THE MANILA WINE MERCHANTS, INC. VS.

THE COMMISSIONER OF INTERNAL REVENUE

GR NO. L-26145. FEBRUARY 20, 1984
SYLLABUS
ADDITIONAL TAX ON ACCUMULATED EARNINGS; EXEMPTION THEREFROM. A prerequisite to the
imposition of the tax has been that the corporation be formed or availed of for the purpose of avoiding the
income tax (or surtax) on its shareholders, or on the shareholders of any other corporation by permitting the
earnings and profits of the corporation to accumulate instead of dividing them among or distributing them to the
shareholders. If the earnings and profits were distributed, the shareholders would be required to pay an income
tax thereon whereas, if the distribution were not made to them, they would incur no tax in respect to the
undistributed earnings and profits of the corporation. The touchstone of liability is the purpose behind the
accumulation of the income and not the consequences of the accumulation. Thus, if the failure to pay
dividends is due to some other cause, such as the use of undistributed earnings and profits for the reasonable
needs of the business, such purpose does not fall within the interdiction of the statute.
WHEN ACCUMULATION IS CONSIDERED UNREASONABLE. An accumulation of earnings or profits
(including undistributed earnings or profits of prior years) is unreasonable if it is not required for the purpose of
the business, considering all the circumstances of the case (Sec. 21, Revenue Regulations No. 2).
"REASONABLE NEEDS OF THE BUSINESS," CONSTRUED. To determine the "reasonable needs" of the
business in order to justify an accumulation of earnings, the Courts of the United States have invented the socalled "Immediacy Test" which construed the words "reasonable needs of the business" to mean the
immediate needs of the business, and it was generally held that if the corporation did not prove an immediate
need for the accumulation of the earnings and profits, the accumulation was not for the reasonable needs of
the business, and the penalty tax would apply. American cases likewise hold that investment of the earnings
and profits of the corporation in stock or securities of an unrelated business usually indicates an accumulation
beyond the reasonable needs of the business.
ACCUMULATION OF EARNINGS, MUST BE USED FOR REASONABLE NEEDS OF BUSINESS WITHIN A
REASONABLE TIME. To justify an accumulation of earnings and profits for the reasonably anticipated future
needs, such accumulation must be used within a reasonable time after the close of the taxable year
INTENTION AT THE TIME OF ACCUMULATION, BASIS FOR REASONABLENESS. In order to determine
whether profits are accumulated for the reasonable needs of the business as to avoid the surtax upon
shareholders, the controlling intention of the taxpayer is that which is manifested at the time of accumulation
not subsequently declared intentions which are merely the product of afterthought. A speculative and indefinite
purpose will not suffice. The mere recognition of a future problem and the discussion of possible and
alternative solutions is not sufficient. Definiteness of plan coupled with action taken towards its consummation
are essential.
ACCUMULATIONS OF PRIOR YEARS TAKEN INTO ACCOUNT IN DETERMINATION OF LIABILITY
THEREFOR. The rule is now settled in Our jurisprudence that undistributed earnings or profits of prior years
are taken into consideration in determining unreasonable accumulation for purposes of the 25% surtax. The
case of Basilan Estates, Inc. v. Commissioner of Internal Revenue further strengthen this rule in determining
unreasonable accumulation for the year concerned. In determining whether accumulations of earnings or
profits in a particular year are within the reasonable needs of a corporation, it is necessary to take into account
prior accumulations, since accumulations prior to the year involved may have been sufficient to cover the
business needs and additional accumulations during the year involved would not reasonably be necessary.

CASE DIGEST
FACTS:
Manila Wine Merchants Inc. is a domestic corporation principally engaged in the importation and sale of
whisky, wines, liquors and distilled spirits.
In 1957 the CIR caused the examination of petitioners book of accounts and found the latter having
unreasonably accumulated surplus of P428,934.32 for the calendar year 1947 to 1957, in excess of the
reasonable needs of the business subject to the 25% surtax imposed by Section 25 of the Tax Code.

The total amount due as of February 26, 1963 amounted to P 126,536.12 representing the surtax and
interest thereon.
Respondent contends that petitioner has accumulated earnings beyond the reasonable needs of its
business because the average ratio of the cash dividends declared and paid by petitioner from 1947 to
1957 was 40.33% of the total surplus available for distribution at the end of each calendar year.
On the other hand, petitioner contends that in 1957, it distributed 100% of its net earnings after income
tax and part of the surplus for prior years. Respondent further submits that the accumulated earnings
tax should be based on 25% of the total surplus available at the end of each calendar year while
petitioner maintains that the 25% surtax is imposed on the total surplus or net income for the year after
deducting therefrom the income tax due.
Another basis of respondent in assessing petitioner for accumulated earnings tax is its substantial
investment of surplus or profits in unrelated business. These investments are itemized as follows:
Particulars
Amount
1
Acme Commercial Co. Inc.
P27,501.00
2
Union Insurance Society of Canton
1,145.76
3
U.S.A. Treasury Bond
347,217.50
4
Wack Wack Golf & Country Club
1.00
TOTAL
P 375,865.26
Respondent found that the accumulated surplus in question were invested to unrelated business
which were not considered in the immediate needs of the Company such that the 25% surtax be
imposed therefrom.
On appeal to the Court of Tax Appeals, it found that:
o The petitioner was not formed for the purpose of preventing the imposition of income tax upon
its shareholders since it has distributed an average of 85.77% of its total surplus available for
distribution at the end of each calendar year for 11 years and not 40.33%.
o The investments 1, 2, & 4 were harmless accumulation of surplus and therefore not subject to
surtax.
o As to the U.S.A. Treasury Bonds amounting to P347,217.50, the Court of Tax Appeals ruled that
its purchase was in no way related to petitioners business of importing and selling wines,
whisky, liquors and distilled spirits.
o That it was one for the purpose of preventing the imposition of surtax upon petitioners
shareholders by permitting its earnings and profits to accumulate beyond the reasonable needs
of the business. Hence, it modified the respondents decision by imposing 25% surtax only on
the USA Treasury Bond in the amount of P86,804.38.
Defenses of petitioner on the USA Treasury Bond:
o That the investment made in 1951 would be used in meeting immediate urgent orders of its
local customers.
o That they decided sometime in 1957 to hold the bills for a few more years in view of their plan to
buy a lot and construct their own building.
o Since they were not yet 60% Filipino owned, they waited until the ownership would reach that
much before making definite plans.
o That in 1959 they were already more than 60% Filipino owned and thus in 1961, they bought a
lot.

ISSUE/S:
(1) Whether the purchase of the U.S.A. Treasury bonds by petitioner in 1951 can be considered as an
improper accumulation of earnings, and
(2) If so, whether the penalty tax of twenty-five percent (25%) can be imposed on such improper
accumulation in 1957 despite the fact that the accumulation occurred in 1951.
RULING:
(1) Yes the purchase of the U.S.A. Treasury bonds by petitioner in 1951 can be considered as improper
accumulation of earnings. It was an investment to an unrelated business and was made for the
purpose of preventing the imposition of the surtax upon petitioners shareholders by permitting its
earnings and profits to accumulate beyond the reasonable needs of the business.
A prerequisite to the imposition of the tax has been that the (1) corporation be formed or availed of for
the purpose of avoiding the income tax (or surtax) on its shareholders, or on the shareholders of any
other corporation (2) by permitting the earnings and profits of the corporation to accumulate instead of
dividing them among or distributing them to the shareholders. If the earnings and profits were

distributed, the shareholders would be required to pay an income tax thereon whereas, if the
distribution were not made to them, they would incur no tax in respect to the undistributed earnings and
profits of the corporation. The touchstone of liability is the purpose behind the accumulation of the
income and not the consequences of the accumulation. Thus, if the failure to pay dividends is due to
some other cause, such as the use of undistributed earnings and profits for the reasonable needs of the
business, such purpose does not fall within the interdiction of the statute.
An accumulation of earnings or profits (including undistributed earnings or profits of prior years) is
unreasonable if it is not required for the purpose of the business, considering all the
circumstances of the case.
To avoid the twenty-five percent (25%) surtax, petitioner has to prove that the purchase of the U.S.A.
Treasury Bonds in 1951 with a face value of $175,000.00 was an investment within the reasonable
needs of the Corporation. This, the petitioner failed to prove.
To determine the "reasonable needs" of the business in order to justify an accumulation of earnings,
the Courts of the United States have invented the so-called "Immediacy Test" which construed the
words "reasonable needs of the business" to mean the immediate needs of the business, and it was
generally held that if the corporation did not prove an immediate need for the accumulation of the
earnings and profits, the accumulation was not for the reasonable needs of the business, and the
penalty tax would apply. American cases likewise hold that investment of the earnings and profits of
the corporation in stock or securities of an unrelated business usually indicates an accumulation
beyond the reasonable needs of the business.
The records reveal that from May 1951 when petitioner purchased the U.S.A. Treasury shares, until
1962 when it finally liquidated the same, it (petitioner) never had the occasion to use the said shares in
aiding or financing its importation. This militates against the purpose enunciated earlier by petitioner
that the shares were purchased to finance its importation business. To justify an accumulation of
earnings and profits for the reasonably anticipated future needs, such accumulation must be
used within a reasonable time after the close of the taxable year.
The arguments of petitioner indicate that it considers the U.S.A. Treasury shares not only for the
purpose of aiding or financing its importation but likewise for the purpose of buying a lot and
constructing a building thereon in the near future, but conditioned upon the completion of the 60%
citizenship requirement of stock ownership of the Company in order to qualify it to purchase and own a
lot. The time when the company would be able to establish itself to meet the said requirement and the
decision to pursue the same are dependent upon various future contingencies.
In order to determine whether profits are accumulated for the reasonable needs of the business as to
avoid the surtax upon shareholders, the controlling intention of the taxpayer is that which is
manifested at the time of accumulation not subsequently declared intentions which are merely
the product of afterthought. A speculative and indefinite purpose will not suffice. The mere
recognition of a future problem and the discussion of possible and alternative solutions is not sufficient.
Definiteness of plan coupled with action taken towards its consummation are essential.
Profits may only be accumulated for the reasonable needs of the business, and implicit in this is further
requirement of a reasonable time.
(2) The petition was wrong in its contention that the 25% surtax should be based on the surplus
accumulated in 1951 and not in 1957.
The rule is now settled in Our jurisprudence that undistributed earnings or profits of prior years are
taken into consideration in determining unreasonable accumulation for purposes of the 25% surtax. The
case of Basilan Estates, Inc. v. Commissioner of Internal Revenue further strengthen this rule in
determining unreasonable accumulation for the year concerned. In determining whether accumulations
of earnings or profits in a particular year are within the reasonable needs of a corporation, it is
necessary to take into account prior accumulations, since accumulations prior to the year involved may
have been sufficient to cover the business needs and additional accumulations during the year involved
would not reasonably be necessary.

CYANAMID PHILIPPINES, INC. VS. THE COURT OF APPEALS, THE COURT OF TAX APPEALS AND
COMMISSIONER OF INTERNAL REVENUE
GR NO. 108067 January 20, 2000
SYLLABUS
TAX ON IMPROPER ACCUMULATION OF SURPLUS AS A PENALTY. When corporations do not declare
dividends, income taxes are not paid on the undeclared dividends received by the shareholders. The tax on
improper accumulation of surplus is essentially a penalty tax designed to compel corporations to distribute
earnings so that the said earnings by shareholders could, in turn, be taxed.
RULE ON ENUMERATION: THE EXPRESS MENTION OF ONE PERSON, THING, ACT, OR
CONSEQUENCE IS CONSTRUED TO EXCLUDE ALL OTHERS. Exemptions from tax are construed
strictissimi juris against the taxpayer. Taxation is the rule and exemption is the exception. The burden of proof
rests upon the party claiming exemption to prove that it is in fact covered by the exemption so claimed.
WORKING CAPITAL NEEDS; CURRENT RATIO. The working capital needs of a business depend upon the
nature of the business, its credit policies, the amount of inventories, the rate of turnover, the amount of
accounts receivable, the collection rate, the availability of credit to the business, and similar factors. Aside from
the Bardahl Formula, other formulas are also used, e.g. the ratio of current assets to current liabilities and the
adoption of the industry standard. The ratio of current assets to current liabilities is used to determine the
sufficiency of working capital. Ideally, the working capital should equal the current liabilities and there must be
2 units of current assets for every unit of current liability, hence the so-called "2 to 1" rule.
BURDEN OF PROOF. If the CIR determined that the corporation avoided the tax on shareholders by
permitting earnings or profits to accumulate, and the taxpayer contested such determination, the burden of
proving the determination wrong, together with the corresponding burden of first going forward with evidence,
is on the taxpayer. This applies even if the corporation is not a mere holding or investment company and does
not have an unreasonable accumulation of earnings or profits.
RELEVANT PROVISIONS OF LAW:
1. SEC. 43 PAR. 2 OF THE CORPORATION CODE OF THE PHILIPPINES
Stock corporations are prohibited from retaining surplus profits in excess of one hundred (100%)
percent of their paid-in capital stock, except: (1) when justified by definite corporate expansion
projects or programs approved by the board of directors; or (2) when the corporation is prohibited
under any loan agreement with any financial institution or creditor, whether local or foreign, from
declaring dividends without its/his consent, and such consent has not yet been secured; or (3) when
it can be clearly shown that such retention is necessary under special circumstances obtaining in
the corporation, such as when there is need for special reserve for probable contingencies.
2. SECTION 25 OF THE OLD NATIONAL INTERNAL REVENUE CODE OF 1977
Sec. 25. Additional tax on corporation improperly accumulating profits or surplus "(a) Imposition of tax. -- If any corporation is formed or availed of for the purpose of preventing the
imposition of the tax upon its shareholders or members or the shareholders or members of another
corporation, through the medium of permitting its gains and profits to accumulate instead of being
divided or distributed, there is levied and assessed against such corporation, for each taxable year,
a tax equal to twenty-five per-centum of the undistributed portion of its accumulated profits or
surplus which shall be in addition to the tax imposed by section twenty-four, and shall be computed,
collected and paid in the same manner and subject to the same provisions of law, including
penalties, as that tax.
"(b) Prima facie evidence. -- The fact that any corporation is mere holding company shall be prima
facie evidence of a purpose to avoid the tax upon its shareholders or members. Similar presumption
will lie in the case of an investment company where at any time during the taxable year more than
fifty per centum in value of its outstanding stock is owned, directly or indirectly, by one person.
"(c) Evidence determinative of purpose. -- The fact that the earnings or profits of a corporation are
permitted to accumulate beyond the reasonable needs of the business shall be determinative of the

purpose to avoid the tax upon its shareholders or members unless the corporation, by clear
preponderance of evidence, shall prove the contrary.
"(d) Exception -- The provisions of this sections shall not apply to banks, non-bank financial
intermediaries, corporation organized primarily, and authorized by the Central Bank of the
Philippines to hold shares of stock of banks, insurance companies, whether domestic or foreign.
BARDAHL FORMULA. The Bardahl formula was first adopted in Bardahl Manufacturing Corp. to allow the
taxpayer to accumulate earnings and profits to provide a working capital reserve sufficient to meet ordinary
operating expenses incurred during one complete operating cycle. The corporations operating cycle was
described as the period of time required to convert cash into raw materials, raw materials into inventory of
marketable products, the inventory into sales and accounts receivable, and the period of time required to
collected its outstanding accounts.

CASE DIGEST
FACTS:
Cyanamid Philippines Inc. is a corporation organized under Philippine laws, is a wholly owned
subsidiary of American Cyanamid Co. based in Maine, USA. It is engaged in the manufacture of
pharmaceutical products and chemicals, a wholesaler of imported finished goods, and an
importer/indentor.
Petitioner was found liable for P3,774,867.50 as 25% surtax on improper accumulation of profits for
1981, plus 10% surcharge and 20% annual interest from January 30, 1985 to January 30, 1987, under
Sec. 25 of the National Internal Revenue Code.
Petitioner claimed that CIRs assessment representing the 25% surtax on its accumulated earnings for
the year 1981 had no legal basis for the following reasons:
(a) That the accumulation of earnings and profits was for reasonable business requirements to meet
working capital needs and retirement of indebtedness;
(b) That petitioner is a wholly owned subsidiary of American Cyanamid Company, a corporation
organized under the laws of the State of Maine, in the United States of America, whose shares of
stock are listed and traded in New York Stock Exchange. This being the case, no individual
shareholder of petitioner could have evaded or prevented the imposition of individual income taxes
by petitioners accumulation of earnings and profits, instead of distribution of the same.
The Court of Tax Appeals made the following pronouncements:
o Petitioners purpose for accumulating its earnings does not fall within the ambit of any of the
specified purposes under Section 43, paragraph 2 of the Corporation Code of the Philippines.
o That there was no need for petitioner to set aside a portion of its retained earnings as working
capital reserve as it claims since it had considerable liquid funds. A thorough review of
petitioners financial statement reveals that the corporation had considerable liquid funds
consisting of cash accounts receivable, inventory and even its sales for the period is adequate
to meet the normal needs of the business. The current ratio of the company was computed to
be 2.21:1. The ratio serves as a primary test of a companys solvency to meet current
obligations from current assets as a going concern or a measure of adequacy of working capital.
ISSUE/S:
Whether the petitioner was liable for accumulated earnings tax for the year 1981.
RULING:
The court concluded that the petitioner was liable for accumulated earnings tax for the year 1981.
Section 25 of the Old NIRC of 1977 discouraged tax avoidance through corporate surplus accumulation. When
corporations do not declare dividends, income taxes are not paid on the undeclared dividends received by the
shareholders. The tax on improper accumulation of surplus is essentially a penalty tax designed to compel
corporations to distribute earnings so that the said earnings by shareholders could, in turn, be taxed.
Petitioners assertion that it is exempt from the tax for being a wholly owned subsidiary of a public owned
company is without merit. The amendatory provision of Section 25 of the 1977 NIRC, which was PD 1739,
enumerated the corporations exempt from the imposition of improperly accumulated tax: (a) banks; (b) non-

bank financial intermediaries; (c) insurance companies; and (d) corporations organized primarily and
authorized by the Central Bank of the Philippines to hold shares of stocks of banks. Petitioner does not fall
among those exempt classes. Besides, the rule on enumeration is that the express mention of one person,
thing, act, or consequence is construed to exclude all others. Laws granting exemption from tax are construed
strictissimi juris against the taxpayer and liberally in favor of the taxing power. Taxation is the rule and
exemption is the exception. The burden of proof rests upon the party claiming exemption to prove that it is, in
fact, covered by the exemption so claimed, a burden which petitioner here has failed to discharge.
Another point raised by the petitioner in objecting to the assessment, is that increase of working capital by a
corporation justifies accumulating income. Petitioner relies on the so-called "Bardahl" formula, which allowed
retention, as working capital reserve, sufficient amounts of liquid assets to carry the company through one
operating cycle. The "Bardahl" formula was developed to measure corporate liquidity.
However, the court noted that the companies where the "Bardahl" formula was applied, had operating cycles
much shorter than that of petitioner. Cynamids operating cycle was 288.35 days, or 78.55% of a year,
reflecting that petitioner will need sufficient liquid funds, of at least three quarters of the year, to cover the
operating costs of the business. In times when there is no recurrence of a business cycle (as in the case of
Cyanamid), the working capital needs cannot be predicted with accuracy. As stressed by American authorities,
although the "Bardahl" formula is well-established and routinely applied by the courts, it is not a precise rule. It
is used only for administrative convenience. Petitioners application of the "Bardahl" formula merely creates a
false illusion of exactitude.
Other formulas are also used, e.g. the ratio of current assets to current liabilities and the adoption of the
industry standard. The ratio of current assets to current liabilities is used to determine the sufficiency of
working capital. Ideally, the working capital should equal the current liabilities and there must be 2 units of
current assets for every unit of current liability, hence the so-called "2 to 1" rule.
As of 1981 the working capital of Cyanamid was P25,776,991.00, or more than twice its current liabilities. That
current ratio of Cyanamid, therefore, projects adequacy in working capital. Said working capital was expected
to increase further when more funds were generated from the succeeding years sales.
The court has held in Basilan Estates, Inc. vs. Commissioner of Internal Revenue that:
"...[T]here is no need to have such a large amount at the beginning of the following year because
during the year, current assets are converted into cash and with the income realized from the business
as the year goes, these expenses may well be taken cared of. Thus, it is erroneous to say that the
taxpayer is entitled to retain enough liquid net assets in amounts approximately equal to current
operating needs for the year to cover cost of goods sold and operating expenses: for it excludes
proper consideration of funds generated by the collection of notes receivable as trade accounts during
the course of the year."
If the CIR determined that the corporation avoided the tax on shareholders by permitting earnings or profits to
accumulate, and the taxpayer contested such determination, the burden of proving the determination wrong,
together with the corresponding burden of first going forward with evidence, is on the taxpayer. This applies
even if the corporation is not a mere holding or investment company and does not have an unreasonable
accumulation of earnings or profits.
As enunciated in the Manila Wine Merchants case, reasonable needs of the business means immediate
needs. In case of failure to prove reasonable needs, the penalty tax would apply.
The working capital needs of a business depend upon the nature of the business, its credit policies, the
amount of inventories, the rate of turnover, the amount of accounts receivable, the collection rate, the
availability of credit to the business, and similar factors. Petitioner, by adhering to the "Bardahl" formula, failed
to impress the tax court with the required definiteness envisioned by the statute.