The Supreme Court ruled that the redemption of preferred shares by Goodyear Philippines from its US-based parent company, Goodyear Tire and Rubber Company (GTRC), was not subject to the 15% final withholding tax (FWT) on dividends. The Court clarified that the redemption price, which included an amount above the par value of the shares, could not be considered dividends because Goodyear Philippines did not have unrestricted retained earnings from which dividends could be declared. This decision clarifies the tax treatment of share redemptions involving foreign entities and the application of the RP-US Tax Treaty.

Redeeming Shares: When is a Gain Not a Dividend?

Goodyear Philippines, Inc. (respondent), sought a refund for erroneously withheld and remitted final withholding tax (FWT) related to the redemption of preferred shares held by its parent company, Goodyear Tire and Rubber Company (GTRC), a US resident. The core legal question was whether the gains derived by GTRC from the redemption of these shares should be subject to the 15% FWT on dividends, or if the transaction qualified for tax exemption under the RP-US Tax Treaty. Understanding this distinction is vital for multinational corporations operating in the Philippines to properly manage their tax obligations.

The controversy began when respondent increased its authorized capital stock, with the preferred shares being exclusively subscribed by GTRC. Later, the respondent authorized the redemption of these shares at a price exceeding their par value. Respondent withheld and remitted FWT on the difference between the redemption price and the par value, taking a conservative approach. Subsequently, the respondent filed for a refund, arguing that the gains were not taxable in the Philippines under the RP-US Tax Treaty. The Commissioner of Internal Revenue (petitioner) contested the claim, asserting that the gain was essentially accumulated dividends and therefore subject to the 15% FWT.

The Court of Tax Appeals (CTA) Division and En Banc both sided with the respondent, prompting the petitioner to elevate the case to the Supreme Court. The petitioner argued that the judicial claim was premature due to the non-exhaustion of administrative remedies. Moreover, the petitioner insisted that the portion of the redemption price exceeding the par value of the shares represented accumulated dividends in arrears and should be taxed accordingly.

The Supreme Court addressed the procedural issue first, emphasizing that the administrative claim’s primary purpose is to notify the CIR of potential court action. According to Section 229 of the Tax Code:

SEC. 229. Recovery of Tax Erroneously or Illegally Collected. – No suit or proceeding shall be maintained in any court for the recovery of any national internal revenue tax hereafter alleged to have been erroneously or illegally assessed or collected, or of any penalty claimed to have been collected without authority, or of any sum alleged to have been excessively or in any manner wrongfully collected, until a claim for refund or credit has been duly filed with the Commissioner; but such suit or proceeding may be maintained, whether or not such tax, penalty, or sum has been paid under protest or duress.

In any case, no such suit or proceeding shall be filed after the expiration of two (2) years from the date of payment of the tax or penalty regardless of any supervening cause that may arise after payment  x x x.

The Court reiterated that taxpayers are not required to await the final resolution of their administrative claims before seeking judicial recourse, especially as the two-year prescriptive period nears expiration. Therefore, the respondent’s judicial claim was deemed timely filed, notwithstanding the short interval between the administrative and judicial filings.

Turning to the substantive issue, the Court examined whether the gains derived by GTRC from the share redemption should be considered dividends subject to the 15% FWT. Section 28 (B) (5) (b) of the Tax Code addresses this issue:

SEC. 28. Rates of Income Tax on Foreign Corporations. –

xxxx

(B) Tax on Nonresident Foreign Corporation. –

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(5) Tax on Certain Incomes Received by a Nonresident Foreign Corporation. –

(b) Intercorporate Dividends. – A final withholding tax at the rate of fifteen percent (15%) is hereby imposed on the amount of cash and/or property dividends received from a domestic corporation, which shall be collected and paid as provided in Section 57 (A) of this Code, subject to the condition that the country in which the nonresident foreign corporation is domiciled, shall allow a credit against the tax due from the nonresident foreign corporation taxes deemed to have been paid in the Philippines equivalent to twenty percent (20%), which represents the difference between the regular income tax of thirty-five percent (35%) and the fifteen percent (15%) tax on dividends as provided in this subparagraph: Provided, That effective January 1, 2009, the credit against the tax due shall be equivalent to fifteen percent (15%), which represents the difference between the regular income tax of thirty percent (30%) and the fifteen percent (15%) tax on dividends;

xxxx

However, since GTRC is a US resident, the RP-US Tax Treaty also plays a crucial role. Article 11(5) of the RP-US Tax Treaty provides that the term “dividends” should be interpreted according to the taxation laws of the state where the distributing corporation resides. In this case, that means the Philippines. Section 73 (A) of the Tax Code defines dividends as:

[T]he term ‘dividends’ when used in this Title means any distribution made by a corporation to its shareholders out of its earnings or profits and payable to its shareholders, whether in money or in other property.

The Supreme Court concluded that the redemption price exceeding the par value could not be deemed accumulated dividends subject to the 15% FWT. Crucially, the respondent’s financial statements showed that it lacked unrestricted retained earnings during the relevant period. As such, the board of directors could not have legally declared dividends, as mandated by Section 43 of the Corporation Code:

Section 43. Power to Declare Dividends. – The board of directors of a stock corporation may declare dividends out of the unrestricted retained earnings which shall be payable in cash, in property, or in stock to all stockholders on the basis of outstanding stock held by them: Provided, That any cash dividends due on delinquent stock shall first be applied to the unpaid balance on the subscription plus costs and expenses, while stock dividends shall be withheld from the delinquent stockholder until his unpaid subscription is fully paid: Provided, further, That no stock dividend shall be issued without the approval of stockholders representing not less than two-thirds (2/3) of the outstanding capital stock at a regular or special meeting duly called for the purpose.

x x x x

The court also noted that dividends typically represent a recurring return on stock, which was not the case here. The payment was a one-time redemption of shares, not a periodic dividend distribution. As cited in Wise & Co., Inc. v. Meer:

The amounts thus distributed among the plaintiffs were not in the nature of a recurring return on stock — in fact, they surrendered and relinquished their stock in return for said distributions, thus ceasing to be stockholders of the Hongkong Company, which in turn ceased to exist in its own right as a going concern during its more or less brief administration of the business as trustee for the Manila Company, and finally disappeared even as such trustee.

“The distinction between a distribution in liquidation and an ordinary dividend is factual; the result in each case depending on the particular circumstances of the case and the intent of the parties. If the distribution is in the nature of a recurring return on stock it is an ordinary dividend. However, if the corporation is really winding up its business or recapitalizing and narrowing its activities, the distribution may properly be treated as in complete or partial liquidation and as payment by the corporation to the stockholder for his stock. The corporation is, in the latter instances, wiping out all parts of the stockholders’ interest in the company * * * .”

In summary, the Supreme Court denied the petition, affirming the CTA’s decision that the gains realized by GTRC from the redemption of its preferred shares were not subject to the 15% FWT on dividends. This ruling underscores the importance of analyzing the specific circumstances and the intent of the parties when classifying distributions as dividends or capital gains, especially in cross-border transactions governed by tax treaties.

FAQs

What was the key issue in this case?	The primary issue was whether the gains derived by a US-based company from the redemption of its preferred shares in a Philippine corporation should be taxed as dividends. The Commissioner of Internal Revenue argued that the gains were essentially accumulated dividends and subject to 15% final withholding tax (FWT).
What did the Supreme Court rule?	The Supreme Court ruled that the gains were not taxable as dividends because the Philippine corporation did not have unrestricted retained earnings from which dividends could be declared. Therefore, the redemption price was not subject to 15% FWT on dividends.
What is the significance of the RP-US Tax Treaty in this case?	The RP-US Tax Treaty was crucial because it dictates that the definition of “dividends” should be based on the tax laws of the country where the distributing corporation is a resident, which in this case is the Philippines. The Tax Code defines dividends as distributions from earnings or profits.
What are unrestricted retained earnings?	Unrestricted retained earnings are the accumulated profits of a corporation that are available for distribution to shareholders as dividends. If a company has a deficit or its retained earnings are restricted, it cannot legally declare dividends.
Why was the timing of the administrative and judicial claims important?	The administrative claim had to be filed with the CIR before a judicial claim could be made. However, the judicial claim had to be filed within two years of the tax payment, regardless of whether the CIR had acted on the administrative claim.
What is the difference between dividends and capital gains in this context?	Dividends are distributions of a corporation’s earnings or profits to its shareholders, while capital gains are profits from the sale or exchange of property, such as shares of stock. They are taxed differently, with dividends often subject to a final withholding tax.
What is a final withholding tax (FWT)?	A final withholding tax is a tax that is withheld at the source of income, and the recipient does not need to declare it further in their income tax return. It is a final tax on that particular income.
What factors did the court consider in determining whether the redemption price was a dividend?	The court considered (1) the availability of unrestricted retained earnings, (2) whether the distribution was a recurring return on stock, and (3) the intent of the parties. Here, the payment was a one-time redemption, not a periodic dividend distribution, and the company had no unrestricted retained earnings.

This case provides valuable guidance on the tax treatment of share redemptions involving foreign entities and highlights the interplay between domestic tax laws and international tax treaties. Taxpayers should carefully consider the availability of unrestricted retained earnings and the nature of the distribution when determining the appropriate tax treatment.

For inquiries regarding the application of this ruling to specific circumstances, please contact ASG Law through contact or via email at frontdesk@asglawpartners.com.

Disclaimer: This analysis is provided for informational purposes only and does not constitute legal advice. For specific legal guidance tailored to your situation, please consult with a qualified attorney.
Source: Commissioner of Internal Revenue v. Goodyear Philippines, Inc., G.R. No. 216130, August 03, 2016