Block 2A 2021 | TAXATION 1 | Montero
139. Chamber of Real Estate Builders’ Assoc. v. Exec. Sec. (Vi)
Mar. 9, 2010| Corona, J. | Special Rules – Minimum Corporate Income Tax
PETITIONER​: CHAMBER OF REAL ESTATE AND BUILDERS'
ASSOCIATIONS, INC.
RESPONDENTS​: THE HON. EXECUTIVE SECRETARY ALBERTO
ROMULO, THE HON. ACTING SECRETARY OF FINANCE JUANITA D.
AMATONG, and THE HON. COMMISSIONER OF INTERNAL REVENUE
GUILLERMO PARAYNO, JR.
SUMMARY​: (I will just focus on the part of the case related to our topic)
Chamber of Real Estate and Builders’ Associations (CREBA) assails Section
27(E) of the Tax Code which imposes a ​minimum corporate income tax
(MCIT) ​of ​2% of the gross income beginning on the 4​th taxable year
immediately following the year it commenced its business operations. The
provision says that w​hen the MCIT is greater than the normal corporate income
tax, pay the MCIT of 2%. If the regular income tax is higher than the MCIT, the
corporation does not pay the MCIT but the income tax instead. ​RR 9-98
implements Sec. 27(E) and provides that the MCIT is imposed when the
corporation has zero or negative taxable income ​or when the MCIT is ​greater
than the normal income tax. CREBA claims the ​MCIT is unconstitutional
because it is highly oppressive, arbitrary and confiscatory which amounts to
deprivation of property without due process of law because gross income as
defined under the provision only considers the cost of goods sold and other
direct expenses while other major expenditures (administrative and interest
expenditures) are not taken into account. This makes it a ​confiscation of capital
because it is not ​“realized gain” ​(CREBA argued that MCIT is an income tax and
shouldn’t be on capital so like any income tax, all expenses should be deducted
before the amount is taxed). ​Issue: Whether imposing the MCIT is
unconstitutional – NO. ​The Court said that the MCIT is ​imposed on gross
income which is arrived at by ​deducting the capital spent ​by a corporation in
the sale of its goods (Sale of Goods - Capital = GI). Capital is deducted from the
sale so it does not tax the capital, only sales. ​The purpose of the MCIT is to
ensure that all corporations will make a minimum contribution to the public
sector. It is not an additional tax imposition. It is imposed ​in lieu of the normal
net income tax, and only if the normal income tax is suspiciously low. If the
regular income tax is higher than the MCIT, then no need to pay the MCIT
anymore. The​ safeguards ​in the law for the MCIT are:
(a) it is only paid from the 4​th​ taxable year from commencement of business,
(b) it ​allows the carry-forward of any excess of the MCIT paid over the normal
income tax which shall be credited against the normal income tax for the three
immediately succeeding years, and
(c) it authorizes the Secretary of Finance to suspend the imposition of MCIT if a
corporation suffers losses due to prolonged labor dispute, force majeure and
legitimate business reverses.
RR 9-98 merely defines the coverage of Sec 27 (E).
DOCTRINE: Sec 27(E) of the Tax Code imposes a minimum corporate
income tax of 2% of the gross income beginning on the 4​th taxable year
immediately following the year it commenced its business operations. The
MCIT is a minimum contribution for corporations to contribute to the
government and if the normal net income tax is higher, pay that one and not
the MCIT. If MCIT is higher, pay this instead of the normal net income tax.
The MCIT is to prevent companies from under-declaring their income. It is
not a tax on the capital but on the income (since the capital spent is deducted
to get the gross income). There are safeguards to the law as well.
FACTS:
1. Chamber of Real Estate and Builders’ Associations (CREBA) is an
association of real estate developers and builders in the Philippines. They
challenged the constitutionality of ​Sec. 27(E) of the Tax Code which
imposes a ​minimum corporate income tax (MCIT) and the ​creditable
withholding tax (CWT) on ​sales of real properties classified as ordinary
assets.
MCIT (main topic in syllabus)
1. Section 27 (E) of RA 8424 provides for MCIT on domestic corporations
and is implemented by RR 9-98. The MCIT imposed is ​2% of the ​gross
income beginning on the 4​th taxable year immediately following the year
it commenced its business operations w​hen the ​MCIT is greater than the
normal corporate income tax​. If the ​regular income tax is higher ​than
the MCIT, the corporation ​does not pay the MCIT (​pay income tax
instead). ​RR 9-98 implements Sec. 27(E) and provides that the MCIT is
imposed when the corporation has zero or negative taxable income or when
the MCIT is greater than the normal income tax.
2. CREBA argued that the use of gross income as MCIT base amounts to a
c​onfiscation of capital because gross income, unlike net income, is not
“​realized gain”​.
CWT
1. Under Sec. 57 of the Tax Code, the 3 categories of income subject to
withholding tax are:
(a) withholding of final tax on certain incomes,
(b) withholding of creditable tax at source, and
(c) tax-free covenant bonds.
CREBA is assailing the constitutionality of the 2​nd​ one.
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2. CREBA sought to invalidate the provisions of RR No. 2-98, also known as
the Consolidated Withholding Tax Regulations, which prescribe the rules
and procedures for the collection of CWT on sales of real properties
classified as ordinary assets, on the grounds that the regulations:
1. Use gross selling price (GSP) or fair market value (FMV) as basis
for determining the income tax on the sale of real estate classified
as ordinary assets, instead of the entity’s net taxable income as
provided for under the Tax Code​;
2. Mandate the collection of income tax on a per transaction basis,
contrary to the Tax Code provision which imposes income tax on
net income at the end of the taxable period;
3. Go against the due process clause because the government collects
income tax even when the net income has not yet been determined;
gain is never assured by mere receipt of the selling price; and
4. Contravene the equal protection clause because the CWT is being
charged upon real estate enterprises, but not on other business
enterprises, more particularly, those in the manufacturing sector,
which do business similar to that of a real estate enterprise.
3. CREBA argues these revenue regulations are contrary to law because:
(a) they ignore the different treatment by RA 8424 of ordinary assets and
capital assets and
(b) Secretary of Finance has no authority to collect CWT, much less, to base
the CWT on the gross selling price or fair market value of the real
properties classified as ordinary assets.
ISSUES:
1. Whether the imposition of the MCIT is unconstitutional – NO
2. Whether the imposition of CWT on income from sales of real properties
classified as ordinary is unconstitutional - NO
RATIO:
1​st​ ISSUE (RELATED ISSUE TO OUR TOPIC)
1. CREBA’s claim - the MCIT is unconstitutional because it is highly
oppressive, arbitrary and confiscatory which amounts to deprivation of
property without due process of law. It explains that gross income as
defined under the provision only considers the ​cost of goods sold and other
direct expenses​, other major expenditures (administrative and interest
expenditures) are not taken into account. This makes it a confiscation of
capital because it is not “realized gain” since there are expenses not
deducted.
2. The Court disagreed with CREBA’s claim and ruled that it is not
unconstitutional.
Income - ​all the wealth which flows into the taxpayer other than a mere
return on capital
Capital - a fund or property existing at one distinct point in time while
income denotes a flow of wealth during a definite period of time.
The requisites for income to be taxable are:
(a) there must be gain,
(b) it must be realized, and
(c) it must not be excluded by law or treaty from taxation.
3. An income tax is arbitrary and confiscatory if it taxes capital because capital
is not income. But, the MCIT is not a tax on capital. The MCIT is ​imposed
on gross income which is arrived at by ​deducting the capital spent ​by a
corporation in the sale of its goods​, i.e., the cost of goods and other direct
expenses from gross sales. (Capital is deducted from the sale = not taxing
the capital, only sales)
Sale of Goods - Capital Spent = GI
4. The MCIT is there to ensure that all corporations will make a minimum
contribution to the public sector. Congress imposed this to stop corporations
from under-declaring their income or saying that they have zero or negative
income. (It was explained that there are companies who keep losing money
and did not pay tax. These businesses should not be in business anymore
since they just keep losing. The law is to prevent this.)
5. Various safeguards were incorporated in the law:
a. The MCIT is imposed only on the ​4th taxable year immediately
following the year in which the corporation commenced its
operations.
b. The law allows the carry-forward of any excess of the MCIT paid
over the normal income tax which shall be credited against the
normal income tax for the three immediately succeeding years.
c. The law authorizes the Secretary of Finance to suspend the
imposition of MCIT if a corporation suffers losses due to
prolonged labor dispute, force majeure and legitimate business
reverses.
2. Also, the MCIT is not an additional tax imposition. It is imposed in lieu of
the normal net income tax, and only if the normal income tax is
suspiciously low. If the regular income tax is higher than the MCIT, do not
pay the MCIT anymore.
3. A lot of countries have their own version of MCIT like USA, Mexico,
Argentina, Tunisia, Panama and Hungary.
4. CREBA claims that RR 9-98 (which implements Sec 27 (E)) is a
deprivation of property without due process of law because the MCIT is
being imposed and collected even when there is actually a loss, or a zero or
negative taxable income but the Court said that RR 9-98 merely defines the
coverage of Sec. 27(E).
5. This means that even if a corporation incurs a net loss in its business
operations or reports zero income after deducting its expenses, it is still
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subject to an MCIT of 2% of its gross income. But the law also says that
MCIT is only paid when it is greater than the normal net income.
2nd ISSUE (not main topic for this part of the syllabus)
1. CREBA is assailing the CWT on sales of real properties classified as
ordinary assets saying that the Sec. of Finance does not have authority to
impose it and it violates the constitution because it uses the GSP/FMV as a
basis per transaction.
2. The Sec. of Finance is given authority in Section 57 (B) of RA 8424 to
require the withholding of a tax on items of income payable to any person,
national or juridical, residing in the Philippines within a 1%-32% range.
3. The income tax base for sales of real property classified as ordinary assets is
still the net taxable income as provided in the Tax Code and reiterated in
RR 7-2003.
4. The taxpayer files its income tax return and credit the taxes withheld (by the
withholding agent/buyer) against its tax due. If the tax due is greater than
the tax withheld, then the taxpayer shall pay the difference. If the tax due is
less than the tax withheld, the taxpayer will be entitled to a refund or tax
credit. (​Just shows that the base is still net income​)
5. The use of the GSP/FMV as basis to determine the withholding taxes is for
practicality and convenience. Obviously, the withholding agent/buyer who
is obligated to withhold the tax does not know how much the taxpayer/seller
will have as its net income at the end of the taxable year. Instead, the agent
only knows about the transaction in which he is a party. So, his basis can
only be the GSP or FMV because these are what he knows in connection
with the performance of his duties as a withholding agent.
6. Also, the collection of income tax by the CWT on a per transaction basis is
not contrary to the Tax Code. (Recap: ​the process is that the withholding
tax is based in the FMV or GSP of a certain property sold in each
transaction​)
7. The taxing power has the authority to also make reasonable classifications.
The real estate industry is a class that can be distinguished from other
businesses. The income from the sale of a real property is bigger and its
frequency of transaction limited.

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140. CIR v. PHILIPPINE AIRLINES (Gohoc c/o Cualoping)
July 7, 2009 | Chico-Nzario, J. | MCIT
PETITIONER: ​Commissioner of Internal Revenue
RESPONDENT:​ Philippine Airlines, Inc.
SUMMARY:​
  ​PAL incurred zero taxable income for the FY 2000-2001 and did
not pay MCIT for that period. They then requested for a refund with the CIR for
unapplied creditable withholding tax. The BIR informed PAL at a conference that
they were denying the latter’s claim for refund and was instead assessing PAL for
deficiency MCIT of about P271m. A formal demand letter prompted PAL to file a
formal written protest. Upon reaching the CTA, the court ruled in favor of PAL,
hence this petition. The issue is whether PAL is liable for deficiency MCIT for FY
2000-2001? - NO.​
A ​ ccording to PD 1590, the franchise of PAL, the taxation of
PAL, during the lifetime of its franchise, shall be governed by two fundamental
rules, particularly: (1) PAL shall pay the Government either basic corporate
income tax or franchise tax, whichever is lower; and (2) the tax paid by PAL,
under either of these alternatives, shall be in lieu of all other taxes, duties,
royalties, registration, license, and other fees and charges, except only real
property tax. In its income tax return for FY 2000-2001, PAL reported no net
taxable income for the period, resulting in zero basic corporate income tax, which
would necessarily be lower than any franchise tax due from PAL for the same
period. Section 13(a) of PD 1590 refers to "basic corporate income tax." PAL
shall compute its basic corporate income tax using the rate and basis prescribed by
the NIRC for the said tax. There is nothing in Section 13(a) of PD1590 to support
the contention of the CIR that PAL is subject to the entire Title II of the NIRC,
entitled "Tax on Income." There is an apparent distinction under the NIRC
between taxable income, which is the basis for basic corporate income tax under
Section 27(A); and gross income, which is the basis for the MCIT under Section
27(E).​
​The evident intent of Section 13 of PD1590 is to extend to PAL tax
concessions not ordinarily available to other domestic corporations. The
imposition of MCIT on PAL, as the CIR insists, would result in a situation that
contravenes the objective of Section 13 of PD1590. The CIR posits that PAL may
not invoke in the instant case the "in lieu of all other taxes" clause in PD 1590, if
it did not pay anything at all as basic corporate income tax or franchise tax. As a
result, PAL should be made liable for "other taxes" such as MCIT. SC already
rejected this “Substitution Theory” in a previous ruling.
DOCTRINE: ​Pursuant to the NIRC, the taxable income of a domestic
corporation may be arrived at by subtracting from gross income deductions
authorized, not just by the NIRC, but also by special laws. PD1590 may be
considered as one of such special laws authorizing PAL, in computing its annual
net taxable income, on which its basic corporate income tax shall be based, to
deduct from its gross income the following: (1) depreciation of assets at twice the
normal rate; and (2) net loss carry-over up to five years following the year of such
loss.
The 2% MCIT under Section 27(E) of the NIRC shall be based on the gross
income of the domestic corporation. The Court notes that gross income, as the
basis for MCIT, is given a special definition under Section 27(E)(4) of the NIRC,
different from the general one under Section 34 of the same Code.
There is an apparent distinction under the NIRC between taxable income, which is
the basis for basic corporate income tax under Section 27(A); and gross income,
which is the basis for the MCIT under Section 27(E).
FACTS:
1. For FY 2000-2001, PAL allegedly incurred zero taxable income which left it
with unapplied creditable withholding tax amounting to P2.3m. PAL did not pay
any MCIT for the period.
2. PAL requested for the refund of its unapplied creditable withholding tax. The
Large Taxpayers Audit and Investigation Division 1 (LTAID 1) of the BIR
Large Taxpayers Service (LTS), issued a Tax Verification Notice authorizing
Revenue Officer Cueto to verify the supporting documents and pertinent records
relative to the claim of PAL for refund of its unapplied creditable withholding
tax for FY 2000-20001.​

3. BIR officers and PAL representatives attended a scheduled informal conference,
whether the BIR told PAL that it was denying its claim for refund and, instead,
was assessing PAL for deficiency MCIT for FY 2000-2001.
4. The PAL representatives argued that PAL was not liable for MCIT under its
franchise.​
T
​ he LTAID 1 issued a preliminary assessment notice for P262m,
representing deficiency MCIT for FY 2000-2001, plus interest and compromise
penalty. PAL protested
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5. LTAID 1 sent PAL a Formal Letter of Demand for deficiency MCIT for FY
2000-2001 in the amount​
o​f P271m.​
T ​ his prompted PAL to file a formal
written protest.
6. The BIR LTS rendered its Final Decision on Disputed Assessment invoking
RMC No. 66-2003. It reiterated the request that PAL immediately pay its
deficiency MCIT for FY 2000-2001, inclusive of penalties incident to
delinquency.
7. PAL filed a Petition for Review with the CTA. The CTA ruled in favor of PAL.
Hence, this petition.
8. The CIR reasons that Section 13(a) of PD1590 (PAL’s franchise) provides that
the corporate income tax of PAL shall be computed in accordance with the
NIRC. And, since the NIRC imposes MCIT, and PAL has not applied for relief
from the said tax, then PAL is subject to the same.
ISSUE:​ W/N PAL is liable for deficiency MCIT for FY 2000-2001? – NO.
9. According to PD 1590, the taxation of PAL, during the lifetime of its franchise,
shall be governed by two fundamental rules, particularly:
a. PAL shall pay the Government either basic corporate income tax or
franchise tax, whichever is lower; and
b. The tax paid by PAL, under either of these alternatives, shall be in lieu
of all other taxes, duties, royalties, registration, license, and other fees
and charges, except only real property tax.
10. ​The ​basic corporate income tax of PAL shall be based on its annual net
taxable income, computed in accordance with NIRC. Franchise tax, on the
other hand, shall be 2% of the gross revenues derived by PAL from all
sources, whether from transport or non-transport operations.
11. ​In its income tax return for FY 2000-2001, ​PAL reported no net taxable
income for the period, resulting in zero basic corporate income tax, which
would necessarily be lower than any franchise tax due from PAL for the
same period.
12. ​First, Section 13(a) of PD1590 refers to "basic corporate income tax." PAL shall
compute its basic corporate income tax using the rate and basis prescribed by the
NIRC for the said tax. There is nothing in Section 13(a) of PD1590 to support
the contention of the CIR that PAL is subject to the entire Title II of the NIRC,
entitled "Tax on Income."
13. ​Second, Section 13(a) of PD1590 further provides that the ​basic corporate
income tax of PAL shall be based on its annual net taxable income.
14. ​Pursuant to the NIRC, the taxable income of a domestic corporation may be
arrived at by subtracting from gross income deductions authorized, not just
by the NIRC, but also by special laws. ​PD1590 may be considered as one of
such special laws authorizing PAL, in computing its annual net taxable income,
on which its basic corporate income tax shall be based, to deduct from its gross
income the following: (1) depreciation of assets at twice the normal rate; and (2)
net loss carry-over up to five years following the year of such loss.
15. ​In comparison, the 2% MCIT under Section 27(E) of the NIRC shall be
based on the gross income of the domestic corporation. ​The Court notes that
gross income, as the basis for MCIT, is given a special definition under Section
27(E)(4) of the NIRC, different from the general one under Section 34 of the
same Code.
16. ​There is an apparent distinction under the NIRC between taxable income,
which is the basis for basic corporate income tax under Section 27(A); and
gross income, which is the basis for the MCIT under Section 27(E).
17. ​Third, even if the basic corporate income tax and the MCIT are both income
taxes under Section 27 of the NIRC, and one is paid in place of the other, the
two are distinct and separate taxes.
18. ​Although both are income taxes, the MCIT is different from the basic corporate
income tax, not just in the rates, but also in the bases for their computation. Not
being covered by Section 13(a) of PD1590, which makes PAL liable only for
basic corporate income tax, then MCIT is included in "all other taxes" from
which PAL is exempted.
19. ​Fourth, ​the evident intent of Section 13 of PD1590 is to extend to PAL tax
concessions not ordinarily available to other domestic corporations. ​Section
13 of PD1520 permits PAL to pay whichever is lower of the basic corporate
income tax or the franchise tax; and the tax so paid shall be in lieu of all other
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taxes, except only real property tax. Hence, under its franchise, PAL is to pay 24. ​Consequently, the insistence of the CIR to subject PAL to MCIT cannot be done
the least amount of tax possible. without contravening Presidential Decree No. 1520.

20. ​The imposition of MCIT on PAL, as the CIR insists, would result in a situation RULING:​ Petition DENIED.
that contravenes the objective of Section 13 of PD1590. In effect, PAL would
not just have two, but three tax alternatives, namely, the basic corporate income
tax, MCIT, or franchise tax. More troublesome is the fact that, as between the
basic corporate income tax and the MCIT, PAL shall be made to pay whichever
is higher, irrefragably, in violation of the avowed intention of Section 13 of
PD1590 to make PAL pay for the lower amount of tax.

21. ​Fifth, the CIR posits that PAL may not invoke in the instant case the "in lieu of
all other taxes" clause in Section 13 of PD1590, if it did not pay anything at all
as basic corporate income tax or franchise tax. As a result, PAL should be made
liable for "other taxes" such as MCIT. This line of reasoning has been dubbed as
the Substitution Theory, and this is not the first time the CIR raised the same.

22. ​The Court already rejected the Substitution Theory in ​Commissioner of

Internal Revenue v. Philippine Airlines, Inc​. The fallacy of the CIR’s
argument is evident from the fact that the payment of a measly sum of one
peso would suffice to exempt PAL from other taxes, whereas a zero liability
arising from its losses would not. There is no substantial distinction between
a zero tax and a one-peso tax liability​.

23. ​And sixth, PD1590 explicitly allows PAL, in computing its basic corporate
income tax, to carry over as deduction any net loss incurred in any year, up to
five years following the year of such loss. Therefore, PD1590 does not only
consider the possibility that, at the end of a taxable period, PAL shall end up
with zero annual net taxable income (when its deductions exactly equal its gross
income), as what happened in the case at bar, but also the likelihood that PAL
shall incur net loss (when its deductions exceed its gross income). If PAL is
subjected to MCIT, the provision in PD1590 on net loss carry-over will be
rendered nugatory. Net loss carry-over is material only in computing the annual
net taxable income to be used as basis for the basic corporate income tax of
PAL; but PAL will never be able to avail itself of the basic corporate income tax
option when it is in a net loss position, because it will always then be compelled
to pay the necessarily higher MCIT.

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141. RR 9-98 (Meryl) ▪ engaged in business as ​Offshore Banking Units (OBUs) on their
August 25, 1998 | Secretary of Finance Edgardo B. Espiritu | MCIT income from foreign currency transactions
▪ with local commercial banks, including branches of foreign banks,
SUBJECT: ​Implementing RA 8424, "An Act Amending the National Internal authorized by the BSP to transact business with Offshore Banking
Revenue Code, as Amended" Relative to the Imposition of the ​Minimum Corporate Units (OBUs),
Income Tax​ (MCIT) on Domestic Corporations and Resident Foreign Corporations ▪ including interest income from foreign currency loans granted to
residents of the Philippines,
TO: ​All Internal Revenue Officers and Others Concerned o subject to a final income tax at ten percent (10%) of such
income; and
(I summarized the provisions about foreign corporations)
(c) resident foreign corporations
Sec. 2.28(A)(2) ​MCIT ON RESIDENT FOREIGN CORPORATION ▪ engaged in business as ​regional operating headquarters
o subject to tax at ten percent (10%) of their taxable income
A minimum corporate income tax of two percent (2%) of the gross income from
(d) firms that are taxed under a special income tax regime such as those in
sources within the Philippines is hereby imposed upon
accordance with RA 7916 and 7227 (PEZA Law and BCDA Act)
▪ any resident foreign corporation,
o beginning on the ​4th taxable year (whether calendar or fiscal Sec. 2.27(E) Illustration on how to carry forward excess MCIT
year, depending on the accounting period employed) ​immediately
following the taxable year in which the corporation
commenced its business operations, Year Tax MCIT Income Tax
− whenever the amount of the minimum corporate income
1998 50,000 75,000 25,000
tax is greater than the normal income tax due for such
year. amount of tax payable – 75,000

In computing for the MCIT due from a resident foreign corporation, the rules 1999 60,000 100,000 40,000
prescribed under Sec. 2.27(E) of these Regulations shall apply: Provided, however,
that ​only the gross income from sources within the Philippines shall be amount of tax payable – 100,000
considered for such purposes.
2000 100,000 60,000
The MCIT shall only apply to ​resident foreign corporations which are subject to
normal income tax. Accordingly, the MCIT shall not apply to the following resident
foreign corporations: The taxpayer shall pay the MCIT whenever it is greater than the regular or normal
EXCEPTIONS​ ​(COHF – carrier, offshore, headquarters, firms) corporate income tax which is imposed under Sec. 27(A) of the Code.

(a) resident foreign corporations
▪ engaged in business as "​international carrier​"
o subject to tax at 2 ½ percent of their Gross Philippine Billings
(b) resident foreign corporations
The comparison between the normal income tax payable by the corporation and the
MCIT shall be made at the end of the taxable year.
Thus, under the example, the taxpayer will pay the MCIT of P75,000.00 since this
amount is greater than the normal income tax of P50,000.00 in 1998.
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In 1999, the firm will also pay the MCIT since the MCIT of P100,000.00 is greater
than the normal income tax of P60,000.00.

In the year 2000, where the normal or regular corporate income tax of P100,000.00 is
greater than the MCIT of P60,000.00, the firm will pay the normal income tax.

The corporation can credit the excess of its MCIT over the normal income tax for
1998 (i.e. P25,000) and 1999 (i.e. P40,000), or a total amount of P65,000 from the
amount of normal income tax which is payable by the firm in the year 2000.

Thus, the amount of income tax payable by the firm is P35,000 after deducting
P65,000 from P100,000. The excess MCIT is creditable against the normal income
tax within the next three (3) years from payment thereof. Thus, in the illustration
above where the corporation had an excess MCIT of P25,000 over its normal income
tax in 1998, the P25,000 can be claimed as a tax credit against the normal income tax
up to the year 2001 and only when the normal income tax is greater than the MCIT.

The excess MCIT cannot be claimed as a credit against the MCIT itself or against
any other losses.

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142. Manila Wine Merchants vs CIR (Myling)
20 February 1984 | Guerrero, ​J ​| Special Rules – Improperly Accumulated Earnings Tax
PETITIONER​: The Manila Wine Merchants, Inc
RESPONDENTS​: CIR
SUMMARY​: CIR assessed Manila Wine for 25% surtax for 1957 for allegedly
accumulating earnings beyond the reasonable needs of its business. This was shown by:
1. Dividends declared being at only 40.33% of total surplus available of each year
from 1947 to 1957
2. Investments in unrelated businesses such as in Acme Commercial Co., Inc, Union
Insurance Society of Canton, US Treasury Bonds, and in Wack Wack Golf &
Country Club.
CTA found that the average percentage of cash dividends distributed for the past 11 years
was really 85.77% thus indicating that Manila Wine was not formed for the purpose of
preventing the imposition of income tax upon its shareholders. The CTA also found the
investments in the supposed unrelated businesses as harmless accumulation of surplus
except for the purchase of US Treasury Bonds.
Manila Wine justifies the US Treasury Bonds as reserve to finance its importations of
wines, whisky, liquors and distilled spirits. Also, the funds in the bonds were said to have
been set aside to purchase a lot and to construct a building. However, the SC found that in
the 11 years that Manila Wine held the Treasury Bonds, it was never used for its
importations. Further, the Court did not buy the reason that Manila Wine had put funds in
the bonds for the lot purchase and building construction as this depended on various
contingencies such as whether Manila Wine would meet the 60% Filipino citizen
requirement and if it would still proceed with its plan later on.
The Court likewise did not agree with Manila Wine that that surplus profits accumulated
as US Treasury Bonds in 1951 should not be subject to surtax in 1957.
DOCTRINE: ​A prerequisite to the imposition of the tax has been that the corporation be
formed or availed of for the purpose of avoiding the income tax (or surtax) on its
shareholders, or on the shareholders of any other corporation by permitting the earnings
and profits of the corporation to accumulate instead of dividing them among or distributing
them to the shareholders.
If the earnings and profits were distributed, the shareholders would be required to pay an
income tax thereon whereas, if the distribution were not made to them, they would incur
no tax in respect to the undistributed earnings and profits of the corporation
The touchstone of liability is the purpose behind the accumulation of the income and not
the consequences of the accumulation. Thus, if the failure to pay dividends is due to some
other cause, such as the use of undistributed earnings and profits for the reasonable needs
of the business, such purpose does not fall within the interdiction of the statute
To determine the "reasonable needs" of the business in order to justify an accumulation of
earnings, the Courts of the United States have invented the so-called "Immediacy Test"
which construed the words "reasonable needs of the business" to mean the immediate
needs of the business, and it was generally held that if the corporation did not prove an
immediate need for the accumulation of the earnings and profits, the accumulation was not
for the reasonable needs of the business, and the penalty tax would apply.
In order to determine whether profits are accumulated for the reasonable needs of the
business as to avoid the surtax upon shareholders, the ​controlling intention of the
taxpayer is that which is manifested ​at the time of accumulation not subsequently
declared intentions which are merely the product of afterthought. A speculative and
indefinite purpose will not suffice. The mere recognition of a future problem and the
discussion of possible and alternative solutions is not sufficient. ​Definiteness of plan
coupled with ​action taken towards its consummation are essential. Profits may only be
accumulated for the reasonable needs of the business, and implicit in this is further
requirement of a reasonable time.
The undistributed earnings or profits of prior years are taken into consideration in
determining unreasonable accumulation for purposes of the 25% surtax. Accumulations
prior to the year involved may have been sufficient to cover the business needs and
additional accumulations during the year involved would not reasonably be necessary.
FACTS:
1. Manila Wine disputes the finding of the CTA finding it liable to pay P86,804.38 or
25% surtax representing tax due for improperly accumulating profits or surplus in
the taxable year 1957 in the form of an investment in US Treasury Bonds.
2. Manila Wine was organized to principally engage in the importation and sale of
whisky, wines, liquors and distilled spirits. In 1963, CIR demanded Manila Wine to
pay P126,536.12 as 25% surtax imposed by Section 25 of the Tax Code. This is for
allegedly accumulating earnings beyond the reasonable needs of its business.
a. CIR claims that Manila Wine has accumulated earnings beyond the
reasonable needs of its business because the average ratio of the cash
dividends it declared and paid from 1947 to 1957 was only at 40.33% of
total surplus available at the end of each year. CIR submits that the
accumulated earnings tax should be based on 25% of the total surplus
available at the end of each calendar year.
b. However, Manila Wine maintains that in 1957, it distributed 100% of its
net earnings after income tax and part of its surplus for prior years.
Manila Wine maintains that this should be imposed on the total surplus or
net income only for the year.
3. CIR is also assessing Manila Wine for the accumulated earnings tax because of its
substantial investment of surplus or profits in unrelated business as follows:
1. Acme Commercial Co., Inc. P 27,501.00
2. Union Insurance Society of Canton 1,145.76
3. U.S.A. Treasury Bond 347,217.50
4. Wack Wack Golf & Country Club 1.00
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375,865.26
4. Mr. NRE Hawkins, president of the Manila Wine, explained the investments as
follows:
a. Acme was a supermarket and was one of the best customers of Manila
Wine. The investment was beneficial in that in 1961, Manila Wine
received dividends amounting to P16,875.00.
b. The investment in Wack Wack was considered negligible.
c. The Union Insurance investment was made when the insurance firm, Wise
& Co, Inc and Manila Wine were common stockholders of Wise Bldg, Co,
Inc and the three companies were all housed in the same building.
d. The USA Treasury Bills were invested in 1951 because in 1950, the funds
of the company in current accounts in various banks were not earning any
interest.
i. This money was used as a reserve to finance importations
because of Manila Wine’s expectation that the Central Bank
would allow no-dollar licenses importation.
ii. When the CB did not relax its policy, Manila Wine held on to
the bills for a few more years after 1957 because of their plan to
buy a lot and construct their building.
iii. Manila Wine’s lease expired in 1957. However, having less than
60% Filipino stocks, the company had to wait to meet the
requirement which it did in 1959. It was in 1961 when it found
a suitable location. The US Treasury Bonds were used to fund
the construction of the building in this location.
5. CIR decided that the investments were made to “unrelated business” which were not
considered in the “immediate needs” of Manila Wine thus making it liable to pay the
25% surtax.
6. With the CTA, it found the average percentage of cash dividends distributed for the
past 11 years was 85.77% and not 40.33% of the total surplus available for
distribution at the end of each calendar year.
a. This is said to indicate that Manila Wine was not formed for the purpose
of preventing the imposition of income tax upon its shareholders.
b. Re the alleged substantial investment of surplus or profits in unrelated
business, CTA found the investments in Acme, Union Insurance and
Wack Wack to be harmless accumulation of surplus thus not subject to the
25% surtax.
c. CTA however found that the purchase of the US Treasury Bonds was in
no way related to Manila Wine’s business of importing and selling wines,
whisky, liquors and distilled spirits. Thus, the investment in the US
Treasury Bonds was found to have been availed of for the purpose of
preventing the imposition of the surtax upon Manila Wine’s shareholders
by permitting its earnings to accumulate beyond the reasonable needs of
its business. Accordingly, the investment was subjected to the 25% surtax
of P86,804.38.
ISSUES:
1. Was the purchase of the US Treasury Bonds in 1951 an investment to an
unrelated business and hence, was availed for the purpose of preventing the
imposition of the surtax upon Manila Wine’s shareholders by permitting its
earnings and profits to accumulate beyond the reasonable needs of the
business? YES
2. Should the penalty tax of 25% be imposed on the improper accumulation in 1957
despite the fact that the accumulation occurred in 1951? YES
RULING: ​CTA affirmed ​in toto.​
RATIO:
1. Section 25 of the Tax Code follows:
"Sec. 25. ​Additional tax on corporations improperly accumulating profits or
surplus.​ — (a) Imposition of Tax. — If any corporation, except banks, insurance
companies, or personal holding companies whether domestic or foreign, is formed
or availed of ​for the purpose of preventing the imposition of the tax upon its
shareholders ​or members or the shareholders or members of another corporation,
through the medium of ​permitting its gains and profits to accumulate ​instead of
being divided or distributed, there is levied and assessed against such corporation,
for each taxable year, a tax equal to twenty-five per centum of the undistributed
portion of its accumulated profits or surplus which shall be in addition to the tax
imposed by section twenty-four and shall be computed, collected and paid in the
same manner and subject to the same provisions of law, including penalties, as that
tax: ​Provided,​ that no such tax shall be levied upon any accumulated profits or
surplus, if they are invested in any dollar-producing or dollar-saving industry or in
the purchase of bonds issued by the Central Bank of the Philippines.
xxx xxx xxx
(c) ​Evidence determinative of purpose.​ — The fact that the earnings of profits of a
corporation are permitted to accumulate beyond the reasonable 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
contrary." (As amended by RA 1823).
2. A ​prerequisite to the imposition of the tax has been that the ​corporation be
formed or availed of for the purpose of avoiding the income tax (or surtax) on
its shareholders​, or on the shareholders of any other corporation ​by ​permitting the
earnings and profits of the corporation to accumulate instead of dividing them
among or distributing them to the shareholders.
a. If the earnings and profits were distributed, the ​shareholders would be
required to pay an income tax thereon whereas, if the ​distribution
were not made to them​, they ​would ​incur no tax in respect to the
undistributed earnings and profits of the corporation.
b. The touch stone of liability is the ​purpose behind the accumulation of
the income​ and not the consequences of the accumulation.
c. Thus, if the ​failure to pay dividends is due to some other cause​, such as
the use of undistributed earnings and profits for the ​reasonable needs of
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the business​, such purpose does not fall within the interdiction of the b. Accumulations prior to the year involved may have been sufficient to
statute. cover the business needs and additional accumulations during the year
3. An accumulation of earnings or profits (including undistributed earnings or profits involved would not reasonably be necessary.
of prior years) is ​unreasonable if it is ​not required for the purpose of the
business​, considering all the circumstances of the case. SEPARATE OPINIONS: ​None
4. Manila Wine argues that it purchased the US Treasury Bonds to CONCURRING:
a. Finance its importations and because the dollar reserves abroad will be
useful in meeting urgent orders of local customers
b. Take care of future expansion including the purchase of a lot and
construction of a building
5. To avoid the 25% surtax, Manila Wine has to prove that the purchase of the US
Treasury Bonds in 1951 was an investment within the “reasonable needs” of the
corporation.
a. To determine the “reasonable needs” of the corporation, US Courts use the
“Immediacy Test”. The test construe “reasonable needs” to mean the
immediate needs of the business.
b. If the corporation did not prove an immediate need for the accumulation of
the earnings and profits, the accumulation was not for the reasonable
needs of the business, and the penalty tax will apply.
6. The CTA findings that the purchase of the US Treasury Bonds was not related to
Manila Wine’s business were factual in nature. Thus, the SC found these binding.
7. Records likewise show that from the purchase of the bonds in 1951 to its liquidation
in 1962, Manila Wine never had an occasion to use these in aiding or financing its
importation. This militates the purpose of financing importations it earlier
enunciated. To justify an accumulation of earnings and profits for the reasonably
anticipated future needs, such accumulation must be used within a reasonable time
after the close of the taxable year.
8. Furthermore, the use of the bonds to purchase the lot and construct the building is
conditioned on when Manila Wine meets the 60% citizenship requirement and a
decision to pursue the same. Whether these contingencies would unfold favorably
to Manila Wine and if so, whether Manila Wine would decide later to utilize the
bonds according to its plan, remains to be seen. From these assertions of Manila
Wine, the Court cannot gather anything definite or certain and thus the Court did not
agree with this.
9. In order to determine whether profits are accumulated for the reasonable needs of
the business as to avoid the surtax upon shareholders, the ​controlling intention of
the taxpayer is that which is manifested ​at the time of accumulation not
subsequently declared intentions which are merely the product of afterthought. A
speculative and indefinite purpose will not suffice. The mere recognition of a future
problem and the discussion of possible and alternative solutions is not sufficient.
Definiteness of plan coupled with ​action taken towards its consummation are
essential. Profits may only be accumulated for the reasonable needs of the business,
and implicit in this is further requirement of a reasonable time.
10. Manila Wine further asserts that surplus profits accumulated as US Treasury Bonds
in 1951 should not be subject to surtax in 1957.
a. The Court held that undistributed earnings or profits of prior years are
taken into consideration in determining unreasonable accumulation for
purposes of the 25% surtax.

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143. CIR v. Tuason (Kua) 3. The request for reinvestigation, although granted, was not acted upon. The
15 May 1989 | Grino-Aquino, ​J ​| Special Rules – Improperly Accumulated Earnings Revenue then issued warrants of distraint and levy to enforce collection of
Tax the total amount originally assessed including amounts already paid.
4. Private respondent then filed a petition for review in the CTA with a request
that pending the determination of the case on the merits, an order be issued
PETITIONER​: Commissioner of Internal Revenue
restraining the Commissioner and/or his representatives from enforcing the
RESPONDENTS​: Antonio Tuason, Inc
warrants of distraint and levy.
5. It was shown that portions of the tax liabilities involved in the assessment
SUMMARY​:
has already been paid, a writ on injunction was issued by the Tax Court
ordering the Commissioner to refrain from enforcing said warrants of
This case involves Respondent Tuason who is assailing the CIR assessment
distraint and levy. It did not require the petitioner to file a bond.
subjecting its accumulated surplus profits to the 25% surtax. According to them
6. In view of the reversal of the decision, petitioner CIR appealed the case to
the surplus was set aside in order to expand its business operations. The CTA
the CA.
upheld Tuason’s argument prompting the CIR to file an appeal.
ISSUES:
Issue: WON Respondent is liable for the 25% surtax. YES, it is liable but only to
1. Whether or not private respondent is a holding company and/or investment
the accumulated surplus profits of 2,489,585.88 PHP not set aside for business
company - YES
operations. All presumption is in favor of the correctness of petitioner’s
2. Whether or not respondent accumulated surplus for the years 1975- 1978 -
assessment against private respondent. It is incumbent upon taxpayer to prove the
YES
contrary—which he failed to do. It is plain to see the company’s failure to
3. Whether or not respondent is liable for the 25% surtax on undue
distribute dividends to its stockholders was for reason other than reasonable needs
accumulation of surplus for the years 1975-1978 pursuant to Section 25
of the business— falling under Section 25 of the Tax Code.
of the NIRC - YES
DOCTRINE:
RULING: ​Petition granted. The 25% surtax against Tucson reinstated but only to
the accumulated surplus profits of 2,489,585.88 PHP
There is a presumption that Antonio Tucson, Inc. was a mere holding or
investment company for the corporation since it did not involve itself in the
development of subdivisions but merely subdivided its lots and sold them for
RATIO:
bigger profits. It derived its income from interest, dividends, and rental
1. Issue (1) & (2): There is a presumption that Antonio Tucson, Inc. was a
realized from sales of realty. The company, at the time of the assessment in
mere holding or investment company for the corporation since it did not
1981, had invested in its business operation only 773,720 PHP out of its
involve itself in the development of subdivisions but merely subdivided its
accumulated surplus profits of 3,263,205,88; the remaining 2,489,585.88 are
lots and sold them for bigger profits. It derived its income from interest,
subject to the 25% surtax.
dividends, and rental realized from sales of realty. Also, the presumption
lies since Antonio Tucson himself owns 99.99% in outstanding stock of
FACTS: Antonio Tuason, Inc.
1. This case is a review of a decision of the Court of Tax Appeal, which 2. The surplus of 3 million PHP of the corporation—instead of distributing
denied petitioner’s claim that Revenue Commissioner’s assessment of them to stockholders—accumulated them from earnings in 1975-1978. Such
1,151,146.98 PHP for 25% surtax of respondent during 1975-1978 was act was done to avoid the imposition of progressive income tax.
erroneous. 3. Their allegation that the surplus profits were set aside was in order for them
2. According to them, the 25% surtax was improper since the accumulation of to capitalize on an expansion program which included the construction of
surplus profits during the years in question was solely for the purpose of apartment building and the purchase of a condominium unit. However, the
expanding its business operations as a real estate broker. Commissioner points out that the corporation did not use up its surplus

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profits. There was a huge discrepancy between the investment cost and the
declared market value of the real estate.
4. Issue (3): The company, at the time of the assessment in 1981, had invested
in its business operation only 773,720 PHP out of its accumulated surplus
profits of 3,263,205,88; the remaining 2,489,585.88 are subject to the 25%
surtax.
5. All presumption is in favor of the correctness of petitioner’s assessment
against private respondent. It is incumbent upon taxpayer to prove the
contrary—which he failed to do.
6. It is plain to see the company’s failure to distribute dividends to its
stockholders was for reason other than reasonable needs of the
business—falling under Section 25 of the Tax Code.

SEPARATE OPINIONS:
CONCURRING:

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144. Cyanamid Philippines Inc. v. CA (Pamie)
January 20, 2000 | QUISUMBING, J | Special Rules- Improperly Accumulated
Earnings Tax
PETITIONER​: CYANAMID PHILIPPINES, INC.
RESPONDENTS​: CA, CTA, CIR
SUMMARY​: In 1985, CIR sent an assessment letter to Cyanamid Philippines,
who protested, particularly the 25% Surtax Assessment. Cyanamid claimed that
the surtax for the undue accumulation of earnings was not proper because the
said profits were retained to increase its working capital and it could be used for
reasonable business needs of the company. Cyanamid contended further that it
availed of the tax amnesty under EO 41, hence, it enjoyed amnesty from civil
and criminal prosecution granted by law. CIR refused to allow the cancellation
of the assessment notices on the ground that the availment of the tax amnesty is
for the cancellation of the assessment issued after August 21, 1986 only.
Cyanamid appealed to the CTA. CTA denied the petition by ruling that there
was no need for Cyanamid to set aside a portion of its retained earnings as
working capital reserve as it claims since it had considerable liquid funds.
Issue​: Is Cyanamid liable for the accumulated earnings tax? - YES. ​Sec. 25.
Provides for the additional tax on corporations improperly accumulating profits
or surplus. First, Cyanamid does not fall under any of the institutions exempted
from this tax. Second, there was no need to increase the working capital of
Cyanamid. The Court determined the working capital sufficiency of Cyanamid
by using the ratio between current assets to current liabilities. The working
capital needs of a business depend upon the nature of the business, its credit
policies, the amount of inventories, the rate of turnover, the amount of accounts
receivable, the collection rate, the availability of credit to the business, and
similar factors. Cyanamid, by adhering to the "Bardahl" formula, failed to
impress the tax court with the required definiteness envisioned by the statute.
The Court agreed with the tax court that the burden of proof to establish that the
profits accumulated were not beyond the reasonable needs of the company,
remained on the taxpayer. Unless rebutted, all presumptions generally are
indulged in favor of the correctness of the CIR's assessment against the taxpayer.
With Cyanamid’s failure to prove the CIR incorrect, SC upheld the CTA’s
ruling.
DOCTRINE: ​Section 25 of the old NIRC discouraged tax avoidance through
corporate surplus accumulation. When corporations do not declare dividends,
income taxes are not paid on the undeclared dividends received by the
shareholders. The tax on improper accumulation of surplus is essentially a
penalty tax designed to compel corporations to distribute earnings so that the
said earnings by shareholders could be taxed.
FACTS:
1. Cyanamid Philippines, Inc., a corporation organized under Philippine laws,
is a wholly owned subsidiary of American Cyanamid Co. based in Maine,
USA. It is engaged in the manufacture of pharmaceutical products and
chemicals, a wholesaler of imported finished goods, and an
importer/indentor.
2. On February 7, 1985, CIR sent an assessment letter to Cyanamid and
demanded the payment of deficiency income tax of P119,817.00.
3. Cyanamid protested the assessments particularly:
a. the 25% Surtax Assessment of P3,774,867.50;
b. 1981 Deficiency Income Assessment of P119,817.00; and
c. 1981 Deficiency Percentage Assessment of P8,846.72.
4. Cyanamid, through its external accountant, SGV & Co., claimed that the
surtax for the ​undue accumulation of earnings was not proper because the
said profits were retained to increase its working capital and it would be
used for reasonable business needs of the company. Cyanamid contended
that it availed of the tax amnesty under EO 41, hence enjoyed amnesty from
civil and criminal prosecution granted by the law.
5. CIR refused to allow the cancellation of the assessment notices and
rendered its resolution, stating that the availment of the tax amnesty under
EO 41 is for the cancellation of the assessment issued ​after August 21,
1986. Said availment does not, therefore, result in cancellation of
assessments issued before August 21, 1986, as in the instant case. Thus, the
liability still subsists.
6. Cyanamid appealed to the CTA. During the pendency of the case, however,
both parties agreed to compromise the 1981 deficiency income tax
assessment and paid a reduced amount of P26,577.00. However, the surtax
on improperly accumulated profits remained unresolved.
7. Cyanamid claimed that CIR's assessment representing the 25% surtax on its
accumulated earnings for the year 1981 had no legal basis for the following
reasons:
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a. It accumulated its earnings and profits for reasonable business
requirements to meet working capital needs and retirement of
indebtedness;
b. It is a wholly owned subsidiary of American Cyanamid Company,
a corporation organized under the laws of Maine, USA, whose
shares of stock are listed in New York Stock Exchange.
c. This being the case, no individual shareholder of Cyanamid could
have evaded or prevented the imposition of individual income
taxes by Cyanamid’s accumulation of earnings and profits, instead
of distribution of the same.
8. CTA denied the petition stating that: Although the law permits a stock
corporation to set aside a portion of its retained earnings for specified
purposes, Cyanamid’s purpose for accumulating its earnings does not fall
within the ambit of any of these specified purposes. Moreover there was no
need for Cyanamid to set aside a portion of its retained earnings as working
capital reserve since it had considerable liquid funds adequate to meet the
normal needs of the business. It further reject the argument that "the
accumulated earnings tax does not apply to a publicly-held corporation".
9. Cyanamid appealed to the CA, who affirmed the CTA decision. Cyanamid
attempts to justify its accumulated surplus earnings by coming up with an
alternative formula lifted from a decision rendered by a foreign court
(Bardahl Mfg. Corp. vs. Commissioner). But this was likewise rejected by
the CA.
ISSUE: Is Cyanamid liable for the accumulated earnings tax? - YES
RATIO:
1. Section 25 of the old NIRC discouraged tax avoidance through corporate
surplus accumulation. ​When corporations do not declare dividends, income
taxes are not paid on the undeclared dividends received by the shareholders.
The tax on improper accumulation of surplus is essentially a penalty tax
designed to compel corporations to distribute earnings so that the said
earnings by shareholders could be taxed.
2. Relying on decisions of the American Federal Courts, Cyanamid stresses
that the accumulated earnings tax does not apply to it, a wholly owned
subsidiary of a publicly owned company​. Citing Golconda Mining Corp. vs.
Commissioner, where it was held that the accumulated earnings tax could
only apply to a closely held corporation.
3. However, a review of American taxation history on accumulated earnings
tax will show that the application of the accumulated earnings tax to
publicly held corporations has been problematic. Initially, accumulated
earnings tax applies to publicly held corporations. Then, Golconda held that
the accumulated earnings tax could only apply to closely held corporations.
In 1984, American legislation nullified the Golconda ruling and held that
the accumulated earnings tax is not limited to closely held corporations.
4. The amendatory provision of Section 25 of the 1977 NIRC, enumerated the
corporations exempt from the imposition of improperly accumulated tax:
a. banks;
b. non-bank financial intermediaries;
c. insurance companies; and
d. corporations organized primarily and authorized by the Central
Bank of the Philippines to hold shares of stocks of banks.
5. Cyanamid does not fall among those exempt classes​. The burden of proof
rests upon the party claiming exemption to prove that it is, in fact, covered
by the exemption so claimed, a burden which Cyanamid here has failed to
discharge.
6. Another point raised is that increase of working capital by a corporation
justifies accumulating income​. Cyanamid asserts that the CTA erred in
concluding that Cyanamid need not infuse additional working capital
reserve because it had considerable liquid funds based on the 2.21:1 ratio of
current assets to current liabilities. Cyanamid relies on the so-called
"Bardahl" formula, which allowed retention, as working capital reserve,
sufficient amounts of liquid assets to carry the company through one
operating cycle.
7. The "Bardahl" formula was developed to measure corporate liquidity. The
formula requires an examination of whether the taxpayer has sufficient
liquid assets to pay all of its current liabilities and any extraordinary
expenses reasonably anticipated, plus enough to operate the business during
one operating cycle. Operating cycle is the period of time it takes to convert
cash into raw materials, raw materials into inventory, and inventory into
sales, including the time it takes to collect payment for the sales.
8. Using this formula, Cyanamid needed at least P33,763,624.00 pesos as
working capital. As of 1981, its liquid asset was only P25,776,991.00. Thus,
Cyanamid had a working capital deficit of P7,986,633.00. Therefore, the
P9,540,926.00 accumulated income as of 1981 may be validly accumulated
to increase the Cyanamid's working capital for the succeeding year.
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9. We note, however, that the companies where the "Bardahl" formula was
applied, had operating cycles much shorter than that of Cyanamid. In the
case of Cyanamid, the operating cycle was 288.35 days, or 78.55% of a
year, reflecting that Cyanamid will need sufficient liquid funds, of at least
three quarters of the year, to cover the operating costs of the business. There
are variations in the application of the "Bardahl" formula, such as average
operating cycle or peak operating cycle. In times when there is no
recurrence of a business cycle, the working capital needs cannot be
predicted with accuracy. Although the "Bardahl" formula is
well-established, it is not a precise rule. It is used only for administrative
convenience. Cyanamid’s application of the "Bardahl" formula merely
creates a false illusion of exactitude.
10. Ideally, the working capital should equal the current liabilities and there
must be 2 units of current assets for every unit of current liability, hence the
so-called "2 to 1" rule.
11. As of 1981 the working capital of Cyanamid was P25,776,991.00, or
more than twice its current liabilities. That current ratio of Cyanamid,
therefore, projects adequacy in working capital. Said working capital
was expected to increase further when more funds were generated from the
succeeding year's sales. Available income covered expenses or indebtedness
for that year, and ​there appeared no reason to expect an impending
'working capital deficit' which could have necessitated an increase in
working capital, as rationalized by Cyanamid.
12. If the CIR determined that the corporation avoided the tax on shareholders
by permitting earnings or profits to accumulate, and the taxpayer contested
such a determination, the burden of proving the determination wrong,
together with the corresponding burden of first going forward with
evidence, is on the taxpayer. This applies even if the corporation is not a
mere holding or investment company and does not have an unreasonable
accumulation of earnings or profits.
13. In order to determine whether profits are accumulated for the reasonable
needs of the business to avoid the surtax upon shareholders, it must be
shown that the controlling intention of the taxpayer is manifested at the time
of accumulation, not intentions declared subsequently, which are mere
afterthoughts. Furthermore, the accumulated profits must be used within a
reasonable time after the close of the taxable year. ​In the instant case,
Cyanamid did not establish, by clear and convincing evidence, that
such accumulation of profit was for the immediate needs of the
business.
14. In Manila Wine Merchants, Inc vs. Commissioner of Internal: "To
determine the 'reasonable needs' of the business in order to justify an
accumulation of earnings, the 'Immediacy Test' is used which construed the
words 'reasonable needs of the business' to mean the immediate needs of the
business, and it was generally held that if the corporation did not prove an
immediate need for the accumulation of the earnings and profits, the
accumulation was not for the reasonable needs of the business, and the
penalty tax would apply.
15. In the present case, the Tax Court opted to determine the working capital
sufficiency by using the ratio between current assets to current liabilities.
The working capital needs of a business depend upon the nature of the
business, its credit policies, the amount of inventories, the rate of turnover,
the amount of accounts receivable, the collection rate, the availability of
credit to the business, and similar factors. Cyanamid, by adhering to the
"Bardahl" formula, failed to impress the tax court with the required
definiteness envisioned by the statute. The burden of proof to establish that
the profits accumulated were not beyond the reasonable needs of the
company, remained on the taxpayer. With Cyanamid’s failure to prove the
CIR incorrect, clearly and conclusively, this Court is constrained to uphold
the correctness of tax court's ruling as affirmed by the Court of Appeals.
-----
"Sec. 25. Additional tax on corporation improperly accumulating profits or
surplus​. —
"(a) Imposition of tax . — If any corporation is formed or availed of for the purpose
of preventing the imposition of the tax upon its shareholders or members or the
shareholders or members of another corporation, through the medium of permitting
its gains and profits to accumulate instead of being divided or distributed, there is
levied and assessed against such corporation, for each taxable year, a tax equal to
twenty-five per-centum of the undistributed portion of its accumulated profits or
surplus which shall be in addition to the tax imposed by section twenty-four, and
shall be computed, collected and paid in the same manner and subject to the same
provisions of law, including penalties, as that tax.
"(b) Prima facie evidence. — The fact that any corporation is mere holding company
shall be prima facie evidence of a purpose to avoid the tax upon its shareholders or
members. Similar presumption will lie in the case of an investment company where
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at any time during the taxable year more than fifty per centum in value of its
outstanding stock is owned, directly or indirectly, by one person.
"(c) Evidence determinative of purpose . — The fact that the earnings or profits of a
corporation are permitted to accumulate beyond the reasonable 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
contrary.
"(d) Exception — The provisions of this sections shall not apply to banks, non-bank
financial intermediaries, corporation organized primarily, and authorized by the
Central Bank of the Philippines to hold shares of stock of banks, insurance
companies, whether domestic or foreign. llcd

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145. RR 2-01 (Anne) corporation to accumulate instead of dividing them among or distributing them to the
March 9, 2001 [February 12, 2001 sa syllabus idk why] | Improperly Accumulated shareholders. The ​rationale is that if the earnings and profits were distributed,
Earnings Tax the shareholders would then be liable to income tax thereon, whereas if the
distribution were not made to them, they would incur no tax in respect to the
Summary: ​RR 2-2001 prescribes the rules and regulations in the implementation
undistributed earnings and profits of the corporation. ​Thus, a tax is being
of the provision on Improperly Accumulated Earnings Tax (IAET). The ​10%
imposed in the ​nature of a penalty to the corporation for the improper accumulation
IAET ​is being imposed in the nature of a penalty to the corporation for the
of its earnings, and as a form of deterrent to the avoidance of tax upon shareholders
improper accumulation of its earnings to avoid the imposition of tax upon its
who are supposed to pay dividends tax on the earnings distributed to them by the
shareholders who are supposed to pay dividends tax on the earnings
corporation. The touchstone of the liability is the purpose behind the accumulation of
distributed to them by the corporation​. If the failure of a corporation to pay
the income and not the consequences of the accumulation. Thus, ​if the failure to pay
dividends is due, however, to some other causes, such as the use of undistributed
dividends is due to some other causes, such as the use of undistributed earnings
earnings and profits for the reasonable needs of the business, as specified in the
and profits for the reasonable needs of the business, such purpose would not
Regulations, the accumulated or undistributed earnings will not be subject to the
generally make the accumulated or undistributed earnings subject to the tax.
10% IAET. The 10% IAET is ​imposed on improperly accumulated taxable
However, if there is a determination that a corporation has accumulated income
income earned starting January 1, 1998 by domestic corporations which are
beyond the reasonable needs of the business, the 10% improperly accumulated
classified as closely-held corporations (the determination of which is specified
earnings tax shall be imposed.
in the Regulations). The IAET, however, will ​not apply to the following
corporations: a) banks and other non-bank financial intermediaries; b)
SEC. 3. Determination of Reasonable Needs of the Business. - An accumulation
insurance companies; c) publicly-held corporations; d) taxable partnerships;
of earnings or profits (including undistributed earnings or profits of prior years) is
e) general professional partnerships; f) non-taxable joint ventures; and g)
unreasonable if it is not necessary for the purpose of the business, considering all the
enterprises duly registered with the PEZA under RA 7916 and enterprises
circumstances of the case. ​To determine the "reasonable needs" of the business in
registered pursuant to the Bases Conversion and Development Act of 1992
order to justify an accumulation of earnings, these Regulations hereby adhere
under RA 7227​, including enterprises under special economic zones which enjoy
to the so-called "Immediacy Test" under American jurisprudence as adopted in
payment of special tax rate on their registered operations or activities in lieu of
this jurisdiction. Accordingly, the term "reasonable needs of the business" are hereby
other taxes, national or local. The IAET will ​not apply on improperly
construed to mean the immediate needs of the business, including reasonably
accumulated income as of December 31, 1997 of corporations using the
anticipated needs. In either case, the corporation should be able to prove an
calendar year basis​. In the case of corporations adopting the fiscal year
immediate need for the accumulation of the earnings and profits, or the direct
accounting period, the IAET will not apply on improperly accumulated taxable
correlation of anticipated needs to such accumulation of profits. Otherwise, such
income as of the end of the month comprising the twelve-month period of fiscal
accumulation would be deemed to be not for the reasonable needs of the business,
year 1997-1998.
and the penalty tax would apply. ​For purposes of these Regulations, the following
constitute accumulation of earnings for the reasonable needs of the business: a.
SECTION 1. Scope. Allowance for the increase in the accumulation of earnings up to 100% of the
paid-up capital of the corporation as of Balance Sheet date, inclusive of
SEC. 2. Concept of Improperly Accumulated Earnings Tax (IAET). - Pursuant accumulations taken from other years; b. Earnings reserved for definite
to Section 29 of the Code, there is imposed for each taxable year, in addition to other corporate expansion projects or programs requiring considerable capital
taxes imposed under Title II of the Tax Code of 1997, a tax equal to 10% of the expenditure as approved by the Board of Directors or equivalent body; c.
improperly accumulated taxable income of corporations formed or availed of for the Earnings reserved for building, plants or equipment acquisition as approved by
purpose of avoiding the income tax with respect to its shareholders or the the Board of Directors or equivalent body; d. Earnings reserved for compliance
shareholders of any other corporation, by permitting the earnings and profits of the
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with any loan covenant or pre-existing obligation established under a legitimate
business agreement; e. Earnings required by law or applicable regulations to be
retained by the corporation or in respect of which there is legal prohibition
against its distribution; f. In the case of subsidiaries of foreign corporations in
the Philippines, all undistributed earnings intended or reserved for investments
within the Philippines as can be proven by corporate records and/or relevant
documentary evidence.
SEC. 4. Coverage. The 10% Improperly Accumulated Earnings Tax (IAET) is
i​mposed on improperly accumulated taxable income earned starting January 1,
1998 by domestic corporations as defined under the Tax Code and which are
classified as closely-held corporations. Provided, however, that Improperly
Accumulated Earnings Tax shall ​not apply to the following corporations: a. Banks
and other non-bank financial intermediaries; b. Insurance companies; c.
Publicly-held corporations; d. Taxable partnerships; e. General professional
partnerships; f. Non- taxable joint ventures; and g. Enterprises duly registered
with the Philippine Economic Zone Authority (PEZA) under R.A. 7916​, and
enterprises registered pursuant to the Bases Conversion and Development Act of
1992 under R.A. 7227, as well as other enterprises duly registered under special
economic zones declared by law which enjoy payment of special tax rate on their
registered operations or activities in lieu of other taxes, national or local. For
purposes of these Regulations, closely-held corporations are those corporations at
least fifty percent (50%) in value of the outstanding capital stock or at least fifty
percent (50%) of the total combined voting power of all classes of stock entitled to
vote is owned directly or indirectly by or for not more than twenty (20) individuals.
Domestic corporations not falling under the aforesaid definition are, therefore,
publicly-held corporations. For purposes of determining whether the corporation is
closely held corporation, insofar as such determination is based on stock ownership,
the following rules shall be applied: 1. Stock Not Owned by Individuals. - Stock
owned directly or indirectly by or for a corporation, partnership, estate or trust shall
be considered as being owned proportionately by its shareholders, partners or
beneficiaries. 2. Family and Partnership Ownership. – An individual shall be
considered as owning the stock owned, directly or indirectly, by or for his family, or
by or for his partner. For purposes of this paragraph, the ‘family of an individual’
includes his brothers or sisters (whether by whole or half-blood), spouse, ancestors
and lineal descendants. 3. Option to Acquire Stocks. - If any person has an option to
acquire stock, such stock shall be considered as owned by such person. For purposes
of this paragraph, an option to acquire such an option and each one of a series of
option shall be considered as an option to acquire such stock. 4. Constructive
Ownership as Actual Ownership. - Stock constructively owned by reason of the
application of paragraph (1) or (3) hereof shall, for purposes of applying paragraph
(1) or (2), be treated as actually owned by such person; but stock constructively
owned by the individual by reason of the application of paragraph (2) hereof shall
not be treated as owned by him for purposes of again applying such paragraph in
order to make another the constructive owner of such stock. Provided, however, that
a branch of a foreign corporation is not covered by these Regulations, the same being
a resident foreign corporation.
SEC. 5. Tax Base of Improperly Accumulated Earnings Tax. - For corporations
found subject to the tax, the "Improperly Accumulated Taxable Income" for a
particular year is first determined by adding to that year’s taxable income the
following: a. income exempt from tax; b. income excluded from gross income; c.
income subject to final tax; and d. the amount of net operating loss carry-over
(NOLCO) deducted. ​The taxable income as thus determined shall be reduced by
the sum of: a. income tax paid/payable for the taxable year; b. dividends
actually or constructively paid/issued from the applicable year’s taxable
income; c. amount reserved for the reasonable needs of the business as defined
in these Regulations emanating from the covered year’s taxable income. The
resulting "Improperly Accumulated Taxable Income" is thereby multiplied by
10% to get the Improperly Accumulated Earnings Tax (IAET). Once the profit
has been subjected to IAET, the same shall no longer be subjected to IAET in later
years even if not declared as dividend. Notwithstanding the imposition of the IAET,
profits which have been subjected to IAET, when finally declared as dividends, shall
nevertheless be subject to tax on dividends imposed under the Tax Code of 1997
except in those instances where the recipient is not subject thereto. For purposes of
determining the source of earnings or profits declared or distributed from
accumulated income for each taxable year, the dividends shall be deemed to have
been paid out of the most recently accumulated profits or surplus and shall constitute
a part of the annual income of the distributee for the year in which received pursuant
to Section 73(C) of the Code. Provided, however, that where the dividends or portion
of the said dividends declared forms part of the accumulated earnings as of
December 31, 1997, or emanates from the accumulated income of a particular year
and, therefore, is an exception to the preceeding statement, such fact must be
supported by a duly executed Board Resolution to that effect.
SEC. 6. Period for Payment of Dividend/Payment of IAET. ​- The dividends must
be ​declared and paid or issued not later than one year following the close of the
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taxable year​, otherwise, the IAET, if any, should be paid within ​fifteen (15) days
thereafter.
SEC. 7. Determination of Purpose to Avoid Income Tax. - The fact that a
corporation is a mere holding company or investment company shall be prima facie
evidence of a purpose to avoid the tax upon its shareholders or members. Likewise,
the fact that the earnings or profits of a corporation are permitted to accumulate
beyond the reasonable needs of the business shall be determinative of the purpose to
avoid the tax upon its shareholders or members. In both instances, the corporation
may, by clear preponderance of evidence in its favor, prove the contrary. For
purposes of these Regulations, the term "holding or investment company" shall refer
to a corporation having practically no activities except holding property, and
collecting the income therefrom or investing the same. The following are prima facie
instances of accumulation of profits beyond the reasonable needs of a business and
indicative of purpose to avoid income tax upon shareholders: a. Investment of
substantial earnings and profits of the corporation in unrelated business or in stock or
securities of unrelated business; b. Investment in bonds and other long-term
securities; c. Accumulation of earnings in excess of 100% of paid-up capital, not
otherwise intended for the reasonable needs of the business as defined in these
Regulations. In order to determine whether profits are accumulated for the
reasonable needs of the business as to avoid the imposition of the improperly
accumulated earnings tax, the controlling intention of the taxpayer is that which is
manifested at the time of accumulation, not subsequently declared intentions which
are merely the product of afterthought. A speculative and indefinite purpose will not
suffice. The mere recognition of a future problem or the discussion of possible and
alternative solutions is not sufficient. ​Definiteness of plan/s coupled with action/s
taken towards its consummation are essential.

SEC. 8 . Transitory Provision.

SEC. 9. Effectivity.

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146. REVENUE MEMORANDUM CIRCULAR NO. 35-2011 (RHALD)
March 14, 2011| Improperly Accumulated Earnings Tax (a) Income subjected to Final Tax P XXX

(b) NOLCO XXX

SENDER:​ KIM S. JACINTO-HENARES
RECIPIENT: ​All Revenue Officers and Others Concerned (c) Income exempt from tax XXX
SUBJECT: ​Clarification of Issues Concerning the Imposition of Improperly
(d) Income excluded from gross income XXX XXXX
Accumulated Earnings Tax Pursuant to Section 29 of the Tax Code of 1997, in
relation to Revenue Regulations No. 2-2001 P XXXX

SUMMARY​: Less:
REVENUE MEMORANDUM CIRCULAR NO. 35-2011 was issued on August
17, 2011. Income Tax paid P XXX

Dividends Declared XXX XXXX

This clarifies issues concerning the imposition of the ten percent (10%)
Improperly Accumulated Earnings Tax (IAET) pursuant to Section 29 of the Tax
Code of 1997, as amended, as it applies to the taxable income earned starting
January 1, 1998 by closely-held domestic corporations, except publicly held
corporations, banks and other non-bank financial intermediaries, insurance
companies and those enumerated under Section 4 of Revenue Regulations (RR)
No. 2-2001.
Under Section 29 of the Tax Code, as amended, a corporation that permits the
accumulation of earnings and profits beyond the reasonable needs of the
business, instead of dividing or distributing said profits, is subject to 10% IAET
on the improperly accumulated taxable income (IATI).
For corporations using the calendar year basis, the accumulated earnings under
tax shall not apply on improperly accumulated income as of December 31, 1997.
In the case of corporations adopting the fiscal year accounting period, the
improperly accumulated income not subject to this tax shall be reckoned as of
the end of the month comprising the 12-month period of the fiscal year
1997-1998.
Total P XXXX
Add: Retained Earnings from prior years
Accumulated Earnings as of December 31, 2010
Less: Amount that may be Retained
(100% of Paid-Up Capital as of Dec. 31, 2010) XXXX
IATI P XXXX
The resulting “Improperly Accumulated Taxable Income” is thereby
multiplied by 10% to arrive at the Improperly Accumulated Earnings Tax
(IAET).
For purposes of this RMC, and in accordance with RR No. 2-2001, the amount
that may be retained, taking into consideration the accumulated earnings within
the “reasonable needs of the business” as determined under Section 3 of the said
RR, shall be 100% of the paid-up capital or the amount contributed to the
corporation representing the par value of the shares of stock, hence, any excess
capital over and above the par shall be excluded.

By way of illustration, IATI is computed as follows:

BACKGROUND:
Taxable Income for the year P XXXX 1. This Revenue Memorandum Circular (RMC) is being issued to clarify
certain issues relative to the imposition of the 10% Improperly Accumulated
Add: Earnings Tax (IAET) pursuant to Section 29 of the National Internal
Revenue Code of 1997 (Code), as amended, as it applies to the taxable
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income earned starting January 1, 1998 by closely-held domestic
(b) NOLCO XXX
corporations, except publicly held corporations, banks and other non-bank
financial intermediaries, insurance companies, and those enumerated under (c) Income exempt from tax XXX
Section 4 of Revenue Regulations (RR) No. 2-2001.
2. Under Section 29 of the Code, as amended, a Corporation that permits the (d) Income excluded from gross income XXX XXXX
accumulation of earnings and profits beyond the reasonable needs of the
P XXXX
business, instead of dividing or distributing said profits, is subject to ten
percent (10%) improperly accumulated earnings tax on the improperly Less:
accumulated taxable income.
Income Tax paid P XXX
DEFINITION OF IMPROPERLY ACCUMULATED TAXABLE INCOME
Section 29(D) of the Code, as amended, defines the term Improperly Accumulated Dividends Declared XXX XXXX
Taxable Income as “taxable income adjusted by:
Total P XXXX

(1) Income exempt from tax; Add: Retained Earnings from prior years
(2) Income excluded from gross income; Accumulated Earnings as of December 31, 2010
(3) Income subject to final tax; and
(4) The amount of net operating loss carry-over deducted; Less: Amount that may be Retained
And reduced by the sum of:
(100% of Paid-Up Capital as of Dec. 31, 2010) XXXX
(1) Dividends actually or constructively paid; and
(2) Income tax paid for the taxable year. IATI P XXXX

Provided, however, That for corporations using the calendar year basis, the
accumulated earnings under tax shall not apply on improperly accumulated income
as of December 31, 1997. In the case of corporations adopting the fiscal year
accounting period, the improperly accumulated income not subject to this tax, shall
be reckoned, as of the end of the month comprising the twelve (12)-month period of
fiscal year 1997-1998.”
COMPUTATION OF IMPROPERLY ACCUMULATED TAXABLE
INCOME
The resulting “Improperly Accumulated Taxable Income” is thereby multiplied by
10% to arrive at the Improperly Accumulated Earnings Tax (IAET).
For purposes of this RMC, and in accordance with RR No. 2-2001, the amount that
may be retained, taking into consideration the accumulated earnings within the
“reasonable needs of the business” as determined under Section 3 of the said RR,
shall be 100% of the paid-up capital or the amount contributed to the corporation
representing the par value of the shares of stock, hence, any excess capital over and
above the par shall be excluded.

REPEALING CLAUSE
Taxable Income for the year P XXXX All BIR rulings and other issuances issued inconsistent herewith are revoked
accordingly.
Add:
All concerned revenue officials are hereby enjoined to be guided accordingly and to
(a) Income subjected to Final Tax P XXX give this Circular as wide a publicity as possible.

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147. BIR Ruling 25-02 (Marian)
June 25, 2002 | BIR | Special Rules - Improperly Accumulated Earnings Tax
Subject Matter​: IMPROPERLY ACCUMULATED EARNINGS TAX;
publicly-held corporation
Addressee​: SGV and Co. (Abbot Phils., Inc.)
Author​: RENÉ G. BAÑEZ, Commissioner of Internal Revenue
SUMMARY​: Abbot-Phils., as a wholly-owned subsidiary of Abbot-US,
will be considered as being ​owned proportionately by Abbott-US
shareholders​. The ownership of a domestic corporation, for purposes of
determining whether it is a closely-held corporation or a publicly-held
corporation, is ​ultimately traced to the individual shareholders of the
parent company​. Accordingly, ​Abbot-Phils. is considered a
publicly-held corporation exempt from the Improperly Accumulated
Earnings Tax. This is based on the representation that as of the year end
2000, Abbot-US had 101 to 272 shareholders holding a combined
1,545,937,133 shares of common stock, and the twenty largest
shareholders of Abbott-US as of September 30, 2001 own an aggregate of
30.1% of Abbot-US issued as outstanding shares. Based on Section 4 of
Revenue Regulations No. 2-2001, closely-held corporations are those
corporations at least 50% in value if the outstanding capital stock or at
least 50% of the total combined voting power of all classes of stock
entitled to vote is owned directly or indirectly by or for not more than 20
individuals. Abbot-Phils. does not fall under the definition of a
closely-held corporation. (BIR Ruling No. 025-2002 dated June 25, 2002)
CONTENTS:
1. Query of SGV: WON client, Abbott-Phils is a publicly held corporation as
defined under Revenue Regulations No. 2-2001, and hence, exempt from
the Improperly Accumulated Earnings Tax (IAET) imposed under Section
29 of the Tax Code.
2. Abbott-Phils info:
a. Office at EDSA
b. Business of manufacturing, buying, selling, importing, exporting,
dealing of various drugs, pharmaceutical products and supplies as
provided in its Articles of Incorporation
c. Wholly owned subsidiary of Abbott-US (organized under laws of
Illinois, USA)
3. Pursuant to ​Section 4 of Revenue Regulations No. 2-2001​, "Implementing
the Provision on Improperly Accumulated Earnings Tax under Section 29 of
the Tax Code of 1997" viz:
a. "For purposes of these Regulations, closely-held corporations are
those corporations:
i. at least fifty percent (50%) in value of the outstanding
capital stock ​or
ii. at least fifty percent (50%) of the total combined voting
power of all classes of stock entitled to vote is
iii. owned directly or indirectly by or for not more than
twenty (20) individuals​.
b. Domestic corporations not falling under the aforesaid definition
are, therefore, publicly-held corporations."
4. To determine WON a corp is a closely held corporation, the ff rates shall be
applied:
Stock Not Owned by Stock owned​ directly or indirectly by or for a
Individuals corporation​, partnership, estate or trust shall be
considered as being ​owned proportionately by its
shareholders​, partners or beneficiaries.
Family and Partnership An individual shall be​ considered as owning the stock
Ownership owned, directly or indirectly, by or for his family, or by
or for his partner.​ For purposes of this paragraph, the
`family of an individual' includes his brothers or sisters
(whether by whole or halfblood) spouse, ancestors and
lineal descendants.
Option to Acquire Stocks If any person has an ​option to acquire stock, such stock
shall be considered as owned by such person​. For
purposes of this paragraph, an option to acquire such an
option and each one of a series of option shall be
considered as an option to acquire such stock.
Constructive Ownership as Stock constructively owned by reason of the application of
Actual Ownership rows (1) or (3) hereof shall, for purposes of applying rows
(1) or (2), be treated as actually owned by such person​,
but stock ​constructively owned by the individual by
reason of the application of row (2) hereof shall not be
treated as owned by him​ for purposes of again applying
such paragraph in order to make another the constructive
owner of such stock.
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5. Such being the case, since Abbott-Phils. is a wholly-owned subsidiary of
Abbott-US, such shares will be considered as being owned
proportionately by the Abbott-US shareholders.
a. The ownership of a domestic corporation for purposes of
determining whether it is a closely held corporation or a publicly
held corporation is ​ultimately traced to the individual
shareholders of the parent company.
6. Thus, where at least 50% of the outstanding capital stock or at least 50% of
the total combined voting power of all classes of stock entitled to vote in a
corporation is owned directly or indirectly by at least 21 or more
individuals, the corporation is considered publicly-held corporation.
7. Pertinent Law: "Sec. 29. Imposition of Improperly Accumulated Earnings
Tax.
a. (B) Corporations Subject to Improperly Accumulated Earnings
Tax. —
b. (1) In General. — The improperly accumulated earnings tax
imposed in the preceding Section shall apply to every corporation
formed or availed for the purpose of avoiding the income tax with
respect to its shareholders or the shareholders of any other
corporation, by permitting earnings and profits to accumulate
instead of being divided or distributed.
c. (2) Exceptions. — The improperly accumulated earnings tax as
provided for under this Section shall not apply to:
d. (a) Publicly-held corporation;

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148. Benaglia v. CIR (Sel)
1937 | Ponente | Special Rules - Improperly Accumulated Earnings Tax
PETITIONER​: Benaglia
RESPONDENTS​: Commissioner of Internal Revenue
SUMMARY​: Benaglia is a manager of hotels in Honolulu where he was given a
suite and received meals from the hotel. He did not report their value in his
income tax return so the CIR sent a deficiency note stating that the fair market
value of rooms and meals should be included as part of his taxable income. he
deficiency note also seems to hold that the rooms and meals were NOT in fact
supplied merely as a convenience to the hotels of the employer.
Issue: Whether the residence and meals at the hotel were compensation and
therefore part of Benaglia’s gross income for which he could be taxed -- NO
From the evidence, there remains no room for doubt that Benaglia’s residence at
the hotel was not by way of compensation for his services, not for his personal
convenience or comfort or pleasure but solely because he could not otherwise
perform the services required of him. The occupation of the premises was
imposed upon him for the benefit of the employer.Under such circumstances, the
value of meals and lodging is not income to the employee, even though it may
relieve him of an expense which he would otherwise bear. This is not to say that
anytime an employee is fed or lodged by the employer that it is not taxable
income (case to case basis).
FACTS:
1. The Benaglias are husband and wife, residing in Honolulu where they filed
their joint income tax returns for 1933 and 1934.
2. Benaglia has been employed as the manager of several hotels in Honolulu
owned and operated by Hawaiian Hotels, Ltd.
3. Benaglia was constantly on duty and for the proper performance of his
duties and entirely for the convenience of his employer, he and his wife
occupied a suite and received meals at and from the hotel, but did not report
their value in his income.
4. The Commissioner determined a deficiency for Benaglia’s joint income so
added $7,845 each year to gross income as compensation from Hawaiian
Hotels, Ltd. holding that this is the fair market value of rooms and meals
furnished by the employer.
5. The deficiency note also seems to hold that the rooms and meals were NOT
in fact supplied merely as a convenience to the hotels of the employer.
6.
ISSUES:
1. Whether the residence and meals at the hotel were compensation and
therefore part of Benaglia’s gross income for which he could be taxed -- NO
RATIO:
1. From the evidence, there remains no room for doubt that Benaglia’s
residence at the hotel was not by way of compensation for his services, not
for his personal convenience or comfort or pleasure but solely because he
could not otherwise perform the services required of him. The occupation of
the premises was imposed upon him for the benefit of the employer.
2. His duty was continuous and required his presence at a moment’s call. The
manager must be alert to all things day and night. He would not consider
undertaking the job and the owners of the hotel would not consider
employing a manager unless he lived there.
3. Plus, even if his compensation was changed from time to time, there was no
mention of his meals, rooms, or service -- the corporation’s books carried
no accounting for it.
4. Under such circumstances, the value of meals and lodging is not income to
the employee, even though it may relieve him of an expense which he
would otherwise bear.
5. This is not to say that anytime an employee is fed or lodged by the
employer that it is not taxable income (case to case basis). If the
Commissioner finds that it was received as compensation and holds it to be
taxable income, the taxpayer contesting this must prove by evidence that it
is not income.
6. The court also looked at the intent of the parties and decided the employer
never intended the room and board to form part of his compensation.
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149. RR 3-98 (MIKA)
May 21, 1998| Special Rules – Fringe Benefit Tax
FACTS: (FB = fringe benefit; FBT = fringe benefit tax)
1. A ​final withholding tax is hereby imposed on ​the grossed-up monetary
value of fringe benefit furnished, granted or ​paid by the employer to the
employee​, whether such employer is an individual, professional partnership
or a corporation, regardless of whether the corporation is taxable or not, or
the government and its instrumentalities ​except when:
a. the fringe benefit is required by the nature of or necessary to the
trade, business or profession of the employer; or
b. when the fringe benefit is for the convenience or advantage of the
employer.
2. The FBT shall be imposed at the following rates:
a. Effective January 1, 1998 - 34%
b. Effective January 1, 1999 - 33%
c. Effective January 1, 2000 - 32%
3. The tax imposed under Sec. 33 of the Code shall be ​treated as a final
income tax on the employee which shall be withheld and paid by the
employer on a calendar quarterly basis as provided under Sec. 57 (A)
(Withholding of Final Tax on certain Incomes) and Sec. 58 A (Quarterly
Returns and Payments of Taxes Withheld) of the Code.
4. How to determine the grossed-up monetary value of the fringe benefit?
Divide the monetary value of the FB by the following percentages:
a. Effective January 1, 1998 - 66%
b. Effective January 1, 1999 - 67%
c. Effective January 1, 2000 - 68%
5. COVERAGE: only those fringe benefits given or furnished to ​managerial or
supervisory employees.
a. RANK AND FILE EMPLOYEES ARE EXEMPT from the
imposition of fringe benefits tax
b. This RR does not cover those benefits properly forming part of
compensation income subject to withholding tax on compensation.
6. Determination of the Amount Subject to the FBT: computation of the FBT
would entail a) valuation of the benefit granted and b) determination of the
proportion or percentage of the benefit which is subject to FBT. Unless
otherwise provided, the valuation of FB shall be as follows:
a. FB is granted in money or is directly paid for by the employer the
value = ​amount granted or paid for
b. FB is granted by the employer in property other than money and
ownership is transferred to the employee fb shall be = ​FMV of the
property
c. Same as (b) but ownership is not transferred to the employee the
value of fb = ​depreciation value of the property
7. Taxation of FB received by a Non-Resident Alien not engaged in trade or
business in the PH:
a. FBT of 25% shall be imposed on the grossed-up monetary value of
the FB
b. The said tax base shall be computed by: Monetary value of the
fringe benefit divided by 75%
8. FBT of 15% shall be imposed on the grossed-up monetary value of the FB
and the said tax base shall be computed by: monetary value of the fringe
benefit divided by 85% IF the FB is received by:
a. Alien individual employed by regional or area headquarters of a
multinational company
b. Alien individual employed by an offshore banking unit of a foreign
bank established in the PH
c. Alien individual employed by a foreign service contractor or by a
foreign service subcontractor engaged in the petroleum operations
in the PH
d. Any of their Filipino individual employees who are employed and
occupying the same position as those occupied or held by the alien
employees.
9. Taxation of fringe benefit received by employees in special economic
zones: FB received by employees in SEZs are subject to the normal rate of
FBT or special rates of 25% or 15%.
10. Definition of Fringe Benefit​: any good, service, or other benefit furnished
or granted by an employer in cash or in kind, in addition to basic salaries, to
an individual employee (except rank and file employee as defined in these
regulations) such as, but not limited to the following:
a. Housing;
b. Expense account;
c. Vehicle of any kind;
d. Household personnel, such as maid, driver and others;
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e. Interest on loan at less than market rate to the extent of the
difference between the market rate and actual rate granted;
f. Membership fees, dues and other expenses borne by the employer
for the employee in social and athletic clubs or other similar
organizations;
g. Expenses for foreign travel;
h. Holiday and vacation expenses;
i. Educational assistance to the employee or his dependents; and
j. Life or health insurance and other non-life insurance premiums or
similar amounts in excess of what the law allows.

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150. RMC 88-2012 (Isa)
December 27, 2012| X. Special Rules- Fringe Benefits Tax
RMC 88-2012 issued on December 28, 2012 ​clarifies the tax implications of
income or gain derived by an employee from the exercise of STOCK
OPTION PLANS.
In BIR Ruling No. 119-2012, it was ruled that any income or gain derived by the
employees from their exercise of stock options is considered as additional
compensation subject to Income Tax, and consequently, to withholding taxes on
compensation. In the said ruling, stock options were granted by domestic
corporations as part of their compensation plan. Under the plan employees were
given the right to buy a specified number of shares of a foreign corporation up to
a specified time/period from the grant date, at a fixed price regardless of the
stocks’s future market price. It was designed to reward employees and the
criteria for the reward was dependent on performance, outstanding business
achievements, and exemplary organization, technical or business
accomplishments/demonstrated expertise yielding significant effects on
business/society. At the same time, all full-time and most part-time employees
were given one-time number of shares upon employment.
Any income or gain derived from stock option plans granted to managerial
and supervisory employees which qualify as fringe benefits is subject to
fringe benefit tax imposed under Section 33 of the National Internal
Revenue Code (NIRC) of 1997, as amended.
In the event that employees subsequently sell, barter, exchange or otherwise
dispose of shares of stock obtained from their exercise of the stock options, the
tax treatment is as follows:
• If the shares involved are shares of stock in a domestic corporation not
traded in the Stock Exchange, the gain, if any, is subject to Capital
Gains Tax. Further, the sale or transfer of the said shares is subject to
the DST, upon execution of the deed transferring ownership or rights
thereto, or upon delivery, assignment or indorsement of such shares in
favor of another.
• If the shares involved are shares of stock listed and traded through the
Local Stock Exchange, the transaction is subject to stock transaction
tax.
• If the shares involved are shares of stock in a foreign corporation, the
gain, if any, is subject to ordinary Income Tax.
Summary: ​This circular stated that any income or gain obtained by the employees
from the exercise of stock options is additional compensation subject to income tax
and, consequently, to withholding tax on compensation. It, however, clarified that
the income or gain obtained by employees in managerial or supervisory
positions—which qualifies as a fringe benefit—is subject to the fringe-benefit tax.
The tax on compensation or fringe-benefit tax applies, whether the shares of stock
involved are those of a domestic corporation or a foreign one.

The additional compensation or the taxable fringe benefit, is the ​difference of

the book value (BV)/ fair market value (FMV) of the shares, whichever is
higher, at the time of exercise of the stock option and the price fixed on the
grant date. The option has value only if, at the time of the exercise, the stock is
worth more than the price fixed on the grant date. The additional compensation
or taxable fringe benefit arises whether the shares of stocks involved are that of a
domestic or foreign corporation.

If the shares to be issued at the exercise of the stock options come from the
unissued shares of stock of the issuing corporation, the original issuance of said
shares is subject to Documentary Stamp Tax (DST).

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151. RMC 79-2014 (Jaya)
October 31, 2014 | Special Rules - Fringe Benefits Tax
REVENUE MEMORANDUM CIRCULAR NO. 79-2014 clarifies the tax
treatment of stock option plans and other option plans.
Stock option are “shares of stocks” as defined by Section 22(L) of the National
Internal Revenue Code (NIRC) of 1997, as amended, and are taxable as such. In
the event that the said option was granted due to an employee-employer
relationship, and where the grantor is the employer and the grantee is the
employee, and no payment was received for the grant of the said option, on the
year an option was granted, the grantor cannot claim deductions for the grant of
the stock option. However, if the option was granted for a price, the full price of
the option shall be considered capital gains, and shall be taxed as such.
Upon issuance of the Option, the same is subject to a Documentary Stamp Tax
amounting to P 0.75 on each P 200.00, or fractional part thereof, of the par value
of the stock subject of the option, or in the case of stock without par value the
amount equivalent to 25% of the Documentary Stamp Tax paid upon the original
issue of the stock subject of the option, as provided for in the Section 175 of the
NIRC of 1997, as amended.
Any grant of an option for consideration, or transfer of the option is subject to
Capital Gains Tax. If the option was granted without any consideration, the cost
base of the option for purposes of computing capital gains shall be zero. If the
option is transferred by the grantee/subsequent owner without any consideration,
the same shall be treated as a donation of shares of stock subject to Donor’s Tax.
The basis shall be the fair market value of the option at the time of the donation.
In equity-settled options, the grantee/subsequent owner pays the exercise price to
the grantor and the latter is obligated to deliver the stocks to the owner of the
option.
In the event the option was granted by an employer involving the employer’s
own shares of stock or shares it owns, upon the exercise of the option by a
rank-and-file employee, an additional compensation equivalent to the difference
of the book value/fair market value of the shares, whichever is higher, at the
time of the exercise of the stock option and the price fixed on the grant date,
shall be recognized and subjected to Income Tax and consequently to
Withholding Tax on compensation. However, if the employee which exercises
the option occupies a supervisory or managerial position, the difference of the
book value/fair market value of the shares, whichever is higher, at the time of
the exercise of the stock option and the price fixed on the grant date, shall be
treated as a fringe benefit subject to Fringe Benefit Tax.
In the event the option was granted to a supplier of goods or services, the
difference between the book value/fair market value of the shares, whichever is
higher, at the time of the exercise of the stock option and the price fixed on the
grant date, shall be recognized as additional consideration for the services
rendered or goods supplied by the said supplier, and shall be subject to the
relevant Withholding Tax at source and other taxes applicable.
In the event the option was granted to a person, natural or juridical, who is not
an employee, or a supplier of goods or services to the grantor, the difference
between the book value/fair market value of the shares, whichever is higher, at
the time of the exercise of the stock option and the price fixed on the grant date
shall be considered a donation, and shall be subject to Donor’s Tax, among
others.
The above rules on equity-settlement option also applies in case of
cash-settlement options. Cash-settled options do not require the actual delivery
of stocks. Instead, the market value, at the exercise date, of the stock is
compared to the exercise price, and the difference (if in a favorable direction) is
paid by the grantor to the holder of the option. The issuing corporation shall
submit to the Revenue District Office where it is registered a statement under
oath within 30 days from the grant of the option indicating the following:
a. Terms and condition of the stock option
b. Names, TINs, positions of the grantees
c. Book value, fair market value, par value of the shares subject of the
option at the grant date
d. Exercise price, exercise date and/or period
e. Taxes paid on the grant, if any
f. Amount paid for the grant, if any
During the exercise period, the issuing corporation shall file a report on or
before the 10th day of the month following the month of exercise stating therein
the following:
a. Exercise date
b. Names, TINs, positions of those who exercised the option
c. Book value, fair market value, par value of the shares subject of the
option at the exercise date/s
d. Mode of settlement (i.e. cash, equity) e. Taxes withheld on the exercise,
if any
e. Fringe Benefits Tax paid, if any
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1. Background
a. A stock option is an option granted by a person, natural or
juridical, to a person or entity entitling said person or entity to
purchase shares of stocks of a corporation, which may or may not
be the shares of a stock of the grantor itself, at a specific price to be
exercised at a specific date or period referred to as
“equity-settlement option”. It may also occur even if no actual
shares of stocks are transferred in a situation wherein a person or
entity is given the right to obtain the difference between the actual
fair market value of a share and the fixed nominal value of the
shares of stock set in the grant of the option, at a specific date or
period, although no actual shares of stocks are transferred referred
to as “cash-settlement option”.
b. The grant, sale, transfer or exercise of the option may result to
taxable events.
c. Stock option are “shares of stock” as defined by Sec. 22 (L) of the
NIRC of 1997, as amended, and are taxable as such.
2. Tax treatment
a. Grant of option
i. In the event the option was granted due to an
employee-employer relationship, and where the grantor is
the employer and the grantee is the employee, and no
payment was received for the grant of the said option, on
the year an option was granted, the grantor cannot claim
deductions for the grant of the stock option. However, if
the option was granted for a price, the full price of the
option shall be considered capital gains, and shall be
taxed as such.
ii. Upon the issuance of the option, the same is subject to a
documentary stamp tax
b. Sale or transfer of option
i. The sale, barter or exchange of stock options is treated as
a sale, barter or exchange of shares not listed on the stock
exchange. Thus, any grant of an option for consideration
or transfer of the option is subject to CGT imposed under
Sec. 24(C) of NIRC. If the option was granted without
any consideration, the cost base of the option for purposes
of computing capital gains shall be zero.
ii. If the option is transferred by the grantee/subsequent
owner without any consideration, the same shall be
treated as a donation of shares of stock subject to donor’s
tax. The basis shall be the fair market value of the option
at the time of the donation.
c. Exercise of option
i. Equity-settlement option - the equity-settled options, the
grantee/subsequent owner pays the exercise price to the
grantor and the latter is obligated to deliver the stocks to
the owner of the option.
ii. In the events the option was granted by an employer
involving the employer’s own shares of stock or shares it
owns, upon the exercise of the option by a rank-and-file
employee, an additional compensation equivalent to the
difference of the book value/fair market value of the
shares, whichever is higher, at the time of the exercise of
the stock option and the price fixed on the grant date, tax
on compensation. However if the employee which
exercises the option occupies a supervisory or
managerial position, the difference of the book
value/fair market value of the shares, whichever is
higher, at the time of the exercise of the subject option
and the price fixed on the grant date, shall be treated a
fringe benefit subject to fringe benefit tax imposed
under Sec. 33 of the NIRC of 1997, as amended.
iii. In the event the option was granted to a supplier of goods
or services, the difference between the book/fair market
value of shares, whichever is higher, at the time of the
exercise of the stock option and the price fixed on the
grant date, shall be recognized as additional consideration
for the services rendered or goods supplied by the
supplier, and shall be subject to the relevant withholding
tax at source and other applicable.
iv. In the event the option was granted to a person, natural or
juridical, who is not an employee, or a supplier of goods
or services to the grantor, the difference between the book
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value/fair market value of the shares, whichever is higher,
at the time of the exercise of the stock option and the
price fixed on the grant date, shall be considered a
donation, and shall be subject to donor’s tax among
others.
d. Cash-settlement option
i. The above rules on equity-settlement option also applies
in cases of cash-settlement options. Cash-settled options
do not require the actual delivery of stocks. Instead, the
market value, at the exercise date, of the stock is
compared to the exercise price, and the differnce (if in
favorable direction) is paid by the grantor to the holder of
the option.
3. Reportorial requirements
a. Grant of option - within 30 days from the grant of option, the
corporation shall submit to the Revenue District Office where it is
registered a statement under oath indicating the following:
i. Terms and conditions of the stock option
ii. Names, TINs, positions of the grantees
iii. Book value, fair market value, par value of the shares
subject of the option at the grant date
iv. Exercise price, exercise date and/or period
v. Taxes paid on the grant, if any
vi. Amount paid for the grant, if any
b. Exercise of option - during the exercise period, the issuing corp
shall file a report on or before the 10th day of the month following
the month of exercise stating therein the following:
i. Exercise date
ii. Names, TINs, positions of those who exercised the option
iii. Book value, fair market value, par value of the shares
subject of the option at the exercise date/s
iv. Mode of settlement (i.e. cash, equity) e. Taxes withheld
on the exercise, if any
v. Fringe Benefits Tax paid, if any
4. General Applicability
a. The tax treatment and reportorial requirements in this circular are
rules of general applicability and also apply to options other than
stock.

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152. CIR v. Filinvest Development Corporation (Cla)
July 19, 2011 | Perez, J. | Transfer Pricing
PETITIONER: ​Commissioner of Internal Revenue
RESPONDENTS: ​Filinvest Development Corporation
SUMMARY:
Filinvest Development Corporation (FDC), a holding company, is
the owner of 80% of the outstanding shares of respondent Filinvest
Alabang Inc. (FAI) and 67.42% of the outstanding shares of
Filinvest Land Inc. (FLI). FDC and FAI entered into a Deed of
Exchange with FLI. FDC and FAI both transferred in favor of FLI
parcels of land. In exchange for said parcels which were intended to
facilitate development of medium-rise residential and commercial
buildings, shares of stock of FLI were issued to FDC and FAI. FDC
extended advances in favor of its affiliates and entered into a
Shareholders' Agreement with Reco Herrera PTE Ltd. (RHPL) for
the formation of a Singapore-based joint venture company.
FDC received from the BIR a Formal Notice of Demand to pay
deficiency income and documentary stamp taxes, plus interests and
compromise penalties. Deficiency taxes were assessed on the
taxable gain supposedly realized by FDC from the Deed of
Exchange it executed with FAI and FLI, on the dilution resulting
from the Shareholders' Agreement FDC executed with RHPL as
well as the "arm's-length" interest rate and documentary stamp
taxes imposable on the advances FDC extended to its affiliates.
Issue: Whether theoretical interests can be imputed on the advances
FDC extended to its affiliates in 1996 and 1997? NO. The CIR's
powers of distribution, apportionment or allocation of gross income
and deductions under Section 43 of the 1993 NIRC and Section 179
of Revenue Regulations No. 2 does not include the power to impute
"theoretical interests" to the controlled taxpayer's transactions.
DOCTRINE:
(PM Reyes) Despite the seemingly broad power of the CIR to
distribute, apportion and allocate gross income under Section 50,
the same does not include the power to impute theoretical interest
even with regard to controlled taxpayers’ transactions. This is true
even if the CIR is able to prove that the interest expense was in fact
claimed by FDC. The term in the definition of gross income that
even those income “from whatever source derived” is covered still
requires that there must be actual or at least probable receipt or
realization of the time of gross income sought to be apportioned,
distributed or reallocated. Finally, under the Civil Code, no interest
shall be due unless expressly stipulated in writing.
FACTS:
1. Filinvest Development Corporation (FDC), a holding company, is
the owner of 80% of the outstanding shares of respondent Filinvest
Alabang Inc. (FAI) and 67.42% of the outstanding shares of Filinvest
Land Inc. (FLI).
2. FDC and FAI entered into a Deed of Exchange with FLI. FDC and
FAI both transferred in favor of FLI parcels of land appraised at
P4,306,777,000.
3. In exchange for said parcels which were intended to facilitate
development of medium-rise residential and commercial buildings,
463,094,301 shares of stock of FLI were issued to FDC and FAI.
4. On January 13, 1997, FLI requested a ruling from the BIR to the
effect that no gain or loss should be recognized in the transfer of real
properties.
5. BIR then issued Ruling No. S-34-046-97 dated Feb. 3 , 1997, finding
that the exchange is among those contemplated under Sec. 34 (c) (2)
of the old NIRC
a. Sec.34 (c)(2)
i. no gain or loss shall be recognized if property is
transferred to a corporation by a person in exchange
for a stock in such corporation of which as a result
of such exchange said person, alone or together with
others, not exceeding four (4) persons, gains control
of said corporation.
6. On the various dates during the years 1996 and 1997:
a. FDC also extended ​advances in favor of its affiliates,
namely, FAI, FLI, Davao Sugar Central Corporation (DSCC)
and Filinvest Capital, Inc. (FCI).
b. FDC also entered into a Shareholders' Agreement with Reco
Herrera PTE Ltd. (RHPL) for the formation of a
Singapore-based joint venture company called Filinvest Asia
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Corporation (FAC), tasked to develop and manage FDC's
50% ownership of its PBCom Office Tower Project (the
Project)
i. FDC subscribed to P500.7 million worth of shares in
said joint venture company to RHPL's subscription
worth P433.8 million. Having paid its subscription
by executing a Deed of Assignment transferring to
FAC a portion of its rights and interest in the Project
worth P500.7 million, FDC eventually reported a net
loss of P190,695,061.00 in its Annual Income Tax
Return for the taxable year 1996.
7. FDC received from the BIR a Formal Notice of Demand to pay
deficiency income and documentary stamp taxes, plus interests and
compromise penalties.
a. Deficiency taxes were assessed on the taxable gain
supposedly realized by FDC from the Deed of Exchange it
executed with FAI and FLI, on the dilution resulting from
the Shareholders' Agreement FDC executed with RHPL as
well as the "arm's-length" interest rate and documentary
stamp taxes imposable on the advances FDC extended to its
affiliates.
8. FAI similarly received from the BIR a Formal Letter of Demand for
deficiency income taxes in the sum of P1,477,494,638.23 for the year
1997.
a. Said deficiency tax was also assessed on the taxable gain
purportedly realized by FAI from the Deed of Exchange it
executed with FDC and FLI.
9. Both FDC and FAI filed their respective requests for
reconsideration/protest, on the ground that the deficiency income and
documentary stamp taxes assessed by the BIR were bereft of factual
and legal basis.
10. In view of the failure of CIR to resolve their request for
reconsideration/protest, FDC and FAI filed a petition for review with
the CTA:
a. No taxable gain should have been assessed from the Deed of
Exchange since FDC and FAI collectively gained further
control of FLI as a consequence of the exchange.
b. CIR’s lack of authority to impute theoretical interests cannot
be demanded in the absence of a stipulation to the effect
c. Cash advances were not subject to DST
d. No income tax may be imposed on the prospective gain from
the supposed appreciation of FDC’s shareholdings in FAC.
11. FDC and FAC both prayed that the subject assessments for
deficiency income and documentary stamp taxes for the years 1996
and 1997 be cancelled and annulled.
12. CIR’s answer:
a. The transfer of property in question should not be considered
tax free since, with the resultant diminution of its shares in
FLI, FDC did not gain further control of said corporation.
b. The cash advances FDC extended to its affiliates were
interest free despite the interest bearing loans it obtained
from banking institutions, the CIR invoked Section 43 of the
old NIRC which, as implemented by Revenue Regulations
No. 2, Section 179 (b) and (c), gave him "the power to
allocate, distribute or apportion income or deductions
between or among such organizations, trades or business in
order to prevent evasion of taxes."
c. FDC realized taxable gain arising from the dilution of its
shares in FAC as a result of its Shareholders' Agreement
with RHPL.
13. CTA: with the exception of the deficiency income tax on the interest
income FDC supposedly realized from the advances it extended in
favor of its affiliates, cancelled the rest of deficiency income and
DST assessed against FDC and FAI for the years 1996 and 1997.
The increase in the value of FDC’s shares in FAC did not result in
economic advantage in the absence of actual sale or conversion
ISSUE:
1. Whether theoretical interests can be imputed on the advances FDC
extended to its affiliates in 1996 and 1997? NO.
RATIO:
1. Section 43 of the 1993 NIRC provides that, “in any case of two or
more organizations, trades or businesses (whether or not
incorporated and whether or not organized in the Philippines) owned
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or controlled directly or indirectly by the same interests, ​the
Commissioner of Internal Revenue is authorized to distribute,
apportion or allocate gross income or deductions between or among
such organization, trade or business, if he determines that such
distribution, apportionment or allocation is necessary in order to
prevent evasion of taxes or clearly to reflect the income of any such
organization, trade or business​."
2. From the definitions of the terms "controlled" and "controlled
taxpayer”, it would appear that FDC and its affiliates come within
the purview of Section 43 of the 1993 NIRC.
a. The term "controlled" includes any kind of control, direct or
indirect, whether legally enforceable, and however
exercisable or exercised. It is the reality of the control which
is decisive, not its form or mode of exercise. A presumption
of control arises if income or deductions have been
arbitrarily shifted.
b. The term "controlled taxpayer" means any one of two or
more organizations, trades, or businesses owned or
controlled directly or indirectly by the same interests.
3. Aside from owning significant portions of the shares of stock of FLI,
FAI, DSCC and FCI, the fact that FDC extended substantial sums of
money as cash advances to its said affiliates for the purpose of
providing them financial assistance for their operational and capital
expenditures seemingly indicate that the situation sought to be
addressed by the subject provision exists
4. From the tenor of paragraph (c) of Section 179 of Revenue
Regulations No. 2, it may also be seen that the ​CIR's power to
distribute, apportion or allocate gross income or deductions between
or among controlled taxpayers may be likewise exercised whether or
not fraud inheres in the transaction/s under scrutiny. For as long as
the controlled taxpayer's taxable income is not reflective of that
which it would have realized had it been dealing at arm's length with
an uncontrolled taxpayer, the CIR can make the necessary
rectifications in order to prevent evasion of taxes.
5. Despite the broad parameters provided, however, the CIR's
powers of distribution, apportionment or allocation of gross
income and deductions under Section 43 of the 1993 NIRC and
Section 179 of Revenue Regulations No. 2 does not include the
power to impute "theoretical interests" to the controlled
taxpayer's transactions.
6. The record yielded no evidence of actual or possible showing that the
advances FDC extended to its affiliates had resulted to the interests
subsequently assessed by the CIR. For all its harping upon the
supposed fact that FDC had resorted to borrowings from commercial
banks, the CIR had adduced ​no concrete proof that said funds were,
indeed, the source of the advances the former provided its affiliates.
7. Susan Macabelda (FDC's Funds Management Department Manager
who was the sole witness presented before the CTA) clarified that
the subject advances were sourced from the corporation's rights
offering in 1995 as well as the sale of its investment in Bonifacio
Land in 1997.
8. Said witness testified that said advances: (a) were extended to give
FLI, FAI, DSCC and FCI Financial assistance for their operational
and capital expenditures; and, (b) were all temporarily in nature since
they were repaid within the duration of one week to three months and
were evidenced by mere journal entries, cash vouchers and
instructional letters."
9. Even if we were, therefore, to accord precipitate credulity to the
CIR's bare assertion that FDC had deducted substantial interest
expense from its gross income, there would still be no factual basis
for the imputation of theoretical interests on the subject advances and
assess deficiency income taxes thereon.
10. Pursuant to Article 1956 of the Civil Code of the Philippines, no
interest shall be due unless it has been expressly stipulated in writing.
11. Considering that taxes, being burdens, are not to be presumed
beyond what the applicable statute expressly and clearly declares, the
rule is likewise settled that tax statutes must be construed strictly
against the government and liberally in favor of the taxpayer.
Accordingly, the general rule of requiring adherence to the letter in
construing statutes applies with peculiar strictness to tax laws and the
provisions of a taxing act are not to be extended by implication.
12. While it is true that taxes are the lifeblood of the government, it has
been held that their assessment and collection should be in
accordance with law as any arbitrariness will negate the very reason
for government itself.
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153. Her Majesty the Queen v. GlaxoSmithKline, Inc. (Charlie)
October 18, 2012| McLachlin CJ| Special Rules - Transfer Pricing
PETITIONER​: Her Majesty the Queen (Canada)
RESPONDENTS​: GlaxoSmithKline, Inc.
SUMMARY​: Glaxo Canada acted as a secondary manufacturer and marketer for
patented drug products. Between 1990 and 1993, they purchased the
pharmaceutical ingredient ranitidine for over $1,500 per kg for the patented drug
Zantac, pursuant to a Licensing Agreement with parent company Glaxo
Holdings, while two generic pharmaceutical were purchasing the same
ingredient for only $194-$304 for their generic drugs. They were reassessed for
the taxation years in question and their income was raised by some $51M on the
basis that it had paid more than a reasonable amount for the purchases. The Tax
Court affirmed the minister’s reassessment, employing the Comparable
Uncontrolled Price (CUP) method in directly comparing the purchase price of
Glaxo with those of the generics companies in finding the purchase price paid to
be unreasonable. The Court of Appeals, however, found that the Tax Court had
erred in not considering the Licensing Agreement in determining whether the
amount paid was reasonable. The CA instead adopted the “reasonable business
person” test, which required looking into the circumstances that an arm’s length
purchaser would consider relevant when deciding what price to pay. The issue is
WON the Licensing Agreement should be considered in determining the
reasonableness of the purchase price paid. The Court held YES. The Canadian
Income Tax Act required an inquiry into the price that would be reasonable in
the circumstances had the non-resident supplier and the Canadian taxpayer been
dealing at arm’s length, and as such, it necessarily involved consideration of all
circumstances relevant to the price paid. Such circumstances then include
agreements that may confer rights and benefits in addition to the purchase of
property where those agreements are linked to the purchasing agreement. In this
case, Glaxo Canada was paying for at least some of the rights and benefits under
the License Agreement as part of the purchase prices for ranitidine from
Adechsa. As such, the Licence Agreement could not be ignored in determining
the reasonable amount paid to Adechsa under the Income Tax Act, which applies
not only to payment for goods but also to payment for services. On the issue of
WON the price Glaxo Canada paid for ranitidine was greater than what would
have been reasonable if Adechsa and Glaxo had been dealing at arm’s length, the
case was remanded to the Tax Court for the determination of reasonableness.
DOCTRINE: ​A proper application of the arm’s length principle requires that
regard be had for the “economically relevant characteristics” of the arm’s length
and non-arm’s length circumstances to ensure they are “sufficiently
comparable”. Where there are no related transactions or where related
transactions are not relevant to the determination of the reasonableness of the
price in issue, a transaction-by-transaction approach may be appropriate.
However, “economically relevant characteristics of the situations being
compared” may make it necessary to consider other transactions that impact the
transfer price under consideration. In each case, it is necessary to address this
question by considering the relevant circumstances and, if required, transactions
other than the purchasing transactions must be taken into account. Such
circumstances will include agreements that may confer rights and benefits in
addition to the purchase of property where those agreements are linked to the
purchasing agreement. The objective is to determine what an arm’s length
purchaser would pay for the property and the rights and benefits together where
the rights and benefits are linked to the price paid for the property.
FACTS:
1. Glaxo Canada, a wholly owned subsidiary of Glaxo Group—which was
itself another wholly owned subsidiary of Glaxo Holdings, a UK
corporation—acted as a secondary manufacturer and marketer of patented
drug products.
2. Between 1990 and 1993, Glaxo Canada purchased ranitidine, the active
pharmaceutical ingredient in the brand-name anti-ulcer drug Zantac, from
Adechsa S.A. (Switzerland), a related non-resident company, for between
$1,512 and $1,651 per kilogram.
3. Glaxo Group owned the Zantac trademark and the patent for its active
ingredient, ranitidine, and granted rights under the patent and trademark to
Glaxo Canada under a License Agreement. Glaxo Canada purchased
ranitidine from Adechsa, a Glaxo Group clearing company located in
Switzerland, under a Supply Agreement.
a. License Agreement - granted rights and benefits (ex. right to
manufacture, use and sell Glaxo Group products; right to use
Glaxo trademarks (Zantac); receive technical assistance; access to
new products; registration and marketing materials, etc.)
b. Supply Agreement - Glaxo Group set the transfer prices of
ranitidine using the resale-price method (gross margin of 60%
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would be retained by the distributors and the ranitidine was priced
accordingly)
c. The Agreements also provided that Glaxo Canada was only to
purchase ranitidine from Glaxo Group-approved sources in order
to enjoy certain rights and benefits.
4. During the same period, two Canadian generic pharmaceutical companies,
Apotex Inc. and Novopharm Ltd., purchased ranitidine from other sources
for use in their generic anti-ulcer drugs for between $194 and $304 per
kilogram.
5. Glaxo Canada was then reassessed for the taxation years in question,
increasing its income by some $51M on the basis that it had paid Adescha
more than a reasonable amount for the purchase of ranitidine.
6. The Tax Court of Canada affirmed the minister’s reassessment, finding that
the appropriate test for the reasonableness of the transaction should have
been to compare the purchase to the highest price paid by the generic
pharmaceutical companies for ranitidine from arm’s length suppliers.
a. In holding so, he employed the Comparable Uncontrolled Price
(CUP) method referred to in the Organization for Economic
Co-Operation and Development (OECD)’s Guidelines.
b. The Tax Court also did not take into account Glaxo’s Licensing
Agreement in determining the reasonableness of the transactions.
7. The Federal Court of Appeals found that the Tax Court had erred in not
considering the License Agreement when determining whether the prices
paid by Glaxo were reasonable as the License Agreement was central to
Glaxo Canada’s business reality and would be so even if the relationship
with Adechsa was at arm’s length.
a. The Federal Court of Appeals instead adopted the “reasonable
business person” test, which required an inquiry into the
circumstances that an arm’s length purchaser would consider
relevant when deciding what price to pay.
ISSUES:
1. WON the Licensing Agreement should be considered in determining
the reasonableness of the purchase price paid - YES.
2. WON the price Glaxo Canada paid for ranitidine was greater than what
would have been reasonable if Adechsa and Glaxo had been dealing at
arm’s length - Undecided. Remanded to the Tax Court for the determination
of reasonableness.
RATIO:
1. Because the Canadian Income Tax Act requires an inquiry into the
price that would be reasonable in the circumstances had the
non-resident supplier and the Canadian taxpayer been dealing at arm’s
length, it necessarily involves consideration of ​all the circumstances of
the Canadian taxpayer relevant to the price paid to the non-resident
supplier.
2. Such circumstances will include agreements that may confer rights and
benefits in addition to the purchase of property where those agreements
are linked to the purchasing agreement. The objective is to determine
what an arm’s length purchaser would pay for the property and the
rights and benefits together where the rights and benefits are linked to
the price paid for the property.
3. The business of Glaxo Canada was the secondary manufacturing and
marketing of brand-name pharmaceuticals, including Zantac. Glaxo Canada
also engaged in research and development although there is no indication
that its research and development work pertained to Zantac. Glaxo Canada’s
purchase of ranitidine must be understood, having regard to this business
reality.
4. It was by virtue of the License Agreement that the Glaxo Canada was
required to purchase its ranitidine from Glaxo approved sources. There were
only two approved sources, one of which was Adechsa. Thus, in order to
avail itself of the benefits of the License Agreement, Glaxo Canada was
required to purchase the active ingredient from one of these sources. This
requirement was not the product of the non-arm’s length relationship
between Glaxo Canada and Glaxo Group or Adechsa. Rather, it arose
because Glaxo Group controlled the trademark and patent of the
brand-name pharmaceutical product Glaxo Canada wished to market. An
arm’s length distributor wishing to market Zantac might well be faced with
the same requirement.
5. The effect of the link between the License and Supply agreements was that
an entity that wished to market Zantac was subject to contractual terms
affecting the price of ranitidine that generic marketers of ranitidine products
were not.
6. As such, the rights and benefits of the License Agreement were contingent
on Glaxo Canada entering into a Supply Agreement with suppliers to be
designated by Glaxo Group. The result of the price paid was to allocate to
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Glaxo Canada what Glaxo Group considered to be appropriate
compensation for its secondary manufacturing and marketing function in
respect of ranitidine and Zantac.
7. Whatever price was determined by Glaxo Group would be subject to the
Income Tax Act and the requirement that the transfer pricing transactions be
measured against transactions between parties dealing with each other at
arm’s length.
8. Thus, it appears that Glaxo Canada was paying for at least some of the
rights and benefits under the License Agreement as part of the
purchase prices for ranitidine from Adechsa. Because the prices paid to
Adechsa were set, in part, as compensation to Glaxo Group for the rights
and benefits conferred on Glaxo Canada under the License Agreement, the
License Agreement could not be ignored in determining the reasonable
amount paid to Adechsa, which applies not only to payment for goods
but also to payment for services.

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 Block 2A 2021 | TAXATION 1 | Montero
154. RR 02-2013 (¥)
January 23, 2013 | Special Rules - Transfer Pricing
The RR was issued on January 23, 2013 further expands the coverage
of taxpayers required to file tax returns and pay taxes through the
Electronic Filing and Payment System (eFPS) to include National
Government Agencies (NGAs) mandatorily required to use the Electronic
Tax Remittance Advice (eTRA). Currently, the following taxpayers are
already mandated to make use of the eFPS: a. Large Taxpayers duly
notified by the Bureau of Internal Revenue (BIR); b. Top 20,000 Private
Corporations duly notified by the BIR; c. Top 5,000 Individual Taxpayers
duly notified by the BIR; d. Taxpayers who wishes to enter into contract
with government offices; e. Corporations with paid-up capital stock of Ten
Million Pesos; f. PEZA-registered entities and those located within Special
Economic Zones; and g. Government Offices, in so far as remittance
of withheld VAT and business tax is concerned. Now that eTRA
System, a sub-system of the eFPS, has been developed, the base of
taxpayers mandated to use eFPS is expanded to include all NGAs
since the latter make use of the TRA in settlement of their
withholding tax liabilities arising from the use of funds being released
by the Department of Budget and Management (DBM). Through the
eTRA System, the NGAs can access the eFPS, file their tax return
electronically and accomplish the eTRA on-line, provided the prescribed
enrollment to the eFPS has already been complied with. The BIR shall
issue a Notification Letter to all NGAs, including their branches and
extension offices located nationwide which have their own
disbursement functions, to inform them that they are mandated to use
the eFPS in filing the required returns and in paying the taxes due
thereon. The Head Office of the concerned NGA shall be responsible
in providing the BIR with the list of all its branches/field or
extension offices located nationwide which have their own
disbursement functions, with information as to their respective
business addresses, agency codes and Taxpayer Identification Numbers
(TINs). All NGAs notified thru the Notification Letter shall enroll in
the eTRA System by enrolling first with the BIR’s eFPS facility. As
part of the enrollment procedures, NGAs shall be required to submit
to the Revenue District Office (RDO) where they are registered the
names of two (2) authorized officers designated to file the required
tax returns pursuant to Section 52 (A) of the Tax Code. In addition,
NGA shall also enroll with any Authorized Agent Bank (AAB) where
it intends to pay through the bank debit system, in cases of remittance of
withheld taxes on funds not coming from the DBM or the payment of
internal revenue taxes thru cash and not thru TRA. NGAs mandated to
file electronically thru the issuance of the Notification Letter shall file
their tax returns enumerated under Section 2.12 of this Regulations,
via the eFPS, whether or not payment shall make use of eTRA. The
staggered filing of returns allowed for withholding agents/taxpayers
enrolled in the BIR eFPS facility shall not apply in the case of the
NGAs. All tax returns must be electronically filed (e-filed) following
the due dates prescribed in the table under Section 7 of this
Regulations. Payment of the tax due must also be made on the same
day the return is e-filed by accomplishing on-line the TRA. The use
of eTRA as payment is limited only to the NGAs’ tax liabilities
arising from the use of funds coming from the DBM. NGAs’ tax
liabilities arising from the use of funds other than those coming from
DBM based on the NGAs Annual Budget, as approved under the
General Appropriation Act (GAA) must be paid using cash through
the bank debit system of the AAB where the NGA shall enrol for
this purpose. A separate tax return must be accomplished for these tax
liabilities since a particular fund is required to have a separate branch
code. In the absence of a separate branch code of the fund, the NGA
shall secure the same from the concerned RDO following existing
procedures in registration. The concerned RDO shall conduct the
mandatory briefing to the concerned NGAs on the eTRA System.
Notified NGAs are required to attend the said briefing on eTRA,
which is a prerequisite to enrollment in the eFPS. The BIR, through its
Information Systems Group, shall generate report of NGAs’ remitted
withheld taxes using TRA based on cut-off dates to be defined under
a separate revenue issuance. The report generated shall be submitted
by the BIR’s Revenue Accounting Division to the Bureau of Treasury
and shall be used by the latter in recording and crediting the same as
BIR’s tax collections. For the pilot roll-out of the eTRA, the
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Withholding Tax Division shall conduct the eTRA briefing with the 1. Large Taxpayers duly notified by the BIR;
selected NGAs. All NGAs which will not be given Notification Letter 2. Top 20,000 Private Corporations duly notified by the BIR;
shall continue to file their tax returns manually by accomplishing the 3. Top 5,000 Individual Taxpayers duly notified by the BIR;
appropriate tax returns and attaching thereto the corresponding TRAs 4. Taxpayers who wishes to enter into contract with government
before having these documents received by the RDOs where the offices;
NGAs are registered. RDOs shall process these tax returns and report 5. Corporations with paid-up capital stock of Ten Million Pesos;
the collections thru TRAs following existing procedures. 6. PEZA-registered entities and those located within Special
Economic Zones; and
The eFPS is open to all taxpayers who wish to make use of 7. Government Offices, in so far as remittance of withheld VAT
the system. It was initially introduced to the taxpayers under the and business tax is concerned.
Large Taxpayers Service. However, the BIR has seen the need to
identify taxpayers who will be mandated to use the system; hence,
the following taxpayers are, at present, already mandated to make use of
the eFPS:

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155. RMO 63-99 (Jen) 3.1 Section 50. Allocation of income and deductions. — In any case of
July 19, 1999 | Special Rules - Transfer Pricing two or more organizations, trades, or businesses (whether or not incorporated
and whether or not organized in the Philippines) owned or controlled directly
or indirectly by the same interests, the Commissioner of Internal Revenue is
SUMMARY:
authorized to distribute, apportion, or allocate gross income or deductions
REVENUE MEMORANDUM ORDER NO. 63-99​ issued August 13, between or among such organizations, trades, or businesses, if he determines
1999 prescribes the policies and guidelines on the determination of taxable that such distribution, apportionment, or allocation is necessary in order to
income on inter-company loans or advances pursuant to Section 50 of the prevent evasion of taxes or clearly to reflect the income of any such
Tax Code, as amended. The arm's length bargaining standard will be used organizations, trades or businesses.
as the ultimate test for determining the correct gross income and 3.2 Section 50 empowers the Commissioner to rectify abnormalities and
deductions between two or more enterprises under common control. distortions in income brought about by common control through the adoption
of standards considered fair, reasonable or at arm's length.
July 19, 1999 3.3 This Order adopts the arm's length bargaining standard as the
REVENUE MEMORANDUM ORDER NO. 63-99 ultimate test for determining the fairness of related party transactions - i.e.,
SUBJECT : Determination of Taxable Income on Inter-company "the standard to be applied in every case is that of an uncontrolled taxpayer
Loans or Advances applying Section 50 of the NIRC, as Amended dealing at arm's length with another uncontrolled taxpayer".
TO : All Revenue Officers Concerned 4. Determination of Taxable Income on Inter-company Loans or
1. Objectives: Advances
1.1 To adopt the arm's length bargaining standard as the ultimate test for 4.1 In general. ​Where one member of a group of controlled entities
determining the correct gross income and deductions between two or more makes a loan or advances directly or indirectly, or otherwise becomes a
enterprises under common control. cdasia creditor of another member of such group, and charges no interest, or charges
1.2 To provide a means of redistributing or reapportioning income and interest at a rate which is not equal to an arm's-length rate as defined in
expenses of taxpayers under common control after applying Section 50 of the subparagraph (2) of this paragraph, the Commissioner may make appropriate
NIRC, as amended. allocations to reflect an arm's length interest rate for the use of such loan or
2. Coverage: advance.
This paper applies to all forms of bona fide indebtedness and includes: 4.1.1 If payments are made to parties under common control according to
2.1 Loans or advances of money or other consideration (whether or not a legally enforceable contract, the contract may still be recognized as valid.
evidence by a written instrument); However, for purposes of determining the true taxable income of the parties
2.2 Indebtedness arising in the ordinary course of business out of sales, involved, the interest rate charged may be subjected to reallocation.
leases, or the rendition of services by or between members of the group, or 4.1.2 Section 50 does not apply only to taxable entities. Reallocation may
any other similar extension; also apply to tax-exempt organizations.
2.3 But does not apply to alleged indebtedness which was in fact a 4.2 Arm's Length interest rate.
contribution of capital or a distribution by a corporation with respect to its 4.2.1 In general. ​For purposes of this Order, the arm's length interest rate
shares. shall be the rate of interest which was charged or would have been charged at
3. Applying Arm's Length on Section 50 of the NIRC, as amended the time the indebtedness arose in independent transaction with or between
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unrelated parties under similar circumstances. All relevant factors will be
considered, including the amount and duration of the loan, the security
involved, the credit standing of the borrower, and the interest rate prevailing
at the situs of the lender or creditor for comparable loans.
4.2.2 For purposes of determining the arm's length rate in domestic
transactions, the interest rate to be used is the Bank Reference Rate (BRR)
prescribed by the Bangko Sentral ng Pilipinas (BSP).
4.2.3 The fact that the interest rate actually charged on a loan or advance is
expressly indicated on a written instrument does not preclude the application
of Section 50 to such loan or advance.
5. Interest Period
5.1 The interest period shall commence at the date the indebtedness
arises, except that with respect to indebtedness arising in the ordinary course
of business out of sales, leases, or supply of goods and services which are
generally considered as trade accounts receivables or payables, the interest
period shall not commence if the taxpayer is able to establish that the normal
trade practice in a given industry is to allow balances, in the case of similar
transactions with unrelated parties, to remain outstanding for a longer period
without charging interest.
5.2 For purposes of determining the period of time for which a balance is
outstanding, payments or credits shall be applied against the earliest balance
outstanding. The taxpayer may, in accordance with an agreement, apply such
payments or credits in some other order in its books only after establishing
that the arrangement is customary for parties in that particular business.
LLjur
6. Effectivity
This Order shall take effect immediately.
(SGD.) BEETHOVEN L. RUALO
Commissioner of Internal Revenue

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