Manila Trading and Supply Co. (MANTRASCO) had an authorized capital stock of P2.5 million divided into 25,000 common shares: 24,700 were owned by Reese and the rest at 100 shares each by the Respondents. Reese entered into a trust agreement whereby it is stated that upon Reese’s death, the company would purchase back all of its shares. Reese died. MANTRASCO repurchased the 24,700 shares. Thereafter, a resolution was passed authorizing that the 24,700 shares be declared as stock dividends to be distributed to the stockholders. The BIR ordered an examination of MANTRASCO’s books and discovered that the 24,700 shares declared as dividends were not disclosed by respondents as part of their taxable income for the year 1958. Hence, the CIR issued notices of assessment for deficiency income taxes to respondents. Respondents protested but the CIR denied. Respondents appealed to the CTA. The CTA ruled in their favor. Hence, this petition by the CIR
Whether the respondents are liable for deficiency income taxes on the stock dividends?
HELD: Dividends means any distribution made by a corporation to its shareholders out of its earnings or profits. Stock dividends which represent transfer of surplus to capital account is not subject to income tax. But if a corporation redeems stock issued so as to make a distribution, this is essentially equivalent to the distribution of a taxable dividend the amount so distributed in the redemption considered as taxable income.
The distinctions between a stock dividend which does not and one which does constitute taxable income to the shareholders is that a stock dividend constitutes income if its gives the shareholder an interest different from that which his former stockholdings represented. On the other hand, it does constitute income if the new shares confer no different rights or interests than did the old shares. Therefore, whenever the companies involved parted with a portion of their earnings to bnuy the corporate holdings of Reese, they were making a distribution of such earnings to respondents. These amounts are thus subject to income tax as a flow of cash benefits to respondents. Hence, respondents are liable for deficiency income taxes.