Atty. Augusto M. Macam

March 19, 1999 Atty. Augusto M. Macam Medel Macam Tolentino Pineda & Larcia 3rd Floor, JAKA II Building 150 Legaspi Street Legaspi Village Makati City S i r : This refers to your letter dated March 9, 1999 requesting opinion on the following queries which we answer in the order they were presented. 1. Is it legal and tenable for a corporation to declare cash dividends on the basis of audited financial statements showing unrestricted retained earnings, when the external auditors' opinion accompanying said financial statements contain a qualification (relating to the corporation's failure to set up loss reserves, or allowance for possible loss, considering that the auditors entertain doubts as to the recoverability of the corporation's advances to its subsidiary, which advances are booked as part of the corporation's investments)? cdll In determining the existence of unrestricted retained earnings for purposes of dividend declaration under Section 43 of the Corporation Code, the Commission primarily relies on the audited financial statements of the corporation as of the last fiscal year immediately preceding the declaration. Under the existing policy of the Commission, for purposes of conservatism, the unrestricted retained earnings to be considered shall be net of any qualification made by the auditor on the reliability of certain asset accounts that would later on possibly reduce the balance thereof. This is to prevent the possibility of allowing the declaration of dividend out of unrestricted earnings that would later on be impaired by losses on account of such qualification. 2. Can cash dividends be directly and entirely applied to the principal stockholder's subscription payables in order to reduce or eliminate the same? 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: Provided, that any cash dividends due on delinquent stock shall first be applied to the unpaid balance on the subscription plus cost and expenses, while stock dividends shall be withheld from the delinquent stockholder until his unpaid subscription is fully paid. ..." (Emphasis supplied) It is clear from the aforecited provision that when a corporation R distributes cash dividends, the same cannot be withheld from the subscribers who have not fully paid their subscriptions, unless they are delinquent on their unpaid subscriptions . The corporation may use the cash dividends to pay off stockholders' unpaid subscriptions which are not declared delinquent only if the stockholders concerned individually consent thereto. (SEC Opinion dated March 18, 1991 addressed to China Banking Corporation) 3. Whether it is possible for the corporation to declare a type of dividends which is neither cash nor stock ( property? ),and hence, not subject to dividend tax, but which could be applied to reduce or totally offset subscription payables? In connection with the above-query, please find enclosed here with a xerox copy of a previous SEC Opinion dated February 5, 1991 addressed to Mr. Benjamin L. Gregori pertaining to some issues relative to "property dividend" ,particularly as to when it can be declared. Inasmuch as under said opinion a dividend payable in "property" is actually a " cash dividend ",the same cannot be applied to unpaid subscription without the consent of the stockholders entitled to it, unless the unpaid subscription of the stockholder is declared delinquent. On the tax issues of dividend declarations, it is advised that you seek clarification directly from the Bureau of Internal Revenue. Finally, unauthorized and improperly declared dividends should be revoked, if prejudicial to the interest of the creditors and/or stockholders. Very truly yours, (SGD.) PERFECTO R. YASAY Chairman