Nationality of Corporations | General Principles | Corporations | BUSINESS ORGANIZATIONS

Nationality of Corporations: General Principles Under Philippine Law

The nationality of a corporation is a significant legal consideration in the Philippines, particularly because of the various constitutional and statutory restrictions on foreign ownership and participation in specific sectors of the economy. Determining whether a corporation is considered "Filipino" or "foreign" is critical for compliance with the Philippine Constitution, the Foreign Investments Act (FIA), and other regulatory laws. Below is an in-depth and meticulous explanation of the relevant principles surrounding the nationality of corporations in the Philippines.

I. Constitutional and Statutory Framework

1. Constitutional Restrictions on Foreign Ownership The 1987 Philippine Constitution limits foreign ownership in certain areas of investment. Among the most significant provisions are:

   • Public Utilities: Article XII, Section 11 of the Constitution limits foreign equity participation in public utilities to a maximum of 40%, meaning that at least 60% of the capital must be owned by Filipino citizens or Filipino corporations.
   • Natural Resources: Under Article XII, Section 2 of the Constitution, foreign ownership in corporations engaged in the exploration, development, and utilization of natural resources is limited to 40%.
   • Media: Article XVI, Section 11 mandates that ownership and management of mass media be wholly owned by Filipino citizens or Filipino-controlled corporations (100% Filipino ownership).
   • Land Ownership: Only Filipino citizens or corporations at least 60% owned by Filipinos may own private land in the Philippines (Article XII, Section 7).

2. Foreign Investments Act of 1991 (RA 7042 as amended by RA 8179) The Foreign Investments Act (FIA) defines restrictions on foreign equity in certain sectors through the Foreign Investment Negative List (FINL). Certain industries are restricted to full Filipino ownership, while others are subject to a maximum foreign equity cap (usually 40%).

II. Control Test and Grandfather Rule

The nationality of a corporation in the Philippines is generally determined by the application of two primary legal doctrines: the Control Test and the Grandfather Rule.

1. Control Test The Control Test is the primary rule used to determine the nationality of a corporation. This test evaluates the ownership of shares with voting rights and control over the corporation. If at least 60% of the outstanding capital stock entitled to vote is owned by Filipino citizens or Filipino-controlled corporations, the corporation is considered a Filipino corporation.

   • Example: If Corporation A has a total of 100 shares, 60 of which are owned by Filipino citizens, the corporation is considered Filipino, regardless of the foreign ownership of the remaining 40 shares.

   The Control Test is favored because it promotes simplicity in determining corporate nationality, focusing on the controlling interest in the corporation. The test was affirmed by the Philippine Supreme Court in the landmark case Narvacan v. Court of Appeals (G.R. No. 93605, May 18, 1993), where the Court emphasized the importance of "beneficial control" rather than just the formal ownership of shares.

2. Grandfather Rule The Grandfather Rule is an alternative method used when there is a need to look beyond the superficial ownership of shares. This rule traces the ultimate ownership of shares to the individual level to determine whether foreign interests hold actual control over a corporation. It is applied where there is a "doubt" about the real nationality of a corporation, especially when there are layers of corporate ownership involved.

   • Mechanics: The Grandfather Rule operates by "piercing the veil" of corporate structures and examining the actual beneficial ownership of shares. If a corporation's shareholders include other corporations, and those corporations are partly foreign-owned, the foreign ownership of these corporations is traced to the individual stockholders to determine the actual foreign interest.

   • Example: If a Filipino corporation (Corp B) owns 60% of another corporation (Corp C), but Corp B is 50% foreign-owned, the Grandfather Rule traces Corp B's foreign equity to Corp C. Corp C would be considered only 30% Filipino-owned (60% × 50%), which would disqualify it from being considered a Filipino corporation if the Grandfather Rule were applied.

3. Supreme Court Jurisprudence on the Control Test and Grandfather Rule The leading case that clarifies the relationship between the Control Test and the Grandfather Rule is Gamboa v. Teves (G.R. No. 176579, October 9, 2012). In this case, the Supreme Court ruled that the Control Test should be the primary standard for determining the nationality of a corporation. However, when there is doubt about the true nationality or when ownership is diluted through layers of intermediate corporate ownership, the Grandfather Rule may be applied.

   The Supreme Court further explained that for corporations engaged in constitutionally restricted activities (e.g., utilities), the 60-40 Filipino-foreign equity structure must reflect "full beneficial ownership and control" by Filipinos. Merely holding shares nominally in favor of foreigners would not satisfy the requirements of the Constitution.

III. Layered Corporate Ownership and the Application of Nationality Tests

The complexity of corporate structures often necessitates a careful application of both the Control Test and the Grandfather Rule. The application becomes particularly intricate in situations where corporations own shares in other corporations, creating layers of ownership.

• First Layer of Ownership: The Control Test is first applied to assess whether at least 60% of the outstanding voting shares in the first corporation are owned by Filipino citizens or Filipino-controlled corporations.
• Second Layer of Ownership: When a corporation is owned by another corporation, the Grandfather Rule may be triggered to determine the true beneficial ownership. The rule traces through layers of ownership to ensure that the Filipino majority requirement is not undermined through complex corporate structuring or nominal ownership.

IV. Special Cases and Considerations

1. Dummy Corporations The use of "dummy corporations" to evade nationality restrictions is prohibited under Philippine law. Dummy arrangements involve Filipino citizens nominally holding shares for the benefit of foreign investors. Such arrangements may be voided, and parties involved may be subject to penalties under the Anti-Dummy Law (Commonwealth Act No. 108, as amended). Violations may result in imprisonment, fines, or the cancellation of licenses to operate.

2. Preferential Rights for Filipino Corporations Filipino corporations often enjoy preferential rights in sectors like public utilities, mining, and agriculture. For example, Filipino-owned corporations may participate in contracts with the government for the development of natural resources under the Mining Act of 1995 (RA 7942) or the Build-Operate-Transfer Law (RA 6957).

3. Foreign Corporations and Licensing Foreign corporations wishing to do business in the Philippines must obtain a license from the Securities and Exchange Commission (SEC). These corporations are generally prohibited from engaging in activities reserved for Filipino-owned corporations unless they comply with applicable foreign ownership limits.

V. Role of the Securities and Exchange Commission (SEC)

The Securities and Exchange Commission (SEC) plays a crucial role in determining corporate nationality. When corporations register with the SEC, they are required to disclose the ownership of shares to verify compliance with the nationality restrictions under the Constitution and applicable laws. The SEC may conduct investigations and audits of corporate records to ensure the proper application of the Control Test and Grandfather Rule.

In 2013, following the Gamboa ruling, the SEC issued Memorandum Circular No. 8, Series of 2013, which provides the guidelines for determining the nationality of corporations. The Circular codifies the procedures for applying the Control Test and, where necessary, the Grandfather Rule, especially for corporations engaged in constitutionally restricted industries.

VI. Conclusion

The nationality of a corporation in the Philippines is a vital consideration in ensuring compliance with constitutional and statutory limits on foreign ownership. The Control Test is the primary method used to determine nationality, focusing on ownership of voting shares. However, the Grandfather Rule may be applied in cases of doubt, particularly in complex corporate structures, to trace the actual beneficial ownership and control by foreign investors. Both rules are critical in safeguarding the constitutional mandate of promoting Filipino participation in strategic industries and ensuring that national assets remain under the control of Filipinos.

The consistent interpretation and enforcement of these principles by the Philippine Supreme Court and the Securities and Exchange Commission ensure the effective regulation of corporate ownership in the country.