BIR Ruling

July 24, 1969 MEMORANDUM FOR The Revenue Operations Head (Assessment) There is returned to you herewith the entire docket bearing on the deficiency income tax case of the Twentieth Century Fox Philippines, Inc., Dee C. Chuan Bldg., Rizal Avenue, Manila, involving the total amount of P59,000.00 for the year 1963. LibLex The records show that the Twentieth Century Fox Philippines, Inc. (hereinafter referred to as the corporation), a domestic corporation engaged in the business of renting cinematographic films to local movie houses, filed its 1963 income tax return on April 2, 1964. It was disclosed in an investigation conducted on January 27, 1967 that the said corporation did not declare dividends for the years 1962, 1963 and 1964; and that as of December 31, 1963 it has an unreasonably accumulated surplus amounting to P200,000.00. On the basis of his findings, our investigating examiner recommended a deficiency income tax assessment against the corporation in the total amount of P59,000.00 which is 25% of P200,000.00 or of the actual surplus reported to be unreasonably accumulated as of December 31, 1963, inclusive of the 1/2% monthly interest. (Memorandum report of Examiner Jacinto J. Fajardo dated January 30, 1967). Up to the present, however, this Office has not issued any assessment notice to the corporation. The questions to be resolved in this case are the following, viz: (1) Whether or not the imposition of the 25% surtax in this case is legal and proper; and (2) Whether or not the right of the Government to assess and/or collect the 25% surtax has already prescribed. The 25% surtax imposed under Section 25 of the Tax Code is levied and assessed against a corporation that has unreasonably accumulated its profits or surplus, in addition to the tax imposed by Section 24 of the Tax Code. The sine quanon to taxability is the purpose of the avoidance of the income taxes on the corporation's shareholders, or the stock holders of some other corporation, through the medium of surplus accumulations. Should the failure to pay dividends be due to some other cause, such as the use of the undistributed earnings and profits for the reasonable needs of the business, then the corporation does not fall within the interdiction of the statute. (Vol. 7, Mertens' Law of Federal Income Taxation). The questions of whether or not the retained earnings of the corporation is reasonable or unreasonable is to be resolved and decided on the basis of the nature of the business, the volume of the business done, the keenness of competition, principles of sound business management, the conditions of the times, the threat of adverse legislation against the industry. (Seaboard Security Co., 38 BTA 560; Montgomery's Federal Taxes, Vol. 1, 1956-1957, p. 827; Williams Investments Co., v. U.S. 3 F Stupp. 225 (CT. CIS; 1953) Law of Federal Income Taxation, Mertens' Vol. 7). An accumulation of earnings or profits (including the undistributed earnings or profits of prior years) is unreasonable if it is not required for the purpose of the business, considering all the circumstance of the case. The records of this case disclosed that the corporation retained or accumulated its earnings or profits beyond the reasonable needs of its business. In this connection, our investigating examiner reported that the "Corporation did not declare her dividends since 1962, 1963 and 1964. It was further verified that the herein corporation has a sound financial condition. Please refer to the financial statement for the period under review. Hence, it is believed that the accumulated Surplus of P200,000.00, is beyond the reasonable needs of the business. The Accountant on one hand, maintained that dividends weren't declared for the simple reason that some of the employees are getting old the corporation has no funds to cover their retirement pay. . . It was also insisted by the undersigned that the corporation set-up a Reserve for Contingencies,". The taxpayer in this case is engaged exclusively in the business of renting films which do not require the retention of a large amount of working capital in pursuance of its business activities. The business of the taxpayer does not require investments in plants nor the provisions of sinking funds since it does not manufacture or process films. In other words, there is no valid reason to permit its surplus to accumulate except, perhaps, if there is no cash available on hand. But it is observed from the financial statements of the corporation that its cash on hand as of December 31, 1963 is P202,632.99 which is more than the accumulated surplus without adversely affecting the working capital even if the total surplus were declared and distributed as cash dividends. Such being the case, the imposition of the 25% surtax on the unreasonably accumulated surplus of the corporation amounting to P200,000.00 is legal and proper. The Secretary of Justice in his Opinion No. 104 dated December 12, 1949 ruled that Section 25 of the Tax Code, as amended, which imposes the additional tax equal to twenty-five per centum (25%) of the undistributed portion of the accumulated profits or surplus of a corporation formed or availed of for the purpose of preventing the imposition of the tax on its shareholders or members through the medium of permitting its gains or profits to accumulate instead of being divided or distributed, clearly establish a penalty for an attempt to circumvent the payment of an internal revenue tax and defraud the Government of a tax legitimately due it. cdlex Accordingly, the right of the Government to assess and/or collect taxes due in this case has not yet prescribed. From April 2, 1964, the date the corporation filed its income tax return, with the financial statement of the corporation for the year ending December 31, 1963 therein attached, the Government has ten (10) years within which to assess the corporation of the said 25% penalty tax pursuant to Section 332 of the National Internal Revenue Code. In view of the foregoing considerations, that Office is instructed to cause the immediate issuance of the corresponding assessments against the Twentieth Century Fox Philippines, Inc. (SGD.) MISAEL P. VERA Commissioner of Internal Revenue