Korteä

Petitioner disputes the decision1 [Rollo, pp. 25-34.] of the Court of Appeals which affirmed the decision2 [CA Rollo, pp. 19-28.] of the Court of Tax Appeals, ordering petitioner to pay respondent Commissioner of Internal Revenue the amount of three million, seven hundred seventy-four thousand, eight hundred sixty seven pesos and fifty centavos (P3,774,867.50) as 25% surtax on improper accumulation of profits for 1981, plus 10% surcharge and 20% annual interest from January 30, 1985 to January 30, 1987, under Sec. 25 of the National Internal Revenue Code.

The Court of Tax Appeals made the following factual findings:

Petitioner, Cyanamid Philippines, Inc., a corporation organized under Philippine laws, is a wholly owned subsidiary of American Cyanamid Co. based in Maine, USA. It is engaged in the manufacture of pharmaceutical products and chemicals, a wholesaler of imported finished goods, and an importer/indentor.

On February 7, 1985, the CIR sent an assessment letter to petitioner and demanded the payment of deficiency income tax of one hundred nineteen thousand eight hundred seventeen (P119,817.00) pesos for taxable year 1981, as follows:

On March 4, 1985, petitioner protested the assessments particularly, (1) the 25% Surtax Assessment of P3,774,867.50; (2) 1981 Deficiency Income Assessment of P119,817.00; and 1981 Deficiency Percentage Assessment of P8,846.72.4 [Id. at 25.] Petitioner, through its external accountant, Sycip, Gorres, Velayo & Co., claimed, among others, that the surtax for the undue accumulation of earnings was not proper because the said profits were retained to increase petitioner’s working capital and it would be used for reasonable business needs of the company. Petitioner contended that it availed of the tax amnesty under Executive Order No. 41, hence enjoyed amnesty from civil and criminal prosecution granted by the law.

On October 20, 1987, the CIR in a letter addressed to SGV & Co., refused to allow the cancellation of the assessment notices and rendered its resolution, as follows:

Petitioner appealed to the Court of Tax Appeals. During the pendency of the case, however, both parties agreed to compromise the 1981 deficiency income tax assessment of P119,817.00. Petitioner paid a reduced amount --twenty-six thousand, five hundred seventy-seven pesos (P26,577.00) -- as compromise settlement. However, the surtax on improperly accumulated profits remained unresolved.

Petitioner claimed that CIR’s assessment representing the 25% surtax on its accumulated earnings for the year 1981 had no legal basis for the following reasons: (a) petitioner accumulated its earnings and profits for reasonable business requirements to meet working capital needs and retirement of indebtedness; (b) petitioner is a wholly owned subsidiary of American Cyanamid Company, a corporation organized under the laws of the State of Maine, in the United States of America, whose shares of stock are listed and traded in New York Stock Exchange. This being the case, no individual shareholder of petitioner could have evaded or prevented the imposition of individual income taxes by petitioner’s accumulation of earnings and profits, instead of distribution of the same. Scl-aw

In denying the petition, the Court of Tax Appeals made the following pronouncements:

Petitioner appealed the Court of Tax Appeal’s decision to the Court of Appeals. Affirming the CTA decision, the appellate court said:

Hence, petitioner now comes before us and assigns as sole issue:

Section 259 [The tax on improperly accumulated income tax underwent changes since the time of assessment of herein petitioner, in 1985, until the enactment of the present tax code, the 1997 NIRC. This provision was subsequently repealed by Executive Order No. 37 which took effect on January 1, 1986. The reason for the repeal was explained by the Commissioner of Internal Revenue through Revenue Memorandum Circular No. 26-86 as follows: "The tax on improper accumulation of surplus is essentially a penalty tax designed to compel corporations to distribute corporate earnings so that the said earnings will be taxed to the shareholders. The exemption of dividends from income tax renders the improperly accumulated surplus tax meaningless. Accordingly, the provisions of the tax on improper accumulation or surplus are repealed and replaced with provisions to govern the taxation of foreign corporation which are lifted from Section 24 (b)." (Annotation, Improper Accumulation of Corporate Surplus or Profit by Severiano S. Tabios, 173 SCRA, pp. 403-408.) However, Section 29 of the New 1997 NIRC provides for the revival of the imposition of improperly accumulated earnings tax. The exemption from this rule now includes publicly held corporation (par. B, 2, Section 29, 1997 NIRC)] of the old National Internal Revenue Code of 1977 states: Sd-aad-sc

The provision discouraged tax avoidance through corporate surplus accumulation. When corporations do not declare dividends, income taxes are not paid on the undeclared dividends received by the shareholders. The tax on improper accumulation of surplus is essentially a penalty tax designed to compel corporations to distribute earnings so that the said earnings by shareholders could, in turn, be taxed.

Relying on decisions of the American Federal Courts, petitioner stresses that the accumulated earnings tax does not apply to Cyanamid, a wholly owned subsidiary of a publicly owned company.10 [A publicly owned corporation was one where the outstanding stock was owned by more than 1,500 persons and not more than 10% of either the total combined voting power, or, the total value of all classes of its outstanding stock was owned at the close of the taxable year, by any one individual, either directly or indirectly, under the provision for attribution of ownership.] Specifically, petitioner cites Golconda Mining Corp. vs. Commissioner, 507 F.2d 594, whereby the U.S. Ninth Circuit Court of Appeals had taken the position that the accumulated earnings tax could only apply to a closely held corporation.

A review of American taxation history on accumulated earnings tax will show that the application of the accumulated earnings tax to publicly held corporations has been problematic. Initially, the Tax Court and the Court of Claims held that the accumulated earnings tax applies to publicly held corporations. Then, the Ninth Circuit Court of Appeals ruled in Golconda that the accumulated earnings tax could only apply to closely held corporations. Despite Golconda, the Internal Revenue Service asserted that the tax could be imposed on widely held corporations including those not controlled by a few shareholders or groups of shareholders. The Service indicated it would not follow the Ninth Circuit regarding publicly held corporations.11 [10 Mertens Law of Federal Income Taxation, Chapter 39, Accumulated Earnings Tax, Sec. 39.05.] In 1984, American legislation nullified the Ninth Circuit’s Golconda ruling and made it clear that the accumulated earnings tax is not limited to closely held corporations.12 [Ibid.] Clearly, Golconda is no longer a reliable precedent. Sl-xm-is

The amendatory provision of Section 25 of the 1977 NIRC, which was PD 1739, enumerated the corporations exempt from the imposition of improperly accumulated tax: (a) banks; (b) non-bank financial intermediaries; (c) insurance companies; and (d) corporations organized primarily and authorized by the Central Bank of the Philippines to hold shares of stocks of banks. Petitioner does not fall among those exempt classes. Besides, the rule on enumeration is that the express mention of one person, thing, act, or consequence is construed to exclude all others.13 [Commissioner of Customs vs. Court of Tax Appeals, 224 SCRA 665, 669-670 (1993); Centeno vs. Villalon-Pornillos, 236 SCRA 197 (1994)] Laws granting exemption from tax are construed strictissimi juris against the taxpayer and liberally in favor of the taxing power.14 [Commissioner of Internal Revenue vs. Mitsubishi Metal Corporation, 181 SCRA 214, 223-224 (1990)] Taxation is the rule and exemption is the exception.15 [Ibid.] The burden of proof rests upon the party claiming exemption to prove that it is, in fact, covered by the exemption so claimed,16 [Ibid.] a burden which petitioner here has failed to discharge.

Another point raised by the petitioner in objecting to the assessment, is that increase of working capital by a corporation justifies accumulating income. Petitioner asserts that respondent court erred in concluding that Cyanamid need not infuse additional working capital reserve because it had considerable liquid funds based on the 2.21:1 ratio of current assets to current liabilities. Petitioner relies on the so-called "Bardahl" formula, which allowed retention, as working capital reserve, sufficient amounts of liquid assets to carry the company through one operating cycle. The "Bardahl"17 [Bardahl Manufacturing Corp. vs. Commissioner, 24 TCM 1030.] formula was developed to measure corporate liquidity. The formula requires an examination of whether the taxpayer has sufficient liquid assets to pay all of its current liabilities and any extraordinary expenses reasonably anticipated, plus enough to operate the business during one operating cycle. Operating cycle is the period of time it takes to convert cash into raw materials, raw materials into inventory, and inventory into sales, including the time it takes to collect payment for the sales.18 [10 Mertens Law of Federal Income Taxation, Chapter 39, Accumulated Earnings Tax, Sec. 39.133.]

Using this formula, petitioner contends, Cyanamid needed at least P33,763,624.00 pesos as working capital. As of 1981, its liquid asset was only P25,776,991.00. Thus, petitioner asserts that Cyanamid had a working capital deficit of P7,986,633.00.19 [Rollo, p. 118.] Therefore, the P9,540,926.00 accumulated income as of 1981 may be validly accumulated to increase the petitioner’s working capital for the succeeding year.

We note, however, that the companies where the "Bardahl" formula was applied, had operating cycles much shorter than that of petitioner. In Atlas Tool Co., Inc. vs. CIR,20 [614 F2d 860.] the company’s operating cycle was only 3.33 months or 27.75% of the year. In Cataphote Corp. of Mississippi vs. United States,21 [535 F 2d 1225.] the corporation’s operating cycle was only 56.87 days, or 15.58% of the year. In the case of Cyanamid, the operating cycle was 288.35 days, or 78.55% of a year, reflecting that petitioner will need sufficient liquid funds, of at least three quarters of the year, to cover the operating costs of the business. There are variations in the application of the "Bardahl" formula, such as average operating cycle or peak operating cycle. In times when there is no recurrence of a business cycle, the working capital needs cannot be predicted with accuracy. As stressed by American authorities, although the "Bardahl" formula is well-established and routinely applied by the courts, it is not a precise rule. It is used only for administrative convenience.22 [10 Mertens Law of Federal Income Taxation, Chapter 39, Accumulated Earnings Tax, Sec. 39.132.] Petitioner’s application of the "Bardahl" formula merely creates a false illusion of exactitude. Sl-xsc

Other formulas are also used, e.g. the ratio of current assets to current liabilities and the adoption of the industry standard.23 [Id. at Sec. 39.128.] The ratio of current assets to current liabilities is used to determine the sufficiency of working capital. Ideally, the working capital should equal the current liabilities and there must be 2 units of current assets for every unit of current liability, hence the so-called "2 to 1" rule.24 [19 Fletcher Cyclopedia Corporations, Chapter 68, Corporation Practice, Section 9248 (1975)]

As of 1981 the working capital of Cyanamid was P25,776,991.00, or more than twice its current liabilities. That current ratio of Cyanamid, therefore, projects adequacy in working capital. Said working capital was expected to increase further when more funds were generated from the succeeding year’s sales. Available income covered expenses or indebtedness for that year, and there appeared no reason to expect an impending ‘working capital deficit’ which could have necessitated an increase in working capital, as rationalized by petitioner.

In Basilan Estates, Inc. vs. Commissioner of Internal Revenue,25 [21 SCRA 17 (1967)] we held that:

If the CIR determined that the corporation avoided the tax on shareholders by permitting earnings or profits to accumulate, and the taxpayer contested such a determination, the burden of proving the determination wrong, together with the corresponding burden of first going forward with evidence, is on the taxpayer. This applies even if the corporation is not a mere holding or investment company and does not have an unreasonable accumulation of earnings or profits.27 [Nolledo and Nolledo, The National Internal Revenue Code of the Philippines, Annotated (1982)]

In order to determine whether profits are accumulated for the reasonable needs of the business to avoid the surtax upon shareholders, it must be shown that the controlling intention of the taxpayer is manifested at the time of accumulation, not intentions declared subsequently, which are mere afterthoughts.28 [Basilan Estates, Inc. vs. Commissioner of Internal Revenue, 21 SCRA 17, 26 (1967), citing Jacob Mertens, Jr., The Law of Federal Income Taxation, Vol. 7, Cumulative Supplement, p. 213.] Furthermore, the accumulated profits must be used within a reasonable time after the close of the taxable year. In the instant case, petitioner did not establish, by clear and convincing evidence, that such accumulation of profit was for the immediate needs of the business.

In Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue,29 [127 SCRA 483 (1984)] we ruled: xl-aw

In the present case, the Tax Court opted to determine the working capital sufficiency by using the ratio between current assets to current liabilities. The working capital needs of a business depend upon the nature of the business, its credit policies, the amount of inventories, the rate of turnover, the amount of accounts receivable, the collection rate, the availability of credit to the business, and similar factors. Petitioner, by adhering to the "Bardahl" formula, failed to impress the tax court with the required definiteness envisioned by the statute. We agree with the tax court that the burden of proof to establish that the profits accumulated were not beyond the reasonable needs of the company, remained on the taxpayer. This Court will not set aside lightly the conclusion reached by the Court of Tax Appeals which, by the very nature of its function, is dedicated exclusively to the consideration of tax problems and has necessarily developed an expertise on the subject, unless there has been an abuse or improvident exercise of authority.31 [Commissioner of Internal Revenue vs. Court of Appeals, 271 SCRA 605, 608 (1997)] Unless rebutted, all presumptions generally are indulged in favor of the correctness of the CIR’s assessment against the taxpayer. With petitioner’s failure to prove the CIR incorrect, clearly and conclusively, this Court is constrained to uphold the correctness of tax court’s ruling as affirmed by the Court of Appeals.

WHEREFORE, the instant petition is DENIED, and the decision of the Court of Appeals, sustaining that of the Court of Tax Appeals, is hereby AFFIRMED. Costs against petitioner.