Authorizing Heads of Agencies to Revise Rates of Fees and Charges

February 5, 1980 BIR RULING NO. 015-80 Selarce Farms, Inc. Novaprima Drive, Barrio San Agustin Novaliches, Quezon City Attention: Mr . Mauro C . Arce, Sr . President and General Manager Gentlemen : This refers to your letter dated June 26, 1978 requesting a ruling as to the consequence of the transaction described as follows: F A C T S "A single proprietorship under the name of Mauro C. Arce, Sr. married to Priscilla S. Arce has a total assets of P2,590,261.56 as well as a total liabilities of P863,061.56; that the said assets and liabilities will be transferred by the couple to Selarce Farms, Inc. in exchange for 17,272 shares of stock of the latter; that Selarce Farms, Inc. was incorporated on July 8, 1977 with an authorized capital stock of Five hundred Thousand (P500,000.00) dividend into Five Thousand shares with a par value of P100.00 each; and that the said capital stock has been increased to P2,000,000.00 divided into 20,000 shares with a par value of P100.00 each. cdt The capital stock of the corporation which have been actually subscribed and the amount paid on their subscription: Name Amount Subscribed Amount Paid on Subscription Mauro C. Arce P230,000.00 P52,750.00 Priscilla S. Arce 80,000.00 22,500.00 Faustito S. Arce 29,000.00 9,000.00 Eloisa Arce Romero 6,500.00 1,500.00 Mauro S. Arce, Jr. 22,000.00 6,750.00 Rodolfo S. Arce 6,500.00 1,500.00 Maurita Arce Kuhn 6,500.00 1,500.00 Cynthia S. Arce 6,500.00 1,500.0 Armida Arce Jimenez 6,500.00 1,500.00 Edmund S. Arce 6,500.00 1,500.00 P400,000.00 100,000.00 ======== ======= that the transferee corporation will assume the liability of the transferor in the amount of P863,061.56; and that after the exchange the transferor will gain control of the transferee corporation by owning 95% of the capital stock of the latter." Q U E S T I O N S "1. What are the tax consequences of the aforementioned exchange? Is the transaction subject to capital gains tax? "2. Is the aforementioned transaction subject to the stock transaction tax?" In reply thereto, I have the honor to inform you that pursuant to Section 35 paragraph (c)(2)(c) of the Tax Code as amended by R.A. No. 4522, no gain or loss shall be recognized if a person exchanges his property for stock in a corporation of which as a result of such exchange said person alone or together with others, not exceeding four persons, gains control of said corporation. The term "control" shall mean ownership of stocks in a corporation possessing at least fifty-one (51%) percent of the total voting power of all classes of stocks entitled to vote. Accordingly, no gain or loss shall be recognized on the transfer of the assets and liabilities of the single proprietorship in exchange for the shares of stock of the aforementioned corporation, it appearing that after the exchange Mr. Mauro C. Arce, Sr. and his wife will gain control of the corporation by owning 95% of the total voting power of all classes of stocks entitled to vote. It should be emphasized, however, that Section 35(c)(2)(c) of the Tax Code merely defers recognition of gain or loss from such transaction, for in determining the gain or loss from a subsequent transaction of the properties or of the stocks involved in the exchange, the original or historical cost of the properties or the stocks is considered. Thus, if the transferors later sell or exchange the shares of stock acquired by them in the exchange, they shall be subject to income tax on the gains derived from such sale or exchange, taking into consideration that the cost basis of the shares of stock shall be the same as the original acquisition cost or adjusted cost basis to the transferors of the properties exchanged therefor; and that the cost basis to the transferee of the properties exchanged for stocks shall be the same as it would be in the hands of the transferors. (Section 35(c)(4) of the Tax Code) If pursuant to the exchange transaction, and as part of the consideration, the transferee corporation assumes the liability of the transferors or acquires from the transferors property subject to a liability, such assumed liability or liabilities shall not be treated as money and/or other property, and shall not prevent the exchange from being tax-free. (See Sec. 35(c)(3)(c), N.I.R.C.) No gain or loss will be recognized on the obligation assumed by the transferee corporation. The cost basis or value of the stocks received by the transferor of property subject to a liability where the liability transferred and assumed by transferee corporation does not exceed the transferor's basis or the original and/or acquisition cost of the property transferred, shall be the difference between the liability or liabilities assumed by the transferee corporation and the acquisition or original cost of the property transferred. On the other hand, where the total liabilities to be assumed by the transferee corporation exceed the original or acquisition cost of the property transferred, the excess shall be recognized as gain to the transferor and the value or cost basis of the stocks to the transferor shall be the difference between the original cost of the property transferred subject to a liability (plus the gain recognized to the transferor) and the liability or liabilities assumed by the transferee corporation (see Sec. 35(c)(4)(a) and (b), N.I.R.C.). However, as the value of the properties exchanged for shares of stock is in excess of the value of the latter, the said excess is considered a donation, pursuant to Section 122 of the Tax Code which provides that "Where property is transferred or less than an adequate and full consideration on money or money's worth, then the amount by which the value of the property exceeded the value of the consideration shall, for the purpose of the tax imposed by this Chapter, be deemed a gift . . . ." Accordingly, the transferors of the properties herein abovementioned shall be subject to the donor's tax imposed by Section 121 of the Tax Code. The transferee corporation is not subject to the stock transaction tax imposed by Republic Act No. 6141, as amended, the stocks involved in the transaction being original issues. In this connection, you are further advised that in order that the parties to the exchange can avail of the non-recognition of gains provided for in Section 35(c)(2)(c) of the Tax Code as amended, they should comply with the requirements hereunder mentioned. (a) The transferors must file with their income tax return for the taxable year in which the exchange was consummated a complete statement of all facts pertinent to the exchange, including: (1) A description of the property transferred, or of their interest in such property, together with a statement of the original acquisition cost or other basis thereof and the adjusted cost basis at the time of the transfer; (2) The kind of stock received and preference, if any; (3) The number of shares of each class received; and (4) The fair market value per share of each class at the date of the exchange. (b) On the other hand, the transferee corporation must file with its income tax return for the taxable year in which the exchange was consummated the following: (1) A complete description of the property received from the transferors; (2) A statement of the original acquisition cost or other basis thereof in the hands of the transferors and the adjusted costs basis at the time of the transfer; (3) Information with respect to the capitals stock of the corporation, including: (a) The total issued and outstanding capital stock immediately prior to and immediately after the exchange, with a complete description of each class of stock; (b) The classes of stock and number of shares issued to the transferors in the exchange; (c) The fair market value of the capital stock as of the date of exchange which was issued to the transferors. In addition to the foregoing requirements, permanent records in substantial form must be kept by the taxpayer participating in the exchange showing the information listed above in order to facilitate the determination of gain or loss from a subsequent disposition of stocks received in the exchange. cdta Very truly yours, RUBEN B. ANCHETA Acting Commissioner