BIR Ruling [DA-011-02]

January 29, 2002 BIR RULING [DA-011-02] S40 (C) (2); S-40-051-2001; 143-95 Atty . Francisco B. Gonzales V, C . P . A . 429-D Shaw Blvd., Mandaluyong City Metro Manila S i r : This refers to your letter dated December 20, 1999 stating that Chua Tee Company, Inc . (CTCI) is a domestic corporation incorporated on December 29, 1954 and operating under the name of Oriental Tin Can Mfg. Company; that it has an authorized capital stock of Fifty Million Pesos (P50,000,000.00), divided into One Hundred Thousand (100,000) shares with a par value of Five Hundred Pesos (P500.00) each; that the stockholders of record of CTCI, with their corresponding shares subscribed and percentage of ownership, are as follows: Name No. of Shares Subscribed % of Ownership Armando L. Chua 21,559 21.559% Rosa S. Chua 13,274 13.274% Armando S. Chua II 1 .001% Marie Bernadette Chua 1 .001% Ramon L. Chua 21,559 21.559% Fely N. Chua 13,274 13.274% Tomas L. Chua 1 .001% Conchita N. Chua 1 .001% Betty N. Ong 1 .001% Norberto Sia 1 .001% GEMECO 30,328 30.328% Total 100,000 100.000% ====== ======= that on the other hand, General Metal Container Corporation of the Philippines (GEMECO) is a domestic corporation registered with the Securities and Exchange Commission under SEC Reg. No. 56379 on June 11, 1974 having an authorized capital stock, under its amended Articles of Incorporations dated June 2, 1997, of Fifty Million Pesos (P50,000,000.00), divided into Five Hundred Thousand (500,000) shares with a par value of One Hundred Pesos (P100.00) per share; that its stockholders of record, with its corresponding shares subscribed and percentage of ownership, are as follows: Name No. of Shares Subscribed % of Ownership Ramon L. Chua 44,150 15.11831% Fely N. Chua 5,750 1.96898% Betty N. Ong 100 0.03424% Armando Chua 44,150 15.11831% Rosa Chua 5,750 1.96898% Armando S. Chua II 100 0.03424% CTCI 192,030 65.75694% Total 292,030 100.00000% ======= ========= that both corporations are engaged in the same line of business; that, due to the internal dispute between the two sets of shareholders of both corporations, which has begun to compete with each other, series or simultaneous transfer or exchange transactions were contemplated in order to simplify and consolidate the ownership of both corporations and to prevent the squabbles of its stockholders; that to achieve the said purpose, a number of shareholders of CTCI transferred and exchanged their shares of stock in CTCI for shares of GEMECO, being currently held by the other group of stockholders, in order to acquire ownership and control over GEMECO; that on the other hand, a group of shareholders of GEMECO transferred and exchanged the shares they held in GEMECO for shares of stock in CTCI also in order to acquire ownership and control over the latter; that the exchange of the shares of stock were effected through the execution of several Deeds of Exchange transferring the shares of a particular shareholder to another shareholder belonging to the opposing group, as follows: 1. Deed of Exchange executed on December 27, 4999, whereby Ramon L. Chua transferred his 29,130 GEMECO shares with a par value of P100.00 per share in exchange for the 10,470 CTCI shares of Armando L. Chua, with a par value of P500.00; 2. Deed of Exchange executed on December 27, 1999, whereby Rosa S. Chua transferred her 4,356 CTCI shares with a par value of P500.00 per share in exchange for the 2,000 GEMECO shares of Fely N. Chua, with a par value of P100.00; 3. Deed of Exchange executed on December 27, 1999, whereby GEMECO transferred its 6,623 CTCI shares with a par value of P500.00 per share in exchange for the 3,750 GEMECO shares of Fely N. Chua, with a par value of P100.00; 4. Deed of Exchange executed on December 27, 1999, whereby Rosa S. Chua transferred her 8,918 CTCI shares with a par value of P500.00 per share in exchange for the 67,515 GEMECO shares of CTCI, with a Par value of P100.00; 5. Deed of Exchange executed on December 27, 1999, whereby GEMECO transferred its 13,891 CTCI shares with a par value of P500.00 per share in exchange for the 15,020 GEMECO shares of Ramon L. Chua, with a par value of P100.00; 6. Deed of Exchange executed on December 27, 1999, whereby Armando L. Chua transferred his 11,089 CTCI shares with a par value of P500.00 per share in exchange for the 71,515 GEMECO shares of CTCI, with a par value of P100.00; and 7. Deed of Exchange executed on December 27, 1999, whereby GEMECO transferred its 9,814 CTCI shares with a par value of P500.00 per share in exchange for the 53,000 GEMECO shares of CTCI, with a par value of P100.00. that the effect of the transfer of the shares of stock between the shareholders of GEMECO and CTCI shall cause the ownership and control of CTCI to be held on by the following shareholders as follows: Name No. of Shares % of Ownership 1. Ramon L. Chua 45,920 45.920% 2. Fely N. Chua 24,253 24.253% 3. Tomas L. Chua 1 .001% 4. Conchita L. Chua 1 .001% 5. Ivee Lyn Chua 1 .001% 6. Cindy Caroline Chua 1 .001% 7. Felimon Dexter Chua 1 .001% 8. Betty N. Ong 1 .001% 9. CTCI 29,821 29.821% Total 100,000 100.000% ======= ======== that GEMECO on the other hand, will have the following shareholders after the exchange, to wit: Name No. of Shares % of Ownership 1. Armando L. Chua 144,795 49.5822% 2. Rosa S. Chua 75,265 25.7730% 3. Armando S. Chua II 200 0.0685% 4. GEMECO 71,770 24.5762% Total 292,030 100.0000% ======= ======== that as a result of the simultaneous transfer of shares of stock, the joint ownership of both groups of shareholder of the two distinct corporations was ended and the two opposing groups of shareholders gained control over their respective corporation; that after the shareholders shall have surrendered the certificates of stock acquired by them in the exchange, their corresponding corporation will issue new certificates of stock in their respective names; that the respective shares of stock reacquired by CTCI and GEMECO shall become treasury shares; that the CTCI shares owned by Armando S. Chua II, Maria Bernadette Chua and Norberto Sia were sold to Ivee Lyn Chua, Cindy Caroline Chua and Felimon Dexter Chua, while the GEMECO shares owned by Betty N. Ong were sold to Armando S. Chua II; and that the capital gains tax on said transactions were already paid. Based on the foregoing, you are requesting in effect, on behalf of your client, for a ruling on the following issues: 1. Whether the above transactions would qualify as a tax-free exchange pursuant to Section 40 (C)(2) of the Tax Code of 1997; and 2. Whether the excess of the amount or value of the shares of stock exchanged is subject to the donor's tax imposed under Section 100 of the Tax Code of 1997. Furthermore, in a supplemental letter dated May 12, 2000, you are requesting that your clients be allowed to pay the capital gains taxes due on the above-mentioned transactions without surcharges, penalties and interest, in view of the fact that the delay in the payment of the capital gains taxes was brought about by your request for a ruling; that pending your request for ruling, you have filed a capital gains tax return informing the Bureau of Internal Revenue of such request and has paid the corresponding documentary stamp tax due on every transaction; and that upon advice that the above transactions would not qualify as a tax-free exchange under Section 40 (C)(2) of the Tax Code, you were prompted to pay the capital gains taxes due thereon, hence, the filing of this request for waiver of surcharges and penalties on the justification that the delay of paying the said taxes was a direct result of your request for a ruling. In reply thereto, please be informed that pursuant to Section 40 (C)(2) and (6)(c) of the Tax Code of 1997, no gain or loss shall be recognized if property is transferred to a corporation by a person, in exchange for stock in such 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 51% of the total voting power of all classes of stocks entitled to vote. Control is determined by the amount of stocks received i.e., total subscribed, whether for property or for services by the transferors. In determining the 51% stock ownership, only those persons who transferred property for stocks in the same transaction may be counted up to a maximum of five. From the foregoing, it is categorically clear that in order to avail of the non-recognition of gain or loss under Section 40 (C)(2) of the Tax Code of 1997, the transferor which may either be natural or juridical person must transfer its property to a corporation in exchange for its shares of stock, and that as a result of such exchange, the transferor, alone or together with others, not exceeding four persons, gains control of said corporation. Accordingly, a transaction whereby two sets of opposing incorporators both having interest in two distinct corporations exchange or swap their shareholdings in one corporation for the shares of stock of the other corporation, all for the purpose of simplifying and consolidating the ownership of both corporations, considering that after the simultaneous transfer of shares of stock each group of stockholders will have separate ownership of their respective corporations, will not qualify as a tax-free exchange within the contemplation of the provision of Section 40 ((C)(2) of the Tax Code of 1997. Such being the case and since in swap transactions both parties thereto are each considered as a transferor and a transferee of property at the same time, the parties in each of the aforementioned seven Deeds of Exchange are subject to the capital gains tax imposed under Section 24(C) of the Tax Code of 1997 for individual taxpayers and Section 27(D)(2) of the same Code for corporate taxpayers. The net capital gains realized by the parties to the aforesaid transactions shall be computed by considering that the selling/transfer price thereof shall be the fair market value of the shares of stock received in exchange and not the fair market value of the shares of stock transferred or exchanged; and that the difference between the fair market value of the shares of stock received and the acquisition cost or adjusted cost of the shares transferred or exchanged represents the gain realized by the parties thereto ( Sec. 141, Revenue Regulations No . 2 ) which is subject to the 5%-10% capital gains tax imposed under Sections 24(C) and 27(D)(2) both of the Tax Code of 1997. (BIR Ruling No. 143-95 dated September 14, 1995) Moreover, pursuant to Section 176 of the Tax Code of 1997, there shall be collected a documentary stamp tax of One peso and fifty centavos (P1.50) on each Two hundred pesos (P200), or fractional part thereof of the par value of the shares of stock sold, delivered or transferred from one person to another. Such being the case, each transfer or swab of shares of stock by and between the several stockholders of CTCI and GEMECO is subject to the documentary stamp tax imposed therein. Both exchanging parties thereto are subject separately and distinctly to the documentary stamp tax. Finally, your request for waiver of the payment of surcharges and penalties is hereby denied for lack of legal basis. The Supreme Court has already clearly ruled that strong reasons of policy support a strict observance of the rule regarding the payment of tax. The imposition of civil penalties on delinquency is, therefore, mandatory. ( Philex Mining Corporation vs . Commissioner of Internal Revenue, Court of Appeals, and The Court of Tax Appeals , G.R. No. 125704. August 28, 1998, citing Jamora v. Meer , 7 Phil. 22) On this basis, the delay in the issuance of this Ruling cannot justify the waiver of such penalties in view of the fact that the tax implication of a swap transaction has already been previously considered and decided upon by this Office. (BIR Ruling No. 143-95; S-40-051-2001 dated June 27, 2001) To rule otherwise would treat the law imposing penalties for delinquency lightly and could render it nugatory and make the revenue raising power of government precariously dependent on the willingness or unwillingness of taxpayers to pay their obligations on time. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) EDMUNDO P. GUEVARA Deputy Commissioner Legal and Inspection Group