COMMISSIONER OF INTERNAL REVENUE vs.

MANNING
L-28398 | Aug 6, 1975 | Petition for Review | Castro
Petitioner: Commissioner of Internal Revenue
Respondents: John Manning, W.D. McDonald, E.E. Simmons & CTA

Quick Summary:
Facts: Reese, the majority stockholder of Mantrasco, executed a trust agreement between him,
Mantrasco, Ross, Selph, carrascoso & Janda law firm and the minority stockholders, Manning, McDonald
and Simmons. Said agreement was entered into because of Reeses desire that Mantrasco and
Mantrasocs 2 subsidiaries, Mantrasco Guam and Port Motors, to continue under the management of
Manning, McDonald and Simmons upon his [Reese] death. When Reese died, Mantrasco paid Reeses
estate the value of his shares. When said purchase price has been fully paid, the 24,700 shares, which
were declared as dividends, were proportionately distributed to Manning, McDonald and Simmons.
Because of this, the BIR issued assessments on Manning, McDonald and Simmons for deficiency income
tax for 1958. Manning et al, opposed this assessment but the BIR still found them liable. Manning et al.
appealed to the CTA, which absolved them from any liability.
Held: The manifest intention of the parties to the trust agreement was, in sum and substance, to treat the
24,700 shares of Reese as absolutely outstanding shares of Reese's estate until they were fully paid.
Such being the true nature of the 24,700 shares, 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.
A stock dividend always involves a transfer of surplus (or profit) to capital stock. A stock dividend is a
conversion of surplus or undivided profits into capital stock, which is distributed to stockholders in lieu of a
cash dividend.

Facts:
1952 - Mantrasco had an authorized capital stock of P2.5M divided into 25,000 common shares.
24,700 of these shares are owned by Julius Reese while the rest, at 100 each, are owned by
Manning, McDonald & Simmons.
February 29, 1958 - a trust agreement was executed between Reese, Mantrasco, Ross, Selph,
carrascoso & Janda law firm, Manning, McDonald and Simmons. Said agreement was entered
into because of Reeses desire that Mantrasco and Mantrasocs 2 subsidiaries, Mantrasco Guam
and Port Motors, to continue under the management of Manning, McDonald and Simmons upon
his [Reese] death.
October 19, 1954 - Reese died. However, the projected transfer of his shares in the name of
Mantrasco could not be immediately effected for lack of sufficient funds to cover the initial
payment on the shares.
February 2, 1955 - after Mantrasco made a partial payment of Reese's shares, the certificate for
the 24,700 shares in Reese's name was cancelled and a new certificate was issued in the name
of Mantrasco. Also, new certificate was endorsed to the law firm of Ross, Selph, Carrascoso and
Janda, as trustees for and in behalf of Mantrasco.
December 22, 1958 - a resolution was passed during a special meeting of Mantrasco
stockholders.
November 25, 1963 - entire purchase price of Reese's interest in Mantrasco was finally paid in full
by Mantrasco.
May 4, 1964 - trust agreement was terminated and the trustees delivered to Mantrasco all the
shares which they were holding in trust.
September 14, 1962 - BIR ordered an examination of Mantrascos books. This examination
disclosed that:
1. as of December 31, 1958 the 24,700 shares declared as dividends had been proportionately
distributed to Manning, McDonald & Simmons, representing a total book value or acquisition
cost of P7,973,660
2. Manning, McDonald & Simmons failed to declare the said stock dividends as part of their
taxable income for the year 1958
 Thus, BIR examiners concluded that the distribution of Reese's 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."
April 14, 1965 - Commissioner of Internal Revenue issued notices of assessment for deficiency
income taxes to Manning, McDonald & Simmons for the year 1958.
Manning, McDonald & Simmons opposed said assessments. BIR still held them liable for these
assessments.
Manning, McDonald & Simmons appealed to the CTA.
CTA: absolved Manning, McDonald & Simmons from any liability 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 changed.
Issues:
1. WON the shares are treasury shares [NO]
2. WON Manning, McDonald & Simmons should pay for deficiency income taxes [YES]
Ratio:
1. Treasury shares are stocks issued and fully paid for and re-acquired by the corporation
either by purchase, donation, forfeiture or other means. Treasury shares are therefore
issued shares, but being in the treasury they do not have the status of outstanding
shares. Consequently, 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 dividends, because
dividends cannot be declared by the corporation to itself, nor 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 still represents a paid-for interest in the property of
the corporation.
In this case, such essential features of a treasury share are lacking in the former
shares of Reese.
The manifest intention of the parties to the trust agreement was, in sum and
substance, to treat the 24,700 shares of Reese as absolutely outstanding shares of
Reese's estate until they were fully paid. Such being the true nature of the 24,700
shares, 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.

Nature of a stock dividend

A stock dividend always involves a transfer of surplus (or profit) to capital stock.
A stock dividend is a conversion of surplus or undivided profits into capital stock,
which is distributed to stockholders in lieu of a cash dividend.

2. The ultimate purpose which the parties to the trust agreement aimed to realize is to make
Manning, McDonalds & Simmons the sole owners of Reeses interest in Mantrasco by
utilizing the periodic earnings of Mantrasco and its subsidiaries to directly subsidize their
purchase of said interests and by making it appear that they have not received any income
from those firms when, in fact, by the formal declaration of non-existent stock dividends in the
treasury they secured to themselves the means to turn around as full owners of Reeses shares.
Manning, McDonald & Simmons, using the trust instrument as a convenient technical device,
bestowed unto themselves the full worth and value of Reese's 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 reinvestment but exclusively for expanding the capital base of
Manning, McDonald & Simmons in Mantrasco, cannot be allowed to deflect their
responsibilities toward our income tax laws.
 All these amounts are subject to income tax as being a flow of cash benefits to
Manning, McDonald & Simmons.

Commissioners assessment is erroneous

Commissioner should not have assessed the income tax on the total acquisition cost of the
alleged treasury stock dividends in 1 lump sum.
The record shows that the earnings of Mantrasco over a period of years were used to
gradually wipe out the holdings of Reese.
Consequently, those earnings should be taxed for each of the corresponding years when
payments were made to Reeses estate on account of his 24,700 shares.

Dispositive: CTA judgment set aside. Case remanded to the CTA for further proceedings for the
recomputation of the income tax liabilities of Manning, McDonald & Simmons.