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CIR VS MANNING

GR NO. L-28398
AUGUST 6, 1985
FIRST DIVISION

J. CASTRO

FACTS:

This is a petition for review of the decision of the Court of Tax Appeals, in CTA case 1626,
which set aside the income tax assessments issued by the Commissioner of Internal
Revenue against John L. Manning, W.D. McDonald and E.E. Simmons (hereinafter referred
to as the respondents), for alleged undeclared stock dividends received in 1958 from the
Manila Trading and Supply Co. (hereinafter referred to as the MANTRASCO) valued at
P7,973,660.

Under a trust agreement, Julius Reese who owned 24,700 shares of the 25,000 common
shares of MANTRASCO, and the three private respondents who owned the rest, at 100
shares each, deposited all their shares with the Trustees. The trust agreement provided
that upon Reese’s death MANTRASCO shall purchase Reese’s shares. The trust agreement
was executed in view of Reese’s desire that upon his death the Company would continue
under the management of respondents. Upon Reese’s death and partial payment by the
company of Reeses’s share, a new certificate was issued in the name of MANTRASCO, and
the certificate indorsed to the Trustees. Subsequently, the stockholders reverted the 24,700
shares in the Treasury to the capital account of the company as stock dividends to be
distributed to the stockholders. When the entire purchase price of Reese’s interest in the
company was paid in full by the latter, the trust agreement was terminated, and the shares
held in trust were delivered to the company.

The Bureau of Internal Revenue concluded that the distribution of the 24,700 shares of
Reese as stock dividends was in effect a distribution of the "assets or property of the
corporation." It therefore assessed respondents for deficiency income taxes as well as for
fraud penalty and interest charges. The Court of Tax Appeals absolved respondent from
any liability for receiving the questioned stock dividends on the ground that their
respective one-third interest in the Company remained the same before and after the
declaration of the stock dividends and only the number of shares held by each of them had
changed.

ISSUE:

Whether the distributed stock dividends were “Treasury shares” and the Taxability of the
"treasury" stock dividends received by the respondents

HELD:
The record shows that the earnings of MANTRASCO over a period of years were used to
gradually wipe out the holdings therein of Reese. Consequently, those earnings, which we
hold, under the facts disclosed in the case at bar, as in effect having been distributed to the
respondents, should be taxed for each of the corresponding years when payments were
made to Reese’s estate on account of his 24,700 shares. With regard to payments made
with MANTRASCO earnings in 1958 and the years before, while indeed those earnings
were utilized in those years to gradually pay off the value of Reese’s holdings in
MANTRASCO, there is no evidence from which it can be inferred that prior to the passage of
the stockholders’ resolution of December 22, 1958 the contributed equity of each of the
respondents rose correspondingly. It was only by virtue of the authority contained in the
said resolution that the respondents actually, albeit illegally, appropriated and partitioned
among themselves the stockholders’ equity representing Reese’s interests in MANTRASCO.
As those payments accrued in favor of the respondents in 1958 they are and should be
liable, for income tax purposes, to the extent of the aggregate amount paid, from 1955 to
1958, by MANTRASCO to buy off Reese’s shares.

On a petition for review, the Supreme Court held that the newly acquired shares were not
treasury shares; their declaration as treasury stock dividends was a complete nullity and
that the assessment by the Commissioner of fraud penalty and the imposition of interest
charges pursuant to the provision of the Tax Code were made in accordance with law.

The judgment of the Court of Tax Appeals absolving the respondents from any deficiency
income tax liability is set aside

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