CIR v. JOHN MANNING, W.D. McDONALD, E.E.

SIMMONS and CTA

1975 / Castro / Dividend income > Kinds of dividends recognized by law > Stock
FACTS
In 1952, Manila Trading and Supply [MANTRASCO] had an authorized capital stock of P2.5M divided into 25k
common shares [Breakdown: 24,700 owned by Julius Reese; 100 Manning; 100 McDonald; 100 Simmons]
[See pp. 17-20 of the SCRA copy] A trust agreement was executed by Reese [owner], MANTRASCO
[company], a law firm [trustees] and the three respondents [managers]. This is because Reese wanted for
MANTRASCO and its subsidiaries to continue under the managers upon his death.
Reese died two years later. HOWEVER, the projected transfer of his shares in MANTRASCOs name could
not be immediately made due to lack of sufficient funds to cover initial payment on the shares. In 1955, MANTRASCO
made a partial payment, so the certificate for the 24,700 shares in Reeses name was cancelled, and a new one was
issued in MANTRASCOs name. On the same day, this new certificate was endorsed to the law firm as trustees for
and in behalf of MANTRASCO (note that Reeses interest has not been fully paid).
In 1958, a board resolution was passed at a special meeting of MANTRASCO stockholdersthe 24,700 shares xxx
be reverted back to the capital account of the company as a stock dividend to be distributed to shareholders xxx at
the close of business xxx.
In 1962, BIR ordered an examination of MANTRASCOs books. The findings are as follows:

As of 1958 yearend, the 24,700 shares declared as dividends had been proportionately distributed to the
managers [the three respondents], representing a total book value or acquisition cost of P7M~

The managers failed to declare said stock dividends as part of their taxable income for 1958

It also made a table on the amounts paid by MANTRASCO to Reeses estate by virtue of the trust
agreement [p. 21]
BIRs conclusion: The distribution of Reeses shares as stock dividends was in effect a distribution of the asset or
property of the corporation as may be gleaned from the payment of cash for the redemption of said stock and
distributing the same as stock dividend!
[In 1963, MANTRASCO was finally able to pay in full the purchase price of Reeses interest. A year later, the trust
agreement was terminated and the trustees delivered to MANTRASCO all the shares which they held in trust.]
In 1965, the CIR issued notices of assessment for deficiency income taxes against the managers [respondents]
for alleged undeclared stock dividends valued at P7M~ received from MANTRASCO in 1958.
CTA set aside the CIRs income tax assessments on the ground that their respective 1/3 interest in MANTRASCO
remained the same before and after the declaration of stock dividends and only the number of shares held by each of
them had changed.
MANAGERS: Agree with CTA ruling
CIR: The full value [P7M~] of the shares redeemed by MANTRASCO from Reese, which were subsequently
distributed as stock dividends, should be taxed as income for the year, the said distribution being in effect a
distribution of cash. After the declaration, their interest in MANTRASCO rose to 33.33% from only .4%.
ISSUE & HOLDING
WON the CIRs assessment of a fraud penalty and the imposition of interest charges are in accordance with law. YES
RATIO
Treasury shares

Stocks issued and fully paid for and re-acquired by the corporation either by purchase, donation, forfeiture or
other means
These are issued shares, but being in the treasury, they do not have the status of outstanding shares
Although a treasury share, not having been retired by the corporation re-acquiring it, may be re-issued or
sold again, such share (as long as it is held by the corporation as a treasury share) participates neither in
o Dividends (because dividends cannot be declared by the corporation to itself) nor
o In the meetings of the corporation as voting stock (for otherwise equal distribution of voting powers
among stockholders will be effectively lost, and the directors will be able to perpetuate their control
of the corporation, though it represents a paid-for interest in the property of the corporation)

ASSUMPTION OF BOTH PARTIES: The 24,700 shares declared as stock dividends were treasury shares.
SUPREME COURT: Shares were NEVER treasury shares! All the essential features listed above are lacking
in the questioned shares!
[See pp. 24-25] The manifest intention of the parties to the trust agreement was to treat Reeses 24,700 shares as
absolutely outstanding shares of Reeses estate until they were fully paid. Hence, their declaration as treasury stock
dividend in 1958 was a complete nullity and plainly violative of public policy. A stock dividend, being one
payable in capital stock, cannot be declared out of outstanding corporate stock, but only from retained
earnings.
Stock dividend

Always involves a transfer of surplus (or profit) to capital stock

Conversion of surplus or undivided profits into capital stock, which is distributed to stockholders in lieu of a
cash dividend

Any distribution made by a corporation to its shareholders, whether in money or in other property, out of its
earnings or profits

Eisner v. Macomber segregation out of surplus account of a definite portion of the corporate earnings as
part of the permanent capital resources of the corporation by the device of capitalizing the same, and the
issuance to the stockholders of additional shares of stock representing the profits so capitalized

Bass v. CIR It is the same as if the corporation had used accumulated earnings to buy any other property
say, the stock of another corporationand had distributed such substituted property in specie as a
dividend to its shareholders
The respondents, using the trust instrument as a convenient technical device, bestowed unto themselves the
full worth and value of Reeses corporate holdings with the use of the very earnings of the companies. Such
package device (obviously not designed to carry out the usual stock dividend purpose of corporate expansion
reinvestmentthe acquisition of additional facilities and other capitalbut exclusively for expanding the capital base
of the respondents in MANTRASCO) cannot be allowed to deflect the respondents responsibilities toward income tax
laws.
The conclusion is that whenever the companies involved parted with a portion of their earnings to buy the corporate
holdings of Reese, they were in effect making a distribution of such earnings to the respondents. All these amounts
are consequently subject to income tax as being a flow of cash benefits to the respondents.
Amount of liability

MANTRASCOs earnings over the years were used to gradually wipe out Reeses holdings therein.
Consequently, those earnings, having been distributed to the respondents, should be taxed for each of the
corresponding years when payments were made to Reeses estate on account of his 24,700 shares.

With regard to payments made with earnings in 1958 and earlier, while the earnings were used to pay off
Reeses holdings, there is no evidence from which it can be inferred that prior to the stockholders resolution,
that the contributed equity of the respondents rose correspondingly. As those payments accrued in their
favor, they should be liable to the extent of the aggregate amount paid by MANTRASCO to buy off
Reeses shares.
The fact that the resolution is null and void is of no moment. Under NIRC, income tax is assessed on income received
from any property, activity, or service that produces income. The Tax Code stands as an indifferent, neutral party on
the matter of where the income comes from.
CTA JUDGMENT SET ASIDE; CASE REMANDED FOR RECOMPUTATION OF INCOME TAX LIABILITIES.