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of whiskey, wines, liquor and distilled spirits. Its original paid up capital wa
s Php 500,000. At one point, they reduced to their capital to Php 250,000 with t
he approval of the SEC but this reduction was never implemented. When the busine
ss began to flourish, they increased their capital to 1 Million Pesos, again wit
h the approval of SEC in 1958. Wine Merchants invested in several companies incl
uding Acme Commercial, Co., Union Insurance of Canton and bought shares in Wack
Wack Golf and Country Club. Wine Merchants also acquired USA Treasury Bills valu
ed at around 347,000 Pesos.
The CIR examined the books of Manila Wine Merchants and found that it had unreas
onably accumulated a surplus of Php 428,000 from 1947-1957 in excess of the reas
onable needs of business subject to the surtax of 2% imposed by Section 25 of th
e Tax Code then demanded payment of the IAET. Wine Merchants appealed to the CTA
. For the CTA, the purchase of shares in Wack Wack, Union Insurance and Acme Com
mercial were harmless and not subject to 25% surtax. However, the purchase of th
e Treasury Bills was in no way related to the business of importing and selling
wines and ordered Manila Wine Merchants to pay IAET on the Treasury Bills. Manil
a Wine Merchants appealed to the CTA. ISSUE: Whether or not Manila Wine Merchant
s unreasonably accumulated earnings in excess of the reasonable needs of busines
s, thus making it liable to surtax under the Tax Code? HELD:
Sec. 29 (A) - Im
position of Improperly Accumulated Earnings Tax (A) In General. - In addition to
other taxes imposed by this Title, there is hereby imposed for each taxable yea
r on the improperly accumulated taxable income of each corporation described in
Subsection B hereof, an improperly accumulated earnings tax equal to ten percent
(10%) of the improperly accumulated taxable income.
Tax on improper accumulation of surplus is essentially a penalty tax. The provis
ion discouraged tax avoidance through corporate surplus accumulation. When corpo
rations do not declare dividends, income taxes are not paid on the undeclared di
vidends received by the shareholders. The tax on improper accumulation of surplu
s is essentially a penalty tax designed to compel corporations to distribute ear
nings so that the said earnings by shareholders could, in turn, be taxed. Immedia
cy Test may be used to determine the reasonable needs of the business. To determine
the reasonable needs of the business in order to justify an accumulation of earni
ngs, the Courts of the United States had developed the Immediacy Test which cons
trued the words reasonable needs of the business to mean the immediate needs of
the business, and it was generally held that; if the corporation did not prove a
n immediate need for the accumulation of the earnings and profits, the accumulat
ion was not for the reasonable needs of the business, and the penalty tax would
apply. Touchstone of liability is the purpose behind the accumulation of the inc
ome and not the consequences of the accumulation.
A prerequisite to the imposition of the tax has been that the corporation be for
med or availed of for the purpose of avoiding the income tax (or surtax) on its
shareholders, or on the shareholders of any other corporation by permitting the
earnings and profits of the corporation to accumulate instead of dividing them a
mong or distributing them to the shareholders. If the earnings and profits were
distributed, the
if the distribution were not made to them. Thus. Taxpayer s intention at the time
of accumulation is controlling.shareholders would be required to pay an income t
ax thereon whereas. The mere recognition of a future problem and the discussion
of possible and alternative solutions is not sufficient. such purpose does not f
all within the interdiction of the statute. Manila Wine Merchants organized in 1
937 was engaged in the importation and sale of whiskey, wines, liquor and distil
led spirits. Its original paid up capital was Php 500,000. At one point, they re
duced to their capital to Php 250,000 with the approval of the SEC but this redu
ction was never implemented. When the business began to flourish, they increased
their capital to 1 Million Pesos, again with the approval of SEC in 1958. Wine