Preferred Shares of Stock — No Debtor-Creditor Relationship Between Corporation and Holders of Preferred Shares

June 21, 1979 BIR RULING NO. 049-79 Preferred shares of stock no debtor-creditor relationship between corporation and holders of preferred shares . This refers to your letter dated April 4, 1978 requesting a ruling on whether or not redeemable preferred shares can be considered as a corporate borrowing and the rate of income tax which BF Homes Incorporated (Hereinafter referred to as the corporation) is required to withhold on the interest which will be paid to the holders thereof. It is represented that the corporation will issue and/or sell to the public 200,000 shares of redeemable preferred shares with a par value of P100.00 per share; that the preferred shares shall be entitled to dividends at such rates and under such terms and conditions as declared and approved by the Board of Directors of the corporation, but not exceed 14% of par value per annum; that the preferred shares are cumulative, non-participating, non-voting and non-convertible; that the preferred shares can be sold upon issuance of the certificates or surrendered to the corporation after three (3) years from date of issue; That such preferred shares shall be redeemable at the option of the corporation; and that the corporation reserves the right to redeem the preferred shares after the first year from date of issue. aisa dc In reply, I have the honor to inform you that the stockholder is not a creditor of the corporation, for he makes a contribution to capital and not a loan. The corporation is not his debtor. (Booth vs. Union Fiber Co., 137 Minn. 7, 162 N.W. 677 cited in Vol. II Tolentino's Commentaries and Jurisprudence on the Commercial Laws of the Philippines) Holders of preferred shares are stockholders in the corporation, with all the rights and liabilities of stockholders, and are not creditors of the corporation. (Warren vs. King, 108 U.S. 389 cited in Vol. II Tolentino's Commentaries supra ). As there is no debtor-creditor relationship between the corporation and the holders of preferred shares, "preferred shares cannot be issued with a fixed annual interest on the face thereof inasmuch as this will change the contract of subscription between the corporation and the shareholders to one of loan and will destroy the well-established corporate theory that shares of stock are not credits or debts due from the corporation to the stockholders". (Rev. Memo. Circular No. 17-71 dated July 12, 1971) In view of the foregoing considerations, this Office is of the opinion that the preferred shares adverted to in your inquiry cannot be considered an indebtedness of the corporation to the holders thereof regardless of the conditions under which such shares are issued and consequently, the "interest" which are actually dividends paid thereon are not deductible from the gross income of that corporation. The dividends or "interest" which will be paid to the holders thereof shall be subject to a creditable withholding tax of 10% pursuant to Section 53 (c) of the National Internal Revenue Code of 1977.