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Problems of Cross-Border Estate Planning

(Article published in the Dec 10, 2008 issue of Manila Standard Today)

A Philippine case book on cross-border estate planning is not going to be complete without the Philippine and American court decisions dealing with the trusts set up over Philippine shares by California spouses Allison J. and Esther K. Gibbs for their five children living in the United States.  The Gibbs trusts are a class of their own.

But first, a disclosure: Allison J. Gibbs is the elder brother of Finley J. Gibbs; both were the lawyer sons of Allison D. Gibbs.  Allison D. Gibbs and William Kincaid, both Americans, established in 1901 in the Philippines a law firm. That firm is considered by the law office that I work for, the Romulo Mabanta Buenaventura Sayoc & De Los Angeles, its progenitor.

As narrated by the Philippine Supreme Court in its decision in the consolidated cases of Gibbs, as trustee v. Collector of Internal Revenue (G.R. No. L-14166) and Collector of Internal Revenue v, Gibbs, as trustee (G.R. No. L-14320) decided on 28 April, 1962, the spouses Gibbs executed on 25 September 1950 five (5) separate documents each, entitled "Deed of Sale and Declaration of Trust."

They transferred, sold and assigned, in trust, 53,000 shares of stock of the Lepanto Consolidated Mining Co., in favor of each one of their five (5) children in consideration of the sum of P26, 227.70, to be paid "on or before December 23, 1950, by selling, mortgaging, hypothecating or pledging part or all of the corpus of the trust." 


The terms and conditions of the ten (10) deeds of trust were identical. The uniform purpose is "to establish an endowment for the support, maintenance, care, health, higher education and travel of the beneficiary and the launching of his career after he becomes of age". Finley J. Gibbs, was named the trustee. Each trust was to terminate when the named beneficiary reached the age of 35. If a named beneficiary died before reaching 35, the trust was to continue for the benefit of the named beneficiary’s legitimate issue and be terminated not later than 20 years after the death of said named beneficiary. In the absence of legitimate issue, the trustee was to turn over the trust assets, share and share alike, to the other named beneficiaries then living.  Fairly standard trusts, one might say.

But, the Gibbs trusts differed from local standard trusts in three ways:  First, they were irrevocable.  Most trusts we now see are revocable.  Second, property was conveyed not by way of donation but instead for consideration. In contrast, present day irrevocable trusts are almost always outright gifts. 

But most significant was that the trust corpus consisted in shares of stock in a domestic corporation although both trustors and their beneficiaries were foreigners.  Most trusts established in the Philippines are established by Filipinos for Filipinos over Philippine-based assets only.  It was this interplay of domestic and foreign elements that gave rise to the problems that confronted the Gibbs trusts.

Explaining why there was a stated consideration, trustor Allison J. Gibbs told the Court of Tax Appeals: “Well, there were tax considerations involved, Your Honor, I have not only to think of the Philippine tax problems but also the United States tax problems... my wife and I …studied and came to the conclusion that we could not afford to make an outright gift of these shares, that the taxes that would result not only to the Philippine government but to the United States government would be too big for us to shoulder, considering the fact that we also are letting off our control of transfers of our right into these substantial portion of our assets. We could not have afforded to do it.”

Stating a consideration was thus calculated to reduce the base of the Philippine gift taxes and at the same time, as Allison J. Gibbs further explained, qualified the gifts to exemptions under California’s tax laws.  Since transferring property in trust for consideration has always been, under both the Philippines and California, a valid way of establishing trusts, what Gibbs did was tax avoidance and not tax evasion. No problems should have arisen. 

The Philippine courts, however, still did not look kindly on the trusts. It turned out that the trustors did not collect the consideration from the trustee even if they had was a chance to do so when Lepanto declared dividends.  Why? Allison J. Gibbs explained: “that would defeat the very objectives for which we created the trusts and at least, one of the objectives was to transfer as much as possible of our Philippine assets to the United States in the form of dollars so as to create dollar assets in the United States on which our children could rely under the trust indentures.”  

The purpose, as thus explained, was actually a legitimate one; but since the consideration was not collected in the Philippines by Gibbs, the Philippine courts declared it to be simulated.  Accordingly, they imposed the Philippine gift taxes on the full market value of the shares at the time of the irrevocable transfer in trust. In sum, the purpose of saving taxes by stating a consideration was frustrated when the stated consideration was not collected. This, despite the fact that both aspects were lawful and legitimate.

The tax difficulties of the Gibbs trusts should have ended right then and there; but they did not.  The Lepanto dividends, because they were paid out by a domestic company were considered under the National Internal Revenue Code as having been sourced from the Philippines.  The Philippine theory is that the dividends ultimately came from the profits of the company’s operations in the Philippines.

Had California followed the same source rules, the Philippine taxes paid on the dividends ought to have been, at least, credited against taxes also due thereon to California.  Unfortunately, instead of considering dividends as sourced from the place where the operations were conducted, California considered dividends as being sourced from the stocks themselves.  Since stocks are, on the principle of mobilia secundum persona, considered located in the place where their owners resided, and the spouses Gibbs were residents of California, the courts of California for their part considered the dividends as sourced from California and subjected them in full to California’s income tax. In effect, the adoption by the Philippines and by California of different source rules resulted in subjecting the same dividends to two taxes. 

The world has, since the Gibbs trusts, become a smaller village and many of the legal pitfalls that gave the Gibbs trusts problems have been remedied.  More and more laws and regulations governing transactions with cross-border implications are being harmonized to eliminate international double taxation.  But the process is exceedingly slow, and still incomplete.  Thus, estate planners ought to remain careful and vigilant when people and capital leave homeland and head for other shores.