02B Income Statutory Inclusions

Taxation Law Case Digests

Atty. Michael Montero

INCOME: STATUTORY INCLUSIONS Compensation for Services 1. Old Colony Trust Co. v. Commissioner 279 U.S. 716 June 3, 1929  Petitioner: Old Colony Trust Co Respondent: Commissioner of Internal Revenue Summary: William M. Wood was president of the American Woolen Company. The Board of Tax Appeals found a deficiency in the federal income tax return of Mr. Wood for the year 1919 of $708,781.93, and for the year 1920 of $350,837.14. The AWC had adopted a resolution, which was in effect in 1919 and 1920: " That this company pay any and all

income taxes, state and Federal, that may hereafter become due and payable upon the salaries of all the officers of the company, including the president, William M. Wood; xxx, to the end that said persons and officers shall receive their salaries or other compensation in full without deduction on account of income taxes, state or federal, which taxes are to be paid out of the treasury of this corporation." This resolution was amended “That, referring to the vote passed by this board on August 3, 1916, in reference to income taxes, state and federal, payable upon the salaries or compensation of the officers and certain employees of this company, the method of computing said taxes shall be as follows, viz.:"The difference between what the total amount of his tax would be, including his income from all sources, and the amount of his tax when computed upon his income excluding such compensation or salaries paid by this company." Now, our issue is "Whether or not the payment by the employer of the income taxes assessable against the employee constitute additional taxable income to such employee?" YES! The taxes were paid upon a valuable consideration -namely, the services rendered by the employee and as part of the compensation therefor. We think, therefore, that the payment constituted income to the employee. Nor can it be argued that the payment of the tax in No. 130 was a gift. The payment for services, even though entirely voluntary, was nevertheless compensation within the statute.

Facts  The petitioners are the executors of the will of William M. Wood, deceased. On June 27, 1925, before Mr. Wood's death, the Commissioner of Internal Revenue notified him by registered mail of the determination of a deficiency in income tax against him for the years 1919 and 1920, under the Revenue Act of 1918.  The deficiency was revised by the Commissioner thus an appeal was taken to the Board of Tax Appeals. A hearing resulted in a decision. The Board approved the action of the Commissioner, and found a deficiency in the federal income tax return of Mr. Wood for the year 1919 of $708,781.93, and for the year 1920 of $350,837.14.  William M. Wood was president of the American Woolen Company during the years 1918, 1919, and 1920. In 1918 he received as salary and commissions from the company $978,725, which he included in his federal income tax return for 1918. In 1919, he received as salary and commissions from the company $548,132.87, which he included in his return for 1919.  In 1916, the American Woolen Company had adopted a resolution, which was in effect in 1919 and 1920: "Voted: That this company pay any and all income taxes,

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state and Federal, that may hereafter become due and payable upon the salaries of all the officers of the company, including the president, William M. Wood; the comptroller, auditor, and following members of the staff, to the end that said persons and officers shall receive their salaries or other compensation in full without deduction on account of income taxes, state or federal, which taxes are to be paid out of the treasury of this corporation." This resolution was amended on March 25, 1918, as follows: "Voted: That, referring to the vote passed by this board on August 3, 1916, in reference to income taxes, state and federal, payable upon the salaries or compensation of the officers and certain employees of this company, the method of computing said taxes shall be as follows, viz.:" o "The difference between what the total amount of his tax would be, including his income from all sources, and the amount of his tax when computed upon his income excluding such compensation or salaries paid by this company." Pursuant to these resolutions, the American Woolen Company paid to the collector of internal revenue Mr. Wood's federal income and surtaxes due to salary and commissions paid him by the company, as follows: o Taxes for 1918 paid in 1919 . . . . $681,169 88 o Taxes for 1919 paid in 1920 . . . . 351,179 27 The decision of the Board of Tax Appeals here sought to be reviewed was that the income taxes of $681,169.88 and $351,179.27 paid by the American Woolen Company for Mr. Wood were additional income to him for the years 1919 and 1920.

Issue: The question certified by the circuit court of appeals for answer by this Court is: "Did the payment by the employer of the income taxes assessable against the employee constitute additional taxable income to such employee?" YES Ratio: Board of Tax Appeals ( you may skip this) The case talks about the powers of the The Board of Tax Appeals which was established by § 900 of the Revenue Act of 1924 and then amended by Revenue Act of 1926. It’s long and complicated so I decided not to include it. There has been a discussion of its powers because this case, as the court says:  We have before us, however, for actual inquiry a case different from one just considered in the regular course of a petition for review of a decision of the Board begun and decided all after the enactment of the Act of 1926. It is one in which the appeal to the Board of Tax Appeals had been taken, but the appeal had not been decided by the Board before the passage of the Act of 1926. That presents what involves a troublesome exception or duplication in the procedure.  Conclusion for this issue: The truth seems to be that, in making provision to render conclusive judgments on petitions for review in the circuit courts of appeals, Congress was not willing, in cases where the Board of Tax Appeals had not decided the issue before the passage of the Act of 1926, to cut off the taxpayer from paying the tax and suing for a refund in the proper district court. But the apparent conflict in such cases can be easily resolved by the use of the principles of res judicata. If both remedies are pursued, the one in a district court for refund and the other on a petition for review in the circuit court of appeals, the judgment which is first rendered will then put an end to the questions involved, and in effect make

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all proceedings in the other court of no avail. Whichever judgment is first in time is necessarily final to the extent to which it becomes a judgment. There is no reason, therefore, in the case before us to decline to take jurisdiction. The Board of Tax Appeals is not a court. It is an executive or administrative board, upon the decision of which the parties are given an opportunity to base a petition for review to the courts after the administrative inquiry of the Board has been had and decided. It is next suggested that there is no adequate finality provided in respect to the action of these courts.

IMPORTANT PART: (COMPENSATION FOR SERVICES) 

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Coming now to the merits of this case, we think the question presented is whether a taxpayer, having induced a third person to pay his income tax or having acquiesced in such payment as made in discharge of an obligation to him, may avoid the making of a return thereof and the payment of a corresponding tax. We think he may not do so. The payment of the tax by the employers was in consideration of the services rendered by the employee, and was again derived by the employee from his labor. The form of the payment is expressly declared to make no difference.

It is therefore immaterial that the taxes were directly paid over to the government. The discharge by a third person of an obligation to him is equivalent to receipt by the person taxed. The certificate shows that the taxes were imposed upon the employee, that the taxes were actually paid by the employer, and that the employee entered upon his duties in the years in question under the express agreement that his income taxes would be paid by his employer. This is evidenced by the terms of the resolution

passed August 3, 1916, more than one year prior to the year in which the taxes were imposed. The taxes were paid upon a valuable consideration -- namely, the services rendered by the employee and as part of the compensation therefor. We think, therefore, that the payment constituted income to the employee. Nor can it be argued that the payment of the tax in No. 130 was a gift. The payment for services, even though entirely voluntary, was nevertheless compensation within the statute. There, it was resolved that a gratuitous appropriation equal in amount to $3 per share on the outstanding stock of the company be set aside out of the assets for distribution to certain officers and employees of the company, and that the executive committee be authorized to make such distribution as they deemed wise and proper. The executive committee gave $35,000 to be paid to the plaintiff taxpayer. The court said: o "In no view of the evidence therefore can the $35,000 be regarded as a gift. It was either compensation for services rendered or a gain or profit derived from the sale of the stock of the corporation, or both, and, in any view, it was taxable as income." It is next argued against the payment of this tax that, if these payments by the employer constitute income to the employee, the employee will be called upon to pay the tax imposed upon this additional income, and that the payment of the additional tax will create further income which will in turn be subject to tax, with the result that there would be a tax upon a tax. This, it is urged, is the result of the government's theory, when carried to its logical conclusion, and results in an absurdity which Congress could not have contemplated. In the first place, no attempt has been made by the Treasury to collect further taxes upon the theory that the payment of the additional taxes creates further income.

Atty. Michael Montero

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The question in this case is, "Did the payment by the employer of the income taxes assessable against the employee constitute additional taxable income to such employee?" The answer must be "Yes."

After the first argument, the Court, on February 18, 1929, made the following order: o Xxx "3. What has been the practice of taxing officers relative to assessments where, by agreement between the parties, the tax laid upon the income actually received by one of them has been paid by another?" o "4. Do applicable statutes authorize the taxing officers to estimate total income by adding to the amount actually received by the taxpayer any tax which another has paid thereon under agreement between the parties?"  "It is suggested that counsel apply to the court below for an amendment, so that the certificate will show distinctly when the original assessments were made, and under what acts. Also when the appeals were taken to the Board of Tax appeals; when they were decided, and when the appeals to the circuit Court of Appeals were perfected."

2. Helvering v. Bruun Petitioner: Helvering (I think this is the IRS) Respondent: Bruun (duh) Date: March 25, 1940 Facts: (1 page digest no need for summary) 1. Respondent, as owner, leased a lot of land and the building thereon for a term of 99 years. The lease provided that lessee might at any time, remove or tear down any building on the land. The lessee was to surrender the land, upon termination of the lease, with all building and improvements thereon 2. The tenant demolished and removed the existing building and constructed a new one. The lease was cancelled for default in payment of rent and taxes, and the respondent regained possession of the land and building. 3. The building which had been erected upon said premises by the lessee had an FMV of $64k+ and that the unamortized cost of the old building, which was removed from the premises to make way for the new building $12k+ thus leaving a net FMV value of $51k+ 4. From the basis of these facts, the petitioner determined that the respondent realized a net gain of $51k+ Issue: WoN the value received is embodied in something separately disposable, or whether it is so merged in the land as to become financially a part of it, something which, though it increases its value, has no value of its own when torn away – Not necessary that it is embodied in something separately to be taxable 1. It is petitioner’s contention that gain was realized when the respondent, through forefeiture of the lease, obtained untrammelled title, possession, and control of the premises, with the added increment value added by the new building. 2. The respondent insists that the realty – a capital asset at the date of the execution of the lease – remained such throughout the terms and after its expiration; that improvements affixed to the soil became part of the realty indistinguishably blended in the capital asset. Such added value, it is argued, can

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Taxation Law Case Digests

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be considered capital gain only upon the owner’s disposition of the asset (because that’s when you get the money equivalent of the increase) We hold that the petitioner was right in assessing the gain as realized in 1933 (lease cancelled) Gain in the amount named was realized by the respondent in the year of repossession. While it is true that economic gain is not always taxable as income, it is settled that the realization of gain need not be in cash derived from the sale of an asset. Gain may occur as a result of exchange of property, payment of the taxpayer’s indebtedness, relief from liability, or other profit realized from the completion of a transaction. The fact that the gain is a portion of the value of property received by the taxpayer in the transaction does not negative its realization. Here, as a result of a business transaction, the respondent received back his land with a new building on it, which added an ascertainable amount to its value. It is not necessary to recognition of taxable gain that he should be able to sever the improvement begetting the gain from his original capital.

Atty. Michael Montero

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Judgment reversed. NOTE (read): If he asks about the cases cited in the cases, just say the Blatt and Hewitt cases, which were relied upon by the respondent, stated that the added value could not be considered rental accruing over the period of the lease. But court said that Hewitt statements were only meant to show that, in the case of a stock dividend, the stockholder’s interest in the corporate assets after receipt of the dividend was the same as and inseverable from that which he owned before the dividend was declared. These statements are not controlling here.

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Dividends 3. COMMISSIONER OF INTERNAL REVENUE v. CA, CTA and A. SORIANO CORP January 20, 1999

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Facts: 1. In the 1930s, Don Andres Soriano, a citizen and resident of the United States, formed the corporation “A. Soriano Y Cia”, predecessor of ANSCOR.  ANSCOR is wholly owned and controlled by the family of Don Andres, who are all nonresident aliens. In 1937, Don Andres subscribed to 4,963 shares of the 5,000 shares originally issued.  In 1945, ANSCOR’s authorized capital stock was increased to 25,000 common shares with the same par value (originally there were only 10,000 shares)  Of the additional 15,000 shares, only 10,000 was issued which were all subscribed by Don Andres. This increased his subscription to 14,963 common shares.  By 1947, ANSCOR declared stock dividends. Other stock dividend declarations were made between 1949 and December 20, 1963.  On December 30, 1964 Don Andres died . As of that date, the records revealed that he has a total shareholdings of 185,154 shares - 50,495 of which are original issues and the balance of 134,659 shares as stock dividend declarations.  One-half of that shareholdings or 92,577 shares were transferred to his wife, Doña Carmen Soriano, as her conjugal share. The other half formed part of his estate.  A day after Don Andres died, ANSCOR increased its capital stock to P20M and in

1966 further increased it to P30M. In December 1966, stock dividends worth 46,290 and 46,287 shares were respectively received by the Don Andres estate and Doña Carmen from ANSCOR. By January 2, 1968, ANSCOR reclassified its existing 300,000 common shares into 150,000 common and 150,000 preferred shares Doña Carmen exchanged her whole 138,864 common shares for 138,860 of the newly reclassified preferred shares. The estate of Don Andres in turn, exchanged 11,140 of its common shares for the remaining 11,140 preferred shares, thus reducing its (the estate) common shares to 127,727. On June 30, 1968, pursuant to a Board Resolution, ANSCOR redeemed 28,000 common shares from the Don Andres’ estate. By November 1968, the Board further increased ANSCOR’s capital stock to P75M divided into 150,000 preferred shares and 600,000 common shares. About a year later, ANSCOR again redeemed 80,000 common shares from the Don Andres’ estate, further reducing the latter’s common shareholdings to 19,727. BIR ruling: In 1973, ANSCOR should be assessed for deficiency withholding taxat-source for the year 1968 and the second quarter of 1969 based on the transactions of exchange and redemption of stocks. This is despite the claim of ANSCOR that it availed of the tax amnesty CTA: Reversed petitioner’s ruling, after finding sufficient evidence to overcome the prima facie correctness of the questioned assessments. CA: affirmed CTA

Issue: Whether ANSCOR’s redemption of stocks from its stockholder as well as the exchange of common with preferred shares can be considered as “essentially equivalent to the distribution of taxable dividend,” making the proceeds thereof taxable under §83. No it’s taxable

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Petitioner’s argument: The exchange transaction is tantamount to “cancellation” under Section 83(b) making the proceeds thereof taxable. Said Section applies to stock dividends which is the bulk of stocks that ANSCOR redeemed and that under the “net effect test,” the estate of Don Andres gained from the redemption. Accordingly, it was the duty of ANSCOR to withhold the tax-at-source arising from the two transactions, pursuant to Section 53 and 54 of the 1939 Revenue Act. ANSCOR’s argument: It has no duty to withhold any tax because the same were done for legitimate business purposes which are (a) to reduce its foreign exchange remittances in the event the company would declare cash dividends, and to (b) subsequently “filipinized” ownership of ANSCOR, as allegedly envisioned by Don Andres. It likewise invoked the amnesty provisions of P.D. 67. (see appendix not

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TAX ON STOCK DIVIDENDS: General Rule Section 83(b) of the 1939 NIRC was taken from the U.S. Revenue Code of 1928. It laid down the general rule known as the ‘proportionate test.’ GR:“A stock dividend representing the transfer of surplus to capital account shall not be subject to tax.” Under the US Revenue Code, this provision originally referred to “stock dividends” only, without any exception, as stock dividends, represent capital and do not constitute income to its recipient. So that the mere issuance thereof is not yet subject to income tax as they are nothing but an “enrichment through increase in value of capital investment.” As capital, the stock dividends postpone the realization of profits because the “fund

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Taxation Law Case Digests

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represented by the new stock has been transferred from surplus to capital and no longer available for actual distribution.” Income in tax law is “an amount of money coming to a person within a specified time, whether as payment for services, interest, or profit from investment.” It means cash or its equivalent. It is gain derived and severed from capital, from labor or from both combined so that to tax a stock dividend would be to tax a capital increase rather than the income. Stock dividends issued by the corporation, are considered unrealized gain, and cannot be subjected to income tax until that gain has been realized. Capital is wealth or fund; whereas income is profit or gain or the flow of wealth. The Exception: Section 83(b) of the 1939 Revenue Act which provides: Sec. 83. Distribution of dividends or assets by corporations. –(b) Stock dividends – A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in

Atty. Michael Montero

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whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent it represents a distribution of earnings or profits accumulated after March first, nineteen hundred and thirteen .” In Eisner v. Macomber: pro rata stock dividends are not taxable income, the exempting clause above quoted was added because corporations found a loophole in the original provision. They resorted to devious means to circumvent the law and evade the tax. Corporate earnings would be distributed under the guise of its initial capitalization by declaring the stock dividends previously issued and later redeem said dividends by paying cash to the stockholder. To plug the loophole the exempting clause was added. The exception was designed to prevent the issuance and cancellation or redemption of stock dividends, which is fundamentally not taxable, from being made use of as a device for the actual distribution of cash dividends, which is taxable. Although redemption and cancellation are generally considered capital transactions, as such, they are not subject to tax. However, depending on the circumstances, the proceeds of redemption of stock dividends are essentially distribution of cash dividends. As qualified by the phrase “such time and in such manner,” the exception was not intended to characterize as taxable dividend every distribution of earnings arising from the redemption of stock dividends. Whether the amount distributed in the redemption should be treated as the equivalent of a “taxable dividend” is a question of fact which is determinable on “the basis of the particular facts of the transaction in question.” No decisive test can be used to determine the application of the exemption because the words “such manner” and “essentially equivalent” negative any idea that a weighted formula can resolve a crucial issue. On this aspect, American courts developed certain recognized criteria, which includes: (a)The presence or absence of real business purpose,(b) The amount of earnings and profits available for the declaration of a regular dividend and the corporation’s past record with respect to the declaration of dividends, (c)The effect of the distribution as compared with the declaration of regular dividend, (c) The lapse of time between issuance and redemption, (d) The presence of a substantial surplus and a generous supply of cash which invites suspicion as does a meager policy in relation both to current earnings

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and accumulated surplus. REDEMPTION AND CANCELLATION: For the exempting clause of Section 83(b) to apply, it is indispensable that: (a) there is redemption or cancellation; (b) the transaction involves stock dividends and most importantly (c) the “time and manner” of the transaction makes it “essentially equivalent to a distribution of taxable dividends.” In the event of redemption the corporation gets back some of its stock, distributes cash or property to the shareholder in payment for the stock, and continues in business as before. In the instant case: there is no dispute that ANSCOR redeemed shares of stocks from a stockholder (Don Andres) twice (28,000 and 80,000 common shares). (requisite a) But where did the shares redeemed come from? If its source is the original capital subscriptions upon establishment of the corporation or from initial capital investment in an existing enterprise, its redemption to the concurrent value of acquisition may not invite the application of Sec. 83(b), as it is not income but a mere return of capital. On the contrary, if the redeemed shares are from stock dividend declarations other than as initial capital investment, the proceeds of the redemption is additional wealth, for it is not merely a return of capital but a gain thereon. It is not the stock dividends but the proceeds of its redemption that may be deemed as taxable dividends. At the time of the last redemption, the original common shares owned by the estate were only 25,247.5. This means that from the total of 108,000 shares redeemed from the estate, the balance of 82,752.5 (108,000 - 25,247.5) must have come from stock dividends. (requisite b) o In the absence of evidence to the contrary, the Tax Code presumes that every distribution of corporate property, in whole or in part, is made out of corporate profits, such as stock dividends The capital cannot be distributed in the form of redemption of stock dividends without violating the trust fund doctrine – wherein the capital stock, property and other assets of the corporation are regarded as equity in trust for the payment of the corporate creditors. Once capital, always capital. With respect to the third requisite (requisite c), ANSCOR redeemed stock dividends issued just 2 to 3 years earlier. The “time” element is a factor to show a device to evade tax Was this transaction used as a “continuing plan,” “device” to evade payment of tax? It is necessary to determine the “net effect” of the transaction between the shareholder-income taxpayer and the acquiring (redeeming) corporation. It is the “net effect rather than the motives and plans of the taxpayer or his corporation.” It also applies even if at the time of the issuance of the stock dividend, there was no intention to redeem it as a means of distributing profit or avoiding tax on dividends. The test of taxability under the exempting clause is whether the redemption resulted into a flow of wealth. If no wealth is realized from the redemption, there may not be a dividend equivalence treatment. The three elements in the imposition of income tax are: (1) there must be gain or profit, (2) that the gain or profit is realized or received, actually or constructively, and (3) it is not exempted by law or treaty from income tax.

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Refuting ANSCOR’s argument: The ruling in the American cases cited and relied upon by ANSCOR that “the redeemed shares are the equivalent of dividend only if the shares were not issued for genuine business purposes” is irrelevant  In the American cases shows the presence of “genuine business purposes” may be material with respect to the issuance or declaration of stock dividends but not on its subsequent redemption.  The existence of legitimate business purposes in support of the redemption of stock dividends is immaterial in income taxation. It has no relevance in determining “dividend equivalence.”  The two purposes invoked by ANSCOR under the facts of this case are no excuse for its tax liability. a. First. the alleged “filipinization” plan cannot be considered legitimate as it was not implemented until the BIR started making assessments on the proceeds of the redemption. o Such corporate plan was not stated in nor supported by any Board Resolution but a mere afterthought o Records show that despite the existence of enormous corporate profits no cash dividend was ever declared by ANSCOR from 1945 until the BIR started making assessments in the early 1970’s. Although a corporation under certain exceptions, has the prerogative when to issue dividends, yet when no cash dividends was issued for about three decades, this circumstance negates the legitimacy of ANSCOR’s alleged purposes. o Moreover, to issue stock dividends is to increase the shareholdings of ANSCOR’s foreign stockholders contrary to its “filipinization” plan, considering that ANSCOR is a family corporation where the majority shares at the time of redemptions were held by Don Andres’ foreign heirs. b. Assuming arguendo, that those business purposes are legitimate, the same cannot be a valid excuse for the imposition of tax, because it was shown that income was generated therefrom. c. Thirdly, ANSCOR argued that to treat as ‘taxable dividend’ the proceeds of the redeemed stock dividends would be to impose on such stock an undisclosed lien and would be extremely unfair to intervening purchasers, i.e. those who buys the stock dividends after their issuance. The undisclosed lien may be unfair to a subsequent stock buyer who has no capital interest in the company. But the unfairness may not be true to an original subscriber like Don Andres, who holds stock dividends as gains from his investments. The subsequent buyer who buys stock dividends is investing capital. The effect of its (stock dividends) redemption from that subsequent buyer is merely to return his capital subscription, which is income if redeemed from the original subscriber.  After considering the manner and the circumstances by which the issuance and redemption of stock dividends were made, there is no other conclusion but that the proceeds thereof are essentially considered equivalent to a distribution of taxable dividends. As “taxable dividend” under Section 83(b), it is part of the “entire income” subject to tax under Section 22 in relation to Section 21 of the 1939 Code. Moreover, under Section 29(a) of said Code, dividends are included in “gross income”. As income, it is subject to income tax which is required to be withheld at source. 8. EXCHANGE OF COMMON WITH PREFERRED SHARES (not important)  The exchange of common stocks with preferred stocks may not produce a recognized gain or loss, so long as the provisions of Section 83(b) is not applicable.

Atty. Michael Montero

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In general, this trade must be parts of merger, transfer to controlled corporation, corporate acquisitions or corporate reorganizations. No taxable gain or loss may be recognized on exchange of property, stock or securities related to reorganizations. ANSCOR reclassified its shares and parts of the common shares of the Don Andres estate and all of Doña Carmen’s shares were exchanged for preferred shares. There was no change in their proportional interest after the exchange. There was no cash flow. Both stocks had the same par value. In this case, the exchange of shares, without more, produces no realized income to the subscriber. There is only a modification of the subscriber’s rights and privileges. WHEREFORE, premises considered, the decision of the Court of Appeals is MODIFIED in that ANSCOR’s redemption of 82,752.5 stock dividends is herein considered as essentially equivalent to a distribution of taxable dividends for which it is LIABLE for the withholding tax-at-source. The decision is AFFIRMED in all other respects.

Appendix:  May the withholding agent, in such capacity, be deemed a taxpayer for it to avail of the amnesty? An income taxpayer covers all persons who derive taxable income. As such, it is being held liable in its capacity as a withholding agent and not in its personality as a taxpayer.  The withholding agent is the payor, a separate entity acting no more than an agent of the government for the collection of the tax in order to ensure its payments; the payer is the taxpayer and the payee is the taxing authority.  The withholding agent is merely a tax collector, not a taxpayer. “the government’s cause of action against the withholding agent is not for the collection of income tax, but for the enforcement of the withholding provision Section 53 of the Tax Code,  Not being a taxpayer, a withholding agent, like ANSCOR in this transaction, is not protected by the amnesty under the decree. By specific provision of law, it is not covered by the amnesty. Emergency: ANSCOR issued stock dividends to the wife and heirs of Andres Soriano and subsequently redeemed these stocks (bought them back). The BIR assessed ANSCOR for withholding tax for these transactions. It was obligated to act as a withholding agent since the heirs of Soriano were all foreigners. Held: ANSCOR is liable for the deficiency withholding tax. Although stock dividends are generally not taxable, if they are subsequently redeemed they constitute gain or income and therefore become taxable. 4. Wise and Co v Meer G.R. No. 48231 June 30, 1947 Petitioner: WISE & CO., INC., EMG Strickland, MJG Mullins, NC MacGregor, JF MacGregor, CJ Lafrentz Respondent: BIBIANO L. MEER, Collector of Internal Revenue

(This case is quite long and also includes an MR. Sorry if the digest is long but it’s a bit hard to understand so I tried to include facts and concepts that would make it more understandable. But if you are too lazy to read the whole case, I made the summary more detailed. ) Summary Facts:

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Taxation Law Case Digests

The plantiffs, all non resident aliens were stockholders of Manila Wine Merchants, Ltd. (Hongkong Company), a foreign corporation duly authorized to do business in the Philippines. Pursuant to the recommendation of its Board of Directors, the stockholders adopted a resolution that would enable the board to sell its business and assets to Manila Wine Merchants, Inc. (Manila Company), a Philippine corporation for the sum of P400,000. The Board later on passed several resolutions to declare dividends, wherein the Hongkong Company made a distribution from its earnings for the year 1937 to its stockholders. At a special general meeting of the shareholders of the Hongkong Company, the stockholders directed that the company be voluntarily liquidated and its capital distributed among the stockholders. The appointed liquidator gave deficiency assessments for the payment of income tax of the plaintiffs based on the dividends they received. HELD: 1. The dividends received by the plaintiffs are liquidating dividends and not ordinary dividends. The distributions were not in the ordinary course of business and with intent to maintain the corporation as a going concern but rather, they were after the liquidation of the business had been decided upon, which makes them payments for the surrender and relinquishment of the stockholders' interest in the corporation, or so-called liquidating dividends. 2. Liquidating dividends are taxable under the Income Tax Law. Where a corporation, etc. distributes all its assets in complete liquidation or dissolution, the gain realized or loss sustained by the stockholder is a taxable income or a deductible loss as the case may be, in effect treated such distributions as payments in exchange for the stock or share.

Issue#3

3. The plaintiffs are subject to both income tax and additional taxes. When a solvent corporation dissolves and liquidates, it distributes to its stockholders not only any earnings it may have on hand, but it also pays to them their invested capital, namely, the amount which they had paid in for their stocks, thus wiping out their interest in the company. 4. The profit realized constitute income from the Philippines and thus subject to Philippine taxes. Hongkong Company was incorporated for the purpose of carrying on business in the Philippine Islands the business. Hence, its earnings, profits, and assets, including those from whose proceeds the distributions in question were made, the major part of which consisted in the purchase price of the business, had been earned and acquired in the Philippines. 5. Regulation No. 81 provides makes the gain realized from the distribution as taxable dividend that but the law makes it taxable income. Since there is a conflict, the law will prevail. FIRST CASE FACTS: (NOTE: the plaintiffs are all non resident aliens)  In 1937, plaintiffs, except Mr. E.M.G. Strickland (who, as husband of the plaintiff Mrs. E.M.G. Strickland, is only a nominal party herein), were stockholders of Manila Wine Merchants, Ltd., a foreign corporation duly authorized to do business in the Philippines.  On May 27, 1937, the Board of Directors of Manila Wine Merchants, Ltd., (hereinafter referred to as the Hongkong Company), recommended to the stockholders of the

Atty. Michael Montero

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company that they adopt the resolutions necessary to enable the company to sell its business and assets to Manila Wine Merchants, Inc., a Philippine corporation formed on May 27, 1937, (hereinafter referred to as the Manila Company), for the sum of P400,000 Philippine currency o This sale was duly authorized by the stockholders of the Hongkong Company at a meeting held on July 22, 1937 o The contract of sale between the two companies was executed on the same date. The final resolutions completing the said sale and transferring the business and assets of the Hongkong Company to the Manila Company were adopted on August 3, 1937 with the purchase price of P400,000 paid. Pursuant to a resolution by its Board of Directors purporting to declare a dividend, the Hongkong Company made a distribution from its earnings for the year 1937 to its stockholders of the total amount of P17,870.63. o Hongkong Company paid Philippine income tax on the entire earnings from which the said distributions were paid. After deducting the said dividend of June 8, 1937, the surplus of the Hongkong Company resulting from the active conduct of its business was P74,182.12. o Later on, with the sale of its business and assets to the Manila Company, the surplus of the Hongkong Company was increased to a total of P270,116.59. So, again, the Board of Directors issued a resolution and declared dividends on July 2, 1937 but paid on 2 different dates (August 4, 1937 and October 28, 1937), for the total amount P265,000 and P5,116.59 respectively. o Philippine income tax was also paid by the Hongkong Company on the said surplus from which the said distributions were made. On August 19, 1937, at a special general meeting of the shareholders of the Hongkong Company, the stockholders by proper resolution directed that the company be voluntarily liquidated and its capital distributed among the stockholders o A liquidator was appointed to duly pay off the remaining debts of the Hongkong Company and distributed its capital among the stockholders including plaintiffs. o The liquidator duly filed his accounting on January 12, 1938, and in accordance with the provisions of Hongkong Law, the Hongkong Company was duly dissolved at the expiration of three months from that date. The plaintiffs paid their income tax but the defendant gave deficiency assessments for the plaintiffs. The plaintiffs paid under protest and subsequently in July 1, 1939 requested from defendant a refund of the said amounts which was refused by the defendant. That this stipulation is equally the work of both parties and shall be fairly interpreted to give effect to their intention that this case shall be decided solely upon points of law.

ISSUES: 1. W/N the dividends declared are ordinary dividends- NO, they are liquidating dividends 2. W/N the dividends are income taxable- YES 3. W/N the dividends are subject to income and additional tax- YES 4. W/N the dividends are income from Philippine Sources- YES 5. W/N under Regulation No. 81 the dividends are non-taxable as income- YES but the law still prevails so it is still taxable as income HELD:

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Atty. Michael Montero

For the foregoing consideration, the judgment appealed from will be affirmed with the costs of both instances against the appellants. So ordered. RATIO:

Issue #1

Petitioner and Respondent Contentions  P: The amounts received by them and on which the taxes in question were assessed and collected were ordinary dividends  R: They were liquidating dividends. o If the first proposition is correct, this assignment would be well-taken, otherwise, the decision of the court upon the point must be upheld.

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relinquishment of the stockholders' interest in the corporation, or so-called liquidating dividends. o The surplus distributed resulted after providing for return of capital and necessary or various expense. o Those distributions were to be made in the course or as a result of the Hongkong Company's liquidation and that said liquidation was to be complete and final. o "A distribution does not necessarily become a dividend by reason of the fact that it is called a dividend by the distributing corporation."

Canal-Commercial T. & S. Bk. vs. Comm'r (63 Fed. [2d], 619, 620) o

SC Findings – They are liquidating dividends

RE: Purchaser and Seller 

It will be noted that the Board of Directors of the Hongkong Co., in recommending the sale, specifically mentioned "a new Company incorporated under the laws of the Philippine Islands under the style of "The Manila Wine Merchants, Inc." as the purchaser, which fact shows that at the time of the recommendation the Manila Company had already been formed, although on the very same day; and this and the further fact that it was really the latter corporation that became the purchaser should clearly point to the conclusion that the Manila Company was organized for the express purpose of succeeding the Hongkong Co. o "The Company" was the Hongkong Company and "the Corporation" was the Manila Company. o For "the Company" to carry on busines s in trust for the "Corporation," it was necessary for the latter to be the owner of the business.

or formal action taken to liquidate it are but evidentiary and not indispensable. 

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If the distribution is in the nature of a recurring return on stock it is an ordinary dividend. o If the corporation is really winding up its business or recapitalizing and narrowing its activities, the distribution may properly be treated as in complete or partial liquidation and as payment by the corporation to the stockholder for his stock.  The corporation is, in the latter instances, wiping out all parts of the stockholders' interest in the company . IMPT: It is our considered opinion that we are not dealing here with "the legal right of a taxpayer to decrease the amount of what otherwise will be his taxes, or altogether avoid them, by means which the law permits", but with a situation where we have to apply in favor of the government the principle that the "liability for taxes cannot be evaded by a transaction constituting a colorable subterfuge", it being clear that the distributions under consideration were not ordinary dividends and were taxable in the manner, form and amounts decreed by the court below. o

While it is true that the contract of sale was signed on July 22, 1937, it contains in its paragraph 4 of the express provision that the transfer "will take effect as on and from the first day of June, One thousand nine hundred and thirty-seven, and until completion thereof, the Company shall stand possessed of the property hereby agreed to be transferred and shall carry on its business in trust for the Corporation"  The parties considered the sale as made as on and from June 1, 1937 — for the purposes of said sale and transfer, both parties agreed that the deed of July 22, 1937, was to retroact to the first day of the preceding month.

RE: Ordinary dividends v liquidating dividends. 

When in the deed of July 22, 1937, by authority of its stockholders, the Hongkong Company thru its authorized representative declared and agreed that the aforesaid sale and transfer shall take effect as of June 1, 1937, and distribution from its assets to those same stockholders made after June 1, 1937, although before July 22, 1937, must have been considered by them as liquidating dividends; for how could they consistently deem all the business and assets of the corporation sold as of June 1, 1937, and still say that said corporation, as a going concern, distributed ordinary dividends to them thereafter? The distinction between a distribution in liquidation and an ordinary dividend is factual; the result in each case depending on the particular

circumstances of the case and the intent of the parties.

RE: Effectivity 

. . . The determining element therefore is whether the distribution was in the ordinary course of business and with intent to maintain the corporation as a going concern, or after deciding to quit with intent to liquidate the business. Proceedings actually begun to dissolve the corporation

The recommendation of the Board of Directors was "that the company should be wound up voluntarily by the members" and that the Company's business be sold. o A Declaration of Solvency was drawn up duly signed before the British Consul-General in Manila by the same directors, and said declaration was returned to Hongkong for filing with the Registrar of Companies. This was approved and ratified. They leave no room for doubt in the mind of the court that said distributions were not in the ordinary course of business and with intent to maintain the corporation as a going concern — in which case they would have been distributions of ordinary dividends — but after the liquidation of the business had been decided upon, which makes them payments for the surrender and

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Issue#2

SC’s Findings – They are taxable The Income Tax Law, Act No. 2833 section 25 (a), as amended by section 4 of Act. No. 3761: Where a corporation, partnership, association, joint-account, or insurance company distributes all of its assets in complete liquidation or dissolution, the gain realized or loss sustained by the stockholder,

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Atty. Michael Montero

whether individual or corporation, is a taxable income or a deductible loss as the case may be. (Emphasis supplied.)  201 (c) of the U.S. Revenue Act of 1918: Amounts distributed in the liquidation of a corporation shall be treated as payments in exchange for the stock or share, and any gain or profit realized thereby shall be taxed to the distributee as other gains or profits. Section 201 (a): "dividend" as "any distribution made by a corporation . . . to its shareholders . . . whether in cash or in other property .. out of its earnings or profits accumulated since February 28, 1913 . . .." Section 201 (c): "amounts distributed in the liquidation of a corporation shall be treated as payments in exchange for stock or shares, and any gain or profit realized thereby shall be taxed to the distributee as other gains or profits." The Income Tax Law of the Philippines: "dividend" in section 25 (a), as amended, as "any distribution made by a corporation . . . out of its earnings or profits accumulated since March 1, 1913, and payable to its shareholders whether in cash or other property."

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Treasury Regulations 45, article 1548:. . . So-called liquidation or dissolution dividends are not dividends within the meaning of the statute, and amounts so distributed, whether or not including any surplus earned since February 28, 1913, are to be regarded as payments for the stock of the dissolved corporation. Any excess so received over the cost of his stock to the stockholder, or over its fair market value as of March 1, 1913, if acquired prior thereto, is a taxable profit. Hellmich vs. Hellman (276 U.S., 233; 72 Law. ed., 544). o The question here is whether the gains realized by stockholders from the amounts distributed in the liquidation of the assets of a dissolved corporation, out of its earnings or profits accumulated since February 28, 1913, were taxable to them as other "gains or profits", or whether the amounts so distributed were "dividends" exempt from the normal tax. Where a corporation, etc. distributes all its assets in complete liquidation or dissolution, the gain realized or loss sustained by the stockholder is a taxable income or a deductible loss as the case may be, in effect treated such distributions as payments in exchange for the stock or share. o Thus, in making the deficiency assessments under consideration, the Collector, among other items, made proper deduction of the "value of shares" or "cost of shares" in the case of each individual plaintiff, assessing the tax only on the resulting "profit realized" and of course in case the value or cost of the shares should exceed the distribution received by the stockholder, the resulting difference will be treated as a "deductible loss." RE: double taxation: o The gains realized by the stockholders from the distribution of the assets in liquidation were subject to the normal tax in like manner as if they had sold their stock to third persons.

Congress clearly expressed its intention, the statute must be sustained even though double taxation results. Plaintiffs received the distributions in question in exchange for the surrender and relinquishment by them of their stock in the Hongkong Company which was dissolved and in process of complete liquidation. o That money in the hands of the corporation formed a part of its income and was properly taxable to it under the then existing Income Tax Law. o The shareholder who received the consideration for the stock earned that much money as income of his own, which again was properly taxable to him under the same Income Tax Law. o

Issue#3 Petitioner and Respondent Contentions P: The non-resident individual stockholder petitioner claims that they were not subject to the normal tax just additional tax. R: Collector contends that they were subject to both the normal and the additional tax. SC’s Findings- They are subject to both income and the additional tax  Such distributions of liquidating dividends under the law were subject to both the normal and the additional tax provided for. o . . . Loosely speaking, the distribution to the stockholders of a corporation's assets, upon liquidation, might be termed a dividend; but this is not what is generally meant and understood by that word. o A dividend is a return upon the stock of its stockholders, paid to them by a going corporation without reducing their stockholdings, leaving them in a position to enjoy future returns upon the same stock . . ..  It is earnings paid to him by the corporation upon his invested capital therein, without wiping out his capital. o On the other hand, when a solvent corporation dissolves and liquidates, it distributes to its stockholders not only any earnings it may have on hand, but it also pays to them their invested capital, namely, the amount which they had paid in for their stocks, thus wiping out their interest in the company.

Issue#4 Petitioner’s Contention P: If the distributions received by them were to be considered as a sale of their stock to the Hongkong Company, the profit realized by them does not constitute income from Philippine sources and is not subject to Philippine taxes, "since all steps in the carrying out of this so-called sale took place outside the Philippines." SC’s Findings – They are income from Philippine sources  The Hongkong Company was at the time of the sale of its business in the Philippines, and the Manila Company was a domestic corporation domiciled and doing business also in the Philippines.  Hongkong Company was incorporated for the purpose of carrying on in the Philippine Islands the business of wine, beer, and spirit merchants and the other objects set out in its memorandum of association.

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o

o

Hence, its earnings, profits, and assets, including those from whose proceeds the distributions in question were made, the major part of which consisted in the purchase price of the business, had been earned and acquired in the Philippines. The distributions were income "from Philippine sources."

Issue#5

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Section 199 of Regulations No. 81: Distributions in liquidation. — In all cases where a corporation . . . distributes all of its property or assets in complete liquidation or dissolution, the gain realized from the transaction by the stockholder . . . is taxable as a dividend to the extent that it is paid out of earnings or profits of the corporation . . .. If the amount received by the stockholder in liquidation is less than the cost or other basis of the stock, a deductible loss is sustained. Regulation No. 81 seems to support the contention that the distributions in question, at least those proceeding from sources other than the earnings or profits of the dissolved corporation, were not taxable. However, taking it together with section 25 (a) of the amended Income Tax Law then in force, we notice that while the regulation limits the taxability of the gain realized by the stockholder "to the extent that it is paid out of earnings or profits of the corporation, "section 25 (a) of the law, far from so limiting its taxability, provides that the gain thus realized, is a "taxable income" — under the law so long as a gain is realized, it will be taxable income whether the distribution comes from the earnings or profits of the corporation or from the sale of all of its assets in general, so long as the distribution is made "in complete liquidation or dissolution". o The regulation makes the gain taxable as a dividend, while the law makes it a taxable income. o An inevitable conflict between the two provisions seems to exist, and in such a case, of course, the law prevails. Treasury Department cannot impose or exempt from income taxes, and regulations purporting to exempt from taxation income specifically taxes would be void. o Any erroneous interpretation of revenue act by regulation of Treasury Department would not estop government from asserting tax on income, though taxpayer had been misled by such interpretation, and by it induced to expose property to taxation.

MOTION FOR RECONSIDERATION – DENIED (Just Briefly) The main issue in the MR is W/N the transactions by the plaintiffs took place "entirely outside the Philippine Islands" or "abroad."  Sale of Company: In accordance with resolution passed at an Extraordinary Meeting of Shareholders held in Manila (underscoring supplied) on July 22, 1937, at 3 o'clock, the Directors of the Manila Wine Merchants Ltd., were authorized to sell the Company as a going concern in accordance with sale agreement presented at the Meeting. o Declaration of dividends authorized was made by the Board of Directors of the same Manila Wine Merchants, Ltd., of whose meeting on that same date, July 22,

1937.

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While the minutes of meeting when the sale was conducted do not reveal the place where that board meeting was held, the fact stated therein that it was held on July

Atty. Michael Montero

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22,1937, the self-same date of the extraordinary meeting of shareholders clearly shows that the said board meeting was held also in Manila, and not in Hongkong or elsewhere abroad, for J.F. Macgregor and E. Heybrook to have participated in both meetings, could not, so far as the record discloses, very well be in Manila and Hongkong or elsewhere abroad on that same date. Indeed, that both meetings must have been held in Manila would seem to be the only natural and logical supposition from the fact that the Manila Wine Merchants, Ltd., was admittedly conducting its business in said city and the Philippines in general. o It seems clear, therefore, that the dividends in question were declared in the Philippine Islands. o The dividends in question were paid to plaintiffs, personally or thru their proxies or agents, in the Philippines. o The liquidation was effected in terms of Philippine pesos, indicating that it was made here. And this in turn would lead to the deduction that the funds and assets liquidated were here.

5. BIR RULING NO. 322-87

GUYS: I have no idea if this was the case itself or the website I got it from chopped it down. I will verify on Monday morning. Sorry. But I looked at digests, and they say the same thing. Ill keep you guys posted ASAP Facts: July 23, 1987, a company is a trading concern and is in the process of liquidation; and that individual stockholders will receive their liquidating dividends in excess of their investment. Held: 1. Since the individual stockholders of your company will receive, upon complete liquidation, all its assets as liquidating dividends, they will thereby realize capital gain or loss. The gain, if any, derived by the individual stockholders consisting of the difference between the fair market value of the liquidating dividends and the adjusted cost to the stockholders of their respective shareholdings in the said corporation (Sec. 83 (a),Sec. 256, Income Tax Regulations) shall be subject to income tax at the rates prescribed under Section 21(a) of the Tax Code. 2. Moreover, pursuant to Section 34(b) of the Tax Code, only 50% of the aforementioned capital gain is reportable for income tax purposes if the shares were held by the individual stockholders for more than twelve months and 100% of the capital gains if the shares were held for less than twelve months 6. BIR Ruling No. 479-11 December 5, 2011 Addressed to: Michelina A. Olondriz, Director/ Trustee of Aguirre Pawnshop Company, Inc. FACTS:

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Taxation Law Case Digests

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Requesting for the issuance of a Certificate Authorizing Registration to allow for the transfer of a parcel of land in Manila of Aguirre Pawnshop Co. (APC) to shareholder Marmitz, Inc. (MI). APC is a corporation duly registered with the Securities and Exchange Corporation on 15 December 1956 14 December 2006 - the corporate term of APC expired and accordingly, APC ceased to exist as a corporate entity and was dissolved ipso facto. 1 December 2009 - a majority of the members of the Board of Directors of APC in their capacity as Trustees of the corporate assets, approved and adopted a resolution ordering the distribution of the remaining assets of APC to its stockholders by way of liquidating dividend.

ISSUES: (1) APC is not liable for income tax either on its transfer of the properties to MI as liquidating dividend or in its receipt of the surrendered shares of MI, citing BIR Ruling No. 039-02 dated 11 November 2002; (2) No documentary stamp tax (DST) is due on the surrender and cancellation of APC shares; (3) No DST is due on the transfer of the properties from APC to MI; (4) MI shall realize capital gain or loss from the transfer of properties by way of liquidating dividends. ANSWER: (ito na yun)  In reply, please be informed that it is the position of this Office that your request cannot be granted for lack of legal basis under the National Internal Revenue Code of 1997, as amended.  Consequently, the previously issued BIR Ruling No. 039-02 cited in your letter and the BIR Rulings cited in the said ruling are reversed and set aside.

7. BIR RULING NO. 039-02 November 11, 2002 Summary: TA Bank is planning to decrease its authorized capital stock. TMBC holds some TA shares. To accomplish the decrease in capital stock, it entered into a deal with TMBC wherein TMBC shall surrender the TA shares it currently holds and give it back to TA. In exchange, TA shall transfer to TMBC both real and personal, tangible and intangible properties. Puyat Jacinto & Santos, the counsel of both banks, asked the opinion of the BIR regarding the payment of taxes for the deal. The SC ruled that TA is not liable for income tax on receipt of surrendered shares or in the transfer of the distributed assets. No documentary stamp tax ("DST") is due on the surrender and cancellation of the TA shares. The transfer by TA to TMBC of real property is not subject to DST on sale or transfer of real property. The transfer by TA of its Loan Portfolio to TMBC is not subject to DST. Transfer or Assignment of any mortgage which stands as security for TA's Loan Portfolio shall be subject to DST. Transfer or Assignment of any mortgage which stands as security for TA's Loan Portfolio shall be subject to DST. Liquidating gain or loss is in the nature of capital gain or loss, as the case may be, and therefore treated in the manner stated in Section 39 of the Tax Code of 1997. Liquidating gain, while

Atty. Michael Montero

characterized as gain from sale or exchange of shares, is subject to the ordinary income tax rates provided under Sections 24(A)(1)(c), 25(A)(1), 27(A) and (E), 28(A)(1) and (2) and (B)(1) of the Tax Code of 1997, depending on the status of the shareholder, and not to the 5%/10% final tax. Facts:  This refers to the letter sent by Puyat Jacinto & Santos dated July 24, 2001 on behalf of its clients, TA Bank of the Philippines, Inc. ("TA") and The Manila Banking Corporation ("TMBC").  TA is a corporation organized and existing under Philippines laws, engaged primarily in commercial banking. o TA has a total authorized capital of Five Billion Pesos (PhP5,000,000,000.00) divided into Twenty Five Million (25,000,000) common shares and Twenty Five Million (25,000,000) preferred shares, each with a par value of PhP100.00 per share. o Its outstanding capital consists of One Billion Two Hundred Fifty Million Pesos (PhP1,250,000,000.00), divided into PhP625,000,000 in preferred shares 1 and PhP625,000,000 in common shares 2 . o All of the outstanding shares of TA are wholly owned by TMBC and its nominees.  TMBC is likewise a corporation organized and existing under Philippine laws, engaged in business primarily as a thrift bank  TA is planning to decrease its authorized capital stock to 1,129,020 common shares, with a par value of PhP100.00 per share, and a total value of One Hundred Twelve Million Nine Hundred Two Thousand Pesos (PhP112,902,000.00) ["Plan"].  Under the Plan, all of TA's outstanding preferred shares, and 5,120,980 of its outstanding 6,250,000 common shares shall be surrendered by TMBC and cancelled immediately upon approval by the TA stockholders, the Securities and Exchange Commission ("SEC") and the Bangko Sentral ng Pilipinas ("BSP") of the said decrease.  In exchange for the surrender of the abovesaid shares by TMBC, TA shall transfer to TMBC both real and personal, tangible and intangible properties listed hereunder, and referred to hereinafter as "Distributed Assets." Issues: (Issue F is probably the most relevant) A. W/N TA shall be liable for income tax either for its receipt of the surrendered shares, or its transfer of the Distributed Assets to TMBC as liquidating dividends.  NO!!! B. W/N documentary stamp tax under Section 176 of the Tax Code is due on the surrender by TMBC of the TA shares and the subsequent cancellation thereof.  NO!!! C. W/N the transfer by TA to TMBC of real property as liquidating dividend is subject to documentary stamp tax on sale or transfer of real property under Section 196 of the Tax Code.  NO!!! D. W/N the transfer by TA of its Loan Portfolio to TMBC is subject to documentary stamp tax under Section 180 of the Tax Code.  NO!!! E. W/N the transfer or assignment of any mortgage which stands as security for TA's Loan Portfolio shall be subject to documentary stamp tax under Section 195 of the Tax Code, based on the outstanding balance of the original loan.  YES!!! F. W/N TMBC shall realize capital gain or loss when it surrenders its shares in TA in exchange for the assets distributed by TA as liquidating dividends, and such

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Taxation Law Case Digests

capital gain or loss shall be subject to final tax under Section 27(D)(2) of the Tax Code.  YES!!!

Atty. Michael Montero

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However, the notarial certification on this deed or deeds of assignment is subject to the documentary stamp tax of P15.00, pursuant to Section 188 of the Tax Code of 1997.

Ratio: ISSUE A  TA is not liable for income tax on receipt of surrendered shares or in the transfer of the distributed assets.  TA shall not be liable for income tax either on its receipt of the surrendered shares, or its transfer of the Distributed Assets to TMBC as liquidating dividends.  In BIR Ruling No. 171-92 dated May 28, 1992, this Office ruled that the transfer by the liquidating corporation of its remaining assets to its stockholders is not considered a sale of these assets. Thus, a liquidating corporation does not realize gain or loss in partial or complete liquidation.  Conversely, neither is a liquidating corporation subject to tax on its receipt of the shares surrendered by its shareholders pursuant to a complete or partial liquidation. ISSUE B  No documentary stamp tax ("DST") is due on the surrender and cancellation of the TA shares.  The Tax Code of 1997 only imposes a DST on the sale, assignment or transfer of shares of stock under Section 176.  No DST under the said provision shall be due on the surrender by TMBC of the shares of stock to TA.  The surrender of the shares does not constitute a sale, assignment or transfer because TA is not taking title to the surrendered shares, and the shares are retired and not retained as treasury shares.  In effect, TA does not realize any benefit, as owner or otherwise, from its receipt of the shares. ISSUE C  The transfer by TA to TMBC of real property is not subject to DST on sale or transfer of real property.  Section 189 of Revenue Regulation No. 26, otherwise known as the "Documentary Stamp Tax Regulations" provides, viz: "SEC. 189. Conveyances by Corporation to Owner of All the Capital. — A conveyance of real estate by a corporation without valuable consideration to an owner of all its capital stock in consequence of its dissolution is not subject to tax.”  Under this provision, a distribution in liquidation, without consideration, of the assets of a corporation consisting of real estate is not subject to DST imposed under Section 196 of the Tax Code of 1997.  Accordingly, the distribution of the assets of TA, consisting of among others, parcels of land, to its controlling and sole stockholder, TMBC, without monetary consideration, is not subject to DST as prescribed under Section 196 of the Tax Code of 1997.  In addition, Section 196 of the Tax Code speaks of "all conveyances, deeds, instruments, or writings, . . ., whereby any land, tenement or other realty sold shall be granted, assigned, transferred, or otherwise conveyed to the purchaser, or purchasers, or to any other person designated by such purchaser or purchasers, . . .".  Since it has been held that a corporation that distributes its assets to its shareholders as liquidating dividends is not deemed to be selling such assets to the latter, then Section 196 of the Tax Code of 1997 shall not apply.

ISSUE D  The transfer by TA of its Loan Portfolio to TMBC is not subject to DST.  The pertinent provisions in the Tax Code of 1997 as regards this issue are as follows: "Sec. 180. Stamp tax on all bonds, loan agreements, promissory notes, bill of exchange, drafts, instruments and securities issued by the Government or any of its instrumentalities, deposits substitute debt instruments, certificates of deposits bearing interest and others not payable on sight or demand. — On all bonds, loan agreements, including those signed abroad, wherein the object of the contract is located or used in the Philippines, bills of exchange (between points within the Philippines), drafts, instruments and securities issued by the Government or any of its instrumentalities, deposit substitute debt instruments, certificates of deposits drawing interest, orders for the payment of any sum of money otherwise than at sight or on demand, on all promissory notes, whether negotiable or non-negotiable, except bank notes issued for circulation, and on each renewal of any such note, there shall be collected a documentary stamp tax of P0.30 on each P200.00, or fractional part thereof, of the face value of any such agreement, bill of exchange, draft, certificate of deposit or note. . ."  SEC. 198. Stamp tax on assignments and renewals of certain instruments. — Upon each and every assignment or transfer of any mortgage, lease or policy of insurance, or the renewal or continuance of any agreement, contract, charter, or any evidence of obligation or indebtedness by altering or otherwise, there shall be levied, collected and paid a documentary stamp tax, at the same rate as that imposed on the original instrument.  The above-quoted Sections clearly provide for the imposition of DST on the renewal or continuance of loan agreements and promissory notes.  In the instant case, DST shall not be imposed on the assignment by TA of its Loan Portfolio (loan agreements and promissory notes) to TMBC, since the same is not for renewal or continuance o The term "assignment or transfer" in Section 198 of the Tax Code of 1997 applies only to "mortgage, lease or policy of insurance". ISSUE E  Transfer or Assignment of any mortgage which stands as security for TA's Loan Portfolio shall be subject to DST.  Pursuant to Section 198, as above quoted, the assignment of any mortgage shall be subject to DST at the same rate as the original document.  Under Section 195 of the 1997 Tax Code, on every mortgage or pledge of lands, estate or property, real or personal, there shall be collected a DST at the following rates: o (a) When the amount secured does not exceed P5,000.00, P20.00; o (b) On each P5,000.00, or fractional part thereof in excess of P5,000.00, an additional tax of P10.00.  Since the DST on mortgage is based on the amount secured, the DST on the assignment of mortgage, if any, shall be based on the outstanding balance of the original loan at the time of the transfer or assignment. ISSUE F  Transfer or Assignment of any mortgage which stands as security for TA's Loan Portfolio shall be subject to DST.

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 

 





The tax treatment of liquidating dividends depends on the characterization of the income in the form of such dividends received by shareholders as a result of the dissolution of the corporation in which they hold shares. The second paragraph of Section 73 (A) of the Tax Code of 1997 states: "Where a corporation distributes all of its assets in complete liquidation or dissolution, the gain realized or loss sustained by the stockholder, whether individual or corporate, is a taxable income or a deductible loss, as the case may be." The amounts distributed in the liquidation of a corporation shall be treated as payments in exchange for stock or shares, and any gain or profit realized thereby shall be taxed to the distributee as other gains or profits. When the corporation was dissolved and in the process of complete liquidation and its shareholders surrendered their stock to it and it paid the sums in question to them in exchange, a transaction took place, which was no different in its essence from a sale of the same stock to a third party who paid therefore. In effect, liquidating gain is to be treated as the gain from the sale or exchange of shares, subject, however, not to the 5%/10% final tax rate under Sections 24(C), 25(A)(3) or (B), 27(D)(2), 28(A)(7)(c) and (B)(5)(c) of the Tax Code of 1997, but to the ordinary income tax rates provided under Sections 24(A)(1), 25(A)(1) and (B) [that is, the 25% rate], 27(A) or (E), 28(A)(1) or (2) and (B)(1) of the Tax Code of 1997, depending on the status of the shareholder/stockholder (for instance, whether the shareholder is a corporation or an individual, resident or non-resident). Finally, this Office also notes that a similar treatment has been given to corporate shareholders of a dissolving corporation, in that the liquidating gain realized is subject to the ordinary corporate income tax rate rather than to the then 10%/20%; or the current 5%/10% final tax rates.

DOCTRINE:  Liquidating gain or loss is in the nature of capital gain or loss, as the case may be, and therefore treated in the manner stated in Section 39 of the Tax Code of 1997.  Liquidating gain, while characterized as gain from sale or exchange of shares, is subject to the ordinary income tax rates provided under Sections 24(A)(1)(c), 25(A)(1), 27(A) and (E), 28(A)(1) and (2) and (B)(1) of the Tax Code of 1997, depending on the status of the shareholder, and not to the 5%/10% final tax.

From Whatever Source 8. James v. United States, 366 U.S. 213 (1961) Decided May 15, 1961 Doctrine: Income derived from both lawful and unlawful activities are taxable. FACTS:  The petitioner is a union official who, with another person, embezzled in excess of $738,000 during the years 1951 through 1954 from his employer union and from an insurance company with which the union was doing business.

Atty. Michael Montero

Petitioner failed to report these amounts in his gross income in those years, and was convicted for willfully attempting to evade the federal income tax due for each of the years 1951 through 1954. He was sentenced to a total of 3 years' imprisonment. The CA affirmed. ISSUE: W/N embezzled funds are to be included in the "gross income" of the embezzler in the year in which the funds are misappropriated. NO. HELD: The judgment of the CA is reversed, and the case is remanded to the District Court with directions to dismiss the indictment. RATIO: WILCOX – not taxable; RUTKIN – taxable  Because of a conflict with this Court's decision in Commissioner v. Wilcox, a case whose relevant facts are concededly the same as those in the case now before us, we granted certiorari. o In Wilcox, the Court held that embezzled money does not constitute taxable income to the embezzler in the year of the embezzlement under § 22(a). Six years later, this Court held, in Rutkin v. United States, that extorted money does constitute taxable income to the extortionist in the year that the money is received under § 22(a). In Rutkin, the Court did not overrule Wilcox, but stated: It only applies to these facts.  The basis for the Wilcox decision was "that a taxable gain is conditioned upon (1) the presence of a claim of right to the alleged gain and (2) the absence of a definite, unconditional obligation to repay or return that which would otherwise constitute a gain. Without some bona fide legal or equitable claim, even though it be contingent or contested in nature, the taxpayer cannot be said to have received any gain or profit within the reach of Section 22(a)." o Both Wilcox and Rutkin obtained the money by means of a criminal act; neither had a bona fide claim of right to the funds. Nor was Rutkin's obligation to repay the extorted money to the victim any less than that of Wilcox. The victim of an extortion, like the victim of an embezzlement, has a right to restitution. o Thus, the fact that Rutkin secured the money with the consent of his victim, is irrelevant. Likewise unimportant is the fact that the sufferer of an extortion is less likely to seek restitution than one whose funds are embezzled. What is important is that the right to recoupment exists in both situations. MAIN TOPIC:  The Income Tax Act of 1913 provided that "the net income of a taxable person shall include gains, profits, and income xxx from xxx the transaction of any lawful business carried on for gain or profit, or gains or profits and income derived from any source whatever. . . ." o When the statute was amended in 1916, the one word "lawful" was omitted. This revealed, we think, the obvious intent of that Congress to tax income derived from both legal and illegal sources, to remove the incongruity of having the gains of the honest laborer taxed and the gains of the dishonest immune. o Thereafter, the Court held that gains from illicit traffic in liquor are includible within "gross income.".. These include protection payments made to racketeers, ransom payments paid to kidnappers, graft, bribes etc. (who the hell would declare this) o

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

A gain "constitutes taxable income when its recipient has such control over it that, as a practical matter, he derives readily realizable economic value from it." o Under these broad principles, we believe that petitioner's contention, that all unlawful gains are taxable except those resulting from embezzlement, should fail. o When a taxpayer acquires earnings, lawfully or unlawfully, without the consensual recognition, express or implied, of an obligation to repay and without restriction as to their disposition, "he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent." o Just as the honest taxpayer may deduct any amount repaid in the year in which the repayment is made, the Government points out that "If, when, and to the extent that the victim recovers back the misappropriated funds, there is, of course, a reduction in the embezzler's income." o We believe that Wilcox was wrongly decided, and we find nothing in congressional history since then to persuade us that Congress intended to legislate the rule. (na hindi taxable ung embezzled cash)

9. REVENUE MEMORANDUM CIRCULAR NO. 13-80 April 10, 1980 Subject: Treatment of Tax Refunds and Tax Credits When Received. To: All Internal Revenue Officers and Others Concerned. 1.

2.

Refunds/Tax Credits under Sec 295 of the Tax Code. — Taxes previously claimed and allowed as deductions, but subsequently refunded or granted as tax credit pursuant to Sec 295 of the Tax Code, should be declared as part of the gross income of the taxpayer in the year of receipt of the refund or tax credit. However, the following taxes, when refunded or credited, are not declarable for income tax purposes inasmuch as they are not allowable as deductions: a. Income tax imposed in Title III of the Tax Code; b. Income, war-profit and excess profits taxes imposed by authority of a foreign country; but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of paragraph (3) of this subsection (relating to credit for taxes of foreign countries); c. Estate and gift taxes; d. Taxes assessed against local benefits of a kind tending to increase the value of the property assessed; e. Stock transaction tax; f. Energy tax; and g. Taxes which are not allowable as deductions under the law. Special Tax Credits granted under R.A. 5186; R.A. 6135 and P.D. 535. — These tax credits and their tax consequences are as follows: a. Sales, compensating and specific taxes are paid on supplies and raw materials imported by a registered export producer. Said taxes are given as tax credit to be used in the payment of taxes, duties, charges and fees due to the national government in connection with its operations. (Sec. 7(a), R.A. No. 6135)

Atty. Michael Montero

b.

The tax credits granted should form part of the gross income to the enterprise in the year of receipt of tax credit as said taxes paid are considered allowable deductions for income taxes purposes. In some cases, a registered BOI and tourism enterprise assumes payment of taxes withheld and due from the foreign lender-remittee on interest payments on foreign loans. In such cases, the enterprise is given a tax credit for taxes withheld subject to certain conditions. (Sec. 7(f), R.A. No. 5186; Sec. 8(c), P.D. No. 535) Said taxes assumed by the registered enterprise represent necessary and ordinary expenses incurred by the enterprise; hence, deductible from its gross income. Therefore, the tax credits granted necessarily constitute taxable income of the enterprise.

It is desired that this Circular be given as wide a publicity as possible. EFREN I. PLANA Acting Commissioner

Inventories 10. BIR Ruling DA 128-08 (August 11, 2008) DA033-04 August 11, 2008

This was addressed to Pilipinas Shell Petroleum Corporation (the one in Valero, Makati) c/o Ms. Maycel Baltazar-Barata,the Indirect Tax Planner and Atty. Nigel T. Avila, the Country Tax Manager. Refers to Shell’s letter dated May 26, 2008 stating that:  Philippines Shell Petroleum Corporation (PSPC), Shell Gas Trading (Asia Pacific), Inc. (SGTAP), and Shell Gas Eastern, Inc. (SGEI), collectively referred to as "Shell Companies" are domestic corporations organized and existing under the laws of the Philippines duly registered with the Securities and Exchange Commission (SEC) on various dates;  that the ultimate parent company of Shell Companies is Royal Dutch Shell Plc (RDS), a company incorporated in the United Kingdom;  that Shell Companies are primarily engaged in the manufacture, importation, distribution and marketing of petroleum products in the Philippines and are using the Weighted Average Method (WAVE) in the valuation of its inventories both for statutory and income tax reporting;  that RDS, and all its affiliates worldwide, is adopting a new computerized accounting system based on Global Systems Application and Product Data Processing or GSAP;  that this new system is globally standardized and will only calculate inventory costs using First-In-First Out (FIFO) method, which is widely accepted in the oil and gas industry worldwide;  that under GSAP, the WAVE method of inventory valuation will not be supported, as it is not compatible with the new system for Shell; and that to be consistent with the accounting system used by its parent company and affiliates abroad, Shell Companies

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will be adopting the use of the FIFO method of inventory valuation for taxable year 2008 for SGTAP and SGEI and 2009 for PSPC. Based on the foregoing representations, Shell requests for an authority to change the inventory method used by Shell Companies from WAVE to FIFO. The change in inventory valuation will be used for statutory and tax reporting purposes for the taxable year 2008 for SGTAP and SGEI, and taxable year 2009 for PSPC. To which the BIR replied:  Please be informed that Section 41 of the Tax Code of 1997 provides that —  "SEC. 41. Inventories. — Whenever in the judgment of the Commissioner, the use of inventories is necessary in order to determine clearly the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Secretary of Finance, upon recommendation of the Commissioner, may, by rules and regulations, prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income. If a taxpayer, after having complied with the terms and conditions prescribed by the Commissioner, uses a particular method of valuing its inventory for any taxable year, then such method shall be used in all subsequent taxable years unless: (i) with the approval of the Commissioner, a change to a different method is authorized; or (ii) the Commissioner finds that the nature of the stock on hand (e.g., its scarcity, liquidity, marketability and price movements) us such that inventory gains should be considered realized for tax purposes and, therefore, it is necessary to modify the valuation method for purposes of ascertaining the income, profits, or loss in a more realistic manner: Provided, however, That the Commissioner shall not exercise his authority to require a change in inventory method more often than once every three (3) years: Provided, further, That any change in an inventory valuation method must be subject to approval by the Secretary of Finance."  Corollarily, Section 2 of Revenue Regulations No. 3-80 provides that — "SEC. 2. Requirement to Change Inventory Valuation Method from LIFO to Weighted Average Method. — Pursuant to the authority vested in the Commissioner of Internal Revenue Code, as amended by Batas Pambansa Blg. 41, all petroleum refining and marketing companies are hereby required to change their inventory valuation method from last-in, first-out (LIFO) to weighted average method on a per product basis. The change shall be effected by a gradual shift to the weighted average method of inventory valuation in two stages as prescribed in Sections 3 and 4 of these regulations."  Moreover, Section 7, supra provides that — "SEC. 7. Requirements for the Use of Weighted Average Method. — The following requirements shall be complied with in adopting the weighted average: (a) The weighted average method shall be applicable to all inventory of 'petroleum products'; (b) The inventory shall be taken at cost, using the full absorption method, regardless of market value; (c) The method shall be used consistently from year to year, unless (i) A change to a different method is approved by the Commissioner; or (ii) A modification is required by the Commissioner."  In the instant case, Shell Companies have been consistently using the weighted average method of reporting inventory values for statutory and income tax purposes in compliance with Revenue Regulations No. 3-80.

Atty. Michael Montero



 

 

However, since the WAVE method of costing inventory is no longer compatible with the new accounting system to be introduced in the Philippines by 2009, and to be consistent with the method of inventory costing used by its parent company and affiliates around the world, Shell Companies will have to shift to FIFO method of inventory effective on the taxable year 2008 for SGTAP and SGEI, and taxable year 2009 for PSPC. The earlier period is to allow SGEI and SGTAP to have annualized values for its inventory at the end of taxable year 2008 which will be the value of its beginning inventory for the taxable year 2009. On the other hand, since PSPC has a number of product inventories in its various terminals and depots all over the country, it will be equipped to adopt FIFO valuation of inventories only in 2009. Considering that the purpose of Shell Companies' change in its inventory method will best conform to its accounting practice as said valuation will clearly reflect the income of the said companies, this Office hereby grants authority to Shell Companies the use of FIFO method in its inventory costing. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered null and void. This was issued by JAMES H. ROLDAN, Assistant Commissioner of the Legal Service

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