BIR Ruling

April 28, 1966 The Corporate Management Associates Suite C. No. 6 Espaa Extension Quezon City Attention: Mr . Luis G . U . Uranza, Jr . Managing Principal Gentlemen : This refers to your letter dated February 12, 1996 requesting a ruling on the question of whether or not the contemplated transfer of merchandise inventories, real estate holdings and corporate securities at fair market value, of certain individual proprietorship businesses in exchange for corporate shares of stock shall constitute a tax-free exchange within the purview of section 35(c) of the Tax Code, as amended by R.A. No. 4522. llcd Briefly, the facts as presented by you, are as follows: Mr. and Mrs. AB, Mr. and Mrs. CB, Mr. BB, Mr. PCS, Mr. PCJ, and Miss ED are in their individual capacities engaged in separate businesses. Said individuals now desire to incorporate their business. For this purpose, they organized ABC corporation with an authorized capitalization of P5,000,000.00. Their respective subscriptions therein, and the amount paid by each, are as follows: Parties Subscription Paid-In Portion Mr. AB P600,000.00 P150,000.00 Mrs. AB 200,000.00 50,000.00 Mr. BB 70,000.00 20,000.00 Mrs. CB 35,000.00 7,000.00 Miss ED 15,000.00 3,000.00 Mr. PCS 30,000.00 8,000.00 Mr. PCJ 15,000.00 5,000.00 P1,000,000.00 P250,000.00 The initial subscriptions were paid in cash to facilitate the registration of the corporation with the Securities and Exchange Commission. The individuals will then transfer to the corporation merchandise at not book value and real properties and securities (some of which are encumbered) at fair market value minus encumbrances for shares of stock of the corporation, with the latter assuming liability for the encumbrance. You now ask the following questions: "1. Would the foregoing set of facts fall within the purview of the conditions prescribed by R.A. 4522 for a tax-free exchange? "2. Would any gain or loss be organized on the portion corresponding to the obligation to be assumed by the corporation, assuming that the facts fall within the purview of R. A. 4522 and a tax-free exchange is permissible?" In reply, I have the honor to inform you that the specific provision of law which will resolved your first query is subsection (c) paragraph (2) of Section 35 of the National Internal Revenue Code, as amended by Republic Act No. 4522 which reads thus "(2) Exceptions: . . . No gain or loss shall also be recognized if a person exchanges his property for stock in a corporation of which as result of such exchange said person, alone or together with others, not exceeding 4 persons, gain control of said corporation provided, that stocks issued for services shall not be considered as issued in return for property." It appearing that under the contemplated incorporation not more than five persons will gain control of the corporation, the transfers by the incorporators of merchandise, real property or securities in exchange for stocks in said corporation come within the purview of law and therefore, no gain or loss shall be recognized as a result thereof. cdpr As regards your second query, the applicable provision of law is subsection (c) paragraph (3)(c) of the abovementioned section of the Tax Code, which provides that "(3)(c) If the taxpayer, in connection with the exchanges described in the foregoing exception, receives stock or securities which would be permitted to be received without the recognition of the gain if it were the sole consideration, and as a part of the consideration, another party to the exchange assumes a liability of the taxpayer, or acquires from the taxpayer property subject to a liability, then such assumption or acquisition shall not be treated as money and/or other property, and shall not prevent the exchange from being within the exception." It is clear from the aforequoted provision of law that the assumption by the corporation of the liability of the transferor for the encumbrance on the property so exchanged will not prevent the exchange from being within the exception. No gain or loss will, therefore, be recognized with respect to the portion corresponding to the obligation to be assumed by the corporation. In this connection, please be further informed that parties to the exchange hereinabove described should comply with the following requirements: 1. A separate deed of assignment or deed of exchange should be executed by each individual exchanging property or asset for shares of stock in a corporation, and said instrument should disclose; (a) the original cost basis or the acquisition cost of every item of property or asset exchanged for stock; (b) the number and par value of the shares of received in consideration for the transfer of every item of property or asset to the corporation; and (c) the amount of the liability assumed by the corporation on account of the transfer of encumbered property; cdta 2. Within ten days after the consummation of the exchange, the parties thereto shall furnish the Bureau of Internal Revenue with a copy of the deed of assignment or deed of exchange. 3. The exchange should be duly recorded in the books of the corporation, which should show the details mentioned in Item No. 1. Such entry or entries should be carried in the books of the corporation from year to year until the individual party to the exchange shall have sold or disposed of the shares of stock received by him in exchange for the asset or property transferred to the corporation. 4. The corporation shall notify the Bureau of Internal Revenue of every sale or transfer of any share or shares of stock involved in every exchange within ten days from the date said sale or transfer is consummated. cdt Very truly yours, (SGD.) MISAEL P. VERA Commissioner of Internal Revenue