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COMMISSIONER OF INTERNAL REVENUE vs.

MANNING L-28398 | Aug 6, 1975 | Petition for Review | Castro Petitioner: Commissioner of Internal Revenue Respondents: John Manning, W.D. McDonald, E.E. Simmons & CTA Quick Summary:
Facts: Reese, the majority stockholder of Mantrasco, executed a trust agreement between him, Mantrasco, Ross, Selph, carrascoso & Janda law firm and the minority stockholders, Manning, McDonald and Simmons. Said agreement was entered into because of Reeses desire that Mantrasco and Mantrasocs 2 subsidiaries, Mantrasco Guam and Port Motors, to continue under the management of Manning, McDonald and Simmons upon his [Reese] death. When Reese died, Mantrasco paid Reeses estate the value of his shares. When said purchase price has been fully paid, the 24,700 shares, which were declared as dividends, were proportionately distributed to Manning, McDonald and Simmons. Because of this, the BIR issued assessments on Manning, McDonald and Simmons for deficiency income tax for 1958. Manning et al, opposed this assessment but the BIR still found them liable. Manning et al. appealed to the CTA, which absolved them from any liability. Held: The manifest intention of the parties to the trust agreement was, in sum and substance, to treat the 24,700 shares of Reese as absolutely outstanding shares of Reese's estate until they were fully paid. Such being the true nature of the 24,700 shares, their declaration as treasury stock dividend in 1958 was a complete nullity and plainly violative of public policy. A stock dividend, being one payable in capital stock, cannot be declared out of outstanding corporate stock, but only from retained earnings. A stock dividend always involves a transfer of surplus (or profit) to capital stock. A stock dividend is a conversion of surplus or undivided profits into capital stock, which is distributed to stockholders in lieu of a cash dividend.

Facts: 1952 - Mantrasco had an authorized capital stock of P2.5M divided into 25,000 common shares. 24,700 of these shares are owned by Julius Reese while the rest, at 100 each, are owned by Manning, McDonald & Simmons. February 29, 1958 - a trust agreement was executed between Reese, Mantrasco, Ross, Selph, carrascoso & Janda law firm, Manning, McDonald and Simmons. Said agreement was entered into because of Reeses desire that Mantrasco and Mantrasocs 2 subsidiaries, Mantrasco Guam and Port Motors, to continue under the management of Manning, McDonald and Simmons upon his [Reese] death. October 19, 1954 - Reese died. However, the projected transfer of his shares in the name of Mantrasco could not be immediately effected for lack of sufficient funds to cover the initial payment on the shares. February 2, 1955 - after Mantrasco made a partial payment of Reese's shares, the certificate for the 24,700 shares in Reese's

name was cancelled and a new certificate was issued in the name of Mantrasco. Also, new certificate was endorsed to the law firm of Ross, Selph, Carrascoso and Janda, as trustees for and in behalf of Mantrasco. December 22, 1958 - a resolution was passed during a special meeting of Mantrasco stockholders. November 25, 1963 - entire purchase price of Reese's interest in Mantrasco was finally paid in full by Mantrasco. May 4, 1964 - trust agreement was terminated and the trustees delivered to Mantrasco all the shares which they were holding in trust. September 14, 1962 - BIR ordered an examination of Mantrascos books. This examination disclosed that: 1. as of December 31, 1958 the 24,700 shares declared as dividends had been proportionately distributed to Manning, McDonald & Simmons, representing a total book value or acquisition cost of P7,973,660 2. Manning, McDonald & Simmons failed to declare the said stock dividends as part of their taxable income for the year 1958 Thus, BIR examiners concluded that the distribution of Reese's shares as stock dividends was in effect a distribution of the "asset or property of the corporation as may be gleaned from the payment of cash for the redemption of said stock and distributing the same as stock dividend." April 14, 1965 - Commissioner of Internal Revenue issued notices of assessment for deficiency income taxes to Manning, McDonald & Simmons for the year 1958. Manning, McDonald & Simmons opposed said assessments. BIR still held them liable for these assessments. Manning, McDonald & Simmons appealed to the CTA. CTA: absolved Manning, McDonald & Simmons from any liability on the ground that their respective 1/3 interest in Mantrasco remained the same before and after the declaration of stock dividends and only the number of shares held by each of them changed. Issues: 1. WON the shares are treasury shares [NO] 2. WON Manning, McDonald & Simmons should pay for deficiency income taxes [YES]

Ratio:

1. Treasury shares are stocks issued


and fully paid for and re-acquired by the corporation either by purchase, donation, forfeiture or other means. Treasury shares are therefore issued shares, but being in the treasury they do not have the status of outstanding shares. Consequently, although a treasury share, not having been retired by the corporation reacquiring it, may be re-issued or sold again, such share, as long as it is held by the corporation as a treasury share, participates neither in dividends, because dividends cannot be declared by the corporation to itself, nor in the meetings of the corporation as voting stock, for otherwise equal distribution of voting powers among stockholders will be effectively lost and the directors will be able to perpetuate their control of the corporation, though it still represents a paid-for interest in the property of the corporation. In this case, such essential features of a treasury share are lacking in the former shares of Reese. The manifest intention of the parties to the trust agreement was, in sum and substance, to treat the 24,700 shares of Reese as absolutely outstanding shares of Reese's estate until they were fully paid. Such being the true nature of the 24,700 shares, their declaration as treasury stock dividend in 1958 was a complete nullity and plainly violative of public policy. A stock dividend, being one payable in capital stock, cannot be declared out of outstanding corporate stock, but only from retained earnings. Nature of a stock dividend A stock dividend always involves a transfer of surplus (or profit) to capital stock. A stock dividend is a conversion of surplus or undivided profits into capital stock, which is distributed to stockholders in lieu of a cash dividend.

its subsidiaries to directly subsidize their purchase of said interests and by making it appear that they have not received any income from those firms when, in fact, by the formal declaration of non-existent stock dividends in the treasury they secured to themselves the means to turn around as full owners of Reeses shares. Manning, McDonald & Simmons,

using the trust instrument as a convenient technical device, bestowed unto themselves the full worth and value of Reese's corporate holdings with the use of the very earnings of the companies. Such package device, obviously not designed to carry out the usual stock dividend purpose of corporate expansion reinvestment but exclusively for expanding the capital base of Manning, McDonald & Simmons in Mantrasco, cannot be allowed to deflect their responsibilities toward our income tax laws.
All these amounts are subject to income tax as being a flow of cash benefits to Manning, McDonald & Simmons. Commissioners assessment is erroneous Commissioner should not have assessed the income tax on the total acquisition cost of the alleged treasury stock dividends in 1 lump sum. The record shows that the earnings of Mantrasco over a period of years were used to gradually wipe out the holdings of Reese. Consequently, those earnings should be taxed for each of the corresponding years when payments were made to Reeses estate on account of his 24,700 shares. Dispositive: CTA judgment set aside. Case remanded to the CTA for further proceedings for the recomputation of the income tax liabilities of Manning, McDonald & Simmons.

2. The ultimate purpose which the parties


to the trust agreement aimed to realize is to make Manning, McDonalds & Simmons the sole owners of Reeses interest in Mantrasco by utilizing the periodic earnings of Mantrasco and