FACTS:

The case involves a dispute between A. Soriano Corporation (ANSCOR) and the Commissioner of Internal Revenue (CIR) regarding the taxability of ANSCOR's redemption and exchange of stocks. ANSCOR, a corporation wholly owned by non-resident aliens, had a complex history of stock issuances, dividend declarations, and capital increase. After the death of the original stockholder, Don Andres Soriano, his wife and estate received stock dividends and subsequently exchanged their common shares for preferred shares. ANSCOR also redeemed some common shares from Don Andres' estate. Revenue examiners assessed ANSCOR for deficiency withholding tax-at-source, but ANSCOR claimed it availed of tax amnesty.

The CIR ruled that the amnesty did not apply to the assessments, and ANSCOR's protest was denied. ANSCOR filed a petition with the Court of Tax Appeals (CTA) which reversed the ruling of the CIR. The Court of Appeals (CA) affirmed the CTA's decision, leading to the present petition before the Supreme Court.

The main issue in the case revolves around the interpretation and application of Section 83(b) of the 1939 Revenue Act, particularly whether the redemption and exchange of stocks can be considered as essentially equivalent to the distribution of taxable dividends.

The case also concerns the taxability of stock dividends. Section 83(b) of the 1939 National Internal Revenue Code (NIRC) states the general rule that stock dividends once issued become part of the capital and are therefore not subject to income tax. However, an exception applies if the corporation cancels or redeems stock dividends in a manner that is essentially equivalent to the distribution of a taxable dividend.

ISSUES:

1. Whether the redemption of stock dividends is essentially equivalent to a distribution of taxable dividends.

2. Whether the redemption of stock dividends in this case falls within the exception under Section 83(b) of the 1939 Tax Code.

3. Whether the proceeds of the redemption of stock dividends are taxable as dividends.

4. Whether the time lapse between the issuance and redemption of stock dividends is a sufficient indicator to determine taxability.

5. Whether the issuance and redemption of stock dividends must be separate and distinct to be considered a legitimate tax scheme.

6. Whether the proceeds from the redemption of stock dividends are exempt from income tax if the redemption is supported by legitimate business reasons.

7. Whether the presence of genuine business purposes justifies the non-taxability of the proceeds of stock dividend redemption.

8. Whether the alleged "filipinization" plan and reduction of foreign exchange remittances can be considered legitimate business purposes.

9. Whether the imposition of tax on the redeemed stock dividends would create an undisclosed lien and be unfair to subsequent buyers.

10. Whether the exchange of common stocks with preferred stocks should be considered as a taxable transaction.

11. Whether the reclassification and exchange of shares in this case resulted in a flow of wealth that can be subject to income tax.

RULING:

1. The redemption of stock dividends may be considered essentially equivalent to a distribution of taxable dividends if it is made at such time and in such manner as to make the distribution and redemption fundamentally the same as a taxable dividend. The determining factor is whether any gain or profit was derived from the transaction.

2. In this case, the redemption of stock dividends falls within the exception under Section 83(b) of the 1939 Tax Code. The Court recognizes that the redemption of stock dividends can be a capital transaction and not subject to tax. However, depending on the circumstances, the proceeds of the redemption may be considered a distribution of cash dividends and become taxable income. The determination of whether a distribution should be treated as a taxable dividend is a question of fact based on the particular facts of the transaction.

3. The proceeds of the redemption of stock dividends may be deemed as taxable dividends. The capital cannot be distributed in the form of redemption of stock dividends without violating the trust fund doctrine. Once capital, it is always capital. However, only the proceeds of the redemption, not the stock dividends themselves, may be considered taxable dividends.

4. The time alone that lapsed between the issuance and redemption of stock dividends is not a sufficient indicator to determine taxability. It is necessary to consider the factual circumstances surrounding the issuance and redemption to determine if it was a device or scheme to evade tax.

5. The issuance and redemption of stock dividends must be separate, distinct, and not related for the redemption to be considered a legitimate tax scheme. Redemption cannot be used as a cloak to distribute corporate earnings. The existence of legitimate business purposes in support of the redemption of stock dividends is immaterial in income taxation. The test of taxability is whether the redemption resulted in a flow of wealth.

6. The proceeds from the redemption of stock dividends are not exempt from income tax, even if the redemption is supported by legitimate business reasons.

7. The presence of genuine business purposes does not justify the non-taxability of the proceeds of stock dividend redemption.

8. The alleged "filipinization" plan and reduction of foreign exchange remittances cannot be considered legitimate business purposes.

9. The imposition of tax on the redeemed stock dividends does not create an undisclosed lien and is not unfair to subsequent buyers.

10. The exchange of common stocks with preferred stocks is generally considered as a taxable transaction, except when it is part of a merger, transfer to a controlled corporation, corporate acquisition, or corporate reorganization.

11. In this case, the reclassification and exchange of shares did not result in a flow of wealth that can be subject to income tax. There was no change in the proportional interest of the stockholders, no cash flow, and the stocks had the same par value. The exchange was merely a corporate paper transaction that did not yield realized income for tax purposes.

PRINCIPLES:

• The exemption under Section 83(b) of the 1939 Tax Code is designed to prevent the use of stock dividends as a device to distribute cash dividends and evade taxation.

• The presence or absence of real business purpose, the amount of earnings and profits available for the declaration of regular dividends, the effect of the distribution compared to the declaration of regular dividends, the lapse of time between issuance and redemption, and the presence of substantial surplus and cash can be used as criteria to determine if a distribution should be treated as a taxable dividend.

• To apply the exemption under Section 83(b), it must be established that there is redemption or cancellation, the transaction involves stock dividends, and the time and manner of the transaction make it essentially equivalent to a distribution of taxable dividends.

• Redemption of stock dividends is the repurchase or reacquisition of stock by a corporation. It may be used as a veil for the constructive distribution of cash dividends. The source of the redeemed shares, whether from original capital subscriptions or stock dividend declarations, is relevant in determining if it falls within the exception under Section 83(b).

• The proceeds of the redemption of stock dividends may be deemed as taxable dividends.

• The time lapse between the issuance and redemption of stock dividends is not a sufficient indicator to determine taxability.

• The issuance and redemption of stock dividends must be separate and distinct to be considered a legitimate tax scheme.

• The existence of legitimate business purposes in support of the redemption of stock dividends is immaterial in income taxation.

• The test of taxability is whether the redemption resulted in a flow of wealth.

• The payment of tax under the exempting clause of Section 83(b) of the National Internal Revenue Code (NIRC) depends on the income of the taxpayer, not the business purposes of a third party.

• The issuance and redemption of stocks are two different transactions, and the presence or absence of genuine business purposes may be relevant to the issuance or declaration of stock dividends but not to its subsequent redemption.

• The substance of the whole transaction, not its form, usually controls the tax consequences.

• A corporation can only act through its Board of Directors, and legitimate corporate purposes require proper Board Resolutions.

• The absence of cash dividends for a significant period of time may negate the legitimacy of alleged corporate purposes to issue stock dividends.

• The proceeds of redeemed stock dividends are deemed taxable dividends if income was generated from the transaction.

• The fairness of an undisclosed lien and subsequent buyers is dependent on the factual milieu of the case and the net effect of the transaction.

• Exchange of common stocks with preferred stocks is generally considered as a taxable transaction, but exceptions apply in specific circumstances.

• Reclassification of shares does not always result in a change in the proportional interest of shareholders.

• The exchange of shares may result in a modification of rights and privileges, but it does not constitute a flow of wealth for tax purposes.

• Taxable dividend may arise only when a subscriber disposes of their entire interest, not when there is still maintenance of proprietary interest.