Determination of Unreasonable Accumulation of Surplus Earnings Penalized under Sec. 25 of Tax Code

June 2, 1986 BIR RULING NO. 072-86 25 000-00 072-86 Gentlemen : This refers to your letter dated May 5, 1986 stating that your client, a domestic corporation is neither a holding company nor an investment company; that it is owned and controlled by foreign interests; that it has consistently declared cash dividends at an average of more than 80% of its net income from 1980 to 1983; that it declared cash dividends for 1984 and 1985 only at an average of 20% of net income resulting in the accumulation of surplus earnings approximating 60% to 80% of paid-up capital; that its projected balance sheet at year-end 1986 is: Assets = Liabilities Capital Current P300,000 Current Liabilities = Paid up Capital P90,000 = P155,000 Fixed and Long term & Other = Retained earnings investments 100,000 15,000 = 140,000 Total P400,000 = P105,000 + P295,000 Percentages 100% = 26% + 74% that the above investments included P35,000 in agricultural undertaking which anticipates an additional funding of P10,000 in 1985; that this is a joint venture approved by the Board of Investments; that your client accumulated most of the profits during the period (1984/1985) of uncertainty in the Philippine business and economic environment; and that declaration of dividends during those times and even up to the present would mean an added burden to the deteriorating foreign exchange reserves of our country. Based on the foregoing representations, you now ask information as to whether your client which in this case, is not identified and whose nature of business is not shown, had an unreasonable accumulation of surplus earnings in 1986 penalized under Section 25 of the Tax Code as amended. In reply, please be informed that in addition to the tax imposed by Section 24 of the Tax Code, a 25% surtax is levied and assessed against a corporation that has unreasonably accumulated its profits or surplus as contemplated under Section 25 of the same Code. The question, however, of whether or not the retained or accumulated earnings of the corporation is reasonable or unreasonable is one of fact and is to be resolved and determined on the basis of the nature of the business, the financial condition of the corporation at the close of the taxable year, the volume of the business done, the keenness of completion, principles of sound business management, the conditions of the times, and the threat of adverse legislation against the industry. (Seaboard Security Co., 38 BTA 560; Whitney Chain & Manufacturing Co., 149 F2d 936 (CCA 2d, 1945) cited Vol. 7 Mertens' Law of Federal Income Taxation) Moreover, in determining whether accumulation of earnings or profits in a particular year are within the reasonable needs of a corporation, it is necessary to take into account prior accumulations, since accumulation 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. (Basilan Estates, Inc. vs. C.I.R., G.R. No. L-22492, Sept. 5, 1967) cdtech Accordingly, if the nature of your client's business is such that the abovementioned retention or accumulation of profits and surplus in 1984 and 1985 is for the reasonable needs of its business, taking into consideration its financial condition at the close of taxable years 1984 and 1985 and the uncertainty in the Philippine business and economic conditions of the times, then your client had no unreasonably accumulated surplus in 1986 subject to the 25% surtax imposed by Section 25 of the Tax Code. Very truly yours, (SGD.) BIENVENIDO A. TAN, JR. Commissioner