Liquidating dividends are not dividends

A dividend is the share given to individuals entitled to a portion of profits or property. It can refer to a fund set aside by a corporation from its profits, distributed among shareholders in proportion to their ownership. (https://thelawdictionary.org

Stock corporations are those which have their capital stock divided into shares and are authorized to distribute dividends or surplus profit allotments to shareholders, based on their shareholding. Nonstock corporations, on the other hand, include all other types of corporations.

Corporations issue several types of dividends:

a. Cash dividend
b. Stock dividend
c. Property dividend
d. Liquidating dividend

The Revised Corporation Code provides that the board of directors of a stock corporation may declare dividends out of the unrestricted retained earnings which shall be payable in cash, property, or in stock to all stockholders on the basis of outstanding stock held by them. (Sec. 42, Revised Corporation Code)

The fourth type of dividend above is distinct and, in fact, is not really a dividend.

Liquidating dividend

A liquidating dividend is defined as the share of each stockholder in the remaining assets of the corporation upon dissolution or liquidation, after the payment of all corporate debts and liabilities. (Fernando v. Sps. Lim, G.R. No. 176282 : Aug 22, 2008)

The distribution of the liquidating dividend to the stockholders is not dependent on the existence of unrestricted retained earnings or the corporation having surplus profits or income. However, payment of this dividend to the shareholders may only be made after the payment by the corporation of its debts and liabilities.

The Revised Corporation Code provides that every corporation whose charter expires pursuant to its articles of incorporation is annulled by forfeiture or whose corporate existence is terminated in any other manner, shall nevertheless remain as a body corporate for three years after the effective date of dissolution. This is for the purpose of prosecuting and defending suits by or against it and enabling it to settle and close its affairs, dispose of and convey its property, and distribute its assets, but not for the purpose of continuing the business for which it was established. (Sec. 139, RCC)

Accordingly, within three years from dissolution, and even after the expiry of this period, the corporation can distribute its assets to its shareholders, which corporations have declared as “liquidating dividends.” (SEC OGC Opinion No. 14-22, August 8, 2014)

It is not a dividend

In the early case of Wise & Co. Inc. v. Meer, et al. (G.R. No. 48231, June 30, 1947), the Supreme Court explained that liquidating dividend is not a “dividend” in the true sense of the word even if it is called a dividend by the distributing corporation.

The court explained that distinction between a distribution in liquidation and an ordinary dividend is factual. It depends on the particular circumstances of the case and the intent of the parties. If the distribution is in the nature of a recurring return on stock it is an ordinary dividend.

However, if the corporation is really winding up its business or recapitalizing and narrowing its activities, the distribution may properly be treated as a complete or partial liquidation and as payment by the corporation to the stockholder for his stock.

Liquidating dividends is a conveyance, not partition

The Supreme Court further clarified in another case that where a corporation decides to dissolve and the stockholders issue a certificate of liquidation, the distribution of the assets of the corporation to the stockholders in proportion to their shareholdings should be treated as a conveyance of the assets and properties with the corresponding deed of conveyance. It is not a simple partition of community property.

The court explained that a corporation is a juridical person distinct from the members composing it. Properties registered in the name of the corporation are owned by it separate from its shareholders such that a shareholder of the corporation does not own the property and assets of the corporation. The transfer of assets of the dissolved corporation cannot be effected without the corresponding deed of conveyance from the corporation to the stockholders.

The issue resolved by the Supreme Court in the case was whether the certificate of liquidation was to be considered a transfer and conveyance by the corporation to the stockholders or a partition of property by co-owners.

The treatment of the distribution of assets of the corporation by reason of the certificate of liquidation as a conveyance meant the stockholders were liable to pay the registration fees and documentary stamp taxes for the registration and transfer of the properties with the Registry of Deeds conveyed by the corporation as opposed to not paying for any registration fee and a minimal documentary stamp tax if the same were treated as a partition of community property. (Stockholders of F Guanzon and Sons Inc. v. Register of Deeds of Manila, G.R. No. L-18216, Oct 30, 1962)

Tax treatment of liquidating dividends

A domestic corporation can distribute stock dividends tax-free, proportionately to all shareholders.

On the other hand, for cash or property dividends received by an individual from a domestic corporation, there is a final tax at the rate of 10 percent. Dividends earned by non-resident alien individuals are subject to a 20 or 25 percent final tax, depending on whether or not they are engaged in trade or business within the Philippines. (Secs. 24 & 25, Tax Code)

Dividends received by a domestic or resident foreign corporation from another domestic corporation are not subject to tax. A domestic corporation receiving foreign sourced dividends may receive it tax-free, subject to certain conditions imposed by the CREATE Law and the Bureau of Internal Revenue.

Dividends received by a non-resident foreign corporation from a domestic corporation are subject to a final withholding tax of 25 percent and, depending on the circumstances, may be reduced to 15 percent or lower or subject to tax treaty provisions.

The taxes on dividends received above are in the nature of a final withholding tax.

On the other hand, liquidating dividends have a different tax treatment than cash, property and stock dividends. The dividend received shall be subject to the ordinary income tax, subject to the income tax rates for individuals (zero to 35 percent) or corporations (20 to 25 percent).

The Tax Code provides that where a corporation distributes all of its assets in complete liquidation or dissolution, the gain realized or loss sustained by the stockholder, whether individual or corporate, is a taxable income or a deductible loss, as the case may be. (Sec. 73)

Any liquidating gain that may be realized by its stockholders, which represents the difference between the fair market value of the properties received and the and the cost basis of their investment in the corporation, shall be treated as a gain from the sale or exchange of shares which is subject to regular income tax.

On the part of the corporation, distribution of liquidating dividends on account of the dissolution of a corporation is not to be treated as sale for purposes of the imposition of capital gains tax as the same is not subject to any consideration. It is also not subject to income tax, creditable withholding tax, and documentary stamp tax on the part of the corporation. (Premium Leisure Corp. v. CIR, CTA Case No. 8940, March 14, 2017)

(The author, Atty. John Philip C. Siao, is a practicing lawyer and founding Partner of Tiongco Siao Bello & Associates Law Offices, an Arbitrator of the Construction Industry Arbitration Commission of the Philippines, and teaches law at the De La Salle University Tañada-Diokno School of Law. He may be contacted at [email protected]. The views expressed in this article belong to the author alone.)