not ordinary me rg er or consoli�� \ dation, nevertheless, it was well within the sta- tutor y "ac4uisition by one corporation of all or substantially all the properties of another corpora-

'. DECISIOll - CASE JO. '134-9 �' ' 7 tion solely for stoc -: . 11 Consequently , it is urged that the ga in resulting fr om the acquisition or ex- chance of stocks should not be recogniz .d under Sec- ' � tion 35( 2) of our Hevenue Code , as amended by Hepublic Act No. 1921.:. We agree with respondent., vlhen the corporate term of the old Bachrach Fetor Ccrnr ,:< r~y <-: X,L):.i..l'ed on May 28 , 1960 , this corporation automatically dls- solved., 11 x x x That the corporate exist ence ~ !a~ ceases upon the eXpiration of the period for v1hich it wns created is as a gen- eral rule, and apart from t he op ~ ration of a modifying statut e , undoubted; when that da te is r ea ched , the corpor~tion is ~ ~~ di s- solved , without any direct acti on on t he part of the state or t he members of t he corporatlono x x 11 (13 Am . Jur. par., 1286 , p . 11 58 .) 11 I f the la\�T under \vhich a corporation is organized, or t he special act creating tho corpora- tion , fixes a definite time \�then its corporate life mllSt end, it is evi dent that vJhen that date is r eached said corporation is ~ facto dissolved , without any direct action on the part of the stat e or its members." (4'1 .&1 , p .. 1298 .) The transfer of the assets and lia billties of the old Ba chrach gator Go . t o the ne'.�T La chrach Botor Coo and Bachrach Transport a tion Gou , Inc . was in effecJ a corporate liquidation . Jhil e t he asset s were never converted into cash f or dist.r:I.bution to the stockholders or for the set tlement of corporate obligations, there was, however, a l iquida tion as J9.2

�I DECISION - CASE NO . 13lr9 8 I' the stockholders received the equivalent value of their holdings when shares of stoc1c of tbe two new corporations were received in exchange of the .. transferred assets and liabilities in proportion to their stockholdings in the old corporation. 'rhus - 11 fnere a corporation surrendered its charter, dissolved, and trans- ferred all of its assets, including �its surplus, to a partnership com- posed of the shareholders in the corporation, who retained the same proportionate interests , under an agreement entered into beforehand to carry on the business as it had be- fore been carried on by the corpora- tion, the transaction was in effect a transfer to each shareholder of the value of his shares of stock, and re- sulted in taxable income a s to the surplus so t;;:ansferred. Huffm,an 1 s Appeal L1924/ 1 B. T. a. LFed./ 52 .il {65 ALR, p. 150.) 'rhere being a dissolution and l j. quidation of the old corporation, the gain realized by the stock- holders in the dissolution and l iquidation is sub- ject to income tax pursuant to Section 83 (a) of the ' Revenue Code, the pertinent provisions of which read: "Sec. 83. Qj.~t .r_ibntioo of divj,.- 9-Jmq~ 2r assets by gq,rno.ra.t;i..on.s. .. - X X X X X "Wher e a corporation d:tstri- butes . all of its ass e ts in coro- pl~te liquidation or dissolution, the gain realized or loss sustained by the stockholder, whether indivi- dual or corporate, is a taxable in- come or a deductible loss, as the case may be. 11 BB3 I.

I I DECISIO CASE JO . 131t9 9 I' The petitioner co.nnot claim non-t>ecognition of the gain realized by Mary M. Bachrach . Sec tion 35(2) of t he Revenue Code , upon which � his claim is based, provides : ' 1(c ) Exchan~e of property- X X X X X 11 (2) F(~ceptions. - No gain or l oss shall be recognized if in pur- . suance of a plan of merg e r or con- solidation (a ) a corporation vJLich is a party t o a merger or consolidation, exchanges property solely for ~tock i n a corpo r 8otri on whi h i s a pa r t y to t he merger co nsol i da t io n , (b) a shareholder exchanges stock in a corporation which is a party to the merger or consolidation sole- ly for the stock of another corpor- ation, also a party to the merger or consolidation , or (c) a security holder of a corporation which is a party to the merger or consolidation exchanges his securities in such cor- poration solely for stock or securi- ties in another corporation, a party to the merger or consolidati on.'' The gener� 1 rule is that upon the sale or ex- change of property, the gain realized therein is subject to income tax and the loss is allowed as deduction for income tax purposes. The law , however , admits of exceptions, that is , no gain or loss shall be recognized if in pursuance of a plan of merger or consolidation , (a ) a corporation , which is a party to the merger or consolidation exchanges property \ solely for stock in a corporo. tion, also a pa rty thereto; (b) a shareholder exchanges s t ock in a cor- 394 �' I_

DECISIOl' - CASE UO . 1349 ,. Hi poration which is a party thereto solely for stock of another corporation, likewise a party thereto ; .. and (c) a security holder of a corpor 8' tion which is a party thereto exchanges his sec~~ities i n su ch corporation solely for stock or securities in another corporation, also a pa rty thereto $ 'fue Code defines ''merger" and "consolidation, 11 thus - 11 Sec. 35. x X X X 11 (5 ) ~finitlous.-(a) x x "(b) 1'he term ' merger' or ' con- solidation,� when used in this s ec- tion, shall be understood to mean: (1) the ordinary merger or consolida- tion, or (2) the acquisition by one corporation of all or substant ially all the properties of another cor- poration solely for stock : t r Qvideg, That for a transaction to be regar d- ed as a merger or consolidation within the purviev; of this s ection, it must be undertaken for a ~ flde business purpose and not solely for the purpose of escaping the burden of taxation: f.r:oyig~g, f urther, The t in determining vJhether a ~ ~ business purpose exists , each and every step of the transaction shall be considered and the v1hole transaction or series of transactions shall be treat Gd as a single unit: Proyideg, finall,x:, 'l'hat in deter- mining whether the property t rans- ferred con3titutes a substantial por- tion of the property of the transferor, the term 'property' shall be taken to include the cash assets of the trans- f.eror 11 In a mer ger, two or more corporations unite by the transfer of property of ull to one of them, wl ich 39 5

� DECISIO CAS""' NO . 1349 11 continues to exi s t 01etror>ol1 tan ..di son Co. vs. Com- missioner of I nternal Bevenue , 98 F . 2d 807) . consolidation occurs 1:1here tv10 or more exi s ting cor por tions are united into a single corpora tion and the existence of the uniting corporation is ter- minated and the organi zat:l.on succeeds in a general v1ay to the f ranchise of and acqui re s the pr ope rty and assets and assumes the obligations of the consti tuent companies Olord s & Phrases , Vol . 8-A, Pf'� 346- 34-7, quot:tng Collinsville Nat. Bank v . Esau , 1'76 P . 51'+ , 515, 74 Okl. 45) . Both mer ger and consolidation ar e promotive of corporate unions or combine s. It is precisely for the promotion of corporate combinations, which bring about the pooling of r esources , that v Congress , in Republi c Act No . 19 21, decreed a differ- ent trea t ment in gains and losses resulting from ex- changes of properties , As explained by the authors of H. B. No . 648 5:: 111rhis method of Philippine Income t ax in dea ling with the problem of re- co gnition of gai n or loss fr om exchange of property in connection with corporate combinations i s a deterrent fa ctor to the economic development of the country. It discourages corpora tions from pooling t heir res ources , thereby blocking one of the mos t i mportant means thru \-Jhich large concentrations of Phili ppine in- dustries can be obtained . In other wofds , the present tax treatment of exehange of propert y under our laws is a disincentive to busines s to com- bine and expand . Actually its net effect is to place corporations in what may be termed ' a tax straight 396 -' I j

� .. DECISI ON - CASE Nv . 131,.9 12 j a cket 1 f rom -v;hich tney could t:scape only at prohibi t ive cost~'~ (hxp lana- tory Note of H. B . Nc . 64-8) . ) As afore- stated , the old Bachroch Mot or Go~ transferred a l l i ts asse ts and liabilities to two nevt corpora ti.on s , the new r)e chrach t�~ot or Co. and the Bachra ch Tran sportation ~o . , I nc. th e st ock- hold er s surrendered their sto c~ s in the t ransferor- company and receiv ed stocks i n the trans fe ree- corpor ation~ ~ The r eor ganization was a divisive type, a split-up . It was , ther efo re , nej_ther a me r ger nor a consolidation. Cbviously , this re- organization cannot quali.fy as o t ax�- free reort;an:l..- za tion under Se c . 35(2) of the Hevenue Code . Hen ce, the gains realized by riary r�: . Ba chra ch in the ex- change are taxable i ncome . In the computation of t he taxable ga in rea lized by r~ ary Ivl . Ba chrach, res pondent Conuni ssioner adopt ed the bodk value ( �2 , 04-3 , 436.02 ) of the shares in t he old Bachra ch Motor co. This value i s not disputed by petitioner . Cons equently , we shall so consider it in computing the taxable ga in. Similarly , in arriving a t the taxable gain, he considered t he original authorized cap:i. tal of t.h.f~ old corporation 0 "150 , 0UU. OO ) as the cost bas is of the sha r es of stock . He de- ducted ~rom the book value of ~2 , 043 , 436 . U2 the ori- gi nal au thorized capita l of !C 15l�, CUL� . cc , ther eby dis- re ga rding the subse que nt incr ea ses in the capital-

.. .. DECISI .. - CASE r1CJ . 13Y�~ 13 �' ' ization . The certifi cat es o � incre ses of the eapital s t ock of t e old corpcrction ~Exhibits 11D, 11 and E 11 11 ), including the t reasurer's cer- tificates, establish the fact tillit said increases in the respective sums of t.3 0Lr,C OO . cu, "-290 , oo . on and 175 ,00 . oo 1.vere paid in cash ., These inc.reas s, totalling ~769,000 .. 00, should be added to the original authorized capi t al of �- 1 5CJ,COCJ.,CJu (which, in t he absence of evidence to the contrary, ~e consider ~s ful ly paid Vp ) because they f orm purt of the p"id- in capital. Cons~ quently , the increases of ~769 , - 000 . CO and t e author iz ed capita l of f 150,UU).OO, vhi ch total 919 1 000 . 00, represent 1.mder the circums- tances the cost basis of the shares of the old Bach- rach Ho tor Co .. r-lfld shou ld be deducted from the book. value. In fi ne, the resulting differen ce of :t< 1, 1:.o.4,- 436.,02 is the t axabl e ga.in rea lized in the liquida- tion. Finally , petitioner questions the income t ax assessment in the amount of i' 10'1 ,848 .. 26 , vJhich re~ pondent considers as the excess over the valuation (�?31 ,442 .. �19 ) of' t he usufruct recetved from Na r y N. Bachrach 's r usband. :rre cont ends for the non- taxa�~ bility as income of t his excess on the ground that 1 t is 'a pa rt of the .Q.Qfl?J~ of the esta te of the husband o ftesponden t, owever, sl�:ggest s that +his 39 8

�/ .... DECISIOrl - CASE NO . 13l+9 ,. excess constitutes an in come of the bequeathed usu- fruct, and, therefore, is taxable under Sec. 29 (b) (3) of the Revenue Code. �. The sum of �100,250 .. 00 , repr esenting stock divi- dends corresponding to the shares of the estate of E. N. Bachrach in the old Bachrach Hot or ~o., is taxable as income in consequence of our resolution of the fir s t issue. �J/i th res pe ct to t he bala.nce of t-7 ,598 . 26 , it may be sta ted that petitioner admits said balance to be proceeds (of the usufruct) from the Consolidated Mines, Inc., eople's Bank & Trust Co. and 11eral.co . Being proce eds of the usufruct they� are taxable as income under 'ec. 2S: (b)(3) of the Revenue Code. But petitioner argues that the proceeds have already been taxed when the :i.nheri ta nce tax on the bequest was paid. 'l'he inheritance tax was assessed on the value of the right of usufruct (see Sec . 91 of the Hevenue Gode). wna t is novJ being taxed is income in pursuance of Se c. 29(b) (3) of the same Code. WHEl{EFORE , the assessment appealed from 1.s he r eby modified and petit ioner Nodesto Te Plores, as co- admi nistrator of the testate estate of the late I� ary 14 . Bactirach, is ordered to pay to the C<?.mmissioner of Internal� Revenue or his rE:presentative the sum of "316,541.00, with i% onthly i nterest from April 18, 1961 to I�'ebruary 12, 1963. If the deficiency 39

.., .... DECISI0IJ - c: E u. 134-Sl 15 tax is not pdid within thirty (30) days from the date this decision becomes final, petitioner is ordered to pa.y surc11arge and interest CIS ll.rovided in Section 51 (e) of the .kevenue Code .. �'.li tll mt costs,. ezon vity, December 29, 1964. I CONCUR: -- ~ROM~AN-l-1-. .-!'�U~l.L.I.___.- . Associate Judge \ 40.0