BIR Ruling

August 25, 1968 Attorney Jose C. Vitug 2nd Floor, Ledesma Building Sta. Lucia Street, Intramuros, Manila S i r : This refers to your letter dated May 3, 1968 requesting legal opinion on queries stated as follows: "Two brothers, Justice Jose B. L. Reyes and Dr. Edmundo Reyes, who are joint-owners pro-indiviso of a parcel of inherited land, propose to dispose off the said land, and several types or manner of disposal are under consideration. " Query No . 1 . Suppose the two brothers sell one-half, pro-indiviso, of the said parcel of land to a buyer or group of buyers and transfer the remaining half to a corporation in exchange for shares of stock of the latter, and in both instances the price of the sale and the transfer value to the corporation are higher than the original cost of acquisition (which is the value when inherited), would the excess of the selling price and the transfer value to the corporation over and above the cost of acquisition or value of the property when inherited, be subject to income tax on the part of the two brothers, particularly considering Sec. 35 of the Tax Code as amended by R.A. No. 4522? " Query No . 2 . If so, would each brother be subject to income tax only on his separate half share of the profit? " Query No . 3 . Assuming that some of the occupants on the land are paying nominal amounts to the two brothers as rent, would the profit resulting from the two transactions adverted to in query no. 1 be subject to income tax as ordinary gain, or capital gain? " Query No . 4 . If, instead of selling one-half of the land to a group of buyers, the two brothers transfer the whole parcel to a corporation in exchange for shares of stock of the latter, and assuming that upon such transfer the two brothers would then own the controlling stock (at least 51%) of the corporation, would the two brothers be exempt from income tax on the excess of the transfer value over and above the original cost of acquisition or value of the property at the time it was inherited? " Query No . 5 . If the answer to Query No. 4 is in the affirmative, would the same rule apply irrespective of whether the corporation is a pre-existing corporation or one that is just organized (incorporated for the purpose of developing the land) with the transfer of the said parcel of land as original contribution to the capital stock on the part of the two brothers as incorporators? " Query No . 6 . Suppose the two brothers acquire only 50% of the capital stock of the corporation as a result of such transfer of the land, would the profit realized from such transfer be taxable income on the part of the two brothers?" In reply, I have the honor to inform you as follows: Anent query No. 1, the gain, consisting of the difference between the original acquisition value (which is the value when inherited) and the selling price, realized by your clients from the sale of of the parcel of land jointly owned by them is taxable pursuant to Section 35(c)(1) of the Tax Code. The question of whether or not the excess of the transfer value over and above the cost of acquisition of the property transferred in exchange for shares of the corporation is exempt from income tax under Section 35(2)(c) of the Tax Code, as amended by Republic Act No. 4522, will depend on whether or not the conditions called for by the Act are net and satisfied. As regard query No. 2, assuming that your clients are taxable in both of the transactions adverted to in query No. 1, each of them is subject to income tax only with respect to his separate share of the profit. Anent query No. 3, the land referred to in your query, being used in a business by your clients, is considered an ordinary asset; hence, any gain derived from the sale thereof is ordinary gain and taxable in full. Coming to the fourth query, the transfer of the parcel of land to a corporation in exchange for at least 51% of its shares of stock may qualify as a tax-free exchange under the provisions of Republic Act No. 4522, provided, however, that the following rules incident to the incorporation are duly complied with: "The transferor 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 original acquisition cost or other basis thereof and the adjusted cost basis at the time 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; "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 transferor; "(2) A statement of the original acquisition cost or other basis thereof in the hands of the transferor and the adjusted cost basis at the time 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 complete description of each class of stock; "(b) the classes of stock and number of shares issued to the transferor in the exchange; "(c) the fair market value of the capital stock as of the date of exchange which was issued to the transferor;" 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 stock received in the exchange. The aforementioned rule regarding tax-free exchange of asset and shares of stock is applicable whether the corporation issuing or exchanging its stock for property is a pre-existing corporation or a corporation organized for the purpose of receiving such property. Finally, Section 35(c)(2) of the Tax Code; as amended by Republic Act No. 4522, provides for the non-recognition of gain or loss upon the transfer by a person of his property to a corporation in exchange for its shares of stock, as a result of which the transferor, alone or together with others, not exceeding four persons, gains control of said corporation; provided, that stocks issued for services shall not be considered as issued in return for property. As defined, the term control means ownership of stocks in a corporation possessing at least fifty-one per cent (51%) of the total voting power of all classes of stocks entitled to vote. Accordingly, if as a result of the transfer of the parcel of land to the corporation your clients acquire only 50% of the capital stock of said corporation, the profit realized from such transfer is subject to income tax. cdta Very truly yours, (SGD.) MISAEL P. VERA Commissioner of Internal Revenue