BIR Ruling

November 16, 1970 Messrs. Carlos J. Valdes & Co. Certified Public Accountants 1130 Perez St., Paco, Manila Gentlemen : This refers to your letter dated July 29, 1970 requesting information as to whether or not a corporation and its stockholder would be subject to income tax as a consequence of a certain transaction they will enter into, and that you would also like to know the basis of the computation as to their respective liability, if any. cdt It is represented that a stockholder in a real estate company wishes to withdraw his investment due to difference of opinion in company policies; that it is contemplated that the corporation would buy said shares of stock as treasury shares because of the inability of the other stockholders of the corporation to buy the holdings of the withdrawing stockholder; and that in view of the non-availability of cash sources for this purpose, the corporation will buy said shares of stock (thereby making it treasury shares) using one of its real estate properties for payment. In reply thereto, I have the honor to inform you that the foregoing transaction between the stockholder and the corporation is an exchange transaction because the former is disposing of his shares of stock in exchange for real properties of the latter. The property received in exchange is essentially different from the property disposed of. (Sec. 140, Revenue Regulations No. 2). However, on the part of the corporation this involves stock redemption. Mertens, in his book FEDERAL LAW OF INCOME TAXATION, Chap. 38 Page 97, vol. 7, dealt on this subject, viz: "It was said that the prevailing and better considered view was that any dealings by a corporation in its own stock constituted a capital transaction. Such a dealing amounted only to a change in the capital of the corporation. A corporation's own shares were not assets but only the convenient machinery for evidencing stockholder's interest, and therefore it was a fallacy to say that it had received or lost anything by such exchange. Furthermore, it was said that were a corporation purchased all of its shares in exchange for its assets (i.e., a liquidation), no gain or loss would be recognized. Logic would dictate that a partial exchange of assets for stock should be governed by the same rule. (L.A. Stock Exchange Bldg., TC Memo Op Dkt 2899 (1946) xxx xxx xxx "The Tax Court has construed the Regulation as meaning that when a corporation purchases its own shares, not as an investment or for the purpose of resale, at a profit, but for some other corporate purpose, such as for sale to its officers and employees under an incentive or profit sharing plan, or for adjusting the respective holdings of different officers or directors, and later the stock is sold either to carry out or to further some other corporate purpose, such as to provide necessary capital for an expansion or replacement program, in which the element of profit on the resale is incidental, the corporation has not dealt in its own shares as it might in the shares of another corporation, and the resulting gain is not taxable. Mertens' Federal Law of Income Taxation, Chap. 38, Page 101, Vol. 7). cd Such being the case, the corporation is not subject to income tax because the above-mentioned transaction involves stock redemption, and that no gain is derived by the corporation by mere stock redemption. On the part of the stockholder, the gain that he will derive from the transaction is subject to income tax pursuant to Section 35(c)(1) of the Tax Code it being not one of the exceptions provided in Section 35(c)(2). For ready reference, these provisions are quoted as follows: "(c) Exchange of property "(1) General rule . Except as herein provided, upon the sale or exchange of property, the entire amount of the gain or loss, as the case may be, shall be recognized. "(2) Exceptions . No gain or loss shall be recognized if in the pursuance of a plan of merger or consolidation (a) a corporation which is a party to a merger or consolidation, exchanges property solely for stock in a corporation which is a party to the merger or consolidation, (b) a shareholder exchanges stock in a corporation which is a party to the merger or consolidation solely for the stock of another corporation, also a party to the merger or consolidation, or (c) a security holder of a corporation which is a party to the merger or consolidation exchanges his securities in such corporation solely for stock or securities in another corporation, a party to the merger or consolidation." xxx xxx xxx For income tax purposes, the income derived shall be determined in accordance with Section 141 of Regulations No. 2 which provides: "SEC. 141. Determination of gain or loss from the exchange of property . The amount of income derived or loss sustained from an exchange of property is the difference between the market value at the time of the exchange of the property received in exchange and the original cost, or other basis, of the property exchanged. If the property exchanged was acquired prior to March 1, 1913, see sections 136 and 137 of these regulations." Under the above-quoted provision of the regulation, the income realized by the stockholder, for income tax purposes, is the difference between the market value of the real properties and the acquisition value of the shares of stock. (See BIR Ruling dated Jan. 5, 1955; Qtrly. Bull., BIR, Vol. IV, No. 1, cited in Araas' Annotations and Jurisprudence on the National Internal Revenue Code, as amended, p. 322, Vol. 1, 1963 Ed.) Very truly yours, MISAEL P. VERA Commissioner of Internal Revenue