DOCTRINE OF PIERCING THE CORPORATE VEIL

CASE: MARVEL BUILDING CORP, ET AL (plaintiff-appellees) VS. DAVID, as Collector of BIR (defendant-appellant)

FACTS:
- Plaintiffs are stockholders of the Marvel Building Corporation.
- They (plaintiff) filed an action to enjoin the defendant (Collector of Internal Revenue) from selling at public
auction three parcels of land (including buildings thereon) all registered under the name of the plaintiff.
- Said properties were seized and distrained by defendant to collect war profits taxes assessed against plaintiff
Maria B. Castro.
-Maria Castro is the President of the Corporation with 250 shares

Plaintiffs’ contention: That the properties were owned by the Corporation and not by Castro
Defendant’s contention: That Castro is the true and exclusive owner of the properties

Trial Court held that the evidence failed to show that Castro is the true owner of all the stock certificates of the
corporation; ordered the release of the properties mentioned and enjoined the defendant from selling the same.

ISSUE: WON Castro is the owner of all the shares of stocks of Marvel Building Corporation and the other
stockholders mere dummies of hers

HELD: YES. The Court held that Castro is the sole and exclusive owner of the shares and that they were only her
dummies.

SC: Evidence that prove the defendant’s contention; these facts are of patent and potent significance:
-The existence of endorsed certificates, discovered by the internal revenue agents between 1948 and 1949 in the
possession of the Secretary-Treasurer;
-the fact that twenty-five certificates were signed by the president of the corporation, for no justifiable reason
- the fact that two sets of certificates were issued, the undisputed fact that Maria B. Castro had made enormous
profits and, therefore, had a motive to hide them to evade the payment of taxes;
-the fact that the other subscribers had no incomes of sufficient magnitude to justify their big subscriptions’
-the fact that the subscriptions were not receipted for and deposited by the treasurer in the name of the
corporation but were kept by Maria B. Castro herself;
-the fact that the stockholders or the directors never appeared to have ever met to discuss the business of the
corporation
-the fact that Maria B. Castro advanced big sums of money to the corporation without any previous arrangement
or accounting, and the fact that the books of accounts were kept as if they belonged to Maria B. Castro alone —
SC: Maria B. Castro would not have asked them to endorse their stock certificates, or be keeping these in her
possession, if they were really the owners. They never would have consented that Maria B. Castro keep the funds
without receipts or accounting, nor that she manages the business without their knowledge or concurrence, were
they owners of the stocks in their own rights.

4. CLASSIFICATION OF SHARES; PAR VALUE, NO PAR VALUE SHARES

CASE: DELPHER TRADES CORPORATION VS IAC and HYDRO PIPES PHILS, INC.

FACTS:
-Delphin and his sister Pelagia Pacheco were the owners of a real estate property locates in Valenzuela. They
leased the said property to Construction Components International Inc.
-Construction Components then assigned its rights and obligations under the lease contract in favor of Hydro Pipes
Phils, Inc. with the consent of the Pacheco’s.
-Then the Pacheco’s executed a deed of exchange with Delpher Trades Corp whereby the former conveyed to the
latter the leased property together with a parcel of land located in Malintafor 2,500 shares of stock of defendant
corporation.
-Hydro filed an amended complaint for reconveyance of the property assailing that it was not given the first option
to buy the subject property pursuant to their agreement.

CFI OF BULACAN: decided in favor of the plaintiff (Hydro)

IAC: Affirmed

Petitioner’s contention: That since Delpher Trades is a family corporation organized by Pelagia Pacheco+ Benjamin
Hernandez (spouses), and Delfin Pacheco and Pilar Angeles (spouses), there was actually no transfer since the
Pachecos remained in control of the property.

ISSUE: WON the Delpher Trades is a business conduit of Pacheco

HELD: YES.

After incorporation, one becomes a stockholder of a corporation by subscription or by purchasing stock directly
from the corporation or from individual owners thereof .

Here, in exchange for their properties, the Pachecos acquired 2,500 original unissued no par value shares of stocks
of the Delpher Trades Corporation. Consequently, the Pachecos became stockholders of the corporation by
subscription "The essence of the stock subscription is an agreement to take and pay for original unissued shares
of a corporation, formed or to be formed." It is significant that the Pachecos took no par value shares in exchange
for their properties.

A no-par value share does not purport to represent any stated proportionate interest in the capital stock
measured by value, but only an aliquot part of the whole number of such shares of the issuing
corporation.
The holder of no-par shares may see from the certificate itself that he is only an aliquot sharer in the
assets of the corporation. But this character of proportionate interest is not hidden beneath a false
appearance of a given sum in money, as in the case of par value shares. The capital stock of a corporation
issuing only no-par value shares is not set forth by a stated amount of money, but instead is expressed to
be divided into a stated number of shares, such as, 1,000 shares. This indicates that a shareholder of 100
such shares is an aliquot sharer in the assets of the corporation, no matter what value they may have, to
the extent of 100/1,000 or 1/10. Thus, by removing the par value of shares, the attention of persons
interested in the financial condition of a corporation is focused upon the value of assets and the amount
of its debts.

It is to be stressed that by their ownership of the 2,500 no par shares of stock, the Pachecos have control of the
corporation. Their equity capital is 55% as against 45% of the other stockholders, who also belong to the same
family group.

What they really did was to invest their properties and change the nature of their ownership from
unincorporated to incorporated form by organizing Delpher Trades Corporation to take control of their
properties and at the same time save on inheritance taxes.

Q You also, testified during the last hearing that the decision to have no par value share in the defendant
corporation was for the purpose of flexibility. Can you explain flexibility in connection with the ownership
of the property in question?
 A There is flexibility in using no par value shares as the value is determined by the board of directors in
increasing capitalization. The board can fix the value of the shares equivalent to the capital requirements
of the corporation.
Q Now also from the point of taxation, is there any flexibility in the holding by the corporation of the
property in question?
A Yes, since a corporation does not die it can continue to hold on to the property indefinitely for a period
of at least 50 years. On the other hand, if the property is held by the spouse the property will be tied up in
succession proceedings and the consequential payments of estate and inheritance taxes when an owner
dies.
Q Now what advantage is this continuity in relation to ownership by a particular person of certain
properties in respect to taxation?
A The property is not subjected to taxes on succession as the corporation does not die.

The "Deed of Exchange" of property between the Pachecos and Delpher Trades Corporation cannot be considered
a contract of sale. There was no transfer of actual ownership interests by the Pachecos to a third party. The
Pacheco family merely changed their ownership from one form to another. The ownership remained in the same
hands. Hence, the private respondent has no basis for its claim of a light of first refusal under the lease contract.

TRUST FUND DOCTRINE

CASE: STEINBERG, as receiver of the Sibuguey Trading Company, Inc. vs. VELASCO

FACTS:

- Steinberg is the receiver of Sibuguey, a domestic corporation.

- It is alleged that the defendants, Gregorio Velasco, as president, Felix del Castillo, as vice-president, Andres L.
Navallo, as secretary-treasurer, and Rufino Manuel, as director of Trading Company, at a meeting of the board of
directors approved and authorized various lawful purchases already made of a large portion of the capital stock
of the company from its various stockholders, thereby diverting its funds to the injury, damage and in fraud of
the creditors of the corporation. 
- the total amount of the capital stock unlawfully purchased was P3,300. That at the time of such purchase, the
corporation had accounts payable amounting to P13,807.50, most of which were unpaid at the time petition for
the dissolution of the corporation was financial condition, in contemplation of an insolvency and dissolution.
SECOND COA: the officers and directors of the corporation approved a resolution for the payment of P3,000 as
dividends to its stockholders, which was wrongfully done and in bad faith, and to the injury and fraud of its
creditors. 

TRIAL COURT’S RULING: Dismissed the complaint

ISSUE: WON the trail court’s ruling is correct.

HELD: No. Decision of the lower court is reversed.

Creditors of a corporation have the right to assume that so long as there are outstanding debts and liabilities, the
board of directors will not use the assets of the corporation to purchase its own stock, and that it will not declare
dividends to stockholders when the corporation is insolvent.

The corporation did not then have an actual bona fide surplus from which the dividends could be paid, and that
the payment of them in full at the time would "affect the financial condition of the corporation."

It is, indeed, peculiar that the action of the board in purchasing the stock from the corporation and in declaring the
dividends on the stock was all done at the same meeting of the board of directors, and it appears in those minutes
that the both Ganzon and Mendaros were formerly directors and resigned before the board approved the
purchase and declared the dividends, and that out of the whole 330 shares purchased, Ganzon, sold 100 and
Mendaros 200, or a total of 300 shares out of the 330, which were purchased by the corporation, and for which it
paid P3,300. In other words, that the directors were permitted to resign so that they could sell their stock to the
corporation. In this situation and upon this state of facts, it is very apparent that the directors did not act in good
faith or that they were grossly ignorant of their duties.

General Duty to Exercise Reasonable Care. — The directors of a corporation are bound to care for its
property and manage its affairs in good faith, and for a violation of these duties resulting in waste of its
assets or injury to the property they are liable to account the same as other trustees. Are there can be no
doubt that if they do acts clearly beyond their power, whereby loss ensues to the corporation, or dispose
of its property or pay away its money without authority, they will be required to make good the loss out
of their private estates. This is the rule where the disposition made of money or property of the
corporation is one either not within the lawful power of the corporation, or, if within the authority of the
particular officer or officers.

And section 458 which says:

Want of Knowledge, Skill, or Competency. — It has been said that directors are not liable for losses
resulting to the corporation from want of knowledge on their part; or for mistake of judgment, provided
they were honest, and provided they are fairly within the scope of the powers and discretion confided to
the managing body. But the acceptance of the office of a director of a corporation implies a competent
knowledge of the duties assumed, and directors cannot excuse imprudence on the ground of their
ignorance or inexperience; and if they commit an error of judgment through mere recklessness or want of
ordinary prudence or skill, they may be held liable for the consequences. Like a mandatory, to whom he
has been likened, a director is bound not only to exercise proper care and diligence, but ordinary skill and
judgment. As he is bound to exercise ordinary skill and judgment, he cannot set up that he did not possess
them.

COMMISSIONER OF INTERNAL REVENUE VS. CA (1999)

FACTS:

-Don Soriano Andres (citizen and resident of the US), formed the corporation A Soriano Y Cia (predecessor of
ANSCOR), with a P1M capitalization divided into 10,000 common shares at a par value of P100/share. Don Andres
then subscribed 4, 963 of the 5,000 shares.
-ANSCOR is wholly owned and controlled by the family of Don Andres
-ANSCOR’s capital stock was increased to P2.5M divided into 25,000 common shares; 10,000 of which were
subscribed by Don Andres (Total na subscription nya: 14, 963 common shares). Later on, 1, 250 shares each were
transferred by Don Andres to his two sons- Jose and Andres Jr.
- By 1947, ANSCOR declared stock dividends. Other stock dividend declarations were made between 1949 and
December 20, 1963. 11 On December 30, 1964 Don Andres died. As of that date, the records revealed that he has
a total shareholdings of 185,154 shares 12 — 50,495 of which are original issues and the balance of 134.659 shares
as stock dividend declarations. 

Correspondingly, one-half of that shareholdings or 92,577 shares were transferred to his wife, Doña Carmen
Soriano, as her conjugal share. The offer half formed part of his estate.

A day after Don Andres died, ANSCOR increased its capital stock to P20M and in 1966 further increased it to P30M.
In the same year (December 1966), stock dividends worth 46,290 and 46,287 shares were respectively received by
the Don Andres estate and Doña Carmen from ANSCOR. Hence, increasing their accumulated shareholdings to
138,867 and 138,864 common shares each.
On December 28, 1967, Doña Carmen requested a ruling from the United States Internal Revenue Service (IRS),
inquiring if an exchange of common with preferred shares may be considered as a tax avoidance scheme. By
January 2, 1968, ANSCOR reclassified its existing 300,000 common shares into 150,000 common and 150,000
preferred shares.

In a letter-reply dated February 1968, the IRS opined that the exchange is only a recapitalization scheme and not
tax avoidance. Consequently, on March 31, 1968 Doña Carmen exchanged her whole 138,864 common shares for
138,860 of the preferred shares. The estate of Don Andres in turn exchanged 11,140 of its common shares for the
remaining 11,140 preferred shares.

In 1973, after examining ANSCOR’s books of account and record Revenue examiners issued a report proposing that
ANSCOR be assessed for deficiency withholding tax-at-source, for the year 1968 and the 2nd quarter of 1969 based
on the transaction of exchange and redemption of stocks. BIR made the corresponding assessments. ANSCOR’s
subsequent protest on the assessments was denied in 1983 by petitioner. ANSCOR filed a petition for review with
the CTA, the Tax Court reversed petitioners ruling. CA affirmed the ruling of the CTA. Hence this position.

ISSUE: Whether ANSCOR's redemption of stocks from its stockholders as well as the exchange of common shares
can be considered as equivalent to the distribution of taxable dividend making the proceeds thereof taxable
under the provisions Section 83 (B) of the 1939 Revenue Act.

HELD: Decision was modified. ANSCOR'S redemption of 82,752.5 stock dividends is herein considered as essentially
equivalent to a distribution of taxable dividends for which it is liable for the withholding tax-at-source.

Tax on Stock Dividends

Proportionate test: wherein stock dividends once issued form part of the capital and, thus, subject to income tax.
Specifically: “A stock dividend representing the transfer of surplus to capital account shall not be subject to tax.”
Stock dividends, strictly speaking, represent capital and do not constitute income to its recipient.  So that the mere
issuance thereof is not yet subject to income tax as they are nothing but an "enrichment through increase in value
of capital investment." As capital, the stock dividends postpone the realization of profits because the "fund
represented by the new stock has been transferred from surplus to capital and no longer available for actual
distribution."

Income in tax law is "an amount of money coming to a person within a specified time, whether as payment for
services, interest, or profit from investment." It means cash or its equivalent. It is gain derived and severed from
capital, from labor or from both combined— so that to tax a stock dividend would be to tax a capital increase
rather than the income. 

In a loose sense, stock dividends issued by the corporation, are considered unrealized gain, and cannot be
subjected to income tax until that gain has been realized. Before the realization, stock dividends are nothing but a
representation of an interest in the corporate properties. As capital, it is not yet subject to income tax. It should be
noted that capital and income are different. Capital is wealth or fund; whereas income is profit or gain or the flow
of wealth. The determining factor for the imposition of income tax is whether any gain or profit was derived from a
transaction. 
EXPN: However, if a corporation cancels or redeems stock issued as a dividend at such time and in such
manner as to make the distribution and cancellation or redemption, in whole or in part, essentially
equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or
cancellation of the stock shall be considered as taxable income to the extent it represents a distribution
of earnings or profits accumulated after March first, nineteen hundred and thirteen.

The proceeds of redemption of stock dividends are essentially distribution of cash dividends, which when paid
becomes the absolute property of the stockholder. Thereafter, the latter becomes the exclusive owner thereof and
can exercise the freedom of choice.  Having realized gain from that redemption, the income earner cannot escape
income tax. 
Whether the amount distributed in the redemption should be treated as the equivalent of a "taxable dividend" is a
question of fact, 82 which is determinable on "the basis of the particular facts of the transaction in question. 

No decisive test can be used to determine the application of the exemption under Section 83(b). The use of the
words "such manner" and "essentially equivalent" negative any idea that a weighted formula can resolve a crucial
issue — Should the distribution be treated as taxable dividend.  On this aspect, American courts developed certain
recognized criteria, which includes the following: 
1) the presence or absence of real business purpose,
2) the amount of earnings and profits available for the declaration of a regular dividends and the corporation's past
record with respect to the declaration of dividends,
3) the effect of the distribution, as compared with the declaration of regular dividend,
4) the lapse of time between issuance and redemption, 
5) the presence of a substantial surplus 87 and a generous supply of cash which invites suspicion as does a meager
policy in relation both to current earnings and accumulated surplus.

REDEMPTION AND CANCELLATION

For the exempting clause of Section, 83(b) to apply, it is indispensable that: (a) there is redemption or cancellation;
(b) the transaction involves stock dividends and (c) the "time and manner" of the transaction makes it "essentially
equivalent to a distribution of taxable dividends." Of these, the most important is the third.

Redemption is repurchase, a reacquisition of stock by a corporation which issued the stock in exchange for
property, whether or not the acquired stock is cancelled, retired or held in the treasury. 
Essentially, the corporation gets back some of its stock, distributes cash or property to the shareholder in
payment for the stock, and continues in business as before. The redemption of stock dividends previously
issued is used as a veil for the constructive distribution of cash dividends.

In this case, there is no dispute that ANSCOR redeemed shares of stocks from a stockholder (Don Andres) twice
(28,000 and 80,000 common shares). If its source is the original capital subscriptions upon establishment of the
corporation or from initial capital investment in an existing enterprise, its redemption to the concurrent value of
acquisition may not invite the application of Sec. 83(b) under the 1939 Tax Code, as it is not income but a mere
return of capital. On the contrary, if the redeemed shares are from stock dividend declarations other than as initial
capital investment, the proceeds of the redemption is additional wealth, for it is not merely a return of capital but
a gain thereon.

It is not the stock dividends but the proceeds of its redemption that may be deemed as taxable dividends. Here, it
is undisputed that at the time of the last redemption, the original common shares owned by the estate were only
25,247.5 91 This means that from the total of 108,000 shares redeemed from the estate, the balance of 82,752.5
(108,000 less 25,247.5) must have come from stock dividends. Besides, in the absence of evidence to the contrary,
the Tax Code presumes that every distribution of corporate property, in whole or in part, is made out of corporate
profits such as stock dividends. The capital cannot be distributed in the form of redemption of stock dividends
without violating the trust fund doctrine — wherein the capital stock, property and other assets of the corporation
are regarded as equity in trust for the payment of the corporate creditors.  Once capital, it is always capital.  That
doctrine was intended for the protection of corporate creditors. 

Reclassification of shares does not always bring any substantial alteration in the subscriber’s proportional
interest. But the exchange is different — there would be a shifting of the balance of stock features, like
priority in dividend declarations or absence of voting rights. Yet neither the reclassification nor exchange per
se, yields realized income for tax purposes. A common stock represents the residual ownership interest in
the corporation. It is a basic class of stock ordinarily and usually issued without extraordinary rights or
privileges and entitles the shareholder to a pro rata division of profits. 126 Preferred stocks are those which
entitle the shareholder to some priority on dividends and asset distribution. 127

Both shares are part of the corporation’s capital stock. Both stockholders are no different from ordinary
investors who take on the same investment risks. Preferred and common shareholders participate in the
same venture, willing to share in the profits and losses of the enterprise. 128 Moreover, under the doctrine
of equality of shares — all stocks issued by the corporation are presumed equal with the same privileges and
liabilities, provided that the Articles of Incorporation is silent on such differences. 129
chanroblesvirtuallawlibrary

In this case, the exchange of shares, without more, produces no realized income to the subscriber. There is
only a modification of the subscriber’s rights and privileges — which is not a flow of wealth for tax purposes.
The issue of taxable dividend may arise only once a subscriber disposes of his entire interest and not when
there is still maintenance of proprietary interest. 

YAMAMOTO VS. NISHINO LEATHER INDUSTRIES, INC.

FACTS:
-Yamamoto (Japanese National) organized under Phil laws Wako Enterprises Manila, Inc., a corp engaged in
leather tanning, now known as Nishino Leather Industries.
- Yamamoto and Nishino (also a Japanese national) forged a MOA where they agreed to enter into a joint venture
wherein Nishino would acquire number of shares of stock equivalent to 70% of the authorized capital of WAKO.
- Eventually, Nishino and his brother1 Yoshinobu Nishino (Yoshinobu) acquired more than 70% of the authorized
capital stock of WAKO, reducing Yamamoto's investment therein to.
-Negotiations subsequently ensued in light of a planned takeover of NLII by Nishino who would buy-out the shares
of stock of Yamamoto.
- In the course of the negotiations, Yoshinobu and Nishino's counsel Atty. Emmanuel G. Doce (Atty. Doce) advised
Yamamoto by letter; pertinent portion of which : “Regarding the above machines, you may take them out with you
(for your own use and sale) if you want, provided, the value of such machines is deducted from your and Wako's
capital contributions, which will be paid to you.”
- Yamamoto filed a complaint against them for replevin

RTC decided in favor of Yamamoto

CA reversed the decision

ISSUE: WON the advice in the letter of Atty. Doce that Yamamoto may retrieve the machineries and
equipment, which admittedly were part of his investment, bound the corporation

HELD: No.

Under the Corporation Law, unless otherwise provided, corporate powers are exercised by the Board of
Directors. Indeed, without a Board Resolution authorizing respondent Nishino to act for and in behalf of the
corporation, he cannot bind the latter.

It bears noting, however, that the aforementioned paragraph 12 of the letter is followed by a request for
Yamamoto to give his "comments on all the above, soonest." What was thus proffered to Yamamoto was not
a promise, but a mere offer, subject to his acceptance. Without acceptance, a mere offer produces no
obligation. (ART 1181, NCC)

In the case at bar, there is no showing of compliance with the condition for allowing Yamamoto to take the
machineries and equipment, namely, his agreement to the deduction of their value from his capital
contribution due him in the buy-out of his interests in NLII. Yamamoto's allegation that he agreed to the
condition35 remained just that, no proof thereof having been presented.

The machineries and equipment, which comprised Yamamoto's investment in NLII, 36 thus remained part of
the capital property of the corporation. It is settled that the property of a corporation is not the property of
its stockholders or members.

Under the trust fund doctrine, the capital stock, property, and other assets of a corporation are regarded as
equity in trust for the payment of corporate creditors which are preferred over the stockholders in the
distribution of corporate assets. The distribution of corporate assets and property cannot be made to depend
on the whims and caprices of the stockholders, officers, or directors of the corporation unless the
indispensable conditions and procedures for the protection of corporate creditors are followed.