Mr. Benjamin L. Gregori

February 5, 1991 Mr. Benjamin L. Gregori Chemphil Building 851 A. Arnaiz Avenue Makati, Metro Manila S i r : This refers to your letter of September 27, 1990, seeking opinion relative to property dividends given the following facts. LexLib As stated, a corporation engaged as a real estate dealer, received land and building worth P2 Million and cash of P500,000.00 as payment for its shares subscribed by five stockholders, one owning majority shares and the other four owning one share each. After two years of operations, the corporation has an accumulated retained earnings of P3,000,000.00. The earnings consisted of income from the lease of land and building, dividends from the stock investments and interests on money market placements. The Board of Directors decided to declare all of its earnings as follows: Property dividend P2,000,000.00 Cash dividends 1,000,000.00 Total P3,000,000.00 Your queries are: 1. Can the land and building be transferred to the major stockholder as property dividend? 2. Is the property dividend not taxable to the stockholder? The pertinent provisions of the Corporation Code provides: "SECTION 43. Power to declare dividends . The board of directors of a stock corporation may declare dividends out of the unrestricted retained earnings which shall be payable in cash, in property, or in stock to all stockholders on the basis of outstanding stock held by them: ..." (Emphasis supplied) From the foregoing, it is evident that dividends must be declared and paid out of the unrestricted retained earnings of the corporation. The term "retained earnings" as defined under the generally accepted accounting principles is understood to mean "the accumulated profits realized out of the normal and continuous operation of the business after deducting therefrom distributions to stockholders and transfers to capital stock or other accounts." ( SEC letter to Carlos Uy Corporation ,citing the minutes of the 31st meeting of the Committee on Revisions of Laws and Codes and Constitutional Amendments at the VIP Lounge at Room "A" Batasan Complex, Quezon City, Metro Manila, March 10, 1980). The Commission, in a letter dated October 15, 1975 addressed to Atty. Manuel Yngson, Jr. ,ruled that: "Authorities agree, that dividends may lawfully be paid in property instead of cash where the surplus is in that form and it is practicable to distribute it among the stockholders and that a dividend payable in property is actually a "cash" dividend. (Fletcher Vol. II, pages 113, 115) Accordingly, the same must be payable out of surplus arising out of the operation of the corporation in accordance with Section 16 of the Corporation Law (now Sec. 43 of the Corporation Code) and no distribution can be made of capital stock or property other than the actual profits until dissolution and payment of all creditors ." (Campos and Lopez-Campos) Recently, the Commission adopted the following concept of retained earnings: "In accordance with the generally accepted accounting principles, retained earnings include not only earnings realized from the ordinary course of business of the corporation but also those arising from transactions not associated with but incidental to or necessary in keeping the business for which the corporation was organized. Examples of these are gains on sale of the Corporation's land, building or investment, as well as earnings from rent, royalties, fees and interests for use by others of the Corporation's assets and resources." ( SEC letter dated May 9, 1990 addressed to Pacific Seamen Services, Inc. ) Accordingly, when a corporation has retained earnings arising out of its operations, properties which represent investments in the capital stock of the corporation may be declared as property dividend out of such retained earnings, provided said properties constitute assets in excess of the other assets which are adequate to support the issued and outstanding capital stock of the corporation. However, in order to rationalize the distribution of property dividends for the protection of the stockholders and creditors, the Commission En Banc in its meeting on January 25, 1991, resolved to allow property dividend only under any of the following circumstances: 1. When the property is no longer intended to be used in the operation of the business and it is practicable to distribute the same to stockholders, or 2. As liquidating dividends. Thus, unless the property dividend is declared under any of the foregoing circumstances, your query is answered in the negative. Relative to your second query, it is advised that the matter be referred to the Bureau of Internal Revenue. LexLib Please be advised accordingly. Very truly yours, (SGD.) ROSARIO N. LOPEZ Chairman