In order to determine whether profits are accumulated for the reasonable needs of the business to avoid the surtax upon the shareholders, it must be shown that the controlling intention of the taxpayer is manifested at the time of the accumulation, not intentions subsequently, which are mere afterthoughts.
Petitioner is a corporation organized under Philippine laws and 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 imported/indentor. In 1985 the CIR assessed on petitioner a deficiency income tax of P119,817) for the year 1981. Cyanamid protested the assessments particularly the 25% surtax for undue accumulation of earnings. It claimed that said profits were retained to increase petitioner’s working capital and it would be used for reasonable business needs of the company. The CIR refused to allow the cancellation of the assessments, petitioner appealed to the CTA. It claimed that there was not legal basis for the assessment because 1) it accumulated its earnings and profits for reasonable business requirements to meet working capital needs and retirement of indebtedness 2) it is a wholly owned subsidiary of American Cyanamid Company, a foreign corporation, and its shares are listed and traded in the NY Stock Exchange. The CTA denied the petition stating that the law permits corporations to set aside a portion of its retained earnings for specified purposes under Sec. 43 of the Corporation Code but that petitioner’s purpose did not fall within such purposes. It found that there was no need to set aside such retained earnings as working capital as it had considerable liquid funds. Those corporations exempted from the accumulated earnings tax are found under Sec. 25 of the NIRC, and that the petitioner is not among those exempted. The CA affirmed the CTA’s decision.
Issue: Whether or not the accumulation of income was justified.
In order to determine whether profits are accumulated for the reasonable needs of the business to avoid the surtax upon the shareholders, it must be shown that the controlling intention of the taxpayer is manifested at the time of the accumulation, not intentions subsequently, which are mere afterthoughts. The accumulated profits must be used within reasonable time after the close of the taxable year. In the instant case, petitioner did not establish by clear and convincing evidence that such accumulated was for the immediate needs of the business.
To determine the reasonable needs of the business, the United States Courts have invented the “Immediacy Test” which construed the words “reasonable needs of the business” to mean the immediate needs of the business, and it is held that if the corporation did not prove an immediate need for the accumulation of earnings and profits such was not for reasonable needs of the business and the penalty tax would apply. (Law of Federal Income Taxation Vol 7) The working capital needs of a business depend on 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 and other similar factors. The Tax Court opted to determine the working capital sufficiency by using the ration between the current assets to current liabilities. Unless, rebutted, the presumption is that the assessment is correct. With the petitioner’s failure to prove the CIR incorrect, clearly and conclusively, the Tax Court’s ruling is upheld.