Kareen S.

Moncada
LLB

Atty. Reyes
Investment Law/Sunday/1:00-3:00 PM

Control Test vs. Grandfather Rule: The true test in determining Philippine Nationality of a
Corporation

In its opinion dated January 19, 1989, the Department of Justice in applying the control
test in determining the nationality of a corporation explained that shares belonging to
corporations or partnership at least 60% of the capital which is owned by Filipinos shall
be considered Philippine National. Upon showing that 60% is Filipino-owned, no further
inquiry shall be made on the nationality of the remaining 40%. Such test is the standard
for determining the nationality of corporations.
On the other hand, the Grandfather rule applies when there are issues about conforming
with the 60-40 requirement. Under this rule, if Filipino citizens own 60% and foreigners
own 40%, then its a straightforward 60-40 venture. Thus as an example given, when the
60-40 corporation invests in another company that is also covered by the 60-40
ownership rule, the foreign component in the cascade company is aggregated.
According to the January 2015 Resolution of the Supreme Court in the case of Narra
Nickel Mining and Development Corp. vs. Redmont Consolidated Mines Corp. (G.R.
No. 195580), the Grandfather test was originally intended to look into the citizenship of
the individuals who ultimately own and control the shares of stock of a corporation for
purposes of determining compliance with the constitutional requirement of Filipino
ownership.
The shareholdings should ideally be traced (i.e. grandfathered) to the point where natural
persons hold the shares. However, this may be impractical and a limit must be set when
tracing through the corporate layers to attribute nationality. Citing a memorandum from
the Securities and Exchange Commission (SEC), the Supreme Court noted the
suggestion of the SEC to apply the Grandfather Rule on two levels of corporate relations
for publicly-held corporations or where shares are traded in the stock exchange, and to
three levels for closely held ones or those which are not traded in any stock exchange.
Clearly, the limits should not go beyond the level of what is reasonable.
The Supreme Court clarified the role of these tests in determining compliance with the
required Filipino equity threshold. The Court explained that the use of the Grandfather

Rule is a supplement to the Control Test in implementing the wisdom of the

Filipinization provisions of the Constitution.
The Supreme Court recognized the intention of the framers of the Constitution to apply
the Grandfather Rule in cases where there is corporate layering. It likewise noted that
corporate layering, while admittedly allowed by the Foreign Investment Act, becomes
illegal if used to circumvent the Constitution and other applicable laws.
The Court further discussed that the Grandfather Rule applies only when the 60-40
Filipino-foreign ownership is in doubt or where there is reason to believe that there is
non-compliance with the provisions of the Constitution on the nationality restriction.
How then we do we determine the existence of doubt? In its Resolution, the high court
clarified that doubt does not automatically mean the mere failure of the Filipino
ownership to meet the 60% threshold of the corporations equity. Doubt refers to
various indicia that the beneficial ownership and control of the corporation do not in
fact reside in Filipino shareholders but in foreign stakeholders.
To demonstrate these signs of doubt, the Court referred to the indicators of a dummy
status as identified in a Department of Justice Opinion on the Anti-Dummy Law. These
would be where the foreign investors provide practically all the funds and technological
support for a joint venture undertaken with their Filipino partners, and where such
foreign investors get to manage the company even while being minority stockholders.
In the Narra Nickel Mining case, the Supreme Court found that while the petitioning
corporations complied with the Control Test, factual circumstances nonetheless raise
doubt as to their true nationality and therefore requires the application of the
Grandfather Rule. Some of the indicators of doubt found by the Court in the said case
are the following: (1) the three mining corporations had the same 100% Canadian owned
foreign investor, (2) the similar corporate structure and shareholder composition of the
three corporations, (3) a major Filipino shareholder within the corporate layering did not
pay any amount with respect to its subscription, and (4) the dubious act of the foreign
investor in conveying its interests in the mining corporations to another domestic
corporation, among others. These instances demonstrate that corporate layering was
utilized to allow a foreign corporation to gain control of these mining corporations in the
Philippines.
After applying the Grandfather Rule, the Supreme Court was able to trace and conclude
that the Filipino shareholders did not actually have the required amount of control and
beneficial ownership in the mining companies, and consequently failed to comply with
the nationality requirement under the Constitution.

In a fitting ending, the Supreme Court enunciated its original April 2014 decision that
the Control Test is still the prevailing mode of determining whether or not a corporation
is a Filipino corporation. It is only in case of doubt, based on the attendant facts and
circumstances of the case, that the Grandfather Rule is applied.