Page 381

Illustrative example of taxation of non-resident foreign corporation on the

redemption of shares subject to a tax treaty

Goodyear Philippines, Inc. (GPI), a domestic corporation duly organized and

existing under the laws of the Philippines. On August 19,2003, GPI's authorized capital
stock of was increased from P400,000,000.00 divided into 4,000,000 shares with a par
value of P100.00 each, to P1,731,863,000.00 divided into 4,000,000 common shares
and 13,318,630 preferred shares with a par value of P100.00 each. Consequently, all
the preferred shares were solely and exclusively subscribed by Goodyear tire and
rubber company (GTRC), which was a foreign company organized and existing under
the laws of the State of Ohio, USA and is unregistered in the Philippines.

On May 30, 2008, GPI's Board of Directors authorized the redemption of GTRC's
3,729,216 preferred shares on October 15, 2008 at the redemption price of
470,653,914.00 broken down as follows: 372,921,600.00 representing the aggregate
par value and 97,732,314.00 representing accrued and unpaid dividends.

On October 15,2008, GPI filed an application for relief from double taxation before
ainternational tax affairs division of the BIR to confirm that the redemption was not
subject to PH income tax, pursuant to RP-US tax treaty. This notwithstanding, GPI still
took the conservative approach and thus withheld and remitted the sum of 14,659,
847.10 to the BIR on Nov. 3, 2008. Representing 15%FWT computed based on the
differences of the redemption price and aggregate par value of the shares.

On October 21, 2010, GPI filed an administrative claim for refund or issuance of a Tax
Credit Certificate (TCC), representing 15% FWT in the sum of P14, 659,847.10 before
the BIR. Thereafter, or on November 3, 2010, it filed a judicial claim, by way of petition
for review, before the CTA.

Is GPI entitled to the refund or issuance of a TCC? Reason out your answer.

Held: Yes. GPI is entitled to a refund of the TCC on the 15% FWT in the sum of
P14,659,847.10 previously paid on the difference of the redemption price and aggregate
par value of the shares.

It must be noted however that GTRC, GPI's principal is a non resident foreign
corporation specifically a resident of the US. Thus, pursuant to the cardinal principle that
the treaties have the force and effect of law in this jurisdiction, the RP-US Tax Treaty
complementarily governs the tax implications of GPI's transactions with GTRC.

Under the RP-US tax treaty, the term "dividends" should be understood according to the
taxation law of the State in which the corporation making the distribution is a resident of
the Philippines. Accordingly, attention should be drawn to the statutory definition of what
constitutes "dividends" pursuant to Section 73 (A) of the tax code which provides that
the term dividends’ x x x x means any distribution made by a corporation to its
shareholders out of its earnings or profits and payable to its shareholders, whether in
money or in other property”

In light of the foregoing, the SC held that the redemption price representing the
amount of P97,732,314.00 received by GTRC could not be treated as accumulated
dividends in arrears that could be subjected to 15% FWT. Verily, GPI’s Audited
Financial Statements (AFS) covering the years 2003 to 2009 show it did not have
unrestricted retained earnings, the board of directors of respondent had no power to
issue dividends. Consistent with Section 73 (A) of the Tax Code, this rule on dividend
declaration- i.e that it is independent upon the availability of URE- was further edified in
Sec.43 of the corporation code of the PH which reads, “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
costs and expenses, while stock dividends shall be withheld from the delinquent
stockholder until his unpaid subscription is fully paid: Provided, further, That no stock
dividend shall be issued without the approval of stockholders representing not less than
two-thirds (2/3) of the outstanding capital stock at a regular or special meeting duly
called for the purpose. X x x x x x (Emphasis Supplied.)

It is also worth mentioning that one of the primary features of an ordinary

dividend is that the distribution should be in the nature of a recurring return on stock
which, however does not obtain in this case. As aptly pointed out by CTA En Banc, the
amount of P97,732,314.00 received by GTRC did not represent a periodic distribution of
dividend, but rather a payment by GPI for the redemption of GTRC’s preferred shares.

PAGE 384

A group of Philanthropists organized a non-stock, non-profit hospital for

charitable purposes to provide medical services to the poor. The hospital also accepted
paying patients although none of its income accrued to any private individual; all income
were plowed back for the hospital’s use and not more than 30% of its funds were used
for administration purposes.

Is the hospital subject to tax on its income?

SUGGESTED ANSWER:
Yes. The hospital is subject to tax at the rate of 10% on its taxable income except
those on certain passive incomes. Thus, the income derived by the hospital from its
paying patients, even if not distributed to its members, is considered as taxable income.

ALTERNATIVE ANSWER:
 No. the hospital is tax exempt because it was organized exclusively for charitable
puposes no part of its income inures to the benefit of any private individual. The income
derived from the paying patients is not subject to tax because such income is necessary
to allow it to sustain its Charitable activities (CIR vs. CA, CTA, YMCA 298 SCRA 83)

ANOTHER ALTERNATIVE ANSWER:

No. the hospital is exempt from taxation. The mere charging of medical and
hospital fees for those who can afford to pay, does not make the non-profit institution
established for profit or gain. It has to meet expenses for operation and maintenance in
order to carry out its lofty purposes to derve humanity (UST Hospital Employees v.
Santo Tomas Hospital 1955, CIR v. St. Paul Hospital Iloilo, 1958)

PAGE 388

Illustration of a resident foreign carrier

Air Canada as an offline international carrier is considered as a resident foreign

corporation. Air Canada as an offline international carrier with no landing rights in the
PH, selling passage tickets in the PH, through a general sales agent is not liable to tax
on Gross Philippine Billings under Sec.28 (A) (3) of 1997 NIRC.

It is a resident foreign corporation doing business in the PH taxable under Sec.28 (A)
(1), imposed 32% (now 30% under RA (337) on income subject to tax subject to any
applicable tax treaty to which the PH is a signatory. Pursuant to Article 8 of RP-Canada
Tax Treaty, Air Canada may only be imposed a maximum tax of 1 ½% of its gross
revenues earned from the sale of tickets in the PH (Air Canada v. CIR, 2016).

The correct interpretation of Sec.28 (A)(3)(a) (which imposes 2 ½% GPB) and Sec.28
(A)(1) (which imposes 39% tax rate) is that |international air carriers maintaining flights
to and from the PH shall be taxed at the rate of 2 ½% of GPB while International air
carriers that do not have flights to and from the PH but nonetheless earn income from
other activities in the Country such as sale of tickets will be taxed at 30% of such
taxable income (South African Airways vs CIR 2010)

While Air Canada is taxable as a resident foreign corporation under Sec. 28 (A)(1) of
the 1997 NIRC on its taxable income from sale of airline tickets in the PH, it could only
be taxed at a maximum of 1 ½% of gross revenues pursuant to RP-Canada Tax treaty
that applies to petitioner as a foreign corporation organized and existing under the laws
of Canada.

PAGE 391

What is the “immediacy test”? Explain briefly.

SUGGESTED ANSWER:
 “An accumulation of earnings, profits or profits (including undistributed earnings
or profits prior years) is unreasonable if it is not necessary for the purpose of the
business, considering all circumstances of the case. To determine the “reasonable
needs of the business” in order to justify an accumulation of earnings, these regulations
hereby adhere to the so called “immediacy test” under American jurisprudence as
adopted in this jurisdiction. Accordingly, the term “reasonable needs of the business”
are hereby construed to mean the immediate needs of the business, including
reasonably anticipated needs. In either case, the corporation should be able to prove an
immediate need for the accumulation of earnings and profits or the direct correlation of
anticipated needs to such accumulation of profits. Otherwise, such accumulation would
be deemed to be not for the unreasonable needs of the business and penalty tax shall
apply. The immediacy test is recognized by the BIR.

PAGE 398

Illustrations of which constitute accumulation of earnings for the reasonable

needs of the business

For purposes of these regulations, the following constitute accumulation of earnings for
the reasonable needs of the business

A. Allowance for the increase in the accumulation of earnings up to 100% of the

paid up capital of the corporation as of balance sheet date, inclusive of
accumulation taken from other years.
B. Earnings reserved for definite corporate expansion projects or program requiring
considerable capital expenditure as approved by the board of directors or
equivalent body
C. Earnings reserved for building, plants or equipment acquisition as approved by
BOD or equivalent body
D. Earnings reserved for compliance with any loan covenant or pre-existing
obligation established under a legitimate business agreement
E. Earnings required by law or applicable regulations to be retained by the
corporation or respect of which there is legal prohibition against distribution
F. In the case of subsidiaries of large foreigb corp in the PH, all undistributed
earnings intended nor reserved for investments within the PH as can be proven
by corporate records and/or relevant documentary evidence.

Page 400

True or false

The capitalization rules may be resorted to by the BIR in order to compel

corporate taxpayers to declare dividends to their stockholders regularly (2010)

SUGGESTED ANSWER:
True.

In 2015, Spratz, Inc.’s net profit before tax was 35 million while its operating
expenses was 31 million. In 2016, its net profit before tax was 40 million while its
operating expenses was 38 million.it did not declare dividends for 2015 and 2016. And it
has no proposed capital expenditure for 2017 and the immediate future. May Spratz be
subject to Improperly accumulated tax on its retained profits for 2015 and 2016?

a. Yes, since the accumulated amounts are reasonable for operations in relation to
what it usually needed annually
b. Yes, since the accumulation is not reasonable necessary for the immediate
needs of the business.
c. No because there is no showing that the taxpayer’s 2015 and 2016 net profit
before tax exceeded its paid-up capital
d. No because the taxpayer is not shown to be a publicly-listed corporation, a bank,
or an insurance company (2011)

SUGGESTED ANSWER: b.

PAGE 402

Under the new constitution, may the government tax income xxx xxx of
non-profit educational institution operated by religious orders? What policy
considerations are to be taken into account? (1974)

SUGGESTED ANSWER:

No. the revenue of non-stock, non-profit educational institutions which are actually,
directly and exclusively used for educational purposes, irrespective of whether or not
they are operated by religious orders under the 1987 constitution are exempt from
income taxation.

The policy consideration is to encourage the establishment of educational institutions

which are not profit motivated. The tax exemption would translate to lower tuition fees
providing access to education for all.