CIR VS. RUFINO ET. AL.,

G.R. Nos. L-33665-68 February 27, 1987

FACTS: The defunct Eastern Theatrical Co., Inc. or the Old Corporation is a corporation organized to engage in the business of operating theaters, opera houses, places of amusement and other related business enterprises, more particularly the Lyric and Capitol Theaters in Manila. The Old Corporation shall terminate in 1959. The new Corporation also in the name of Eastern Theatrical Co Inc., was organized on 1958, engaged in the same kind of business as the Old Corporation. 

Upon the recommendation of the BOD, it was decided that the Old Corporation and New Corporation should merge to continue the exhibition of moving pictures at the Lyric and Capitol Theaters even after the expiration of the corporate existence of the Old Corporation. Hence, a Deed of Assignment providing for the conveyance and transfer of all the business, property, assets and goodwill of the Old Corporation to the New Corporation in exchange for the latter’s stocks was made. 

As agreed, the New Corporation issued to the stockholders of the former stocks in the New Corporation equal to the stocks each one held in the Old Corporation. Consequently, Bureau of Internal Revenue found that the merger of the corporations was not undertaken for a bona fide business purpose but merely to avoid liability for the capital gains tax on the exchange of the old for the new shares of stock. Accordingly, he imposed the deficiency assessments against the private respondents.

The petitioner points to the exchange was only on paper as the New Corporation did not actually issue stocks in exchange for the properties of the Old Corporation at the time of the supposed merger; that the increase in capitalization of the New Corporation was registered with the Securities and Exchange Commission only 37 days after the Old Corporation expired; that prior to such registration, it was not possible for the New Corporation to effect the exchange provided for in the said agreement because it was capitalized only at P200,000.00 as against the capitalization of the Old Corporation at P2,000,000.00. Consequently, as there was no merger, the automatic dissolution of the Old Corporation on its expiry date resulted in its liquidation, for which the respondents are now liable in taxes on their capital gains.

For their part, the private respondents insist that there was a genuine merger between the Old Corporation and the New Corporation pursuant to a plan aimed at enabling the latter to continue the business of the former in the operation of places of amusement, specifically the Capitol and Lyric Theaters; that those mentioned by the petitioner did not have to be completed at the time of the merger such as the increase and distribution of the stock of the New Corporation. Moreover, the Old Corporation was dissolved on January 1, 1959, pursuant to the Deed of Assignment, and not on January 25, 1959, its original expiry date. As the properties of the Old Corporation were transferred to the New Corporation before that expiry date, there could not have been any distribution of liquidating dividends by the Old Corporation for which the private respondents should be held liable in taxes.

The CTA ruled that there was a valid merger and no taxable gain should be imposed. 

ISSUE: Whether or not there is a taxable gain and a valid merger.

HELD: There was a valid merger although the actual transfer of the properties subject of the Deed of Assignment was not made on the date of the merger.

It was necessary for the Old Corporation to surrender its net assets first to the New Corporation before the latter could issue its own stock to the shareholders of the Old Corporation because the New Corporation had to increase its capitalization for this purpose. This required the adoption of the resolution to this effect, the registration of such issuance with the SEC, and its approval took place after the date of the merger but they were deemed part and parcel of, and indispensable to the validity and enforceability of, the Deed of Assignment.

The Court finds no impediment to the exchange of property for stock between the two corporations being considered to have been effected on the date of the merger. That, in fact, was the intention, and the reason why the Deed of Assignment was made retroactive to January 1, 1959. Such retroaction provided in effect that all transactions set forth in the merger agreement shall be deemed to be taking place simultaneously on January 1, 1959, when the Deed of Assignment became operative.

On the tax issue, the basic consideration is the purpose of the merger, as this would determine whether the exchange of properties involved therein shall be subject or not to the capital gains tax. The Court stated that one certain indication of a scheme to evade the capital gains tax is the subsequent dissolution of the new corporation after the transfer to it of the properties of the old corporation and the liquidation of the former soon thereafter.

In this case, the purpose of the merger was to continue the business of the Old Corporation, whose corporate life was about to expire. Moreover, the New Corporation was not dissolved after the merger agreement in 1959. On the contrary, it continued to operate the places of amusement originally owned by the Old Corporation and transferred to the New Corporation, particularly the Capitol and Lyric Theaters, in accordance with the Deed of Assignment. On an additional note, the Supreme Court further held that it was not possible for a corporation, by mere amendment of its charter, to extend its life beyond the time fixed in the original articles; in fact, this was specifically prohibited. The prohibition made it necessary for the Old and New Corporations to enter into the questioned merger, to enable the former to continue its unfinished business through the latter.