[KINDS OF SHARES OF STOCK] payment of cash for the redemption of said stock and distributing the same as stock

10 CIR v. JOHN L. MANNING, W.D. McDONALD, E.E. SIMMONS and THE COURT OF TAX dividend."
APPEALS • CIR issued notices of assessment for deficiency income taxes amounting to about P2.5M to
August 6, 1975 | Castro, J. | each of the private respondents

Facts: Appeal to CTA

• In 1952 the MANTRASCO had an authorized capital stock of P2,500,000 divided into 25,000 • CTA absolved the respondents from any liability for receiving the questioned stock
common shares dividends on the ground that their respective ⅓interest in MANTRASCO remained the
- 24,700 owned by Julius S. Reese same before and after the declaration of stock dividends and only the number of shares
- 100 owned by John L. Manning held by each of them had changed.
- 100 owned by W.D. McDonald
- 100 owned by E.E. Simmons CIR’s Arguments:
• February 29, 1952 — in view of Reese's desire that upon his death MANTRASCO and its two • The full value (P7,973,660) of the shares redeemed from Reese by MANTRASCO which
subsidiaries, MANTRASCO (Guam), Inc. and the Port Motors, Inc., would continue under were subsequently distributed to the respondents as stock dividends in 1958 should be
the management of the respondents, a trust agreement on his and the respondents' taxed as income of the respondents for that year, the said distribution being in effect a
interests in MANTRASCO was executed by and among Reese, MANTRASCO, the law firm distribution of cash.
of Ross, Selph, Carrascoso and Janda (trustees), and the respondents (managers).
• The respondents' interests in MANTRASCO were only .4% prior to the declaration of the
• When Reese died, the projected transfer of his shares in the name of MANTRASCO could stock dividends in 1958, but rose to 33 ⅓% each after the said declaration
not, however, be immediately effected for lack of sufficient funds to cover initial payment
on the shares. Issue:
• Feb 2, 1955 — After MANTRASCO made a partial payment of Reese's shares, the certificate 1. W/N the 24,700 shares declared as stock dividends were treasury shares — NO
for the 24,700 shares in Reese's name was cancelled and a new certificate was issued in 2. W/N the “treasury” stock dividends are taxable — YES
the name of MANTRASCO.
• On the same date, and in the meantime that Reese's interest had not been fully paid, the Held:
new certificate was endorsed to the law firm of Ross, Selph, Carrascoso and Janda, as 1. NO. The said shares were not, on December 22, 1958 or at anytime before or after that
TRUSTEES for and in behalf of MANTRASCO. date, treasury shares.
• Dec 22, 1958 — at a special meeting of MANTRASCO stockholders, a resolution was passed • Both parties assume that the stock dividends were treasury shares
reverting the 24,700 shares back to the capital account of the company as a stock • TREASURY SHARES are stocks issued and fully paid for and re-acquired by the
dividend to be distributed to shareholders of record at the close of business on Dec. 22, corporation either by purchase, donation, forfeiture or other means.
1958 ESSENTIAL FEATURES
• November 25, 1963 — entire purchase price of Reese's interest in MANTRASCO was finally - They are issued shares, but being in the treasury they do not have the status of
paid in full by MANTRASCO outstanding shares.
- A treasury share, not having been retired by the corporation re-acquiring it, may be re-
• May 4, 1964 — trust agreement was terminated and the trustees delivered to MANTRASCO
issued or sold again.
all the shares which they were holding in trust.
- BUT such share, as long as it is held by the corporation as a treasury share, participates
• BIR examined MANTRASCO’s books which revealed that: neither in dividends, because dividends cannot be declared by the corporation to itself,
(a) as of December 31, 1958 the 24,700 shares declared as dividends had been nor in the meetings of the corporation as voting stock, for otherwise equal distribution
proportionately distributed to the respondents, representing a total book value or of voting powers among stockholders will be effectively lost and the directors will be able
acquisition cost of P7,973,660; to perpetuate their control of the corporation, though it still represents a paid-for
(b) the respondents failed to declare the said stock dividends as part of their taxable interest in the property of the corporation.
income for the year 1958;
(c) from 1956 to 1961 amounts were paid by MANTRASCO to Reese's estate by virtue of
the trust agreement • 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
- They concluded that the distribution of Reese's shares as stock dividends was in effect a
- It is always a transfer of surplus (or profit) to capital stock
distribution of the "asset or property of the corporation as may be gleaned from the
 - Because it is payable in capital stock, it cannot be declared out of outstanding corporate
stock, but only from retained earnings
- The essence of a stock dividend is the segregation out of surplus account of a de􏰀nite
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

APPLIED TO THE CASE:

• The essential features of a treasury stock are lacking in the questioned shares.
- Under the trust agreement, the trustees were authorized to vote all stock standing in
their names at all meetings and to exercise all rights "as owners of said shares"
- Any and all dividends paid on said shares after the death of the OWNER (Reese) shall be
subject to the provisions of the trust agreement
- The amount of retained earnings to be declared as dividends was made subject to the
approval of the trustees of the 24,700 shares
- The choice of corporate directors was delegated exclusively to the trustees who were
also given the authority to transfer qualifying shares to such directors
- MANTRASCO and its two subsidiaries were expressly prohibited from paying "dividends
except as may be authorized by the TRUSTEES;” mention was also made of "dividends
on OWNER'S SHARES" which shall be applied to the liquidation of the liabilities of the
three companies for the price of Reese's shares
• The manifest intention of the parties to the trust agreement was 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.
• The respondents, 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, e.g. the acquisition of additional facilities and other
capital budget items, but exclusively for expanding the capital base of the respondents in
MANTRASCO, cannot be allowed to deflect the respondents' responsibilities toward our
income tax laws.

2. Whenever the companies involved herein parted with a portion of their earnings "to buy"
the corporate holdings of Reese, they were in ultimate effect and result making a distribution
of such earnings to the respondents. All these amounts are consequently subject to income
tax as being, in truth and in fact, a flow of cash benefits to the respondents.

Dispositive
ACCORDINGLY, the judgment of the Court of Tax Appeals absolving the respondents from
any deficiency income tax liability is set aside, and this case is hereby remanded to the Court
of Tax Appeals for further proceedings. More specifically, the Court of Tax Appeals shall
recompute the income tax liabilities of the respondents in accordance with this decision and
with the Tax Code, and thereafter pronounce and enter judgment accordingly.