BIR Ruling

February 28, 1967 Messrs. Sycip, Gorres, Velayo & Co. Certified Public Accountants 6760 Ayala Avenue Makati, Rizal Attention: Mr . B . V . Abela Tax Department Gentlemen : This refers to your letter, dated January 3, 1967, on behalf of your client, International Construction Corporation, seeking the advice of this Office on the tax consequences of a proposed transaction between the corporation and one of its stockholders, under which the latter will contribute a parcel of land to the corporation solely in exchange for shares of stock of the corporation, the present stock ownership of which is represented as follows: cdtech Percentage Stockholder of Ownership A 29% B 41% C 15% D 7.5% E 7.5% 100% It is also represented that Stockholders, B C and E are the children of Stockholder A; that Stockholder D is the spouse of Stockholder E; that the parcel of land proposed to be contributed by Stockholder A to the corporation has a cost basis of P500,000 and an appraised value of P3,000,000; that the corporation desires to embark on new business ventures and needs a larger capital base to obtain financing from lending institutions; that it is a condition set by financial institutions on the loan application of the corporation that it should increase its paid-up capital stock by at least P3,000,000; and, that since Stockholder A owns a parcel of land with an appraised value equal to the required capital increase, he proposes to contribute the said property at appraised value solely in exchange for shares of stock of the corporation. cdt You expressed the view that the foregoing transaction may be consummated without income or fit tax consequences to Stockholder A, to the corporation and to the other stockholders of the corporation. In support of this view, you advance the following reasons: 1. That under existing rulings of this Office, the incorporation by an individual taxpayer of his business and other properties solely in exchange for stock of the new company to be formed can be accomplished on a tax-free basis; 2. That under Republic Act 4522, the foregoing transaction can be accomplished on a tax-free basis because this law provides that "no gain or loss shall be recognized if a person exchange 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"; 3. That the legislative policy of encouraging the incorporation of business enterprises, as expressed in Republic Act 4522, has been consistently implemented by this Office, so that the proposed transaction outline above should come within the letter and spirit of the law and the existing policy of this Office; 4. That the above transaction constitutes nothing more than "a mere transfer from one pocket of the taxpayer to the other" since it is evident that there is a "continuity of interest" in the transferee corporation and there are sound business reasons supporting the transaction, without any intent at all to evade the payment of taxes, and that if upon the original incorporation of a business this Office has allowed a tax-free treatment on the transfer of the assets to the new company solely in exchange for stock, there is no reason why the same treatment should not be accorded to additional transfers of property by the stockholders to the same company after it has been organized; 5. That the net effect of the proposed transaction is merely to postpone the payment of income tax, since the cost basis to the corporation, for tax purposes, of the property to be transferred will still be the original cost basis of said property in the hands of Stockholder A, the transferor, and that, similarly, the tax basis in the hands of Stockholder A of the shares of stock issued by the corporation in exchange for the parcel of land to be conveyed will continue to be the original cost basis of the latter property, so that gain or loss will be recognized only upon a subsequent disposition of the parcel of land or of the shares of stock, as the case may be, on the part of the party disposing of whichever property; and 6. That no gift tax should be imposed on the transaction inasmuch as full and adequate consideration will be received by the transferor and the transferee corporation from the transaction and that there will also be no tax consequence to the other stockholders of the corporation arising from the contemplated transaction. cdll In reply, I have the honor to inform you as follows: Considering the express provision of Republic Act No. 4522 providing that "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 the said corporation", and that the proposed transfer would result in the control of the corporation by transferor stockholder and in the light of American decisions interpreting a similar provision of the Federal Internal Revenue Code of 1954 granting a tax-free treatment to transfers made by a stockholder in exchange for stocks of a corporation (Cf Section 351 of the Federal Internal Revenue Code of 1954; Ralph E. Cotter, par. 61, 202, P-H Memo TC, Vol. 30, and Stephen J. Maczmarek, par. 62, 131 P-H Memo TC Vol. 31), the proposed transaction can be accomplished on a tax-free basis. If, as represented, the transfer value of the property actually represents the true and actual fair market value, then no gift can be recognized in the exchange. llcd In connection with the exchange herein involved, Stockholder A must file with his 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 his interest in such property, together with a statement of the cost or other basis thereof, adjusted to the date of transfer; (2) The kind of stock received and preference, if any; (3) The number of shares of each class received; (4) The fair market value per share of each class at the date of the exchange; (5) If securities of the corporation are received, the principal amount and terms and the fair market value at the date of exchange; (6) The amount of money receive, if any; and (7) If other property is received (a) a complete description of each separate item, and (b) the fair market value of each separate item at the date of exchange On the other hand, the transferee corporation must file with its income tax return for the taxable year in which the exchange was consummated (1) A complete description of all property received from the transferors; (2) A statement of the cost or other basis thereof in the hands of the transferors adjusted to the date of transfer; (3) Information with respect to the capital 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 each transferor in the exchange and the number of shares of each class of stock owned by each transferor immediately prior to and immediately after the exchange; and (c) the fair market value of the capital stock as of the date of exchange which was issued to each transferor; (4) If securities are issued by the corporation, information on (a) the principal amount and terms of all securities outstanding immediately prior to and immediately after the exchange; aisadc (b) the principal amount and terms of securities issued to each transferor in the exchange with a statement showing each transferor's holdings of securities of the corporation immediately prior to and immediately after the exchange; (c) the fair market value of the securities issued to the transferors on the date of the exchange; and (d) a statement as to whether the securities issued in the exchange are subordinated in any way to other claims against the corporation; (5) The amount of money; if any, which passed to each of the transferors in connection with the transaction; and (6) If other property passed to each transferor (a) a complete description of each separate item; and (b) the fair market value of each separate item at the date of exchange In addition to the foregoing requirements, permanent records in substantial form must be kept by every 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 stock or securities and other property, if any, received in the exchange. LibLex Very truly yours, (SGD.) MISAEL P. VERA Commissioner of Internal Revenue