Certain provisions of the Philippine Constitution were crafted to protect the rights of Filipino

citizens to utilize our natural resources and to engage in nationalized activities. However, this
should not deter foreign economic investments that would allow the country to efficiently
explore these natural resources and effectively operate public utilities or reserved activities.

In determining compliance with the minimum Filipino equity requirement, there are two
acknowledged tests. One is the control test or the liberal rule. The other is the Grandfather
Rule, which is known to be the stricter and more stringent test. In applying these tests, there
had been confusion as to whether one method excludes the use of the other.

The control test provides that shares belonging to corporations or partnerships at least 60% of
the capital of which is owned by Filipino citizens shall be considered of Philippine nationality.
This test is straightforward and does not scrutinize further the ownership of the Filipino
shareholdings.

On the other hand, the Grandfather Rule determines the actual Filipino ownership and control
in a corporation by tracing both the direct and indirect shareholdings in the corporation.

According to the January 2015 Resolution of the Supreme Court in the case of Narra Nickel
Mining and Development Corp. vs. Redmont Consolidated Mines Corp. (G.R. No. 195580),
the Grandfather test was originally intended to look into the citizenship of the individuals who
ultimately own and control the shares of stock of a corporation for purposes of determining
compliance with the constitutional requirement of Filipino ownership.

The shareholdings should ideally be traced (i.e. grandfathered) to the point where natural
persons hold the shares. However, this may be impractical and a limit must be set when tracing
through the corporate layers to attribute nationality. Citing a memorandum from the Securities
and Exchange Commission (SEC), the Supreme Court noted the suggestion of the SEC to
apply the Grandfather Rule on two levels of corporate relations for publicly-held corporations or
where shares are traded in the stock exchange, and to three levels for closely held ones or
those which are not traded in any stock exchange. Clearly, the limits should not go beyond the
level of what is reasonable.

The Supreme Court clarified the role of these tests in determining compliance with the required
Filipino equity threshold. The Court explained that the use of the Grandfather Rule is a
supplement to the Control Test in implementing the wisdom of the Filipinization provisions of
the Constitution.

The Supreme Court recognized the intention of the framers of the Constitution to apply the
Grandfather Rule in cases where there is corporate layering. It likewise noted that corporate
layering, while admittedly allowed by the Foreign Investment Act, becomes illegal if used to
circumvent the Constitution and other applicable laws.

The Court further discussed that the Grandfather Rule applies only when the 60-40 Filipino-
foreign ownership is in doubt or where there is reason to believe that there is non-compliance
with the provisions of the Constitution on the nationality restriction.
How then we do we determine the existence of doubt? In its Resolution, the high court clarified
that doubt does not automatically mean the mere failure of the Filipino ownership to meet the
60% threshold of the corporations equity. Doubt refers to various indicia that the beneficial
ownership and control of the corporation do not in fact reside in Filipino shareholders but in
foreign stakeholders.

To demonstrate these signs of doubt, the Court referred to the indicators of a dummy status as
identified in a Department of Justice Opinion on the Anti-Dummy Law. These would be where
the foreign investors provide practically all the funds and technological support for a joint
venture undertaken with their Filipino partners, and where such foreign investors get to
manage the company even while being minority stockholders.

In the Narra Nickel Mining case, the Supreme Court found that while the petitioning
corporations complied with the Control Test, factual circumstances nonetheless raise doubt as
to their true nationality and therefore requires the application of the Grandfather Rule. Some of
the indicators of doubt found by the Court in the said case are the following: (1) the three
mining corporations had the same 100% Canadian owned foreign investor, (2) the similar
corporate structure and shareholder composition of the three corporations, (3) a major Filipino
shareholder within the corporate layering did not pay any amount with respect to its
subscription, and (4) the dubious act of the foreign investor in conveying its interests in the
mining corporations to another domestic corporation, among others. These instances
demonstrate that corporate layering was utilized to allow a foreign corporation to gain control of
these mining corporations in the Philippines.

After applying the Grandfather Rule, the Supreme Court was able to trace and conclude that
the Filipino shareholders did not actually have the required amount of control and beneficial
ownership in the mining companies, and consequently failed to comply with the nationality
requirement under the Constitution.

In a fitting ending, the Supreme Court enunciated its original April 2014 decision that the
Control Test is still the prevailing mode of determining whether or not a corporation is a Filipino
corporation. It is only in case of doubt, based on the attendant facts and circumstances of the
case, that the Grandfather Rule is applied.
The Constitution and various laws reserve certain areas of activities to Philippine citizens or to
corporations that have a minimum percentage of Filipino ownership. For example, with respect
to corporations, ownership of land is limited to corporations at least sixty per centum of whose
capital is owned by Philippine citizens. If 60% of the capital of a Philippine corporation is
owned by individuals who are Philippine citizens, then there would be no issue on whether the
Philippine corporation is a Philippine national qualified to own land. On the other hand, an issue
would arise if 60% of the capital of the Philippine corporation is owned, in turn, by another
Philippine corporation that has foreign stockholders.

If a Philippine corporation has corporate stockholders, how does one determine whether such
Philippine corporation is a Philippine national? Two tests have been employed in the
Philippines: (a) the grandfather rule; and (b) the control test.

To illustrate how these tests are applied, lets take a Philippine corporation (called Corporation
X) with the following ownership structure:

(a) Non-Philippine citizens own 40% of the capital stock outstanding and entitled to vote of
Corporation X;

(b) Another Philippine corporation (called Corporation Y) owns 60% of the capital stock
outstanding and entitled to vote of Corporation X.

On other hand, Corporation Y has the following ownership structure:

(a) Non-Philippine citizens own 40% of the capital stock outstanding and entitled to vote of
Corporation Y;

(b) Philippine citizens own 60% of the capital stock outstanding and entitled to vote of
Corporation Y.

Lets also assume that Philippine citizens constitute at least 60% of the members of the board of
directors of each of Corporation X and Corporation Y.

If the grandfather rule is applied, Corporation X will not be deemed a Philippine national
because the grandfather rule takes into account the direct and indirect foreign equity of
foreigners in Corporation X (see SEC Opinion re: Silahis International Hotel, May 4, 1987).
Applying the grandfather rule, the direct and indirect foreign equity in Corporation X would be
64%, calculated at follows:

Direct foreign-owned equity in Corporation X 40%

Indirect foreign owned equity in Corporation X 24%

Under the above scenario, the foreigners are deemed to have a 24% indirect foreign equity in
Corporation X because foreigners own 40% of Corporation Y, which in turn owns 60% of
Corporation X (i.e., 40% multiplied by 60% equals 24%). Thus, under the grandfather rule,
Corporation X is not qualified to own land.

On the other hand, if the control test is applied, Corporation X is deemed to be a Philippine
national qualified to own land.

Under the control test, Corporation X is considered a Philippine national since at least 60% of its
capital stock outstanding and entitled to vote is held by Corporation Y, which is also considered
a Philippine national since at least 60% of its capital stock outstanding and entitled to vote is
held by Philippine citizens.

Which of these two tests should be applied? Watch out for a subsequent article on this topic.
So diba you have Narra, which is owned by 3 corporations: A, B, and C
So si A, B, and C are each owned also by corporations.
So si A owned siya by D and E. Now, we have to know the nationality of A.
Si D 60% filipino siya, 40% foreign. Si E 10% Filipino, 90% foreign.
So si D = Filipino nationality, E = Foreign.
In A, D owns 60%, E owns 40%. Since D is Filipino, A filipino. THEN WE COMPUTE.
To know what percentage the Filipino ownership of D in A:
60% x 60% = 36%. So si D 36% filipino ownership in A.
Then you repeat the process for B and C.
Then you add to get the Filipino percentage in Narra