CTA Case No. 2500 (Decision)

U06L1C 0 p fill\! P~UU~PI ""\ COURT OF TAX AP'PEA QUUON Cl'r.f P.I. MANUFACT'RING, INC., ~ Petitioner, - versus - C.T.A. CASE NO. 2500 THE COMMISSIONER OF INTERNAL REVENUE, Re spon.den t. X- - - - -- -- - -X DEC I S I 0 N Petitioner P.I. Manufacturing, Inc., appeals from a decision dated January 15, 1973 of resp6ndent Commissioner of Internal Revenue denying it protest against an assessment f r deficiency income tax and 25% surtax for improper accumulation of profits or surplus, both for the fiscal year ended June 30, 1965, in the respective amounts of ~114,377.40 and ~883,191.06. On May 12, 1975, however, the deficiency income tax of ~114,377.40, on a motion for summary judgment by petitioner, was declared by this Court of no force and effect after finding it barred by prescription. For determination therefore, after hearin~ and pre- sentation of evidence as well as submission of memo- randa by the .parties, . is the correctness of the assess- ment of P883,191.06 as 25% surtax for unreasonable accumulation of surplus.or profits imposed under Section 25� of tl1c National Internal Revenue Code. 21d ...

DECISION - CTA CASE NO. 2500 - 2- � Section 25(a) of the National Internal Revenue Code imposes an additional tax upon ..a corporu tion formed or availed of for the purpose of p reven ~ing the imposition of the ta~ upon its shareholder s Ol he shareholde r s of any other corporation thro1gh the medium of permitting its gains and profits to accumulate instead of being divided or distributed. And Section 25(c) provides th~t the fact that earninga or profits of a corporation a~e permitted to accumulate beyond the re~sonable needs of the business shall be de te rminative of the purpose to avoid the tax on share- holders unless the corporation shall prove to the con- trary by_a clear preponderance of the evidence. Petitioner is a corporati '~ !i July organized and existing under Philippine law, with principal office and place of business at No. 97, Industrial Avenue, Northern Hillb, Malabon, Metro Manila. It is engaged in the manufacture and sale of electrical appliances and plumbing supplies. � Or1.0ctober 14, 1965, petitioner whose accounting period is the fiscal year, filed its income tax return for the fiscal year ended June 30, 1965. After veri- fication of the return and investigation of petitioner 1 s books of accounts and other accounting recorJs, res� pendent Commissioner of Internal Revenue, upon 21J I

DECISION - CTA CASE NO. 2500 - 3- �recommendation of the investigating revenue exa1iner, assessed and demanded from petitioner the amount of P883,191 .06 representing surtax o f 25% and ~% ~ntere st on the latter's unreasonable accumulated surplus i the amount of ~2 ,993 ,867 . 25, computed as follows: y 1964- :.. 965 Unreasonably accumulated surplus .!l2,993,86_7.2~ 25% surtax due thereon .!?1 748,467.00 Add: ~% monthly inte r es. from . _134, 724 ....Qii l .)-16- 65 to 10-1 6-6 8 � � Total amount due a nd collectible � �l==~~~�1~l~2~ The assessment and demand were con tained in a letter of respondent dated October 12, 19 70. In a letter dated Dscember 11 , 1970, petitioner protested the assessment . However, on Janua ry 15, 1973, re pendent denied petitioner's pL c test and reiterated the d8mand for payment of the assessment . gence, �the petition f or review. The sole issue fo r _decision is whether petitioner P.I. Man ufactu ri ng, Inc. was availed of in the fiscal year ended June 30, 1965 f or the purpose of avoiding the �impos ition of the income tax on its shareholders by permitt i ng its earnings a.d profits to accumulate instead of dividing and distributing the m. The pertinent provisions of Section 25 of the National I 1ternal Revenue Code, the l ~w under which respondent'commissioner of I 1ternal Rev e nue assessed 220 I ..

DECISION - CTA CASE NO. 2500 - 4- ~the corr e~ponding 25% surtax for un reasona ble accumulation of surplus f or the fiso~l yea r 1064- 1965, read at the time as fo llows: SEC. 25. Additional ta ;i_-D.__~orpo :a tion impLQL~rly ac_c~mulat.in g profits or su rplus .- (a) Impos ition of tax.- If an y corporati on, except ba nks, insuranc e co~p ~ri es, or per- son - 1 holding companies, whether domestic or foreign, is formed or availed cf for the purpose of preventing the imposition of the tax upon its s hareh ld~rs or msJbers or the shar eholde rs o r me mbera ~z a nothe r corpo- ration, t hrough the medium tif permitting its g in s and prof its to a ccum late instead of being divided or distributed, there is levied and assessed against such corp ration, for each taxable year, a tax equal to twenty- f ive 12er ~!ltum of t!.e undistrituted portion of its accumulated profits or sur~lus whicl shall be in addition to the tax i:mposeJ by section twenty-four, and shall be computed, collec ted and paid i n the same manner and subject to the same provisio~s of law, in- cluding penalt ies , as that tax. XXX XXX (c) . Ev idence det ermin 2.t~i.Y..~.L.Euq~ se .- The fact that the earnings or profits of a corporation are permitted to accum1late � beyond the reasor.~ble needs of the business shall be determinative of the purpose to avoid the tax upon its shareholders or members unless the corporation, by clear preponderance of evidence, shall prove the contr ary. Since the provisions of Section 25 of the NaLional Inter nal Reven ue Code were bodily l ' fted from Section 102 of the u.s. Internal Revenue Code of 1939, including the regulations issued in c onnection therewith, it wo uld be proper to refer to applicable cases decided by the I /

DECISION - CTA CASE NO. 2500 -5 - '"Americ an Federal Courts for guida.:ce and enlighten- ment. (Manila vhne Merch an ts I I nc . vs. CommisG ioner of Internal Revenue , No. L-26145, Feb. 20, 1984, 127 SCRA 4? 3.) A prerequisite to the impositi n of the tax h2s been that the corporation be formed or availed of for th e Eu r po se of avoiding the income tax {or surt ~x ) on it s ch are holde r 1 or on ~h~ snareholders of any other corporation by perm itting the earn~ngs and pro- fits of the corporation to accumulate inste2d of dividing them among or distributing them.to the share- holder s. If the failure to p a y dividends i~ du0 t o some other cause, such as the use of the und is tributed earning s a nd profits for the reasonable ne de of the business, such purpose does not fall within the in te r- diction o f the statute. (Mer~ cns , Law o f Federal Income Taxation, 7 01 . 7, Chapt.:.. r 3 9 1 p. 44; See also Sec . 21, Rev. Re gs . No. 2; Man il a Wine Merchants, Inc . vs. Commissioner o f Internal Revenue, �.!:!J2~�J . � Inasmucn as pur p o se involves a state of mi nd or intent, it ls always necessary t o look at t be sur- round i ng circumstances ar.d the attendant facts in each individual case to determine whether the purpose of the failure to make ~ i ~tribution was to pe rmit t: e s haLeholders to avoid the income tax or f or -orne othe r I 22 ~ ./

DECISIOlJ - CTA CASE NO. 2500 - 6- ~purpose, such as the use of the earnings ~nd profits for the reasohable needs of the business. In th~s regard, although the testimony of the taxpayer, officers and stockholders is entitled to some weight, generally the issue is to be resolved in the light of the surrounding circumstances, including the in- t rests of lhose in control and their actual conduct. (Mertens, Law of Federal .inc._,me'Ta:x:ation, Vol. 7, Chapter 39, p. 45.) The applicable principles of law are clear and in the end the decision in this case must rest upon its own peculiar facts and cir- curnstances. The circumstances relied upon by respondent as ind i cating that retitioner has permitted its earnings to accumulate beyond the reasonable needs of the busi- ness are as follows: {Examiner's memo ... andum, Exh. "3 11 , pp. 56-58, B!R records; See also Exh. "1", pp. 28-29 & Exh. "B", pp. b9-90, BIR records.) a. The payment of management fees to its sister company; b. The fact that the company has not declareJ dividends in the past; c. The retention of treasury stock; d. The fact that at the time ~f examination the company s financial con- dition warrants the declaration of divid~nds. The findings of respondent's examiner with regard 22,} I

PECI SI ON - CTA CASE NO. 2500 - 7- ~t o ~he manage 1ent fees paid by petitioner to the Go Soc & Sons and Sy Gui Huat, Inc.~ as stated in his memorandum reports, are as follcws: "Verification shows tha t the P.r. Manufacturing, Inc., is a sister corpo- ration of the Go Soc & S ns & Sui Gue Huat, Manila nd Phi l ippine Paints, Inc., al s o of Malabon, Rizal. The se three corporations are family corporations, in the s ens2 t hat the s tockholders of these three corporatio ~ s a re the same. The President of P. I. :'1-a:.ufactur ing ~ Mrs. Co r r e lia Co is also one time pres i. Je :1t of Go Soc & Sons & Sui Gue Huat. The same is true with respect to Mr. Jose P. Sy. Members of the board o f directors of Go Soc are likewise me mbers of t he board of directors of P.I. Furthermor e, the stockholders cf t he three corporation are related if not by consanguinity by affinity." (Exh. "A", also Exh. "1", p. 29, BIR records.) XXX XXX "This facts (sic) created an awkward situation which c~nvinced the undersig .ed to assert that the taxpa ye r h ~ rein has placed itself in an untenable position � . This becomes a case wherein the decisions and actuations of the officers and/or board of directors of the P.I. Manufact- uring, Inc. is subject to manage m2 nt and review by another company whose officers and/or board of directors are the same o fficers being manc..,;;Jed. 11 (Exh. "3", p. 57, BIR records. ) "x x x i t may be claimed in this regard that the payment of the management fee by the compa ny to a sister company constitutes a way of or a device to deplete its surplus i~ ~ ome for the pur- pose of evading the imposition of the surtax under Section 25(c) of the National Internal Revenue Code as a~ended . 11 (Exh. "B", p. 89, BIR records.) I !-

DECISION - CTA CASE NO. 2500 - 8- ~ There is merit in respondent's contention. Al t hough the deductibility of the management fees a s an operating expense is no longer in issue in thi s case, nevertheless , it bears close scrutiny, sinc e t h~ payment of man a g ement fe~s by petitioner t o a company whos~ control l ing stockholders are one and the same as peti ion r 's is material to the issue on hand. . As correctly noted by respondent's examiner, the records show that the management c~ntract between pe t itioner P.I. Manufacturing, Inc. and th0 Go Soc & So n s a nd Sy Gui Huat, Inc. wa s signed on D8cembar 20, 1963 by Sy Ching as execu t ive v i ce president of the P. I. Ma nufact'Jrit:g, Inc. and by Cornelia L. Co as pr esident cf the Go Soc & Sons and Sy Gui Luat, Inc . (p . 1 7, BIR records . ) The income tax returns o: the P.I . Manufacturing, Inc. for the fiscal year ended J une 30, 1965 was signed by C2rn~lia L . Co as its pl..esiden t also. (p. 21, BI R records . } When said exam i ner testifie durirg the h earing of tte case , ~1e reiterated the same findings contained in h i s memorandum reports and insisted on tl:e c onnection of the payment of manag ement fees to the issue of un- r ea ~ anable accumulation .of sutrlus. Upon cross exam- ination, counsel for petitioner failed to discredit 22cJ t

DECISION - CTA CASE NO. 2500 - 9- �the testimony of the ab~ve witness for respondent, neither did the former present any rebutt 1 evidence to controvert the latter's assertions. (t.s.n~, pp. 8-18, pp. 40-45, August 6, 1982.) It a.pears, therefore, f~om the uncv~Lradicted findings of re~)ondent's examiner that pet~tioner and . the Go Soc & Sons and Sy Gui H�n'~., In"'. have the same stockholdersf the same bor.t.LJ v� directors and are closely held corporations. Corporations most vulne- rable to th~ accumulated ea~nings tax ha a been cor- porations the stock of which was owned or controlled by a single fa:uily or at the most by a fe-vJ indiv.,_cuals. {Mertens , Law of Federal Income Ta~ation, Vol. 7, Chapter 39, p. 111.) Thus, the management fees paid by petitioner to its sister company have to be care fully examined. By the terms of the management contract, the compensation o r man~gement fee to be paid by pcti- i:.ioner to the manager"for the services to be rendered by the latter to the former shall be the equivale~t in pesos, Ph1llppine Currency, of t ree per csnt (3%) of the first one million pesos (Pl,OOO,OOO.CJ) .of net sales for each fiscal year; and five per cent (5%) ono of such s ~les in excess o. f OnP- ml'lll'on n.. esos :(.D!:l', u , 000 � 00)�". (Management Contract, p. 18, BIR r ecords.) 22ti

DECISION - CTA CASE N0.2500 - 10 - . The following is an analysis of petitioner's rna agem~nt fees paid, total adm ini st~ative and general expenses which include management fees, percent2ge of management fees to general and administrative expenses and net income before income taxes for the fiscal yc~rs ending June 30, 1958 through June 30, 1 65, as reflected in the financia l statements subm1tted by petitioner: .~ drr� ; '1 is t rat i v e Percentage Net c. General Ex-� of Management Income Fiscal penses including fee to Adm. J::.efo~e Year Exh. Ended Management Han�agernc.. n t Fees and Ge ner al Income No. Fees E~�-penses 'I'<::x E-2 June 30, 1958 :Ell47,884.32 J:i281,401.35 52.55% ~818,757.56 E-2 June 30, 1959 180,129.43 380,632.31 47.32% 1,138,49:.01 F-2 June 30, 1960 199,262 o7 2 482,306.38 4!.:.<:1% 1,447,117 . 32 F-2 J t:n e 30, 1961 183,035. 48 568,150.49 3:..:..2 1% 615,488.87 G-2; G-4 June 30, 1962 262,899.00 1,058,442 .32 24.83% 1,097,544.33 G-2; G-4 June 30, 1963 264,884.70 l.,J.. 67, 045.11 22 . 69% 638!228.86 H-2; June �30, 1964 267 967 .30 652,725.65 41.05% 588,416.98 H-4 H 2; June 30, 1965 311.,804.08 648,709 . 51 48.06% 1,087,985.74 H-4 The above 2nalysis shows that the management fees paid fer the fisc al year ending June 30, 1965 in the amounL of ~311,804.08 was 48.06% of the t~ta1 adminis- trative and general expenses amounting to P64&,709.51 for that �ear . Had this management fee not been ex- pended, :t would have formed part of net income which would later on be credited to ret ined earnings. The same holds true f r the n~<.. ;;agement fees paid in i.:.h" previous ye..ir s. if these fees had not bee-~ paid they

DECISION - CTA C AS ~ NO. 2500 - 11 - ~ould hav bee n subs antial ad di t ions to re t a i ned earnings, since the financial s t atements r eveal th a t t he manage men t fee was the l argest e x pens e i n ~ ~red every year alt.ong the a d mi nistr a tive and g e n e ral ex- penses, e xc e pt f or the fiscal years_ending J une 30, 1 96 2 n d 1 963 when i t wa s second on ly t o t axe s and licenses. (See Exh;;. 11 E-2", "F - 2", " G- 4 ", "H~ 4 " a n d "I-4", p e titi one r's en v e lop..:.:. ) Consid e r i ng that pe titioner d id not prove the re ason a b lene s s of its paymen t of such manage me nt fees to a company whose controlling stockholde r s are the same as peti t ioner ' s, we fi n d re spondent's stand u n thi ~ matter well taken . App ar ently, t h e clos relation - shi p bet ve e ~ petit ion . r and the Go Soc & Son s and Sy Gui Huat, Inc., be c a u s e of c omplete own e rship a n d con t rol by the same stockholde rs a d th e sa r ~ b o ard of d i rec ors, was used in e f f e ct for t he pur pos of avoid i ng the su r t ax. With reg ard t o the dividend distribut i o n , petitioner clai s tha t con t r ary to r e sponde nt's alleg ation , it had be en paying s ubs ta n tial d i vi de nds prior to 196 4 ~ nd 19G5 in amo unts it c ou l d affor d su bjec t to its wo rking capital needs u!1d i t s ex an 3 ion progr a m. To t r ace the h istory of dividend dis tr ibutions made by petitioner a s di 2clo s e d b y its f i na n ci a l st a t e me n ts, summar ize d in Annex "A" are petiti o ner's net inc o me a ft e r 22ci

DECISION CTA CASE NO. 2500 - 12 - ~ta xes, a justrnen ts to earned su rplus , dividen d s declar e d and e ar n ed surplus ba l ances ~ for th e fiscal . years e nding JJne 30, 1 956 to June 30, 1 96 5 . No te th a t for the years 195 8, 196 0 , 1964 nd 1965 ther e were no dividends declar ed although pet i - t ioner r e al ized s u bs ta ntial p~ofits and had s uf fic ient ea rned s urplus� b alance s in those years. For t~e tax- able ye a rs 1956, 19 57 , 1959 l 0 6 l , 19 62 and 19 63 the ye a rs when dividends were dec l ared, al l dividend dis- tribu t ions made were in stock , except for 1959 and 1961, whe n 42 . 48% and 50 % r e spec tively of the total d ivide nds d i str ibuted we re in cash and t he balances in stee L . While i t i s tr e t h at petit i oner declared dividends in the years ment i oned, its stockhol ders were subj e ct to tax o nly on the c ash dividends they received for the years 1959 a nd 1961. Stock dividends even t hcugh t a x exempt neve r theless capital i ze earn ing s a nd result in a reduction of profits avai lable for distribution wher e the purpose a t the time . of i ssuance of the ctock dividend is tax avoidlnce. In the ligh t o f r espondent ' s other findings, suc h a div i dend policy as petitioner's invites jud ic ial sus- p icion that the prosc ribed purpo se mo st l ike ly ex ists. Th e principa l re ason advance d by pe t itioner for its fail ure t o pay dividends f o r t he year s ending 1 964 22d /

DECISION - CTA CAS E NO. 250 0 - 13 - �a nd 1 965 wa s the fa ct t hat t he comp any \�la s c o�1strained t o ac quire treasury stock o f 11 ,116 . 4 6 sh::;���2s i n 1 964 , wh i ch wa s increased by a mi nor amount in 1 9ci 5 to 11 , 121 .6 shares 3 at a t otal c os t of P2, 043, 417.2 2; and as a result of t his acquisition of t re asury stock , petitioner's d ividends i n 1�65 wer e restr ict .d to the equ i valen t of t heir acquisiti n c os t f or a3 long as th e s hares \ve re held in t rc .: stL y , p urs uant to 'the requirement by the Se c uriti es a nd E ~change Commission as l aid down in it s ru l ings . (Petiti oner' s Ilemo randum , p. 204, CTA re co ~{s ~ ~P� 218 - 220, CTA reco r d s .) On the o the hand , re P?onde nt po i nt s out t hd t t h is acq u isiti o n a nd rete ntion o f treasu r y stock l�.S an o~.t-.1.ne r circ umstance that indica tes that pe ti tioner unreason � bly accumulated its surplus. We agree wi t h r esponde nt's i e w. Treasu r y Stock is customar "ly de fine d as s tock of a corpora t ion t hat has been legally issued as fully paid and t hereafter has been r e acquired by t he corpo- ration throug t purchas e , donat ion or settlement of an obliga t ion a~d has not been f ormally c a ncelled. I n th e in s ta n t c as e, �etitioner reacq~i red it s s t ock by purch cse in 1J64 a nd held this in treasury in 1965 t hrough 1966 . A~ indicated in i ts balance sheet f o r 19 G5 (Exh . " H- 1 " ) '� t he re demption c o ~:; t of 230 I

DECISION �- CTA C SE NO. 2500 - 14 - ~1 , 116.6 shares in 196 4 was P 2,042,522.22 which was increased to P2,0 43,447 . 22 � n 196 5 with the addition of 5 shares, br "n ging t he total numb er of sha r es t o ll,l2l. J . The �earne d surplus ba l a nceu t th8 end of the fisc a l yea r s 1964 and 1965 were ~ 2 , 224,277.51 and (See Annex The . P 2, 99 3,867. 25, r es ec t ivel y. " A 11 .) balanc e sheet for the year en d~n g J ne 30, 1967, with comparative f i gures for 1 9 6 '~ (.::d1 . "I-1") '� sho ws u n der "Stockholu ers E-:1ui ty" that these tr e asury shares re mained in the tre a sury through 1966 and were sold in 1967. On the asset side of the same balance sheet are re flected Q two receivabl e accou n ts from stockhold e rs in 19~ 7 as follows: Due from stockholders - curr e nt portion (Note 2) �����.� . ���� �� . ~ 458,437.37 Due from a stockholder - net of por t i on shoqn unde r c u rrent ass e ts (Not e 2) � � � � � � � � � � Pl, 4 07 , 840 . 0~ To t a 1 The exp lanat iG n for these accounts reads : (Exh . "I - 5") "N te 2. Due from S tock ho l de rs Th is r e pre s e n ts t he unpaid balances on t he c omp any's t reasury stock sold to stockhol ~e rs together with the interest accrued the r e on . A s toc kholde r who pur- chased 10 ,871.3 2 sh a res of the treasury st o c~ at an original amou nt of P2,011,194.20 will pay t h~ company in s ixt y equ l month l y i nstal :;nen t:s of P33,5 20 .00 un til December 2, 19 71 at c::tn i.n t0 res t ra te of 8% per annum." Thus as of June 30, 1967, t he total outstanding amo1nt due fr om stockholders on acc o unt of their purchas e 2 3.1 /

DECISIO L'l - CTA CASE NO. 25 00 - 15 - ~f t he tre asur y s ha r es was ~ 1,866,277. 3 1 o f wh:c h ~1 1 407,840.00 was due f rom one s t ockho l d er p a abl e in equal mo nthly in s ta.llments up to December 2, . 197 1 as e xp l ained above . The mere fact of red er, ption of .stock f urni sLes no basis for i rnpcs iti o n of t he surt a x . Whe n, however , the redempt 'on is do. e out of cash accumulatiomwhich r e a so na bly may be thoug ht ex ;e~s 1 ve , s uch a p urc ha~ e , along with o the r f actors a y a ppropriately be cons i- dere d in ar ri vi ng at t he ul t iroate findin g . (Me rtens , Law of Federal I1 c o me Taxat ion , Vol. 7, Chapter 39, p. 7 . } The t o ~c h s~one o f l i a b ility is the purp0se behind the accui..ulc:<tion of t he income and not the con- s ~ q ue n ce o f the ac cLmul at ion . Thus, if tha fai lure to ,p a y d i vi de n ds is due to some o t h er c ause suc h as t he us e of undi stribu ted earnings and profi ts for the r ea s ona b le nee ds c~ th e b usi ness , s u ch p ur pose does not f a ll w ' th in t h e interd ic tion of th e s t a tute. (Ma nila Wine Mercl1 an~s , Inc. v s. Commissi o ner of I nterna l Re v enu e, s:tDra , ci ting Herten s, ~, at.v of F0 (~ �:: r al Income Ta x ation , Vol . 7, Cha p ter 39 , pp. 4 5 and 4 7 . ) The qtesti on is: w ~ s th e purpo se mo ti vating petitioner ' s acquis i t i on of t r easu ry stock i n 1 96 4 and its r c Lent i on in 1965 for the re asonabl e needs of the bus iness�? 23 ~ t

DECISION - CTA CASE NO. 2500 - 16 - ~ To show tha t t here was a legiticiate a nd proper corporate object ia the above ac q:J isition of tre a sx y stock by petitioner, witness f or petitioner, its ch ief accountan t, tes ti fi ed in court a s follo ws: (�-. s. n . , pp . 2- 4, February 12, 1980. ) "Atty . Quiogue With t he permission of this Honorable Co urt . Q. Mr. Sup e , duri ng the hearing of March 5, 197 9, among the� reasons r aised by you for j ustifying you r company!s re t ained e arni..g is the acquis ition by your company of treasury s hares m~ king it ia capa ble of declar:ng ca s h divi de nd i as required by SEC ru ling, to the extent of t he cost of t reasury stock. Howe ver, the acquisition of such treasury shares mus t be justified f or some cogen t reason . Could you p l ea se enlighten us on� t he r easons ty which your company ac- quired treas ury sh a:.e~ ? A. The company W3S compelled to buy SLares for the mai n re ason that cer tain stockholde rs set up the: r ow ~ busi - ne s s simila~ t o ou r b1siness so th at we do not want t ';�.::-m as stock- holder s since t hey are already stock- holders of c ompeting company. And othe r steel h ol d~ rs sold their share t o t he company becaus e they resign from t he c on~any. Q. These stockholders who p ut up th eir own company , wou ld you say that th ey would con stitute a threat to the c ompa~y if they r e ma in as stock- holder s? A. Yes. Actual ly they own 4 0 to 50% of

DECISION - CTA CASE NO . 2500 - 17 - the ownership of the compa ny. That wou l d afford them substantial share in the secret of the company. Q. Is tha t actu a lly one o f the reasons why yo~ r comp2ny pur ch ased thei r sha~es? A. Actually, they put u p their o wn business similar .to our business. Q. Is that business still in existence? A. That is still in existence. JUDGE FILLER Q. Wh aL is t ~ e name of . the busines s ? A. F ilipinas Elec tr onic ;;; . 11 No compete nt evidence, oral or documen t a r y , wa s presented by petitioner in support t hereo f. The t ~r e s tate ment of a ch ief accountant that sor:1e stockholders set up a bus ine ss si2ilar to petitioner 's, and peti- tioner had t o buy their shares, unacc o mp anied by ade quate evidence, ha s no weight with the Court . It shou ld be n o t ed that an accounta~t is n o t in charge of t h e adrnin ~s - tration and manag eme nt of a c ompany and does no t us ually lay down bus iness pol i cies. There is no other evidence in the rec or ds which suffi ci e ntly shows that .the ac qui- sition of t he treasu ry stock wa s indeed for v a lid bu~i ness reasons as alleged by pe ti tioner. I n fact, the said pur chase of treasu r y sh ares wa~ a d ra in on pe ti tioner' s financial resour ces, in view of the s ubstan tial amount inv olve d. And ev en more, s ai d s ha res were ret a ined f or 2, 't I

DECI SI ON - CTA CASE NO. 25 00 - 18 - two y ea r s, 1 965 to 1 96 6, in t he treas u ry , a f te r wh i ch th ey we r e sold o n a c c ount to pe t iti oner 's stoc kho lder s in 19 6 7 , pa r t i c u la r ly to on e stoc~h olde r at a n ori g in a l amoun t a f p ? ,Q l _ ,l 9~ .20 , p a yabl e in sixty equal mon th l y in s ta ll me nts un ti l De c e mbe r 2 , 1 9 71 at an i n t e rest r a t e of 8 % pe r arm u rn . Whi l e e v idenc e of what the ta ~pa y er in f ac t di d subsequent to the t axable y 2 ~r daes no t of itsel f pr ove o r Clis pr ove t he r ca sCl! able nc s s . of an accumul ::i ti on i n the t axa b le yea r, it bears upon the we i ght to be a t t a ched to t he e v i dence o f the taxpayer's i nte nt ions i n the t ax- ab l e y e ar . (Mer t ~ :-1s , Lav.1 o f Fe de r al In come Tax a U ':)n, Vol . 7, Ch ap te r 39 , p. 78, ) It is t hus c l e a r beyond doubt th a t pe t itione r fin a . ce d t he sale of its tr ea~ur y s t oc k t o its s t ock - holder s . Co rpo rat e fu nd s were ut i l:zed i n t ~ e tr ~n - sac t i on t o e na ble its c toc kholder s t o pu r chase the t r easury s t ock on cred i t. Al l the et he r cir cums t a nc es wh ic h migh t be c on s ~rue d a s e vi dence o f the pu rp ose -o av o i d t he t a ~ o n s h a r eho l d e r s c~n not be out li ne d, bu t a mon g ethe r t h ~. n gs , deal L"?. g s b c~ t', ;e en th e c orpo ra t i on an d i t s s har e h o l d ~ r s , a uc h a s w ~t hdr a w als by t he s har e- ho l der s as pe r son .1 l oans o r t he e xfs ndi tur e of f unds by the corpora tion f o r t he personal bene f it of t he stoc kho lder s are cons i de re d . (Se c . 1 9 , Rev . Re g s . No . 2. ) 2 3v ,.

- - - - - --- DECISION CTA CASE NO. 2:0 0 - 19 - ~here was no pro�f th a t the acquisition o f t reasury stock wa s for the real an d i mmediat2 b e ne fit of petitione r. On t he contrary, it appears that th e sa i- a quis ition wa s for the bene fit of the stock- holde rs. A hi hl y im~o~tant f actor of proof in connection . . with a purpose to escape t ax on the stockholde r is the presence of lo ur: s made L o ~_; :.:.oc!~holders; such loc.:ns te nd to prove t he lac k o f necess ity of the accum�lation of surplus by t he corporatio � It has been held to be immaterial that the stockholder is willing t a pay a highe r r ate of inte rest than bank s or other third parties, or t hat the s toc kholder guarantee s to p Gy inter est. Qui e n atur a lly the q~estio n immediate Jy -r i s es as to why the co rporation does not pay d ivi- de nJs t o i t s stoclaolde rs if it is able to make loans to them ou t of it s Ga ; nings and profits. UJJ.e rte ns, Law o f Fede r al Inco me Taxat ion , Vol. 7, Chapter 39, p. 71 .) It is clear fr om the fo r e goi ng t hat in ret3ining i t s tr easury shares i n 1965 f er t he purpose of selling them on cr edit to i t s ~cckholders, petitioner has a llowed :Lts e a ni:1gs a n profits t.o accumulate beyond the� reason- able ne-d s of the business, wh ich i s de te rrein at ive of the purpose t o avoid the tax on its sha reholders . 23 t1 I

DECISION - CTA CASE NO. 25 00 - 20 - The other gr ounds cited by petitioner to justift its accumulation of earnings were it~ long r a nge ex- pa n si on program and its ne e d for mo re working c apital . I t is argued by peti t ioner that its surplus has ~ n fact bee n p lowed back into its tusiness in the form of fixed assets acquired in pursuance of a long-range expans ion p rog r am. To evi Gc nce th ~ i mplem e n t ati on of its long range program petitioner introduced extsnsive exhibits showing t he various a ddi~ io ns to its f'xed a3sets f r om J uly 1, 1958 to June 30 , 1967 amounting to P3 ,79 0,J20 . 77. However, petitioner did no t submit p roofs of specific, definite and f easible ~l a ns for the accum ulaLi on in the ta xa bl e year in qu e st~ o n . Th u3 : "To determine t he 'reasona:Jle needs 1 of t he bus i ne ss in order to justify an accumulatio~ of earnings, the Cour t s of the Un ited States have i .ven ted the ~a c alled 'Imme iacy Test' which c onstrue d t he t'ords 'r easonable needs of t he bu si-~ ness' t o mean th e immediate needs of t he bus iness, and it was generally he ld . t h~t if t he cor pol' tion did not prove an i ~ ediate nee d for t~e accumula tion of the ea r ni 1gs and p r ofits , t he a c cumulation wa s not for the re as onab le needs c f the bu s ines;:;, and the penalty tax \�leu l d e1:::?J.y ." (Manila Win e Mer cha n t s, Inc . v. Com ~iss io ne r of Ir';tern � l Reve r:ue , ~u p r ::.,!..) . Such pl ans a s the c or porati o n h a._, fo r use of ~ccumul~te~ e ~ rn i ngs mus t be in e xistence at the c lose

DECI SIOJ.~ - CTA C ~SE NO . 2500 - 21 - ~f t he ye ar in which the accumulat i on i $ made. In rder to de termine whethe r profi ts were accumulated f or the reasonable needs of the business or t o avoid the sur ta2. L,po'i shareholders, t he controlling i nt en tio:1 of the t ax~ayer i s that which i s mani~ested at th e time / of t he accumula tion, not subsequently d c lared inten- . tions which are me r ely th e pr oi uct s of afte rlhought . (Bus ilan Estates, Inc. vs. (:)m::1is sioner of Inte rn al Reven ue, 21 SCRA 1 7 citing Jac ob Mertens , J r., The Law uf Federal Inc ome T~xat ion, Vo l. 7, Cumu!ativa Supp l e- men t , p � 213 . ) Petitioner pl aced grea t emphasi s o n the use of th e "D ardah l" formula to as c e rt al n :U:.s wor k ing ca pital ne ed ., for one lY 1 s ine ss eye l e. AP!:jly in g the Bc..rdi..d.ll . f o r mula , p _ti t ion er tried to s::ovJ �chat i t needed f\.u:ds to p ro vid e wo rkin g c a pital in t he amou nt of ~4 , 6 72, 118.06 f or one opera ting cycl e . (S>: h. " J" .) Since its net liqu i d ~ssets as o f t he end of the tax year 1 �6 5 was only P3 ,1.5 2, 16 5. 30 (Exh. "H-1") ' � t he sho:..: tzcg e of working capi t al amountc j t o Pl, 5 1 9,952.76. (Pet itioner 's Memo - ran ~u m, p. 216, C ~A res ord s .) 'l' hc use of a subst an ti a l p.a.rt of peti tio ne r's fu nc1s to :1cquire t rea::;u ry stock c:t:~d th e rest r icti on of its ea _ned sLrplus as a c onseqile nce of the retent io n o_f sa 1� a SL.J,.. OCK' 1� n 1 '~J.-.,-:-;;, l1. s 1. nc ons 1. stent vl l. Lh pct l.tl.oner ' s f~

\. DEC IS ION - CTA CASE NO. 2 50 0 - 22 - ~ l airned s ho rtag e of wo rking capital . If pet ition er was i n dir e need of f u~ds , then it sh9uld nG~ have burdeneJ i tself with the pu rchase of t re a sury stoc k and the n facil itated i ts sa le on c redit t o its stock- holder s. The s a l e of sa id share s could have been made direc t ly from th e wi thdrawing s t oc kholde rs to the r e ma ining stock hol�..::e r s , withou t c ours i ng tL e tr Z: nr: ~ ct i o n th ro ugh the corporat j. on a nd the end res ult woul d have be e n the s ame . Und e r Secti on 25(c) ~a lt houg h t he existence o f a ac...cum~: lat.~o n be :y�vnd the r eas o nab le business needs i s determi n~ti ve of the pu rp ose to av oi d the ta x uyo n share holders, the ta x1 a ye r may overcome th e pre s umpti on by pr ov ing to t he contra ry by a c lear pr eponde rance of t he evide nce. The taxpayer's e vi0c nce mu s t be Ci~e c ted to a c0mp l ete lack f the p rosc ri bed purpose , as t he c:dste nce of even a bonafide business purpose is not inconsisten t with anot her purpose to reduce the s ur - t ax b' r en of its shareholders . In come Ta xat i on , Vo l. 7, Chapte r 39, p . 5 3. ) What w~s he l d in Pelton Castin g Co., 28 TC 153 (195 7) ~ aff'd 251 P2d 278 (CA 7t h, 1958 ) ~ci tin g Trice Produ c ts Co rpor~t ion, 46 B. T . A. 346, 374 (1942 ) ~ i s a pp ropr ia te he re and we q uote: " I f tl1e r ea s o r1 al) le 112eds o f tl1e business are to be re lied up on ss a means of c onvincing us o f the complete innocence 23 ~i I

DECISION - CTA CASE LJ D. 2500 - 23 - of petitione r' s p urr c:>e , L,is must at leas t requ ir e a d e mons tr at~on th at t here 111as a pur po se to p rovi de fo r those business needs s o satisfying and per sJ as 've t hat it is unnecessary to l ook f urther f or a motive for the a ction un der c riticis m. And to t his it m~st be a dde d th at a de monstrat e d p u rpo se may be ' no t i nc o n sist e nt wi t h anot he r pur pos e t o r educe inc ome tax es ~y h av ing a co rpo r ati o n ac c umula te it s gains an::-1 pro f i ts r a t.. her than distr �- bute ~he m } * * * And 'it is to this c omp lete lack of the con denn ed pu rpose t ha t its e vi den c e mu st be J ir e cted a nd if it do0 s not fair ly prove an a bsence of su ch purpo se it must fai l reg ardless of what ot her J ur p~s e s it may pr ov e.' *** Ev e n if t he y sa t i sf i e d us that t he ac cumul ation s we re c aused i n par t by the plcn or pur pose t o pr o�ide f or re a sonable l:; 1 s iness needs : th e re would rem ain to be 0 Xamined what is enpre ssly E.l d v anced aS tbe p rin cipal pt.>;~ pos e. The inciden t a l ones would sti ll appear as excus es, o r afterthought s , rathe r than evidence o f an a bsence o f t he purpose descri bed by the s t atute." The Co urt r ecogn ize s that in co nson a nce wit h well- establ ished principles, the Commissione r's determination is pre s ump t ivel y c orr e c t a nd c ast s upo n petitioner t he bur den of of f er i ng evid e nc e in o ppos ition thereto . The burden of proo f is on t Le ta xpaye r c on t estin g t he vali- dity or cor rec t ness of an assessme..t to prove no t only t hat t he Commissioner of Internal Revenue is wr o ng but tl i' th e (taxpay.:?r ) is r i9: 1t.� (Lin o Gutier r ez v r::.� Co l - l e ctor of Inter na l Rev enue , CTA Ca s e No . 504, J an ~ ar y 28 , 24u

DECISION - CTA CASE NO . 2500 "!... 24 - ~962; Tan Guan v s . Court of Tax Appeals, L-236 76 , A"rl"l 27 19 QQ3 � L . . t-' . f 1a-'6�7 I - "Q-' r'-�p� '~-~ ; r ~V<l"lf- _re~~.�n- Ca,_�eso~~a vs . Bureau o f Int erna~ Revenue , etc., CTA Case No . 3713, January 25, 1985, certiorari denied in G.R . No . 707 58, Aug. 21, 19o5 .) And un d er Sec tion 25 (c) o f t he Hev u we Code , s u~J:2, 1 the fact th at the earnings or &ref it s of ~ corporation are permitte J to =c~umulate beyond the r co. sonable needs o f tile busin-::: ss s h a ll be determinative c~ the purpose to avoid the tax upon i ts shareholders or membe rs un1e d ~ the c orporat ion , by clear pr eponde rance of evidence, shall prove t he c ontr a r y. Onc e s uch evidence i.s presented, tl::.: question tlur.:.. is whether under all the evid - nce, petition e r h iO. s sus t ained by clear pre pon~erance of evidence t he bu:d e n which th e statute pl~ces upo n it to over c ome the presumpti o n that it was availed of for tho prohit iteC purpose. Such pr es umpt i on arises !) y virtue o f a fi nJin9 that peti - tione r accumulate profits bey ond the re asona ~ le needs of its busi nes s � .When we conside r t.i:~e f ~ cts and circum - st ance3 o f tj~ case a3 discuss e d above - p~;ment of management f _es to its sist e r 6ompany; history of d b-:vid end distri but ion s made by pc:titioner from June 30, 1956 to Ju ne 30, 1965 ; retention of treasury stock and suus e qucnt sale on credit thereof to stockholders ~ 24J.

DECI S ION - CTA CASE NO . 2 500 - 25 - absenc e of specific, de finite and f easible plans f or the ..ace 1mu l ation in the t axable y ea r in question - all of these f ac t s and circ ums tan ces , taken t ogethe r, t end to su ppor t th e c onc lu sic n that pet it :oner was ava i led o f in the f i scal year ending June 30 , 1 965 f or the purpos e of pr e vent i ng the i mp o si t ion of the t ax upon ;ts s har eholders . And because of petitioner' s fa ilur e t o sustain t he bu r den which t he l aw 2 ppli cable pla~es upo n i t to overcome by c ea r p reponde ra nce of e vidence , the determ ination of respondent that petitione r was <lva i led o f f or t he p rc�'�ib ited purpose in the fi sca l ye or 1n qu e sti on , mu s t be sustain ed . Accor din gly, pet itio ne r P. I . ~anu fnct u rin g , I nc ., is h ereby o rde r ed t o p ay to r espond e nt Commissio1:e r of I n tern a l Reve nue t ~e amount of P88 3,191. 06 representing surtax for petition er's i ~0 r0 ~2 r a c cumulation of su rplus for the f isc al year 1964-1965, pl us sur ch arge s a nd inter es t incident to del i nq ue ncy f.Jllrsuan t to the p r ov i sion s of Secti c� n 51 (e) o f the a pp li cabl e Nat5. on al I nternal Revenue Code , as amen ded . ~\TH EREFORE, the cle ci sion appeal ed fr om is hereby af f irrued at pet i tione r' s cos ts . SO ORDERED . Quez on Cit.y, ~ktr o :.::: nile: , De cember 27 , 1 985 . 24 2

ANNE X "A" Ex h ibit .F i s c a l Ye ar Net Inc ome Ot h0 r Ad- Current cDaisvhi-dend s P ai d Earned Sur - No . Ended afte r Ta ;{es j u s t me n t s Earni ng s st oc k p l us Balances t o Earned Avail ab le a t th e en d of t he y ~ar c Surplus f or Divid e nds (af ter div i de nd s) D Jun e 30, 1956 ~ 48 5 ,9 8 7.67 ~ 400 . 00 ~ 4 8 ~, 9 8 7. 6 7 f! 50 , 000 . 00 ~ 53 97,7 29 . 80 E-1 ,J un e 30, 195 7 649 ,236 . 68 850 , 0 00 . 00 E- 1 June 30, 195 3 7 24 , 6 11.5 6 649 , 236. 5 8 1 ,~, 9c.261 , 966 �."0'.'84 ~ F-1 June 30 , 1 9 59 8 91, 567.01 7 2 '~ , 211. 5 6 ~ 5 54 , 88 0 .00 151,200. 0 0 F-1 J u rre 30, 19 60 891 , 567 . 0 1 , 978 G- 1 ~Jun e 30, 1961 1 , 0 21,397.32 1,021, 397 . 3 2 1 25 , 050.00 325 ,0 50. 0 0 G-1 Jun e 30 , 1962 438,791.87 43 8 , 791. 87 35 6 , 2 7 2. 4 0 1 �7..0. 7, , L,1 65 .� 0 5 J une 30, 1 96 3 77 6, 2 76 . 3 3 7 76 , 27 ':~ . 3 3 587,849 . 50 1~' 5/2. 8 r 8 6 L,,- . 37 H- 1 June 30 , 1964 45 4 , 67 6 . 86 4 54 ,6 76 . 8 6 17 ,554. 24 tv H-1 June 30, 1 96 5 4 1 9 , 89 1.9 8 4 19 , 89 1. 98 ~I f 9 37 , 558 769 ; 5 89 . 7 4 76 9,5 8 9 . 74 1. ' ~ , .2l,, 820244 1 ~'J ~ ~ �--~~' "' -' ' ' - 2 . �'<.. ' J .:Jl , 9 9 ..-, 867 .25 ({JrJ"JQ) I t J:.