When grandfather rules: Test in determining the nationality of a corporation

Foreign investments are vital to the economic growth of the Philippines. The government encourages foreign investments to curb unemployment through job-generation and to increase revenue. While foreign investors are welcome, the Philippine Constitution however, reserves some activities or industries to Filipinos only. These ‘nationalized’ or ‘partly-nationalized’ industries require zero or a limited percentage of foreign participation. In these types of industries or activities, the nationality of the investors is critical.

One activity which is nationalized is the exploration, development and utilization of natural resources under Article XII, Section 2 of the Philippine Constitution. Under the Constitution, these activities must be under the full control and supervision of the State. The State, however, may directly undertake such activities, or it may enter into co-production, joint venture, or production-sharing agreements with Filipino citizens, corporations or associations. For corporations or associations, the fundamental law requires that at least 60 percent of its capital is owned by Filipinos. 

The determination of the 60 percent Filipino ownership in a corporation is, thus, essential when engaging in activities reserved for Filipinos, such as the exploration, development and utilization of natural resources. The Supreme Court of the Philippines recently had the occasion to rule on the determination of the nationality of corporations interested in engaging in mining activities in the Philippines.  In the case of Narra Nickel Mining and Development, Tesoro Mining and Development, Inc. and MacArthur Mining, Inc. vs. Redmont Consolidated Mines Corp. (GR No. 195580), the Supreme Court discussed the tests used to determine whether a corporation is effectively Filipino-owned.

This subject case stemmed from a dispute over the mining and exploration of certain areas in Palawan. The respondent Redmont Consolidated Mines, Inc. (“Redmont”) questioned the nationality of the three petitioner corporations, which are prior applicants for Mineral Production and Sharing Agreements (MPSA) on the same area. Redmont alleged that these three corporations are not qualified as they do not meet the “at least 60% owned by Filipinos” requirement under the Constitution. It further argued that at least 60% of the capital stock of Narra Nickel, Tesoro and MacArthur are owned and controlled by MBMI Resources, Inc., which is a 100% Canadian corporation.  

In this case, the Supreme Court acknowledged that there are two tests previously used in determining the nationality of a corporation, the “control test” and the “grandfather rule”.   The court quoted Paragraph 7 of the DOJ Opinion No. 020, Series of 2005 wherein it provides that as follows:

“Shares belonging to corporations or partnerships, at least 60 percent of the capital stock of which is owned by Filipino citizens, shall be considered as of Philippine nationality, but if the percentage of Filipino ownership in the corporation or partnership is less than 60 percent, only the number of shares corresponding to such percentage shall be counted as of Philippine nationality. XXX”

The High Court explained that the first part of the quoted paragraph pertains to the control test or the liberal rule, while the second part refers to the stricter and more stringent grandfather rule. In applying these rules to the present case, the Court did not limit the application of the grandfather rule to instances when the Filipino stockholdings are less than 60 percent.  It stated that when there is doubt over the 60-40 Filipino equity ownership, the grandfather may be applied, contrary to the allegations by the petitioners that the control test should be used as it was the test applied under Republic Act 7042 as amended (otherwise known as the Foreign Investments Act or FIA).

In applying the grandfather rule, the Supreme Court looked into the actual ownership of MBMI in each of the three corporations by further checking the actual structure of the other shareholder corporations of each company. In MacArthur Mining Corporation, MBMI has 3998 shares while Madridejos Mining which is a Filipino corporation, has 5,997 shares. On its face, it would seem like the Filipino corporation owns at least 60 percent of MacArthur. However, upon closer look on the ownership of Madridejos, it can be seen that MBMI also has substantial shares in it.  

In this case, the Supreme Court acknowledges that while corporate layering is allowed by the FIA, such practice becomes illegal if used to circumvent the Constitution and pertinent laws.

Through the application of the grandfather rule, the Supreme Court held that petitioners Narra Nickel, Tesoro and MacArthur Mining are not considered Philippine nationals  since MBMI, a 100 percent Canadian corporation, owns 60 percent or more of their equity shares interests. Hence, as non-Philippine nationals, they are disqualified to participate in the exploitation, utilization and development of the Philippines’ natural resources.

While the Supreme Court applied the grandfather rule instead of the control test in this subject case, it must be clarified that the Court did not totally abandon the control test. The Court concluded that the control test is still the prevailing mode of determining the nationality of a corporation, within the ambit of the Constitution, as to who is entitled to participate in the exploration, development and utilization of the natural resources of the Philippines. The grandfather rule would only apply if based on the surrounding facts and circumstances, there is doubt on the 60-40 required Filipino-equity ownership in the corporation.  

As doubt may arise from several factors, it would therefore be prudent to ensure that any corporate layering resorted to by an entity would not result to the contravention of the Constitution. Although this may prove to be quite difficult, it would always be better to be on the side of caution.

Elaine P. de Guzman is a supervisor from the tax group of R.G. Manabat & Co. (RGM&Co.), the Philippine member firm of KPMG International.

This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.

The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or RGM&Co. For comments or inquiries, please email [email protected] or [email protected].

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