HOW TO DETERMINE THE NATIONALITY OF A CORPORATION

The Constitution and various laws reserve certain areas of activities to Philippine
citizens or to corporations that have a minimum percentage of Filipino ownership.
For example, with respect to corporations, ownership of land is limited to
corporations at least sixty per centum of whose capital is owned by Philippine
citizens. If 60% of the capital of a Philippine corporation is owned by individuals
who are Philippine citizens, then there would be no issue on whether the Philippine
corporation is a Philippine national qualified to own land. On the other hand, an
issue would arise if 60% of the capital of the Philippine corporation is owned, in turn,
by another Philippine corporation that has foreign stockholders.
If a Philippine corporation has corporate stockholders, how does one determine
whether such Philippine corporation is a Philippine national? Two tests have been
employed in the Philippines: (a) the grandfather rule; and (b) the control
test.
To illustrate how these tests are applied, lets take a Philippine corporation (called
Corporation X) with the following ownership structure:
(a) non-Philippine citizens own 40% of the capital stock outstanding and entitled to
vote of Corporation X;
(b) another Philippine corporation (called Corporation Y) owns 60% of the capital
stock outstanding and entitled to vote of Corporation X.
On other hand, Corporation Y has the following odwnership structure:
(a) non-Philippine citizens own 40% of the capital stock outstanding and entitled to
vote of Corporation Y;
(b) Philippine citizens own 60% of the capital stock outstanding and entitled to vote
of Corporation Y.
Lets also assume that Philippine citizens constitute at least 60% of the members of
the board of directors of each of Corporation X and Corporation Y.

If the grandfather rule is applied, Corporation X will not be deemed a Philippine

national because the grandfather rule takes into account the direct and indirect
foreign equity of foreigners in Corporation X (see SEC Opinion re: Silahis
International Hotel, May 4, 1987). Applying the grandfather rule, the direct and
indirect foreign equity in Corporation X would be 64%, calculated at follows:
Direct foreign-owned equity in Corporation X

40%

Indirect foreign owned equity in Corporation X

24%

Under the above scenario, the foreigners are deemed to have a 24% indirect foreign
equity in Corporation X because foreigners own 40% of Corporation Y, which in turn
owns 60% of Corporation X (i.e., 40% multiplied by 60% equals 24%). Thus, under
the grandfather rule, Corporation X is not qualified to own land.
On the other hand, if the control test is applied, Corporation X is deemed to be a
Philippine national qualified to own land. Under the control test, Corporation X is
considered a Philippine national since at least 60% of its capital stock outstanding
and entitled to vote is held by Corporation Y, which is also considered a Philippine
national since at least 60% of its capital stock outstanding and entitled to vote is
held by Philippine citizens.
Which of these two tests should be applied? Watch out for a subsequent article on
this topic.

WHAT ARE THE TESTS IN DETERMINING THE NATIONALITY OF

CORPORATIONS?

1. Incorporation test Determined by the state of incorporation, regardless of the

nationality of the stockholders.
2. Domiciliary test Determined by the principal place of business of the
corporation.
3. Control test Determined by the nationality of the controlling stockholders or
members. This test is applied in times of war.

4. Grandfather rule Nationality is attributed to the percentage of equity in the

corporation used in nationalized or partly nationalized area.

HOW TO DETERMINE THE NATIONALITY OF A CORPORATION

(PART 2)
The July 26 post describes two tests for the determining the nationality of a
corporation: the control test and the grandfather rule. Which one applies? As
discussed below, the control test is the primary test for determining the nationality
of a corporation; however, a recent decision of the SEC raises the question of
whether the SEC is now abandoning the control test in favor of the grandfather rule.
The control test as the primary test
As a rule, the control test applies. The primacy of the control test over the
grandfather rule can be traced to DOJ Opinion No. 19, s. 1989 (the 1989 DOJ
Ruling), which states:
. . . the Grandfather Rule, which was evolved and applied by the SEC in several
cases, will not apply in cases where the 60-40 Filipino-alien equity ownership in a
particular natural resource corporation is not in doubt. (underscoring supplied)
In other words, according to the Department of Justice, the control test generally
applies, with the grandfather rule applicable only when the 60-40 Filipino-alien
equity ownership is in doubt.
On the basis of the 1989 DOJ Ruling, the SEC issued several opinions doing away
with the grandfather rule. For example, in a May 30, 1990 opinion, the SEC stated:
. . . the Commission En Banc, on the basis of the Opinion of the Department of
Justice No. 18., S. 1989 dated January 19, 9189 voted and decided to do away with
the strict application/computation of the so called grandfather rule. . . and instead
applied the so-called control test method for determining corporate nationality.
(underscoring supplied)(see also SEC Opinion dated August 6, 1991; SEC Opinion
dated October 14, 1991)
Around two years after the issuance of the 1989 DOJ Ruling, Congress enacted the
Foreign Investments Act of 1991 (FIA), which expressly embodied the control test.
Section 3(a) of the FIA (as amended by Republic Act No. 8179) provides:
. . . the term Philippine national shall mean a citizen of the Philippines; or a
domestic partnership or association wholly owned by citizens of the Philippines; or a
corporation organized under the laws of the Philippines of which at least sixty
percent (60%) of the capital stock outstanding and entitled to vote is owned and
held by citizens of the Philippines; or a corporation organized abroad and registered
as doing business in the Philippines under the Corporation Code of which one
hundred percent (100%) of the capital stock outstanding and entitled to vote is
wholly owned by Filipinos or a trustee of funds for pension or other employee
retirement or separation benefits, where the trustee is a Philippine national and at
least sixty percent (60%) of the fund will accrue to the benefit of Philippine

nationals: Provided, That where a corporation and its non-Filipino stockholders own
stocks in a Securities and Exchange Commission (SEC) registered enterprise, at
least sixty percent (60%) of the capital stock outstanding and entitled to vote of
each of both corporations must be owned and held by citizens of the Philippines and
at least sixty percent (60%) of the members of the Board of Directors, in order that
the corporation shall be considered a Philippine national. (underscoring supplied)
Similarly, Section 1(a) of the rules and regulations implementing the FIA expressly
provides for the application of the control test:
Philippine national shall mean a citizen of the Philippines or a domestic partnership
or association wholly owned by the citizens of the Philippines; or a corporation
organized under the laws of the Philippines of which at least sixty percent (60%) of
the capital stock outstanding and entitled to vote is owned and held by citizens of
the Philippines; or a corporation organized abroad and registered as doing business
in the Philippines under the Corporation Code of which 100% of the capital stock
outstanding and entitled to vote is wholly owned by Filipinos or a trustee of funds
for pension or other employee retirement or separation benefits, where the trustee
is a Philippine national and at least sixty percent (60%) of the fund will accrue to the
benefits of the Philippine nationals; Provided, that where a corporation and its nonFilipino stockholders own stocks in Securities and Exchange Commission (SEC)
registered enterprise, at least sixty percent (60%) of the capital stock outstanding
and entitled to vote of each of both corporations must be owned and held by
citizens of the Philippines and at least sixty percent (60%) of the members of the
Board of Directors of each of both corporation must be citizens of the Philippines, in
order that the corporation shall be considered a Philippine national. The control test
shall be applied for this purpose. (underscoring supplied)
While the control test was enshrined in the FIA and its implementing rules, the SEC
continues to apply the grandfather rule when the Filipino equity ownership is in
doubt (as provided in the 1989 DOJ Ruling). For example, in SEC-OGC Opinion No.
22-07 dated December 7, 2007, the SEC stated:
. . . when there is doubt as to the actual extent of Filipino equity in the investee
corporation, the Commission is not precluded from using the Grandfather Rule.
My former professor at the UP College of Law, Prof. Raul Palabrica, makes a great
summary of the SEC position in his Philippine Daily Inquirer column:
. . . this should not be taken to mean that the grandfather rule is already history. In
an inverse way, the SEC pointed out that the grandfather rule will not apply in
cases where the 60-40 Filipino equity ownership is not in doubt.
The rule therefore is: While the control test shall be used as standard to determine
the nationality of corporations, the grandfather rule will be applied if there are
questions about compliance with Filipino ownership requirements. (see Raul
Palabrica, Nationality Ownership Rule, Philippine Daily Inquirer, October 19, 2007)
Based on the FIA and its implementing rules and regulations (which embody the
control test), my personal view is that the control test should be the test used in
determining the nationality of a corporation. While the 1989 DOJ opinion made

reference to the application of the grandfather rule when the 60-40 equity
ownership interest is in doubt, the 1989 DOJ opinion was issued prior to the
enactment of the FIA. Also, I believe that if there is doubt as to the 60-40 Filipinoalien equity ownership interest in the investing corporation that has a 60% equity in
a corporation engaged in a partly nationalized activity, what should be applied is
the Anti-Dummy Law (in conjunction with the control test), not the grandfather rule.
Thus, if 60% of the shares of the investing corporation is held by Filipinos as
dummies for foreigners, that 60% equity in the investing corporation will not be
deemed held by Philippine nationals. Applying the control test, the investee
corporation will not also be a Philippine national.
A return to the grandfather rule?
It is noteworthy that a recent SEC case raises the issue of whether the SEC is now
going back to the grandfather rule as the primary test for determining the
nationality of a corporation. In Redmont Consolidated Mines Corporation vs.
McArthur Mining Corporation, SEC En Banc Case No. 09-09-177 dated March 25,
2010, the SEC applied the grandfather rule because the foreign investor provided
practically all the funds of the Philippine mining companies; as such, the SEC
concluded that the 60-40 Filipino alien equity ownership was in doubt and therefore
the grandfather rule should be applied. However, the SEC did not stop there the
SEC made statements that seem to indicate a return to the grandfather rule. The
SEC said:
The avowed purpose of the Constitution is to place in the hands of Filipinos the
exploitation of our natural resources. Necessarily, therefore, the Rule interpreting
the constitutional provision should not diminish that right through the legal fiction of
corporate ownership and control. But the constitutional provision, as interpreted and
practiced via the 1967 SEC Rules, has favored foreigners contrary to the command
of the Constitution. Hence, the Grandfather Rule must be applied to accurately
determine the actual participation, both direct and indirect, of foreigners in a
corporation engaged in a nationalized activity or business.
Compliance with the constitutional limitation(s) on engaging in nationalized
activities must be determined by ascertaining if 60% of the investing corporations
outstanding capital stock is owned by Filipino citizens, or as interpreted, by
natural or individual Filipino citizens. If such investing corporation is in turn owned
to some extent by another investing corporation, the same process must be
observed. One must not stop until the citizenships of the individual or natural
stockholders of layer after layer of investing corporations have been established,
the very essence of the Grandfather Rule.
Lastly, it was the intent of the framers of the 1987 Constitution to adopt the
Grandfather Rule.
While the constitutional deliberations certainly made reference to the grandfather
rule, there is nothing in the Constitution that ultimately embodied the grandfather
rule. In the absence of any provision in the Constitution embodying the grandfather
rule, I believe that Congress can adopt a law (in this case the FIA) embodying the
control test.

Hopefully, the statements made by the SEC in Redmont do not signal a return to the
grandfather rule. A change in the rules of the game will have a tremendous adverse
impact on investor confidence in the Philippines.
One final note. Redmont involved mining companies that require 60% Filipino
ownership because these mining companies apparently applied for a Mineral
Production Sharing Agreement (which can be granted to Philippine nationals only).
In Redmont, the SEC appears to have reached the conclusion that the 60-40
Filipino-alien equity ownership was in doubt because the foreign investor provided
practically all the funds of the Philippine mining companies. My own view is that
the fact that the foreign investor may have contributed a big chunk of the corporate
funds should not, by itself, put the 60-40 Filipino-alien equity ownership in doubt.
The important consideration is whether the Filipino stockholders legally and
beneficially own and control 60% of the shares in the relevant company (and do not
otherwise act as dummies for the foreigners). If the foreigner wishes to provide
greater financial support for the mining project, that should be fine for as long as
Filipinos remain the legal and beneficial owner of 60% of the shares in the mining
company (or in a layered structure, the investing company). We should not deprive
Filipinos of the ability to enter into contracts with foreigners whereby foreigners
provide greater funding to projects that remain under Filipino control.