RULES TO DETERMINE THE EXISTENCE OF PARTNERSHIP Ramil F.

De Jesus

Introduction The primary business setting the early stage of civilization and development of mankind is through sole proprietorship. In this form of business setting the resources are put up by the owner and manage his own affairs. But being sociable by nature man associate with others to engage in business and other undertakings. And so contract of partnership was created through necessity. By the contract of partnership two or more persons bind themselves to contribute money, property, or industry to a common fund, with the intention of dividing the profits among themselves. Two or more persons may also form a partnership for the exercise of a profession. (Art. 1767 New Civil Code). There are however, essential characteristics elements that would establish the existenceof partnership. The contract of partnership is consensual, nominate, bilateral, onerous, commutative, principal and preparatory. Partnership is a legal concept, but the determination of the existence of a partnership may involve inferences drawn from an analysis of all circumstances attending its creation. As a form of business organization, it falls between two extreme organizational form the single proprietorship and the

corporation(Comments and Cases on Partnership, Agency and Trusts, De Leon and De Leon). Objective To discuss the rules to determine existence of partnership.

Discussion In general, to establish the existence of a partnership, all of its essential features or characteristics must be shown to be present. However, the New Civil Code enumerates the rules to determine the existence of a partnership, it provides: Art. 1769. In determining whether a partnership exists, these rules shall apply: (1) Except as provided by Article 1825, persons who are not partners as to each other are not partners as to third persons; (2) Co-ownership or co-possession does not of itself establish a partnership, whether such-co-owners or copossessors do or do not share any profits made by the use of the property; (3) The sharing of gross returns does not of itself establish a partnership, whether or not the persons sharing them have a joint or common right or interest in any property from which the returns are derived; (4) The receipt by a person of a share of the profits of a business is prima facie evidence that he is a partner in the business, but no such inference shall be drawn if such profits were received in payment:

(a) As a debt by installments or otherwise; (b) As wages of an employee or rent to a landlord; (c) As an annuity to a widow or representative of a deceased partner; (d) As interest on a loan, though the amount of payment vary with the profits of the business; (e) As the consideration for the sale of a goodwill of a business or other property by installments or otherwise. (n)

Using the above criteria or rules to determine the existence of a partnership, the Supreme Court in G. R. No. 126881 declared that no partnership exist and stated that:

In the light of the aforequoted legal provision, we conclude that Tan EngKee was only an employee, not a partner. Even if the payrolls as evidence were discarded, petitioners would still be back to square one, so to speak, since they did not present and offer evidence that would show that Tan EngKee received amounts of money allegedly representing his share in the profits of the enterprise. Petitioners failed to show how much their father, Tan EngKee, received, if any, as his share in the profits of Benguet Lumber Company for any particular period. Hence, they failed to prove that Tan EngKee and Tan Eng Lay intended to divide the profits of the business between themselves, which is one of the essential features of a partnership.

Persons not partners as to each other are not partners as to third persons. There must be a partnership in order that they may deal with third persons as partners, except in cases of partnership by estoppel. One who, by words or conduct directly represents himself to anyone as a partner in an existing partnership or in a non- existing partnership or Indirectly represents himself by consenting to another representing him as a partner in an existing partnership or in a non-existing partnership. If all actual partners consented to the representation, then the liability of the person who represented himself to be a partner or who consented to such representation and the actual partner is considered a partnership liability. When there is no existing partnership and all those represented as partners consented to the representation, then the liability of the person who represented himself to be a partner and all who made and consented to such representation, is joint or pro-rata. However, when there is no existing partnership and not all but only some of those represented as partners consented to the representation, or none of the partnership in an existing partnership consented to such representation, then the liability will be separate(http://www.batasnatin.com/law-library/civil-law/partnership/2380partnership-by-estoppel.html). It is not only the partners that may be estopped from the denying the existence of a partnership, the third person who dealt with the partnership and considered it as such can no longer deny its existence.

The Supreme Court ruled in G.R. No. L-7991, March 21, 1956 that while an unregistered commercial partnership has no juridical personality,

nevertheless, where two or more persons attempt to create a partnership failing to comply with all the legal formalities, the law considers them as partners and the association is a partnership in so far as it is a favorable to third persons, by reason of the equitable principle of estoppel. In Jo Chung Chang vs. Pacific Commercial Co., 45 Phil., 145, it was held that although the partnership with the firm name of TeckSeing and Co. Ltd., could not be regarded as a partnership de jure, yet with respect to third persons it will be considered a partnership with all the consequent obligations for the purpose of enforcing the rights of such third persons. Da Costa and Gorcey cannot deny that they are partners of the partnership Stasikinocey, because in all their transactions with the Respondent they represented themselves as such. Petitioner McDonald cannot disclaim knowledge of the partnership Stasikinocey because he dealt with said entity in purchasing two of the vehicles in question through Gorcey and Da Costa. As was held in Behn Meyer & Co. vs. Rosatzin, 5 Phil., 660, where a partnership not duly organized has been recognized as such in its dealings with certain persons, it shall be considered as partnership by estoppel and the persons dealing with it are estopped from denying its partnership existence. The sale of the vehicles in question being void as to Petitioner McDonald, the transfer from the latter to Petitioner Benjamin Gonzales is also void, as the buyer cannot have a better right than the seller.( Macdonald et. al v. The National City Bank of New York). Co-ownership or co-possession does not of itself establish a partnership, whether such-co-owners or co-possessors do or do not share any profits made by the use of the property A partner is co-owner with his partners of specific partnership property. As such he has an equal right with his partners to possess specific partnership property for partnership purposes; but he has no right to possess such property for any other purpose without the consent of his partners( Art. 1811).

From the above it appears that the fact that those who agree to form a coownership share or do not share any profits made by the use of the property held in common does not convert their venture into a partnership. Or the sharing of the gross returns does not of itself establish a partnership whether or not the persons sharing therein have a joint or common right or interest in the property. This only means that, aside from the circumstance of profit, the presence of other elements constituting partnership is necessary, such as the clear intent to form a partnership, the existence of a juridical personality different from that of the individual partners, and the freedom to transfer or assign any interest in the property by one with the consent of the others (Padilla, Civil Code of the Philippines Annotated, Vol. I, 1953 ed., pp. 635-636) It is evident that an isolated transaction whereby two or more persons contribute funds to buy certain real estate for profit in the absence of other circumstances showing a contrary intention cannot be considered a partnership. In order to constitute a partnership inter se there must be: (a) An intent to form the same; (b) generally participating in both profits and losses; (c) and such a community of interest, as far as third persons are concerned as enables each party to make contract, manage the business, and dispose of the whole property.(Municipal Paving Co. vs. Herring 150 P. 1067, 50 III 470.) In ruling the G.R. 78133 the Court stated that In the present case, there is clear evidence of co-ownership between the petitioners. There is no adequate basis to support the proposition that they thereby formed an unregistered partnership. The two isolated transactions whereby they purchased properties and sold the same a few years thereafter did not thereby make them partners. They shared in the gross profits as co- owners and paid their capital gains taxes on their net profits and availed of the tax amnesty thereby. Under the circumstances, they cannot be considered to have formed an unregistered

partnership which is thereby liable for corporate income tax, as the respondent commissioner proposes. The common ownership of property does not itself create a partnership between the owners, though they may use it for the purpose of making gains; and they may, without becoming partners, agree among themselves as to the management, and use of such property and the application of the proceeds therefrom. (Spurlock vs. Wilson, 142 S.W. 363,160 No.App. 14.) Sharing of Gross Returns The sharing of returns does not in itself establish a partnership whether or not the persons sharing therein have a joint or common right or interest in the property. There must be a clear intent to form a partnership, the existence of a juridical personality different from the individual partners, and the freedom of each party to transfer or assign the whole property(G.R. 78133). Persons who contribute property or funds for a common enterprise and agree to share the gross returns of that enterprise in proportion to their contribution, but who severally retain the title to their respective contribution, are not thereby rendered partners. They have no common stock or capital, and no community of interest as principal proprietors in the business itself which the proceeds derived. (Elements of the Law of Partnership by Flord D. Mechem 2nd Ed., section 83, p. 74.as cited in G.R. 78133). The reason behind the rule is a sound and practical one, for when business is carried on in behalf of a given person as partner, he is conceived as being interested in its failure as well as success; its chance of gain or loss which characterizes a business, whether in the form of a partnership or otherwise. As a matter of experience, therefore, it is found generally that where the contract requires a given portion of gross returns to be paid over, the portion paid over

as commission, wages, rent, interest on loan, etc. ( Scheleicker vs. Krier, 218 Wis. 376 as cited in De Leon). In ruling the case of Obillos et al vs. CIR, the Court reiterated the rule on the sharing of gross returns as to the existence of partnership and stated:

Article 1769(3) of the Civil Code provides that "the sharing of gross returns does not of itself establish a partnership, whether or not the persons sharing them have a joint or common right or interest in any property from which the returns are derived". There must be an unmistakable intention to form a partnership or joint venture.* Such intent was present in Gatchalian vs. Collector of Internal Revenue, 67 Phil. 666, where 15 persons contributed small amounts to purchase a two-peso sweepstakes ticket with the agreement that they would divide the prize The ticket won the third prize of P50,000. The 15 persons were held liable for income tax as an unregistered partnership. The instant case is distinguishable from the cases where the parties engaged in joint ventures for profit. Thus, in Oa case where: ** This view is supported by the following rulings of respondent Commissioner: Co-owership distinguished from partnership.-We find that the case at bar is fundamentally similar to the De Leon case. Thus, like the De Leon heirs, the Longa heirs inherited the 'hacienda' in question pro-indiviso from their deceased parents; they did not contribute or invest additional ' capital to increase or expand the inherited properties; they merely continued dedicating the property to the use to which it had been put by their forebears; they individually reported in their tax returns their corresponding shares in the income and expenses of the 'hacienda', and they continued for many years the status of co-ownership in order, as conceded by respondent, 'to preserve its (the 'hacienda') value and to continue the existing contractual relations with the Central Azucarera de Bais for milling purposes. Longa vs. Aranas, CTA Case No. 653, July 31, 1963). All co-ownerships are not deemed unregistered partnership.Co-Ownership who own properties which produce income should not automatically be considered partners of an unregistered partnership, or a corporation, within the purview of the income tax law. To hold otherwise, would be to subject the income of all co-ownerships of inherited properties to the tax on corporations, inasmuch as if a property does not produce an 7

income at all, it is not subject to any kind of income tax, whether the income tax on individuals or the income tax on corporation. (De Leon vs. CI R, CTA Case No. 738, September 11, 1961, cited in Araas, 1977 Tax Code Annotated, Vol. 1, 1979 Ed., pp. 77-78).

Commissioner of Internal Revenue, L-19342, May 25, 1972, 45 SCRA 74, where after an extrajudicial settlement the co-heirs used the inheritance or the incomes derived therefrom as a common fund to produce profits for themselves, it was held that they were taxable as an unregistered partnership. It is likewise different from Reyes vs. Commissioner of Internal Revenue, 24 SCRA 198, where father and son purchased a lot and building, entrusted the administration of the building to an administrator and divided equally the net income, and from Evangelista vs. Collector of Internal Revenue, 102 Phil. 140, where the three Evangelista sisters bought four pieces of real property which they leased to various tenants and derived rentals therefrom. Clearly, the petitioners in these two cases had formed an unregistered partnership. Receipt of Share in the Profits An agreement to share both profits and losses tends stronglyto establish the existence of a partnership, and conversely, the lack of such an agreement tends strongly to negate the existence of a partnership. But mere fact of a right under the contract to participate in both profits and losses of a business does not itself have the effect of establishing partnership between those engaged therein. In PhilexMinings v. CIR, the petitioner is claiming that no partnership between them but the Supreme Court ruled that the agreement denominated as the Power of Attorney indicates that the parties had intended to create a partnership and establish a common fund for the purpose. They also had a joint interest in the profits of the business as shown by a 50-50 sharing in the income of the mine. The strongest indication that petitioner was a partner in the Sto Nio mine is the fact that it would receive 50% of the net profits as compensation under

paragraph 12 of the agreement.

The entirety of the parties contractual

stipulations simply leads to no other conclusion than that petitioners compensation is actually its share in the income of the joint venture. Article 1769 (4) of the Civil Code explicitly provides that the receipt by a person of a share in the profits of a business is prima facie evidence that he is a partner in the business. Petitioner asserts, however, that no such inference can be drawn against it since its share in the profits of the Sto Nio project was in the nature of compensation or wages of an employee, under the exception provided in Article 1769 (4) (b).[24] On this score, the tax court correctly noted that petitioner was not an employee of Baguio Gold who will be paid wages pursuant to an employer employee relationship. To begin with, petitioner was the manager of the project and had put substantial sums into the venture in order to ensure its viability and profitability. By pegging its compensation to profits, petitioner also stood not to be remunerated in case the mine had no income. It is hard to believe that petitioner would take the risk of not being paid at all for its services, if it were truly just an ordinary employee. Consequently, we find that petitioners compensation under paragraph 12 of the agreement actually constitutes its share in the net profits of the partnership. Indeed, petitioner would not be entitled to an equal share in the income of the mine if it were just an employee of Baguio Gold.[25] It is not surprising that petitioner was to receive a 50% share in the net profits, considering that the Power of Attorney also provided for an almost equal contribution of the parties to the St. Nino mine. The compensation agreed upon only serves to reinforce the notion that the parties relations were indeed of partners and not employer-employee.

All told, the lower courts did not err in treating petitioners advances as investments in a partnership known as the Sto. Nino mine. The advances were not debts of Baguio Gold to petitioner inasmuch as the latter was under no unconditional obligation to return the same to the former under the Power of Attorney. As for the amounts that petitioner paid as guarantor to Baguio Golds creditors, we find no reason to depart from the tax courts factual finding that Baguio Golds debts were not yet due and dem andable at the time that petitioner paid the same. Verily, petitioner pre-paid Baguio Golds outstanding loans to its bank creditors and this conclusion is supported by the evidence on record.

Conclusion In determining the existence of a partnership, it is important that the essential elements and characteristics of partnership must be determined first and that its existence depends on the circumstances surrounding its creation.

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