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Tax pierces the corporate veil

Tax pierces the corporate veil by: Atty. Joy S. Formaran-Duclan

The worldwide economy seems to be coping up from the recent financial crisis.  Many foreign investors are now coming in the Philippines to invest. Even local investors are venturing into the Philippine market either to expand their current business or simply to exercise their entrepreneurship skills for the first time.

The first question that is usually asked by prospective investors is the best type of organizational structure to incorporate their business taking into consideration the rights, liabilities, and tax aspects of the different types of entities that could be set up.

In general, there are at least three (3) types of organizational structure that could be set up such as sole proprietorship, partnership and corporation. Briefly, a sole proprietorship is an individual person who is engaged in trade or business. For tax purposes, all of the income of a single proprietor from his/her business is subject to graduated tax rates of 5% to 32%.  In terms of liabilities, the sole proprietor may be held liable to the extent of his personal properties. 

A partnership is an association of two or more persons who bind themselves to contribute money, property, or industry to a common fund, with the intention of dividing the profits among themselves. It has a juridical personality separate and distinct from that of each of the partners. A partnership (except a general professional partnership) is taxed as a corporation thus its taxable net income is subject to 30%.  Although a partnership has a juridical personality separate and distinct from the partners, the law requires that at least one partner should be a general partner who may be held liable to the partnership obligations to the extent of his personal properties. 

And lastly, a corporation is an artificial being created by operation of law, having the right of succession and the powers, attributes and properties expressly authorized by law or incidents to its existence.  A corporation acquires its juridical personality from the time of the issuance of its certificate of registration with the Securities and Exchange Commission. The liability of a stockholder to the corporation’s obligations is limited only to the extent of his contribution to the corporation. For tax purposes, the taxable income earned by a corporation is subject to corporate income tax of 30%.   

Based on the foregoing, it would appear that a corporation is the best structure to set up.  However it is noteworthy to emphasize that a stockholder’s liability is not absolutely limited to the extent of his capital contributions.  The Bureau of Internal Revenue (BIR) in conducting its tax investigation in several occasions has issued tax assessments directly to the stockholders totally disregarding the juridical personality of the corporation.

In a number of cases, the Supreme Court has shredded the veil of corporate identity and ruled that where a corporation is merely an adjunct, business conduit or alter ego of another corporation or by its stockholders or when they practice fraud on our internal revenue laws, the fiction of separate and distinct corporate identities shall be disregarded, and both entities (including individual stockholders) shall be treated as one taxable person, subject to assessment for the same taxable transactions.

Some of the circumstances where the Court has pierced the corporate veil are when the owner of one corporation or the stockholders directs and controls the operations of the others, and the payments effected or received by one are for the accounts due from or payable to the other; or when the properties or products of one are sold to the other, which in turn immediately sells them to the public, as substantial evidence in support of the finding that the two corporations or its stockholders are actually one juridical taxable personality (CIR vs. Norton and Harisson Company, L-17618 dated August 31, 1964; CIR vs. Toda, GR No. 147188 dated September 14, 2004; CIR vs. Menguito, GR No. 167560 dated September 17, 2008).

This tax jurisprudence should serve as an eye opener to every stockholder that although generally his liability is limited to their capital contributions, the Court may pierce the corporate veil and hold them liable together with the corporation for any tax assessment deficiency. Also, it is a known fact that there are some corporations who discontinue their operations without undergoing the normal process of dissolution based on the false belief that the tax authority cannot run after the individual stockholders.  This is not an absolute truth.  The moral of the story is that no one can escape from paying their deficiency taxes.  The corporate veil is not an absolute shield to protect individual stockholders from being liable to more than what they have contributed or invested in the corporation.