G.R. No. L-24059. November 28, 1969
C. M. HOSKINS & CO., INC., PETITIONER, VS. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
TEEHANKEE, J.:
We uphold in this taxpayer’s appeal the Tax Court’s ruling that
payment by the taxpayer to its controlling stockholder of 50% of its
supervision fees or the amount of P99,977.91 is not a deductible ordinary and
necessary expense and should be treated as a distribution of earnings and
profits of the taxpayer.
Petitioner, a domestic corporation engaged in the real estate
business as brokers, managing agents and administrators, filed its income tax
return for its fiscal year ending September 30, 1957 showing a net income of
P92,540.25 and a tax liability due thereon of P18,508.00, which it paid in due
course. Upon verification of its
return, respondent Commissioner of Internal Revenue, disallowed four items of
deduction in petitioner’s tax returns and assessed against it an income tax
deficiency in the amount of P28,054.00 plus interests. The Court of Tax Appeals upon reviewing the
assessment at the taxpayer’s petition, upheld respondent’s disallowance of the
principal item of petitioner’s having paid to Mr. C. M. Hoskins, its founder
and controlling stockholder the amount of P99,977.91 representing 50% of
supervision fees earned by it and set aside respondent’s disallowance of three
other minor items. The Tax Court therefore
determined petitioner’s tax deficiency to be in the amount of P27,145.00 and
on November 8, 1964 rendered judgment against it, as follows:
“WHEREFORE, premises considered, the decision of the
respondent is hereby modified.
Petitioner is ordered to pay to the latter or his representative the sum
of P27,145.00, representing deficiency income tax for the year 1957, plus
interest at 1/2% per month from June 20, 1959 to be computed in accordance with
the provisions of Section 51(d) of the National Internal Revenue Code. If the deficiency tax is not paid within
thirty (30) days from the date this decision becomes final, petitioner is also
ordered to pay surcharge and interest as provided for in Section 51(e) of the
Tax Code, without costs.”
Petitioner questions in this appeal the Tax Court’s findings that
the disallowed payment to Hoskins was an inordinately large one, which bore a
close relationship to the recipient’s dominant stockholdings and therefore
amounted in law to a distribution of its earnings and profits.
We find no merit in petitioner’s appeal.
As found by the Tax Court, “Petitioner was founded by Mr. C. M.
Hoskins in 1937, with a capital stock of 1,000 shares at a par value of P1.00
each share; that of these 1,000 shares, Mr. C. M. Hoskins owns 996 shares (the
other 4 shares being held by the other four officers of the corporation), which
constitute exactly 99.6% of the total authorized capital stock (p. 92, t.s.n.); that during the first four years of its existence,
Mr. C. M. Hoskins was the President, but during the taxable period in question,
that is, from October 1, 1956 to September 30, 1957, he was the chairman of the
Board of Directors and salesman-broker for the company (p. 93, t.s.n.); that as chairman of the Board of Directors, he
received a salary of P3,750.00 a month, plus a salary bonus of about P40,000.00
a year (p. 94, t.s.n.); that he was also a
stockholder and officer of the Paradise Farms, Inc. and Realty Investments
Inc., from which petitioner derived a large portion of its income in the form
of supervision fees and commissions earned on sales of lots (pp. 97-99, t.s.n.; Financial Statements, attached to Exhibit ‘1’, p.
11, BIR rec.); that as chairman of the Board of Directors of petitioner, his
duties were: ‘To act as a salesman; as a
director, presides over meetings and to get all of the real estate business I
could for the company by negotiating sales, purchases, making appraisals,
raising a funds to finance real estate operations where that was necessary’ (p.
96, t. s. n.); that he was familiar with the contract entered into by the
petitioner with the Paradise Farms Inc. and the Realty Investments Inc. by the
terms of which petitioner was ‘to program the development, arrange financing,
plan the proposed subdivision as outlined in the prospectus of Paradise Farms,
Inc., arrange contract for road constructions, with the provision of water
supply to all of the lots and in general to serve as managing agents for the
Paradise Farms, Inc. and subsequently for the Realty Investments, Inc.”
(pp. 96-97, t.s.n.)
Considering that in addition to being Chairman of the board of
directors of petitioner corporation, which bears his name, Hoskins, who owned
99. 6% of its total authorized capital stock while the four other
officers-stockholders of the firm owned a total of four-tenths of 1%, or
one-tenth of 1% each, with their respective nominal shareholdings of one share
each, was also salesman-broker for his company, receiving a 50% share of the
sales commissions earned by petitioner, besides his monthly salary of
P3,750.00 amounting to an annual compensation of P45,000.00 and an annual
salary bonus of P40,000.00, plus free use of the company car and receipt of
other similar allowances and benefits, the Tax Court correctly ruled that the
payment by petitioner to Hoskins of the additional sum of P99,977.91 as his
equal or 50% share of the 8% supervision fees received by petitioner as managing
agents of the real estate, subdivision projects of Paradise Farms, Inc. and
Realty Investments, Inc. was inordinately large and could not be accorded the
treatment of ordinary and necessary expenses allowed as deductible items within
the purview of Section 30 (a) (i) of the Tax Code.
If such payment of P99,977.91 were to be allowed as a deductible
item, then Hoskins would receive on these three items alone (salary, bonus and
supervision fee) a total of P184,977.91, which would be double the petitioner’s
reported net income for the year of P92,540.25.
As correctly observed by respondent, if independently, a one-time
P100,000.00-fee to plan and lay down the rules for supervision of a subdivision
project were to be paid to an experienced realtor such as Hoskins, its fairness
and deductibility by the taxpayer could be conceded; but here 50% of the
supervision fee of petitioner was being paid by it to Hoskins every year since
1955 up to 1963 and for as long as its contract with the subdivision owner
subsisted, regardless of whether services were actually rendered by Hoskins,
since his services to petitioner included such planning and supervision and
were already handsomely paid for by petitioner.
The fact that such payment was authorized by a standing
resolution of petitioner’s board of directors, since “Hoskins had
personally conceived and planned the project” cannot change the
picture. There could be no question that
as Chairman of the board and practically an absolutely controlling stockholder
of petitioner, holding 99.6% of its stock, Hoskins wielded tremendous power
and influence in the formulation and making of the company’s policies and
decisions. Even just as board chairman,
going by petitioner’s own enumeration of the powers of the office, Hoskins
could exercise great power and influence within the corporation, such as
directing the policy of the corporation, delegating powers to the president
and advising the corporation in determining executive salaries, bonus plans and
pensions, dividend policies, etc.[1]
Petitioner’s invoking of its policy since its incorporation of
sharing equally sales commissions with its salesmen, in accordance with its
board resolution of June 18, 1946, is equally untenable, Petitioner’s Sales
Regulations provide:
“Compensation of
Salesman
“8. Schedule I
— In the case of sales to prospects discovered and worked by a salesman, even
though the closing is done by or with the help of the Sales Manager or other
members of the staff, the salesmen get one-half (1/2) of the total commission
received by the Company, but not exceeding five percent (5%). In the case of subdivisions, when the office
commission covers general supervision, the 1/2-rule does not apply, the
salesman’s share being stipulated in the case of each subdivision. In most cases the salesman’s share is 4%. (Exh. ‘N-1).”[2]
It will be readily seen therefrom that when the petitioner’s commission covers
general supervision, it is provided that the 1/2 rule of equal sharing of the
sales commissions does not apply and that the salesman’s share is stipulated in
the case of each subdivision.
Furthermore, what is involved here is not Hoskins’ salesman’s share in
the petitioner’s 12% sales commission, which he presumably collected also from
petitioner without respondent’s questioning it, but a 50% share besides in
petitioner’s planning and supervision fee of 8% of the gross sales, as
mentioned above. This is evident from
petitioner’s board’s resolution of July 14, 1953 (Exhibit 7), wherein it is
recited that in addition to petitioner’s sales commission of 12% of gross
sales, the subdivision owners were paying to petitioner 8% of gross sales as
supervision fee, and a collection fee of 5% of gross collections, or total
fees of 25% of gross sales.
The case before us is similar to previous cases of disallowances
as deductible items of officers’ extra fees, bonuses and commissions, upheld by
this Court as not being within the purview of ordinary and necessary expenses
and not passing the test of reasonable compensation.[3]
In Kuenzle & Streiff,
Inc. vs. Commissioner of Internal Revenue decided by this Court on May 29,
1969,[4]
we reaffirmed the test of reasonableness, enunciated in the earlier 1967 case
involving the same parties, that:
“It is a general rule that ‘Bonuses to employees made in good faith
and as additional compensation for the services actually rendered by the
employees are deductible, provided such payments, when added to the stipulated
salaries, do not exceed a reasonable compensation for the services rendered’
(4 Mertens, Law of Federal Income Taxation, Sec.
25.50, p. 410). The condition precedents
to the deduction of bonuses to employees are:
(1) the payment of the bonuses is in fact compensation; (2) it must be
for personal services actually rendered; and (3) the bonuses, when added to the
salaries, are ‘reasonable x x x
when measured by the amount and quality of the services performed with relation
to the business of the particular taxpayer’ (Idem, Sec. 25.44 p. 395).
“There is no fixed test for determining the reasonableness
of a given bonus as compensation. This
depends upon many factors, one of them being ‘the amount and quality of the
services performed with relation to the business.’ Other tests suggested
are: payment must be ‘made in good
faith’; ‘the character of the taxpayer’s business, the volume and amount of its
net earnings, its locality, the type and extent of the services rendered, the
salary policy of the corporation’; ‘the size of the particular business’; ‘the
employees’ qualifications and contributions to the business venture’; and
‘general economic conditions’ (4 Mertens, Law of
Federal Income Taxation, Sec. 25.44, 25.49, 25.50, 25.51, pp. 407-412). However, ‘in determining whether the
particular salary or compensation payment is reasonable, the situation must be
considered as a whole. Ordinarily, no
single factor is decisive. x x x it is important to keep in
mind that it seldom happens that the application of one test can give
satisfactory answer, and that ordinarily it is the interplay of several
factors, properly weighted for the particular case, which must furnish the
final answer.”
Petitioner’s case fails to pass the test. On the right of the employer as against
respondent Commissioner to fix the compensation of its officers and employees,
we there held further that while the employer’s right may be conceded, the
question of the allowance or disallowance thereof as deductible expenses for income
tax purposes is subject to determination by respondent Commissioner of
Internal Revenue. Thus: ‘As far as petitioner’s contention that as
employer it has the right to fix the compensation of its officers and employees
and that it was in the exercise of such right that it deemed proper to pay the
bonuses in question, all that We need say is this: that right may be conceded, but for income
tax purposes the employer cannot legally claim such bonuses as deductible
expenses unless they are shown to be reasonable. To hold otherwise would open the gate of
rampant tax evasion.
“Lastly, We must not lose sight of the fact that the
question of allowing or disallowing as deductible expenses the amounts paid to
corporate officers by way of bonus is determined by respondent exclusively for
income tax purposes. Concededly, he has
no authority to fix the amounts to be paid to corporate officers by way of
basic salary, bonus or additional remuneration – a matter that lies more or
less exclusively within the sound discretion of the corporation itself. But this right of the corporation is, of
course, not absolute. It cannot exercise
it for the purpose of evading payment of faxes legitimately due to the
State.”
Finally, if should be noted that we have here a case practically
of a sole proprietorship of C. M. Hoskins, who however chose to incorporate his
business with himself holding virtually absolute control thereof with 99.6% of
its stock with four other nominal shareholders holding one share each. Having chosen to use the corporate form with
its legal advantages of a separate corporate personality as distinguished from
his individual personality, the corporation so created, i.
e. petitioner, is bound to comport itself in accordance with corporate norms
and comply with its corporate obligations.
Specifically, it is bound to pay the income tax imposed by law on
corporations and may not legally be permitted, by way of corporate resolutions
authorizing payment of inordinately large commissions and fees to its
controlling stockholder, to dilute and diminish its corresponding corporate tax
liability.
ACCORDINGLY, the decision appealed from is hereby
affirmed, with costs in both instances against petitioner.
Concepcion, C.J., Reyes, J.B.L., Dizon, Makalintal, Zaldivar, Sanchez, Castro, Fernando, and Barredo, JJ., concur.
[1]
Petitioner’s Reply Brief, pp. 5-6.
[2]
Emphasis supplied.
[3]
Cf. Alhambra vs. Collector 105 Phil. 1337; Kuenzle
& Streiff, Inc. vs. Collector, 106 Phil.
355; Alhambra vs.
Commissioner 21 SCRA 1111 (1967).
[4]
28 SCRA 366.