Publishing the Resolution of the Supreme Court in the Case Entitled "Collector of Internal Revenue vs. University of the Visayas", G. R. No. L-13554, Promulgated on October 30, 1964

November 19, 1964 REVENUE MEMORANDUM CIRCULAR NO. 03-65 SUBJECT : Publishing the Resolution of the Supreme Court in the Case Entitled "Collector of Internal Revenue vs. University of the Visayas", G. R. No. L-13554, Promulgated on October 30, 1964 TO : All Internal Revenue Officers and Others Concerned For the information and guidance of all concerned, the resolution in the abovementioned case is hereby published: LLpr "REPUBLIC OF THE PHILIPPINES SUPREME COURT MANILA "COLLECTOR OF INTERNAL G. R. No. L-13554 REVENUE, Petitioner, Present: Bengzon, C. J . Bautista Angelo Concepcion Reyes, J. B. L. Barrera Paredes -versus Dizon Regala Makalintal Bengzon, J. Zaldivar, JJ . UNIVERSITY OF THE VISAYAS, Promulgated: Respondent, October 30, 1964. "RESOLUTION ON MOTION TO RECONSIDER "REYES, J. B. L., J .: "The Commissioner of Internal Revenue has moved for the reconsideration of our decision in the above-entitled case affirming the decision of the Court of Tax Appeals in its interpretation and application of Section 27(e) of the tax code, and declaring: (1) that appellee University of the Visayas be exempt from income tax under Section 27(c) of the Internal Revenue Code; (2) annulling the income tax assessments for 1946 to 1950 made against the University and (3) ordering the refund of previous income taxes collected from it. "The petitioner-movant re-asserts his position that the respondent University of the Visayas is not tax-exempt because the legislature intended to remove from the purview of the exemption provided for in Section 27(e) of the Revenue Code not only organizations or corporations distributing cash dividends to any stockholder or individual but also those whose income inures to the benefits of any Stockholder or individual. In support thereof, he emphasizes the difference between the old law (Comm. Act No. 466) thus: (f) Corporation or association organized and operated exclusively for religious, charitable, scientific, athletic, cultural, or educational purposes, no parts of the net income of which is distributed to any stockholder or individual: . . . and its amendment by Republic Act No. 82, as follows: (e) Corporation or association organized and operated exclusively for religious, charitable, scientific, athletic, cultural or educational purposes, or for rehabilitation of veterans no part of the net income of which inures to the benefit of any private stockholder or individual . . .' and finally cites, and relies on the explanatory note to House Bill No. 729, which became Republic Act No. 82. The pertinent portions of the explanatory note are hereunder quoted: 'The attached bill, therefore, proposes to increase the present rates of income tax and to modify the other features of the present law with a view to providing additional revenue. A brief explanation of the changes proposed to Title II (Income Tax) of the National Internal Revenue Code is set forth below. 4. Amendment of provision granting exemption in favor of religious, charitable, scientific, athletic, cultural or educational organizations or institutions . The present law (section 27(f), National Internal Revenue Code exempts the organizations if no part of their net income is distributed to any private stockholder or individual. The provision has been authoritatively construed as exempting such organization or associated from payment of the income tax for any year in which no dividends are distributed to stockholders. The present law as so construed, therefore, makes it possible for a corporations to avoid the payment of income tax by simply desisting from declaring a dividend during any given year, notwithstanding the fact that it may have earned a very substantial amount of income in that year. Furthermore, if the corporation desires to distribute dividends, it could effect the distribution during a taxable year in which it expects no suffer a loss, or derive only a small income, thus making it possible for such corporation to entirely avoid the payment of the income tax by availing of the loophole in the law to suit its advantage. Under the proposed amendment, the above mentioned corporations and associations will pay income tax on their profits in any year although no dividends are declared for such year. (Congressional Record, House of Representatives, Sept. 9, 1946, Vol. I No. 69, p. 1599) prll "The Revenue Commissioner further argues that the undistributed dividends necessarily increase the value of the stockholders' equity, and that, in the particular case, it is not denied that the market value of the shares of the University of the Visayas has increased considerably; hence, it is urged, the undistributed dividends actually inured to the benefit of its private stockholders, thus coming within the purview of the statutory requisite for taxability. "In reply, the appellee University of the Visayas argues that the foregoing explanatory note lends no assistance to the movant's position because it merely states the intended safeguard or remedy against tax evasion without, however, expressing that the intent of the legislature was to withdraw the exemption from income tax of the corporations or institutions enumerated in Section 27(e). The law itself, it is argued, sanctions the exemption; and if the exemption were withdrawn, the law would have simply taxed educational institutions that produce a net income or profits. Appellee further urges that literally understood, the said Section 27(e) would tax all the institutions mentioned therein that have any net income whatever, since the production of net income naturally (although not necessarily) results in the increase of the stockholders' equity in the corporation; but such a literal interpretation has no justification, and would make the law senseless in its application by granting and, at the same time, withdrawing the exemption. "Finally, appellee argues that under the interpretation advocated by the Revenue Commissioner, only educational institutions without net income would be exempt; and that the increase of a stockholder's equity in the corporation is not only theoretical while the shares are not disposed of, or the corporation liquidated, but may arise from causes unconnected with its net income. That what is referred to by the phrase 'net income inures to the benefit of any private stockholder or individual' is the disposition or channeling of the net income of the corporation to the benefit of the stockholder or individual is an indirect or manipulative manner. "We have carefully reexamined the records of this case, and reached the conclusion that while the arguments advanced by the appellee educational institution are observing of careful consideration and bear weight, the peculiar circumstances of the present case clearly indicate that said original appellee is not entitled to claim exemption, contrary to our original decision. The reason is that the facts of record prove that the corporation is under absolute control of the president and his immediate family (who hold 85% of the capital stock) to an extent that warrants the conclusion that the corporate entity is but an alter ego or a business conduct for said stockholders; wherefore, is a disregard of the corporate fiction is justified, and the net income of the corporation may well be viewed as that of the controlling group (cf. Koppel (Phil.) Inc. vs. Yatco, 77 Phil. 496, and authorities cited). "The corporation of the appellee educational enterprise was indeed limited to educational purposes, and the income derived solely from admission, tuition, diploma, laboratory and ROTC fees paid by students. However, the net income of P302,479.02 from 1946 to 1950, with the exception of the relatively small amount of P28,000 intended for operating expenses, were invested in the purchase of real properties. Said properties, it is admitted, belong to the university, but they have been placed in the name of the president alone, or in the name of his wife, or both. The reason is that, as the president truthfully admitted, he is the university and the university belongs to him. Shares of stock belonging to other stockholders were acquired by the president, and although not at their market value, nevertheless, at prices very much more than par value. No less than the president testified that for every peso share the value is not P119. This increase in value is due not only to the operation of the educational enterprise but also in the increase of its permanent assets, including those that had been placed in the name of the president, his wife, or both. One of the facts clearly denoting that the personality of the university and that of the president is one is that the board of directors of the university had once proposed the issuance of additional shares on the accumulated net income or profits. The president, however, objected to this proposal of the majority of the persons composing the board for the reason that the same would be a useless and unnecessary gesture, as he was practically the corporation. The objection of the president defeated the proposal. cdta "Considering that the net income, except for the sum of P28,000.00 set aside for operational expenses, was invested in permanent assets placed in the name of the president, his wife, or both, it is very obvious that such net income realized by the university inured to the benefit of the president and his family. It is thus perfectly understandable that the president would decline to declare dividends. Having the permanent assets consisting of seven buildings in his name, or that of his wife, he is certainly benefited by desisting from declaring any kind of dividend. If dividends had been declared and distributed the funds and assets of the university would be diminished, insofar as the president and his family is concerned, to the amount, although insignificant, that has to be distributed to the stockholders holding 15% of the shares. However, if no dividends are declared or distributed, 100% of the net income or accumulated funds or assets of the corporations would remain with him, so that he would benefit not only from his 85% holdings but also from the 15% holdings of others. "The foregoing proves in a clear manner, not only on the basis of a statement under oath but also on the history of the respondent institution from incipiency to the present time when the tax is being collected, the existence of a set-up designed to avoid the payment of taxes. If the net income of the institution inured to the benefit of the university, as claimed by its president under the aforementioned circumstances, it likewise inured to the benefit of the president, as the two are admittedly, and shown to be, the same. Hence, the university is liable for income tax under the amendment. "In view of the foregoing considerations, the original decision of 28 February 1961 is hereby reconsidered and set aside, and another one entered (a) reversing the decision of the Court of Tax Appeals, in CTA Cebu Civil Case No. R-3434, and declaring appellee University of the Visayas not entitled to the refund of P13,811.31, for income taxes previously paid; (b) denying the refund aforesaid; (c) declaring that the Commissioner of Internal Revenue was lawfully empowered to assess and collect income taxes from the appellee, University of the Visayas; and (d) ordering the said appellee to pay the amount of P37,212.06, as taxes on its income for the years 1946 to 1950, together with one per centum (1%) monthly interest on the sum of P31,780.72 until paid, plus the sum of P40 and P100 as administrative penalties for lateness in filing returns and payment. No cost. "(Sgd.) JOSE B. L. REYES "WE CONCUR: "(Sgd.) CESAR BENZON "(Bautista, J., took no part. "(Sgd.). ROBERTO CONCEPCION "(Sgd.) JESUS G. BARRERA "(Sgd.) JOSE MA. PAREDES "(Sgd.) ARSENIO P. DIZON "(Sgd.) ROBERTO REGALA "(Sgd.) QUERUBE C. MAKALINTAL "(Sgd.) JOSE P. BENGZON "(Sgd.) CALIXTO O. ZALDIVAR" The above-quoted resolution of the Supreme Court reversed the decision of the Court of Tax Appeals dated January 22, 1958 in (Cebu) Civil Case No. R-3434, and reconsidered and set aside the original decision of the Supreme Court in the same case dated February 28, 1961. cdti The motion for reconsideration of the above-quoted resolution filed by the respondent University of the Visayas was denied by the Supreme Court in a Resolution dated December 8, 1964, which reads as follows: "Passing upon the motion to reconsider filed by appellee in G.R. No. L-13554 (Collector of Internal Revenue vs. University of the Visayas), wherein movant invokes our decision in Collector of Internal Revenue vs. V.G. Sinco Educational Corporation, 53 O.G. 2470; considering that said decision is not a binding president for the present case, in view of the disparity of facts proved, particularly the absence of circumstances such as those enumerated in our present decision showing that the president and the University are regarded as practically one and the same, the Court resolved to DENY the motion." Features of the Resolution (1) A corporation, although organized exclusively for educational purposes, is not entitled to exemption from income tax under Section 27(e) of the National Internal Revenue Code, as amended by Republic Act No. 82, where its net income inures to the benefits of any stockholder or individual. (2) The net income of a corporation inures to the benefit of private stockholders or individuals and, therefore, the corporation is not entitled to exemption from income tax under Section 27(e) of the Tax Code, where the corporation, although organized exclusively for educational purposes, is under the absolute control of its president and his immediate family to an extent that warrants the conclusion that the corporate entity is but an alter ego or business conduit for said stockholders and justifies a disregard of the legal fiction of separate corporate entity. (3) The net income of a corporation organized exclusively for educational purposes inures to the benefit of private stockholders or individuals where its net income is invested in permanent assets placed in the name of its president, his wife, or both. It shall be understood that the foregoing are merely illustrative, not exclusive, of the facts and circumstances showing that the net income of a corporation, organized exclusively for educational purposes, inures to the benefit of a private stockholder or individual. Enforcement and Publicity All internal revenue officers and others charged with the enforcement of internal revenue laws are enjoined to be guided accordingly and to give this Circular as wide a publicity as possible. cdll (SGD.) BENJAMIN N. TABIOS Acting Commissioner of Internal Revenue