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(Article published in the July 16, 2001 issue of TODAY, Business Section)

The estate tax is a tax on the net estate of a resident decedent. There are therefore two major methods of reducing the amount due: claim as many allowable deductions from the gross estate as possible and report as small a gross estate as is legally permitted. All the better if both techniques can be employed because the lower the net taxable estate, the lower the estate tax rate that applies. And, consequently, less the estate tax liability.

Tax authorities, however, have become wise to the wiles of the deduction method. For almost every item that is allowed to be deducted from the gross estate, Section 86 of the Tax Code imposes restrictions and limits. Some examples: (1) Actual funeral expenses are allowed to be deducted, but only to the extent of 5 percent of the gross estate, or P200,000, which ever is lower. (2) Creditors’ claims are deductible but if the loans were contracted within three years before the death, the debt instrument must be notarized and there must be proof of where the money went. (3) The fair market value of a family home is deductible but must not exceed P1 million.

The more flexible technique therefore is to avoid dying with property in your name. The logic is impeccable. Since the estate tax falls on what you own upon your death, then the estate tax cannot reach those which you do not own at the time of your death. Transferring property during one’s lifetime is, thus, a common device used to avoid the estate tax.

But not all transfers do the trick. The estate owner must make sure that his maneuver hurdles three obstacles, namely, (a) the pitfall of continuing possession, enjoyment or control, (b) the mistake of giving away too much and to the detriment of one’s self or one’s dependent; and (c) the danger of impairing the rights of one’s creditors. Any one of these will spoil what otherwise is a good move.

There are reasons for making transfers during one’s lifetime that nevertheless maintain a substantial connection between the transfer and the transferee. For instance, in order to give himself flexibility, an estate owner may wish to retain the right to revoke the transfer. Moreover, an estate owner may wish to continue enjoying the possession of the property or its rents and fruits during his lifetime, intending to give up full ownership upon his death.

Recognizing the legitimacy of these reasons, the Tax Code permits the arrangement to govern the private parties. However, because the reserved prerogative resemble the perquisites of an owner, the law refuses to permit the transfer to reduce the gross estate. In order words, for estate tax purpose, it is as if no transfers were made even as, between the parties, the transfers were valid agreements.

When the transfers touch on sensitive issues of public policy, however, the law does not hesitate to put its foot down. The law expects a person to keep himself and his dependents from becoming a public charge. Consequently, while a person is allowed to donate all his present property, he must reserve, in ownership or usufruct, sufficient means for his support and for all his relatives who are by law entitled to his such. If he does not, then those affected may ask the courts to reduce the transfer accordingly (Art. 750, Civil Code).

But the law is at its most solicitous when its comes to the welfare of creditors. Transfer, whether by gift or by onerous title, may be rescinded if they are meant to defraud creditors. The recent case of China Banking Corporation v. the Hon. Court of Appeals et al, G.R. No. 129644, promulgated on 07 March 2000, illustrates the lengths at which the courts protect lenders.

Alfonso and his wife, Kiang, were owners of a residential lot in San Juan, Metro Manila, of undetermined distance from Polk Street. Because of Alfonso’s failure to pay his debts to Metro Bank, the bank’s brilliant lawyers sued Alfonso for payment and were able to levy on his one-half conjugal share in the property. The certificate of sale in favor of Metro Bank was annotated on the title on December 22, 1987.

While the case of Metro Bank was going on, China Bank filed its own case against Alfonso and was eventually able to get a judgment in its favor on November 7, 1985. Alfonso appealed the decision, but his appeal was thrown out on September 29, 1988. Levy on execution of the China Bank decision was made against Alfonso’s one-half share on February 4, 1991, and the certificate of sale was eventually annotated on May 4, 1992.

Before the one-year redemption period after the annotation of the Metro Bank execution sale expired, but soon after the Court of Appeals dismissed his appeal of the China Bank decision, Alfonso, on November 21, 1988, sold his right to redeem his property to his son Paulino for P100,000. Paulino paid off Metro Bank on the same day. The sale of the right to redeem was annotated on March 14, 1989.

Paulino then sued on May 20, 1993, for the cancellation of the annotation of China Bank’s levy on execution and annulment of the sale. He claimed that since he redeemed the property of his father from Metro Bank before China Bank annotated its levy on execution on the same property, he had a better and prior right to the property than China Bank.

The Supreme Court held, following Article 1387 of the Civil Code, that, since the China Bank decision was rendered in 1985 against Alfonso, Alfonso’s transfer in 1988 of his right to redeem, although for valuable consideration paid by Paulino, was nevertheless presumed to be with intent to defraud Alfonso’s creditors. At the time of the transfer, father and son knew that the Alfonso was heavily indebted and with neither money to pay nor other property to satisfy his obligations. The sale was rescinded and the execution sale to China Bank was upheld.

Transferring property during one’s lifetime is an effective means of reducing one’s taxable estate. But the transfers must cut and cut cleanly, must be in good faith and not prejudicial to one’s own well-being nor detrimental to one’s dependents and not prejudicial to one’s creditors.