Lido Export, Inc. v. Court of Tax Appeals

NINTH DIVISION [CA-G.R. SP. No. 39000. October 28, 1999.] LIDO EXPORT, INC. , petitioner , vs . HON. COURT OF TAX APPEALS and the COMMISSIONER OF INTERNAL REVENUE , respondents . D E C I S I O N SALAZAR-FERNANDO , J p : Before us is a Petition for Review filed by Lido Export, Inc. seeking for the reversal of the decision of the Court of Tax Appeals ordering petitioner to pay the amount of P3,007,633.82 as deficiency final withholding tax on income of non-resident stockholders and the sum of P2,912.19 as deficiency final withholding tax on cash dividends, plus 25% surcharge and 29% interest from May 11, 1990 up to the full payment thereof. The factual background of the case is as follows: Lido Export, Inc. (Lido) is engaged in the manufacture and export of table linens and other tabletop accessories which are exported to W/C: Imports, Inc. in the United States. Prior to April 14, 1987, seventy-five percent (75%), or majority of the outstanding capital stock of Lido was owned by spouses Robert and Virginia Cromwell, both American nationals. On April 14, 1987, the Cromwell spouses sold their shareholdings to Metonic Investments Limited, a Jersey channel islands corporation, under a Stock Purchase and Sale Agreement executed by: Robert H. and Virginia J. Cromwell, on one hand, and Metonic Investments Limited, on the other hand. Cromwell spouses were residing then at Newport Beach, California, USA. To protect the buyer, two (2) separate Non-competition Agreements were executed: 1. Between petitioner Lido and Metonic Investment Limited on one hand, and Robert H. Cromwell on the other hand; and 2. Between petitioner Lido and Metonic Investments Limited on one hand, and Virginia J. Cromwell on the other hand. LexLib As consideration thereto, Lido and Metonic were made jointly and severally liable to pay US$250,000 to the Cromwell spouses, payable to the Cromwells on March 31, 1988 or one year from the Closing Date, whichever would come first. In petitioner's (Lido) book of account, the US$250,000 payable to Cromwell spouses was recorded as a deferred asset account "Non-competition covenant payable" for P5 Million. The Stock Purchase and Sale Agreement and the Lido Non-competition Agreements were executed on April 14, 1987 in Newport Beach, California. These instruments were marked "Execution Draft" but were not notarized. On the same day, Spouses Cromwell sold their shareholdings in W/C Imports, Inc., a corporation based in California, USA, to Ashling Corporation, likewise based in California. W/C Imports was the buyer of 97% to 98% of petitioner's products in the USA. By virtue of this sale, another two (2) Non-competition Agreements were made between: 1. Robert H. Cromwell on one hand and W/C Import, Inc. and Ashling Corporation on the other hand; and 2. Virginia J. Cromwell on one hand and W/C Import Inc., and Ashling Corporation on the other hand. Under the W/C Non-competition Agreements, W/C Import and Ashling Corporation bound themselves to pay to each of the Cromwell spouses the sum of US$223,500.00 as a consideration for the Cromwell spouses' covenant not to compete. The petitioner's liability to the Cromwell spouses under the Lido Non-competition Agreement had a peso equivalent of P5,112,500.00 based on the prevailing foreign exchange rate and was made as a basis for computing the alleged deficiency assessment for 30% withholding tax, to be amortized over 5 years from the period of the effectivity of the non-competition covenant. The amortization for the months of April, May and June, 1987 (the reckoning date was the date of execution of the non-competition agreements, April 14, 1987) or a total of P256,500.00, was charged to operation and deducted from gross income, for income tax purposes for the fiscal year ending on June 30, 1987 by the petitioner. It could be deduced from the records of the case that the Lido Non-competition Agreement and W/C Import Non-competition Agreement were later rescinded. The reasons given the petitioner for the rescission were as follows: "Rescission of the Noncompetition Agreements 20.01 The rescission of the Lido Noncompetition Agreements and the W/C Noncompetition Agreements was made when it was brought to the attention of the parties that Petitioner and its majority stockholder (Metonic Investments Limited) had been erroneously included as parties to the Noncompetition Agreements. 20.02 Since Petitioner's products were marketed in the United States, the covenant not to compete would logically be performed by the Cromwells in the United States. 20.03 As mere producer or supplier of the merchandise being sold by W/C Imports, Inc. in the United States, Petitioner and its majority stockholder would not gain anything by the noncompetition covenants. 20.04 It was W/C Imports, Inc. that would be benefitted (sic) since it was the one marketing the products of Petitioner in the United States. Otherwise put, it was W/C Imports, Inc. and not petitioner who would be affected adversely should there be any competition from the Cromwells (TSN Hearing, March 29, 1993, p. 26). 21. To correct this error, the parties rescinded the Lido Noncompetition Agreements on March 31, 1988 in their entirety. Robert H. Cromwell and Virginia J. Cromwell, individually, and Petitioner, Metonic Investments Limited, W/C Imports, Inc. and Ashling Corporation executed two separate Memorandums of Understanding Regarding Noncompetition Agreements and Related Agreements to rescind the Lido Noncompetition Agreements (Exhs. B and C) . . . 22.01 The other reasons for the rescission of the Lido Noncompetition Agreements were the following: 22.02 The parties realized that the business and economic conditions in the Philippines did not warrant or require a covenant not to compete in the Philippines from the Cromwells. This is expressly stated in the last of the whereas clauses of the Memorandums of Understanding, to wit: "WHEREAS, certain business and economic conditions in the Philippines have changed such that each of the parties to these Memorandum (collectively the "Parties" and individually a "Party") desires to make certain amendments, clarifications and/or rescissions related to the various agreements described hereinabove. . . 22.03 The Central Bank Regulations in force at that time prohibited the incurring of any foreign currency obligations. 22.04 Petitioner was in poor financial condition at that time . . . 22.05 It is uniformly stipulated in paragraph 2 of the said Memorandums of Understanding that: "2. The Original Lido Noncompetition Agreement, the Amended Lido Noncompetition Agreement; the Tax Agreement, the Guaranty Agreement, and the Letter of Credit, Memorandum are hereby rescinded in their entirety. The Parties intend that this rescission shall release all parties to the foregoing agreements from any and all obligations thereunder as if the agreements, and each of them, had never been made; provided however, and notwithstanding anything in this Section 2 to the contrary, the Parties specifically acknowledge and agree that increased payment obligations owing to Cromwell under the Amended W/C Noncompetition Agreement represent payment obligations arising the Original Lido Noncompetition Agreement such that Cromwell shall continue to be entitled to make drawings upon the Letter of Credit in accordance with the terms and provisions. In making any such drawings upon the Letter of Credit, Cromwell shall be entitled to present a sight draft certifying that the amount shown on the draft represents a sum due and payable to Robert H. Cromwell under the Original Lido Noncompetition Agreement." (Emphasis supplied)" 1 In the same manner as the "Stock Purchase and Sale Agreement" and the "Lido Non-competition Agreements," the Memoranda of Understanding were marked "Execution Draft" on the first pages but were not notarized. The W/C Non-competition Agreements were then amended to include the consideration under the rescinded Lido Non-competition Agreement with a total of US$250,000 effective on April 14, 1987 making the W/C Non-competition Agreement with a total of $348,500.00. As a result thereto, petitioner reversed the accrual of liability and the related unamortized deferred charges and reflected 'no balance' for "Deferred Charges" and "Other current liabilities" account in their Audited Comparative Balance Sheets as of June 30, 1987 and 1988. LexLib The eliminated amortization expenses were then reported as income for the tax year ending June 30, 1988. The following were done by petitioner in view of the rescission of the Lido Non-competition Contract: 2 "28. To be consistent, Petitioner also reversed and reported an income for the tax year ending June 30, 1988 the corresponding amortization expense, which had been claimed as deduction from gross income for the fiscal year ending on June 30, 1987, in the amount of P256,500. This represented the amortizations for the months of April, May and June 1987 . . . 29. Petitioner likewise reversed the monthly amortization expenses relating to the noncompetition covenant from July 1987 to February 1988 during the fiscal year ending June 30, 1988 and prior to the execution of the Memorandum of Understanding on March 31, 1988. 30. With the reversal of the accrued liability to the Robert H. Cromwell and Virginia J. Cromwell the related non-competition asset account and the amortization expenses for the fiscal year ended June 30, 1988 and the recognition as income of the amortization expense claimed as deductible expense in 1987, the Lido Noncompetition Agreements were cancelled in the books of Petitioner as if said agreements never existed. 31. This implemented the intention of the parties expressed in the memorandums of Understanding to "release all parties to the foregoing agreements, from any and all obligations thereunder as if the agreements, and each of them, had never been made . . . 32.01 In accordance with the Memorandums of Understanding . . . and the Amended W/C Noncompetition Agreements . . ., W/C Imports, Inc. paid $250,000 to Robert H. Cromwell and Virginia J. Cromwell. . . . 32.02 Petitioner did not reimburse W/C Imports for the US$250,000 . . . 32.03 Neither did Petitioner reimburse or pay W/C Imports, Inc. by way of transfer pricing, because the former increased its selling price to the latter after Metonic acquired 75% interest in Petitioner . . . ." Respondent Commissioner of Internal Revenue (CIR), however, declared the rescission document as sham and assessed petitioner for deficiency 30% withholding tax at source or the P5,112,500.00 (US$250,000) which was allegedly due to the Cromwell spouses pursuant to section 22(b) of the Tax Code. In another transaction, respondent CIR assessed petitioner for deficiency withholding tax dividends in the amount of P2,742.59 for fiscal year ending June 1987. As alleged by petitioner, the factual background of the assessment of the deficiency withholding tax on dividend is as follows: 3 "34.01 In 1986, Robert H. Cromwell advanced money to Petitioner for working capital requirements . . . 34.02 The amount owed to Mr. Robert H. Cromwell was recorded in the books of petitioner as "Due to Mr. Cromwell" account. . . 34.03 To document these loans, Petitioner executed two promissory notes in favor of Robert H. Cromwell in the amount of P351,000 and P322,500 dated January 18, 1986, respectively. 34.04 The two promissory notes expressly provide for the payment of interest at the rates of 11.25% and 11% a year, respectively. . . . cdll 34.05 Respondent considered the payments made to Mr. Robert H. Cromwell as cash dividends instead and accordingly assessed Petitioner for deficiency withholding tax on dividends." Shown below were the details of the Bureau of Internal Revenue's assessment for the payment of P3,016,788.23 representing deficiency withholding taxes for tax year 1987 accrued from the preceding facts: 4 Deficiency Final Withholding Tax (Non-Resident Stockholders) January to June, 1987 Accrued Amount per Audited Financial Statement ($250,000) P5,112,500.00 Withholding tax due thereon (30%) P1,533,750.00 Less: Amount withheld P Deficiency Withholding Tax P1,533,750.00 Add: 25% surcharge 383,437.50 20% int. fr. 07-21-87 to 05-11-90 P1,075,446.32 Compromise 15,000,00 TOTAL AMOUNT DUE AND COLLECTIBLE P3,007,633.82 =========== Deficiency Final Withholding Tax (Cash Dividends) January to June, 1987 Amount subject to tax P14,432.76 Withholding tax due thereon (10%) P1,443.27 Less: Amount paid P________ Deficiency Withholding Tax P1,443.27 Add: 25% surcharge 358.32 20% int. fr. 07-21-87 to 05-11-90 1,010.60 Compromise 100.00 __________ TOTAL AMOUNT DUE AND COLLECTIBLE P2,742.59 Deficiency Expanded Withholding Tax January to June, 1987 Withholding taxes due (various) P11,247.76 Less: Payment per return 8,099.81 Deficiency expanded withholding tax P3,147.95 Add: 25% surcharge 786.98 20% int. fr. 07-21-87 to 5-11-90 2,207.29 Compromise P100.00 __________ TOTAL AMOUNT DUE AND COLLECTIBLE P6,242.22 Petitioner in a protest with the CIR filed on November 10, 1992 maintained the following defenses: 5 "(1) It has no obligation to withhold at the time of accrual based on the Mar Fishing Co., Inc. v. Commissioner of Internal Revenue, (October 4, 1999, affirmed in CA GR No. 29839 dated January 31, 1994). (2) On the authority of Bayer Pharmaceuticals, Inc. vs. The Commissioner of Internal Revenue, CTA Case No. 2846, March 16, 1979, affirmed by the Supreme Court in GR No. 72054 dated October 16, 1986, Petitioner has no obligation to withhold the tax upon the accrual of the liability in 1987, because it could not have remitted payments to Robert H. Cromwell and Virginia J. Cromwell under the then prevailing Central Bank regulations restricting the incurring of foreign currency obligations. (3) The rescission of the Noncompetition Agreements is legally effective and enforceable. (4) Even if we assume arguendo that the amounts stipulated in the rescinded Lido Noncompetition Agreements constitute income to the Robert H. Cromwell and Virginia J. Cromwell, such income is income earned outside the Philippines and is therefore not subject to Philippine income tax." With reference to the third item in the assessment, the petitioner claimed that as early as November 21, 1989, the proposed expanded withholding tax assessment of P5,904.02 inclusive of surcharge, interest and compromise penalty had been paid as evidenced by BIR Payment Order No. 6537793 and Central Bank Confirmation Receipt No. 18451366. 6 Respondent CIR denied the protest on the disputed assessment on September 11, 1992, a copy of which was received by petitioner on November 10, 1992. llcd A petition for review was filed by petitioner with the Court of Tax Appeals on November 26, 1992. Petitioner claimed in the Petition for Review that the sum of $250,000,00 representing the consideration under the Lido Non-competition Agreement is not subject to Philippine income withholding tax since the said agreements were rescinded and no remittance was made. The previously accrued $256,500.00 liability and pre-rated as P256,500.00 had been added to gross income for income tax purposes in 1988. Petitioner further claimed that: 7 "15. Moreover, the consideration payable to the Cromwells under the Noncompetition Agreements is considered derived from a foreign source because the activities which the Cromwells are prohibited from engaging in are those taking place abroad, particularly the United States. Consequently, the Cromwells are not subject to Philippine income or withholding tax on such consideration due them under the Noncompetition Agreements since the Cromwells are nonresident alien individuals, and, as such are taxable only on income derived from Philippine sources. cdlex 16. The interest payments made by petitioner to its former stockholder, Robert H. Cromwell, are likewise not subject to withholding tax since there is nothing in the statute which requires the debtor-payor, petitioner herein, to withhold tax thereon. The interests were paid by petitioner on a valid and genuine indebtedness incurred in pursuit of petitioner's trade or business. 17. The contention of respondent that the interest payments were actually dividend distributions is devoid of any factual and legal basis. Petitioner executed a promissory note in favor of Robert H. Cromwell to guarantee the payment of the loan, with the promissory note providing for a market rate of interest, fixed maturity date, and other provisions for the protection of the lender. The indebtedness contracted by petitioner thus clearly involved a legal liability to pay interest. 18. The imposition of surcharges, interest, and compromise penalties is likewise devoid of any factual and legal basis as the underlying deficiency withholding tax assessments mentioned above were issued contrary to law and lack factual basis." In the decision promulgated on April 24, 1995, respondent CTA denied the petition for review and ordered the petitioner to pay the amount of P3,007,633.82 as deficiency final withholding tax on non-resident stockholder and the sum of P2,912,19 as deficiency final withholding tax on cash dividends, plus 25% surcharge and 20% annual interest from May 11, 1990 up to the full payment thereof. It was stated in the decision that the defense of 'no payment was actually effected since the Non-competition Agreements were rescinded' was never used by petitioner in its protest letter with the Commissioner of Internal Revenue. The BIR examiners were surprised when petitioner presented a rescission document wherein W/C Import assumed and paid the liability. Neither was it mentioned in the Memorandum nor in the Petition for Review filed with the CTA that W/C Imports is a sister company of petitioner. The fact was only found out in the testimony of petitioner's witness, Mr. Patrick J. McCullagh, W/C Imports business manager, that W/C Imports and Lido Export are closely related. Mr. McCullagh, aside from being the business manager of W/C Import, was the President and Director of Ashling Corporation (buyer of the stocks of the Cromwells in W/C Imports), (100% owner of W/C Imports), director of Metonic Investments, Ltd. and director of Lido Export, Inc. From there, CTA safety concluded that petitioner was one and the same with W/C Imports or at least closely related to each other, thus necessitated the piercing of the veil of the corporate entity. The claim of petitioner that the reason why there was rescission was that it did not stand to derive any economic benefit from the said non-competition agreements, was not believed either. Lido as the sole manufacturer of the goods which W/C Imports sold will likewise stand to be benefited by the non-competition covenants. It is elementary that when the demand from the United States decreases because of a competing company, the sale of Lido will be affected. It was also found out that the Sanwa Bank standby Letter of Credit, which allegedly proved that the Cromwells were not paid by W/C Imports, was in the name of 'Clark & Trevithick Trust Account/Metonic'. The Letter of Credit still included the petitioner as a party to the Non-competition Agreements. 8 With regard to petitioner's claim that the consideration for the covenant not to compete is considered income derived from the United States and as such, not subject to Philippine withholding tax since the payee were non-resident aliens, was disregarded. Respondent court claimed that having established that petitioner paid the Cromwells, it was, therefore, subject to 30% withholding tax being income derived by non-resident aliens not engaged in trade or business within the Philippines. On the deficiency final withholding tax on dividend payment, respondent was not convinced that the promissory notes were payment for debt because the total amount of the notes was more than the amount declared in the financial statement. It was then treated as cash dividend subject to final withholding tax. A Motion for Reconsideration was filed by petitioner on May 19, 1995. The motion claimed that the rescission documents were not fictitious and were valid and never concealed from the BIR. If at all, the rescission document would be declared null and void for being designated as an execution draft. The Non-competition Agreements which were similarly designated as execution drafts but not notarized should be nullified. The motion further claimed that respondent court had no jurisdiction to pass upon the issue of whether or not the separate juridical personality of petitioner and W/C Imports because the same was never rescinded in the pleadings. Relying on the ruling in Mar Fishing Co. Inc., vs. CIR, 9 petitioner claimed that it was not liable to withhold the tax because it merely accrued the amount payable to the Cromwells but it never actually paid the same. In its Resolution promulgated on October 4, 1995, CTA presented a tabulation 10 of the Exhibits offered by petitioner to support its conclusion in piercing the veil of corporate entity of the petitioner and W/C Imports. The tabulation showed that in all three (3) Non-competition Agreements, there were only three (3) signatories namely: Robert H. Cromwell, Virginia J. Cromwell and Patrick J. McCullagh. Robert H. Cromwell signed for his own behalf, his wife's behalf, as President of Lido Export and as President of W/C Imports, Inc. On the other hand, Patrick McCullagh signed as Attorney in Fact of Metonic Investments, Ltd. or as Director of the same company, as President of Ashling and as President of W/C Imports, Inc. Virginia J. Cromwell signed only for herself. Thus, respondent court was not convinced with the arguments presented by petitioner in its Motion for Reconsideration. Hence, this petition for review filed on November 15, 1995. Since the issues in this Petition for Review were the same as the petition filed with the respondent court, the same need not be enumerated but shall be mentioned or referred to in the following discussion. The first issue that this Court finds proper to be discussed in the allegation of petitioner that respondent court had no jurisdiction to decide the issue of whether or not the separate corporate personality of petitioner and W/C Imports, Inc. should be disregarded since it was never raised in the pleadings. cdll Petitioner claimed that 'nowhere in respondent's denial of the protest, the Petition for Review and respondent's Answer did respondent (CIR) treat or even hint that W/C Imports, Inc. was a dummy corporation used by petitioner as a shield for tax evasion and that its separate juridical personality should be disregarded." 11 We agree that respondent CIR did not treat W/C Imports, Inc. as a dummy corporation of petitioner because in the denial of the protest, 12 W/C Imports was referred to as a sister company. "While it is argued that the subsidiary of the parent company assumed the liability under a separate argument, this merely constitute a ploy to circumvent the laws. Since the original contract agreement was done and executed in the Philippines where Lido is a resident corporation does not relieve them to withhold the final tax of 30% as such income payment even if the payment was assumed by the sister company in the U.S.A." The above was based on the findings of the investigating officers of respondent CIR. At the onset, it is glaring that Lido Export, W/C Imports, Metonic Investments and Ashling Corporation are closely interrelated. For one, prior to the sale, Lido and W/C Imports were practically owned and controlled by the Cromwells. When the stock of the Cromwells were sold to Metonic Investments and Ashling Corporation, the scenario changed. But if we delve deeper, a common denominator between the two companies can still be discovered. Metonic Investments and Ashling Corporation were managed in common by Mr. Patrick McCullagh. This only leads us to conclude that the rescission document would only serve the purpose of evading the payment of tax by petitioner. Whereby, in situations like this, the Supreme Court held that where it appears that business enterprises are owned, conducted and controlled by the same parties, both law and equity will disregard the legal fiction that the corporations are distinct entities, and treat them as identicals. 13 Applicable to this case is the dissertation of the Supreme Court in one case: "Piercing the veil of corporate entity requires the court to see through the shroud which exempts its stockholders from liabilities that ordinarily, they could be subject to, or distinguishes one corporation from a seemingly separate one, were it not for the existing corporate fiction. But to do this, the court must be sure that the corporate fiction was misused, to such an extent that injustice, fraud, or crime was committed upon another, disregarding, thus, his, her, or its rights." It is axiomatic that taxes are the lifeblood of the nation through which the government agencies continue to operate and with which the State effects its functions for the welfare of its constituents. 14 Any fraudulent means employed by taxpayers to evade payment of taxes should be discouraged and stopped at the earliest stage. On the payment of deficiency withholding tax on cash dividend, this Court is not convinced with the argument of the petitioner. It failed to overturn the findings of respondent CIR which resulted to the assessment. cdll Well-settled is the rule that factual findings of quasi-judicial agencies like the CTA which have acquired expertise because their jurisdiction is confined to specific matters are generally accorded not only respect but at times even finality if such findings are supported by substantial evidence. 15 WHEREFORE, premises considered, the Decision promulgated on April 24, 1995 of the Court of Tax Appeals is hereby AFFIRMED IN TOTO in this petition is DISMISSED. SO ORDERED. Guerrero and Alio , JJ ., concur. Footnotes 1. Petition for Review, Rollo p. 9-11. 2. Ibid, pp. 12-13. 3. Petition for Review, Rollo p. 14. 4. Petition for Review, Rollo p. 3. 5. Petition for Review, Rollo p. 15. 6. Petition for Review, Annex "A", Records p. 53. 7. Petition for Review, Rollo pp. 56-57. 8. CTA Decision 4879, Rollo p. 71. 9. CA G.R. No. 29839 dated January 31, 1994. 10. CTA Resolution, Rollo p. 101. 11. Petition for Review, Rollo p. 40. 12. Annex "E", Rollo p. 113. 13. Tomas Lao vs. NLRC, 278 SCRA 716. 14. CIR vs. CTA, 234 SCRA 342. 15. Villareal vs. CA, 219 SCRA 293.