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Perils of crossing the divide between tax avoidance and tax evasion.

(Article published in the Oct 5,2005 issue of Manila Standard Today)

When I was young and full of hope (if I may begin with a favorite phrase of the great philosopher Roque Ferriols, S.J), I had the job sweeping the scraps that fell from the Round Table of King Jobo.  Camelot was Far East Bank and Trust Company, its head office fronting Muralla Street, where the moat that surrounded England’s castles of old is replicated up to today every time it rains heavily in present-day Manila.

 At the board room on the fourth floor Jose B. Fernandez, Jr., held court, as soon as the Cathedral tolled the Angelus or when the sun touched the lips of the near-by bay (whichever came first), imparting to his knights errant and, sometimes, erring, principles of sound banking, secrets of safe investing, technique of holding alcohol and formula for winning in balut (i.e. being the CEO).  One evening, he had a mission for me.

 I was told to accompany a bank client the following day to a young but already famous lawyer named Teodoro Regala.  I did so and found myself beneficiary of a most instructive dialogue.

          The bank client, who considered it a moral fraility to pay taxes (in fact a sin to pay for anything at all) if he could get away with it, wanted to engage the services of Teddy’s law firm to do some corporate and tax work for him.  He laid out one after the other the legal vehicles he wanted to be put up and the transactions he wanted to be executed.  At the end, he asked rhetorically, “After all is said and done, I wouldn’t have to pay any taxes, right?”

 Teddy matter-of-factly asked, “what would be the bona fide business purpose for all that?” When he was met by dumbfounded silence from the bank client, Teddy simply said, “you cannot form all those corporations and do those transactions just to avoid tax. You need a legitimate purpose.”  End of meeting.

 That night, I was top story teller at Camelot.  And more than three decades later, the Supreme Court was to reiterate the same test in Commissioner of Internal Revenue v. The Estate of Benigno P. Toda, Jr. (438 SCRA 290).

 Citing the most authoritative and yet easiest to read summation of Philippine tax law in print today, Tax Law and Jurisprudence by retired Supreme Court Justice Jose C. Vitug and current Presiding Justice of the Court of Tax Appeals Ernesto D. Acosta, the Supreme Court explained how tax avoidance is different from tax evasion:


 “Tax Avoidance and tax evasion are the two most common ways used by taxpayers in escaping from taxation.  Tax avoidance is the tax saving device within the means sanctioned by law.  This method should be used by the taxpayer in good faith and at arms length.  Tax evasion, on the other hand, is a scheme used outside of those lawful means and when availed of, it usually subjects the taxpayer to further or additional civil or criminal liabilities.”

 In theory, it is easy to spot “avoidance” from “evasion”. What makes a tax mitigation device “avoidance” is that it is “within the means sanctioned by law”; and what makes it “evasion” is that it is “outside of those lawful means.”  In practice, as Benigno P Toda, Jr. demonstrates, the demarcation is very thin.

 On 02 March 1989, Cibeles Insurance Corporation (CIC) authorized its President and 99.99% equity owner, Benigno P. Toda, Jr. to sell the Cibeles Building and the two parcels of land on which the building stands (Cibeles Property) for an amount of no less than Php 90 million. 

About two months thereafter, CIC received from Royal Match, Inc. (RMI) the amount of Php 40 million.  This amount RMI recorded in its accounting records as “other inv.-Cibeles Bldg.”  A substantial portion was withdrawn from CIC by Toda by way of cash dividends to all stockholders.  After a period of less than three months, another Php 40 million was recorded by RMI as “other inv.-Cibeles Bldg.”

 On 30 August 1989, two documents of sale over the same Cibeles Property were recorded in the books of a notary.  First to be entered as document no. 91, Page 20, Book I, series of 1989, was a Deed of Absolute Sale by a Rafael A. Altonaga in favor of RMI.  The second was another Deed of Absolute Sale, document No. 92, also on Page 20, Book I, series of 1989,  by CIC to Altonaga. 

 There is on record information,-- unverified, hearsay and inadmissible as evidence-- that “Altonaga was a close business associate and one of the many trusted executives of Toda.”  But regardless, the fact “that Altonaga was a mere conduit finds support in the admission of the respondent Estate (of Toda) that the sale to him was part of the tax planning scheme of CIC.”

 Zeroing in on the tax planning device, the Supreme Court held: “The scheme resorted to by CIC in making it appear that there were two sales of the subject properties…cannot be considered a legitimate tax planning.  Such scheme is tainted with fraud….”

 “Here”, the Supreme Court observed, “it is obvious that the objective of the sale to Altonaga was to reduce the amount of tax to be paid especially that the transfer from him to RMI would then subject the income to only 5% (now 6% under the Tax Reform Act of 1997) individual capital gains tax, and not the 35% (now 32% but soon to be back to 35%) corporate income tax.  Altonaga’s sole purpose of acquiring and transferring title of the subject properties on the same day was to create a tax shelter.”

 The Court continued: “ Altonaga never controlled the property and did not enjoy the normal benefits and burdens of ownership.  The sale to him was merely a tax ploy, a sham, and without business purpose and economic substance.  Doubtless, the execution of the two sales was calculated to mislead the BIR with the end in view of of reducing the consequent income tax liability.”

 The Court thus summed up: “in a nutshell, the intermediary transaction, i.e. the sale of Altonaga, which was prompted more on the mitigation of tax liabilities than for legitimate business purposes constitutes one of tax evasion.”

 The fraud in the Altonaga transaction, to the misfortune of BenignoToda, Jr.’s heirs, contaminated his estate.  Ordinarily, a corporation is separate and distinct from its stockholders and the fact that an individual owned 100% of the shares, by itself, does not justify disregarding this separation of personality (Palay, Inc. v. Clave, 124 SCRA 638).  But then, when Toda sold his shares in CIC to a certain Le Hun T. Choa about one year after the Altonaga transaction, he made himself personally liable for all of CIC’s tax liabilities.  This contractual undertaking by Toda made his estate pay for the wages of his corporation’s sin.

The clear lesson for estate planner is that while no one is bound to pay more taxes than the law prescribes, one must not to concoct legal vehicles and enter into transactions just to lessen one’s tax. Or else.