CTA Case No. 4951 (Decision)

REPUBLIC OF THE PHILIPPINES COURT OF TAX APPEALS QUEZON CITY HAWAIIAN-PHILIPPINE COKPANY, Petitioner, - versus - C.T.A. CASE NO. 4951 COKKISSIONER OF INTERNAL I REVENUE, l Respondent. ! X- - l ! t r:, I DE C I S 0N 't\ L' I !,. f Thia ia a petition �or review �rom a deciaion o� r'� '~ ~ respondent Commissioner denying petitioner's protest I� against a disputed assessment �or de�iciency income [ ~ ;~ taxes �or the taxab1e years 1986 and 1987. The �acts r are as stated in the opinion o� the Court. Petitioner is a domestic corporation engaged in the business o� sugar mi11ing. Sometime in 1981, petitioner entered into a Management Agreement with Jardine Davies, Inc. <JDI> whereby Jardine Davies was appointed to manage the entire business and operations o� petitioner, in exchange �or which JDI was paid management �ees amounting to P2,500,000 per annum or �ive per centum (5X> o� the gross receipts o� petitioner during the year, whichever is higher. It appears that on Ju1y 13, 1988, respondent Commissioner o� Interna1 Revenue, through Regiona1 47

DECISION - C.T.A. CASE NO. 4951 - - 2- Director Beethoven L. Rualo, Revenue District Office No. 56 stationed at Bacolod City, issued Letter of Authority Ass. � 068-56-6-000332-86 and 068- 56-6-000341-87, directing Revenue Enforcement Officers Prudencio Arabejo and Virgie S. Virata to examine the books of account of petitioner to determine its liability, if any, for unpaid internal revenue taxes for 1987 and prior years <Exh. 1>. After examining petitioner's records, the two Revenue Officers submitted a memorandum <Exh. 2> addressed to� Revenue District Officer Rualo, detailing their findings. In brief, the two revenue officers recommended that petitioner be assessed for deficiency income taxes for the years 1986 and 1987 totalling ~12,703,764.00. The recommendation was based on the finding of said revenue officers that the management fees paid by petitioner to JDI during the taxable years in question, and which petitioner claimed as deduction from its gross income for the same period, were not ordinary and necessary expenses and should therefore be disallowed. In due course, the memorandum of the two revenue officers was indorsed to respondent Commissioner. In an "Indorsement" dated December 15, 1989 <Exh. AB>, respondent Commissioner concluded that the disallowance of the management fees paid by 48 I'

DECISION - C.T.A. CASE NO. 4951 - - 3- petitioner to 3DI �cannot be legally sustained" since the same were both �ordinary and necessary� expenses. Howeverp on April 24P 1990p petitioner received a Letter o� Demand No. FAN-1-86-90-00132930p together with Assessment Notices Nos. FAN-1-86-90-001329 and FAN-1-87- 90-001130 �rom respondentp assessing petitioner �or alleged de�iciency income taxesp inclusive o� ' interests and penaltiesp �or the taxable years t' 1986 and 1987. The amounts assessed against petitioner !�:,�;_:�</',,._.� were P5,345,054.00 and P7,358,710.00 �or the years 1986 'i and 1987, respectively, or a total o� P12,703,764.00 <Exhs. 3 and 3-A>. In a letterp dated April 26, 1990p addressed to respondent <Exh. AC>P petitioner protested the twin assessments. However, on December 20, 1992 <Exh. respondent denied with �inality petitioner's protest on the ground that the management �ees paid by it to 301 were in �act non-deductible dividends subject to tax. Hence this petition. It appears that during the pendency o� this petitionp respondent issued a warrant o� distraint and levy against petitioner's properties <Exh. 6). Petitioner requested respondent to recall the warrantp and o��ered its various machineries as collateral �or its tax liabilities. Howeverp the record does not show what action was taken by 49

DECISION - C.T.A. CASE NO. 4951- -4- respondent in respect of such offer. The sole question brought before Us is whether ,f: respondent Commissioner correctly disallowed the deduction of the management fees paid by petitioner to JDI from its gross income on the ground that such management fees are, in truth, disguised dividends subject to tax. In concluding that the management fees in question were in reality disguised dividends subject to tax, ~~ 'I respondent Commissioner reasoned that the separate juridical personalities of petitioner and JDI should be disregarded since petitioner is a mere alter ego or business conduit of JDI. It then pointed to the following factors attending the relationship between petitioner and JDI: "<a> Jardine Davies, Inc., your parent company, owns 87.83Y. of your capital stock~ <b> the management contract was signed by Messrs. Mesa and Vorster, and it is a fact that Mr. Vorster, President of Jardine Davies, Inc. is also a member of your Board of Directors~ (c) there is no clear evidence that the management services allegedly rendered are necessary as it appears that in your business locale, there are other sugar centrals like First Milling Marketing Co. and Victorias Milling, Inc. that can maintain viable operations without hiring managers~ <d> that as to stockholdings, it is only the shares of stock of Jardine Davies, Inc. that are listed in the stock exchange and open to the public whereas in your case, you are not an open or public corporation as you are fully controlled by the said parent corporation. 50

! �! DECISION - G.T.A. CASE NO. 4951 - -5- "Finally, your protest is devoid o� any proo� to justi�y the inordinate amounts claimed by you as management �ees so as to � show the nature o� the services rendered, the person rendering those services, the extent thereo� and in general, such evidence that would establish a proportionate connection between the amounts claimed by you as management expenses and the quality and quantity o� the services supposedly rendered." We are not persuaded by respondent's arguments. A care�ul and more circumspect perusal o� the records o� this case shows that respondent Commissioner -. erred in disregarding the separate juridical j. ~ I personalities o� petitioner and its parent company JDI. It is an elementary and �undamental principle o� corporation law that a corporation is an entity separate and distinct �rom its stockholders and �rom other corporations to which it may be connected. It is only when the notion o� legal entity is used to de�eat public convenience, justi�y wrong, protect �raud, or de�end crime, the law will regard the corporation as an association o� persons or in the case o� two corporations merge them into one. <Koppel [Phil.], Inc. vs. Yatco, 7 Phil 496, citing 1 Fletcher Cyclopedia o� Corporation, Perm. Ed., pp. 135-136~ United States vs. Milwaukee Re�rigeration Transit Go., 142 Fed., 247, 255 per Sanborn, J. > Otherwise stated, when the corporation is the "mere alter ego or business conduit o� a person, it may be disregarded." <Koppel [Phil. l, Inc. vs. Yatco, supra. >

DECISION - C.T.A. CASE NO. 4951 - -6- We do not believe that there is sufficient evidence on record to show that petitioner is the mere alter ego of JDI or vice versa, nor that the separate juridical personalities of the two corporations was used to defraud the government and avoid the payment of taxes. It has been held that the intention to minimize taxes, when used in the context of fraud, must be proved to exist by clear and convincing evidence amounting to more than mere preponderance, and cannot be justified by a mere speculation. This is because fraud is never lightly to be presumed. Fraud is never imputed and courts never sustain findings of fraud upon circumstances which, at the most, create only suspicion <Yutivo Sons Hardware Co. vs. Court of Tax Appeals, 1 SCRA 160 �19611>. Neither are We convinced that under the circumstances, the mere payment by petitioner to JDI of I the management fees in question vas purposely resorted to in order to evade the payment of taxes. The record shows that the rendition by JDI of management services to petitioner vas in accordance with, and pursuant to, a concededly valid and subsisting management agreement between the two entities. Under said agreement, JDI undertook to provide various services to petitioner, including the following: 52

DECISIO~ - C.T.A. CASE NO. 4951- -7- 1. To take charge o� the management and operations o� the business o� the COMPANY (re�erring to petitioner> subject to the supervision and control o� the President and Board o� Directors o� the COMPANYP 2. To be responsible �or the marketing/selling o� such products or by- products manu�actured by the COMPANYP 3. Upon receipt o� written advice �rom the COMPANY, to make the necessary purchase/importation o� such merchandise, materials, supplies and equipment, �or and on behal� o� the COMPANYP 4. To negotiate �or and on behal� o� the COMPANY, milling and/or cane purchase contracts with existing and prospective sugar cane plantersp 5. To be responsible �or the installation and audit o� in�ormation systems but not the development o� speci�ic computer programs which shall be separately charged/billed to the COMPANYP 6. Generally, to exercise such other managerial powers as may be con�erred and to per�orm such other services or duties necessary or appropriate to be per�ormed �or and on behal� o� the COMPANY in the transaction and control o� its business. �s. Finance and Invest�ents 1. To invest the �unds o� the COMPANY in worthy securities, money market and loan investmentsp 2. To ascertain that all documents concerning any �orm o� investment are prepared and �inalized and held by the COMPANY �or sa�ekeepingp 3. To manage the plan company �unds such that the COMPANY will always have su��icient �unds to meet all the required disbursementsp 53

DECISION - C.T.A. CASE NO. 4951 - -8- 4. To supervise and control company accounts; 5. To appoint a competent internal auditor and make sure that books o� the COMPANY are audited by such auditor at such intervals/periods as may be necessary it being understood that the cost o� such audit shall be �or the account o� the COMPANY. �c. Tax. Legal and Corporate 1. To supervise and cause to be kept �ull and complete corporate records o� the COMPANY and provide �ull corporate secretarial and trans�er services; 2. To provide legal and tax services, including scheduling o� payment o� appropriate taxes and preparation o� related returns as may be required by existing government regulations. 3. To monitor complete compliance with all regulatory requirements. �D.Labor and Corporate Relations Services 1. To provide advice and assistance on labor relations and other personnel matters. It cannot be gainsaid that the �oregoing services are not necessary, nay even essential, �or the conduct o� petitioner's business. This being the case, any expenses incurred by petitioner in procuring such services must, o� necessity, also be classi�ied as necessary business expenses. More revealing, however, is the �act that, as admitted by respondent, the management �ees were re�lected in JDI's own books o� account as Income and not as a liability reserve, which would have otherwise 54

DECISION - C.T.A. CASE NO. 4951 - 9- been the case i� said �ees were intended to be subsequently distributed directly to JDI's stockholders as dividends. The case o� Yutivo Sons Hardware Co ~ Court o� Tax Appeals (supra) relied on by respondent weakens, rather than strengthens, respondent's case. In that case, the Supreme Court based its conclusion that Southern Motors <SM> vas a mere alter ego or business conduit o� Yutivo Sons Hardware Co. in its �inding, among others, that the management �ees paid by SM to Yutivo were re�lected in the latter's books as a liability reserve rather than as income. Thus: "Proceeding to another aspect o� the relation o� the parties, the management �ees due �rom SM to Yutivo were taken up as expenses o� SM and credited to the account o� Yutivo. I� it ~ to be assumed that the two organizations ~ separate juridical entities. the corresponding receipts ~ receivables should have been treated ~ income on the part o� � Yutivo. But such management �ees ~ recorded ~ "Reserve �or Bonus" and ~ there�ore ~ liability reserve and not an income account. This reserve �or bonus ~ subsequently distributed directly to and credited in �avor o� the emolovees and directors o� Yutivo, thereby clearly showina that the management �ees ~ paid directly to Yutivo o��icers and employees." <underscoring supplied> The situation is di��erent in the case�at bar. As already ,stated, the management �ees paid by petitioner to JDI were re�lected as expenses in petitioner's books and were correspondingly treated as income in JDI's 55

DECISION - C.T.A. CASE NO. 4951 - - 10 - books. This is clearly indicative o� the �act that there was no commingling o� the separate juridical personalities o� petitioner and JDI, contrary to respondent's �indings. It should likewise be noted at this point that in his Indorsement dated December 15, 1989, then Commissioner Jose U. Ong concluded that the management �ees paid by petitioner to JDI were "ordinary and necessary" business expenses and as such, may be allowed as deductions �rom petitioner's gross income. Thus: "In the instant case, it appears that the disallowed management �ee expenses in question are both ordinary and necessary. Ordinary and necessary in the sense that the same connote payments which, although not normal in relation to the business o� the taxpayer, ~ be considered prooer �or the purpose o� realizing pro�it ~ appropriate or help�ul in the development o� the taxpayer's business considering that the taxpayer is based in Silay City, Negros Occidental, hence, by opting to have its a��airs managed by its parent company who has a substantial interest in it in terms o� investment, it is able not only to ~ Q.!!. the cost o� maintaining !:!!.!!. o��ice in Metro Manila and in other cost incident to its business but at the ~ time avail o� the bene�its arising �rom the various services being provided ~ its parent company as a consequence o� the a�orementioned management agreement the consideration o� which ~ be considered ~ �air under the circumstances. "In view thereo�, it is believed that the disallowance o� the management �ee expenses being claimed by the taxpayer �or the years 1986 and 1987 cannot be legally sustained. " <underscoring supplied> 56

DECISION - C.T.A. CASE NO. 4951 - - 11 - It bears emphasis that the �oregoing conclusion o� then Commissioner Ong was based on exactly the same set o� �acts which were used as basis �or his subsequent yet contradictory decision denying petitioner's protest o� the disputed assessments. Thus, while concluding in the �irst instance, that the management �ees paid by petitioner to JDI were ��air under the circumstances� \ considering the bene�its derived by petitioner �rom the management agreement, respondent subsequently and without the bene�it o� any new evidence being adduced reversed himsel� and concluded that such �ees were "inordinate� and "disproportionate� to the services rendered by JDI. We �ind this unjusti�ied �lip-�lopping totally untenable. Finally, We �ind petitioner's contention that the separate corporate personalities o� petitioner and JDI should be disregarded simply on the basis o� the �act that the �ormer is a subsidiary o� latter as being �raught with dangerous consequences. I� respondent were to be upheld, it would be tantamount to saying that no parent company can ever manage its subsidiary since this would in each and every case be a ground �or disregarding the otherwise separate juridical personalities o� the two entities. We are not prepared to sanction such a theory. 57

DECISION - C.T.A. CASE NO. 4951 - - 12 - WHEREFORE. judgment is hereby rendered REVERSING and SETTING aside the decision of respondent Commissioner o� Internal Revenue dated December 15, 1992 denying petitioner's protest. The warrant of distraint and levy issued by respondent against petitioner's properties is hereby LIFTED, and respondent Commissioner is hereby DIRECTED to release any collateral petitioner may have submitted to guarantee the payment of its tax liabilities under the disputed assessments. No pronouncement as to costs. SO ORDERED. GRUBA Judge WE CONCUR: / CERTIFICATION I hereby certify that this decision was reached after due consultation among the members of the Court of Tax Appeals in accordance with Section 13, Article VIII of the Constitution. ~.~ ERNESTO D. ACOSTA Presiding Judge , Court of Tax Appeals 58