BIR Ruling

1997 MEMORANDUM FOR: The Commissioner This refers to the internal revenue tax case of A. H. ROBINS (PHILS.) CO., INC. (now c/o Wyeth-Suaco Laboratories, Inc.), with address at the 14th Floor, Strata 100 Building, Pasig City, involving the amounts of P928,659.20 and P10,320,403.75 as 1984 deficiency income tax and as additional tax on improperly accumulated profits or surplus for the fiscal year ending November 30, 1984, issued under FAS-1-84-89-000597 on April 13, 1989. The records disclose the following facts and circumstances: 1. A. H. Robins (Phils.) Co., Inc. was incorporated on May 18, 1965, by five (5) Filipinos for the following stated purpose: "To manufacture, process, compound, repack, prepare for market, import, export, buy, sell at wholesale, distribute, transport and promote general merchandise, goods and wares of all kinds and descriptions, particularly but not limited to pharmaceutical preparations, drugs, medicines, chemicals, compounds, druggists' sundries and supplies, cosmetics, perfumeries, toilet articles, scientific apparatus, and physicians' and hospital supplies; and likewise to apply for, obtain, register, purchase, lease or otherwise acquire, and to hold, use, exercise, develop, operate and introduce, and to sell, assign, grant licenses or territorial rights in respect of, or otherwise to turn to account or dispose of, any trade marks, trade names, brands, labels, patents, inventions, formulas or processes for such products." 2 For the fiscal year ending November 30, 1984, the taxpayer reported in its annual income tax return (p. 164) a taxable net income of P28,537,537.00, and paid as tax thereon the amount of P1,973,377.00; 3. For the same taxable year, the taxpayer reflected in its balance sheet (p. 159) as retained earnings the amount of P41,281,615.00, and; in its income statement, the amount of P22,440,451.00 as operating expenses; 4. Upon examination, the taxpayer was found to have over-charged sample expenses by P1,658,319.81, computed as follows (p. 186): Computation of Salesmen's Samples, Literature and other supplies Amount charged to profit and loss statement P3,435,594.00 Beginning balance per books (p. 8) P522,269.53 Add: Production Cost of samples to manufacture (pp. 17 & 26) 1,747,440.43 Total Samples Available P2,269,709.96 Less: Ending Balance of samples (p. 8) 492,436.53 Cost of samples distributed free 1,777,273.43 OVER-CHARGED SAMPLES EXPENSES P1,658,319.81 5. On the basis of the foregoing findings, the taxpayer was assessed a deficiency income tax of P928,659.20, computed as follows: cdta Net Income per ITR P28,537,537.00 Add: Disallowances Salesmen's samples over-charged 1,658,319.81 Net Income per Investigation P30,195,856.81 Tax Due thereon per investigation P10,558,550.00 Less: Tax already paid 9,978,138.00 Deficiency income tax per investigation P580,412.00 Plus 20% interest from 3-15-85 to 3-15-89, maximum of 60% 348,247.20 AMOUNT DUE & COLLECTIBLE P928,659.20 6. Based on the taxpayer's protest contained in its letter dated May 25, 1989 and on the report of the Section Chief of the International Tax Affairs Division (ITAD) dated September 4, 1992, the Chief of ITAD recommended, on September 14, 1992, that the income tax liability of the taxpayer be adjusted as follows: From To Net income per return P28,537,537.00 P28,537,537.00 Add: Total adjustment 1,658,319.81 289,535.34 Adjusted Net income P30,195,856.81 P28,827,172.34 Less: Exemptions Taxable Net income P30,195,856.81 P28,827,172.34 Tax Due P10,558,550.00 P10,089,510.00 Less: Tax paid /return 9,978,138.00 9,978,138.00 Deficiency P580,412.00 P111,372.00 Add: Surcharge 27,843.00 Interest 348,247.20 83,529.00 Compromise TOTAL AMOUNT DUE P928,659.20 P222,744.00 7. Insofar as the imposition of the 1984 surtax on improperly accumulated profits is concerned, the examiner reported on March 1, 1989 the following findings: cdti Retained Earnings as of November 30, 1984 P41,281,615.00 25% Surtax under Section 25 (then) Tax Code P10,320,403.75 Balance Sheet of A.H. Robins, as of November 30, 1984 & 1983 Stockholders' Equity 1984 1983 Capital Stock, issued & outstanding P8,784,460.00 P8,784,460.00 Retained Earnings 41,281,615.00 22,725,324.00 Capital Ratio 467.94% 258.70% As justification, the examiner noted that there was no appropriated retained earnings for future expansion projects or programs approved by the board of directors, coupled with the fact that there was a very unusual supply or stock of raw material good for nine (9) months period considering that the bulk of raw materials imported are readily available from its parent company, A.H. Robins, (USA). As rebuttal, taxpayer raised the following arguments: a). That the requirement on the distribution of surplus profits in excess of 100% of paid-in capital as dividend applies only to stock corporations which are: (a) publicly-held or with twenty or more stockholders; and (b) corporations whose securities are listed in the stock exchange or with permits to sell securities to the public (Sec Rulings dated Sept. 14, 1973 and Jan. 8, 1974); b). That there was, at that time, a moratorium on foreign exchange (August 21, 1983 up to about October 14, 1984) so that it resorted to buying its raw material with every available foreign exchange that may be sourced in order that it could continually produce its products. Before we proceed to discuss the merits of the case, let us first scan the provision of the law imposing the 25% surtax on unreasonable accumulation of retained earnings/surplus. Section 25 of the (then) Tax Code imposes the 25% penalty tax if the corporation is shown to be formed or availed of for the purpose of avoiding the imposition of income tax upon its shareholders by permitting its earnings and profits to accumulate , instead of being distributed . . . It is clearly shown in the law that the touchstone of the liability is the very purpose behind the accumulation of surplus so as to avoid or prevent the imposition of income tax upon its shareholders the fact of accumulation or the size of the accumulated retained earnings/profits, would not be sufficient basis for the imposition of the surtax unless it can be established that the accumulation of surplus was intentionally done to prevent the imposition of tax on its stockholders. After a thorough and careful study of the facts of the case, as well as the law and jurisprudence applicable thereto, it is submitted and we agree with the taxpayer's contention that it is not subject to the 25% surtax. First of all, it should be pointed out that the requirement on the distribution as dividends of surplus profits in excess of 100% of the paid-in capital applies only to stock corporations which are publicly-held or with twenty (20) or more stockholders (SEC Opinion, Sept. 14, 1973). It does not apply to wholly owned subsidiaries of foreign corporations (SEC Opinion, Jan. 8, 1974). As correctly argued by the taxpayer, A.H. Robins is not publicly listed but is a wholly-owned subsidiary of A.H. Robins Co., Inc., a foreign corporation based in Richmond, Virginia, U.S.A., which owns 99.99% of the capital stock of the former. This fact is supported even by the findings of the examiner in his report dated March 1, 1989, a portion of which is hereby quoted: aisadc "It has been granted by A.H. Robins Co., Inc. of Richmond, Virginia, U.S.A. the exclusive right to import, process and distribute in the Philippines "ROBINS" ethical pharmaceutical products in consideration of a three (3) percent royalty fee on the net sales. As the corporation grew bigger and bigger in the succeeding years of operation, A.H. Robins Co., Inc., U.S.A. from whom the Filipino Corporation adopted its name, gradually bought out the Filipino stockholders . Thus, becoming a wholly owned Foreign Corporation . . . ." (Emphasis Ours) Records show that as of November 18, 1980, the Authorized Capital Stock of A.H. Robins was increased to P24,500,000.00. The subscribed and paid shares of stock increased to P8,769,100 is broken down as follows: Name of Stockholder Citizenship No. of Shares Ratio 1. A.H. Robins (USA) American 876,900 99.99885% 2. E. Robins, Jr. Filipino 2 .00115% 3. G.E.R. Miller American 2 .00115% 4. W.A. Forrest American 2 .00115% 5. W.D (illegible) American 2 .00115% 6. F. Feliciano Filipino 2 .00115% TOTAL 876,910 From the foregoing facts, it would be clearly unfair to the taxpayer if we impose the 25% surtax on its retained earnings considering that the requirement on the distribution as dividends of surplus profits, in excess of the 100% paid-in capital, does not apply to it. Moreover, we are equally impressed with the taxpayer's contention that it was not guilty of unduly accumulating surplus profits. Undue accumulation of surplus is a relative term, which can be established by preponderance of evidence and is dependent upon a consideration of all circumstances of each case (Basilan Estate Inc. vs. CIR, 21 SCRA 17). As such, the touchstone of liability is the purpose behind the accumulation of the income and not the consequences of the accumulation. Neither the size of the retained earnings nor the net liquid asset alone is determinative of improper accumulation (Manila Wine Merchants Inc. vs CIR, J-26145, Feb. 20, 1984). Based on the foregoing judicial pronouncements, we find the reliance by the examiner merely on the size of retained earnings plus the unusual inventory of raw materials, insufficient to declare that taxpayer was unduly accumulating its profits to avoid the imposition of income tax upon the stockholders. We are of the opinion that the action of the taxpayer (in retaining surplus profits and having a substantial supply of raw materials) was a sound business prerogative at that time. It is a matter of public knowledge that the years following the assassination of former Senator Benigno S. Aquino (in 1983) were considered dark years for the Philippine economy. The large depreciation of the peso exchange rate and scarcity of foreign exchange triggered the surge in domestic prices and hoarding of commodities. Doubts and uncertainties described the business environment making businessmen worry about their investments. cdtech In anticipation of further uncertainties brought about by the foreign exchange moratorium, taxpayer resorted to buying raw materials with every foreign exchange that may be sourced in order to ensure a steady supply of its products to the general public. Taxpayer is engaged, in the year involved, in the processing and distribution of pharmaceutical products, and as a dealer of essential commodities, we find it natural for the taxpayer to make sure that its supplies are plenty enough to protect the needs of its clients. All facts considered, we find strong basis to support the contention that the imposition of the 25% surtax is not in order and should be cancelled. In view of all the foregoing, this Division respectfully recommends the reduction of the taxpayer's 1984 deficiency income tax from P928,659.20 to P222,744.00 and cancelling the assessment for 25% surtax on undue accumulation of retained earnings in the amount of P10,320,403.75. cdt Respectfully submitted: (SGD.) RODULFO L. SALAZAR Chief, Appellate Division I CONCUR: (SGD.) ALICIA P. CLEMENO Assistant Commissioner Legal Service By: (SGD.) ALICIA L. TOMACRUZ Head Revenue Executive Assistant (Legal Service) Recommendation APPROVED (SGD.) LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue