BIR Ruling [DA-028-05]

January 24, 2005 BIR RULING [DA-028-05] DA 419-04 SGV & Co. 6760 Ayala Avenue Makati City Attention: Atty. R.C. Vinzon Tax Services Gentlemen : This refers to your letter dated December 28, 2004 stating that your client, Bayan Telecommunications, Inc. (Bayantel) is a corporation duly organized and existing under and by virtue of the laws of the Philippines with principal office address at No. 234 Roosevelt Avenue, Del Monte, Quezon City; that it is a subsidiary of Bayan Telecommunications Holdings Corporation, a holding company that is also incorporated in the Philippines; that Bayantel is the holder of a legislative franchise to provide telecommunications services of all types; that the National Telecommunications Commission has authorized Bayantel to provide and operate the following major services; local exchange carrier, international gateway facility, leased line service, and cellular mobile telephone systems; that Bayantel suffered recurring net losses of P7,713,200.00 and P5,214,300.00 during the years ended December 31, 2003 and 2002, respectively; that as of those dates, its current liabilities exceeded its current assets by P33,431,200.00 and P29,225,700.00, respectively; that the company's financial position is such that its authors have expressed the existence of a material uncertainty which may cast doubt on Bayantel's ability to continue operations normally; that in order to address this problem, Bayantel requested its creditors for the restructuring of its bank loans and bonds payable; that the debt restructuring plan includes, among others, the extension of the repayment of terms of Bayantel's outstanding loans and bonds, reduction in interest rates and conversion of certain debt into equity; that on July 30, 2003, one of Bayantel's creditors, for and on behalf of the bond creditors of Bayantel, filed a Petition for Corporate Rehabilitation of Bayan Telecommunications, Inc. with the Pasig Regional Trial Court; that the court approved the financial rehabilitation of the company subject to the following clarifications and/or amendments: 1. All creditors will be treated equally and that this equal treatment will be extended to all payment terms and treatment of past due interest; 2. Secured creditors can continue to hold on to their security or collateral, which can be foreclosed if the rehabilitation fails and creditors resort to liquidation; 3. The level of sustainable debt shall be amortized over a period of 19 years; 4. Unsustainable debt shall be converted into an appropriate instrument that shall not be a financial burden for the company; 5. All provisions relating to equity in the rehabilitation plan must strictly conform to the requirements of the Constitution limiting foreign ownership to 40%; and 6. A Monitoring Committee shall be formed composed of representatives from all classes of the restructured debt. The Receiver's role shall be limited to monitoring and overseeing the implementation of the rehabilitation plan. that the change in the payment scheme does not include the reduction of the principal liability but only the reclassification of the debt into sustainable (68.933% of the total debt) and unsustainable debt (31.067% of the total debt), recalculation of interest expense based on lower interest rates provided by the court, which also form part of the unsustainable debt, and the waiver of penalties; and that pursuant to the rehabilitation plan, a portion of the debt, specified as unsustainable debt, will be settled only when there are available excess cash, and any outstanding amount at the end of the 19 year rehabilitation period will be converted to equity to a maximum limit of 40% outstanding shares. Based on the foregoing representations, you now request for confirmation of your opinion that any gain resulting from the condonation of Bayantel's debt through a court-approved debt restructuring plan is not taxable for income tax purposes. Furthermore, any conversion of debt into equity as a result of the debt restructuring plan is likewise not subject to income tax. In reply thereto, please be informed that this Office has already the occasion to rule on the matter, when it said in BIR Ruling No. 076-89 dated April 17, 1989 that "Cancellation and forgiveness of indebtedness may amount to a payment of income, to a gift, or to a capital transaction, dependent upon the circumstances. If for example, an individual performs services for a creditor who, in consideration thereof cancels the debt, income to that amount is realized by the debtor as compensation for his services. If, however, a creditor merely desires to benefit a debtor and without any consideration therefor cancels the debt, the amount of the debt is a gift from the creditor to the debtor and need not be included in the latter's gross income. If a corporation to which a stockholder is indebted forgives the debt, the transaction has the effect of the payment of a dividend. ( Sec. 50, Revenue Regulations No. 2 ) The waiver of interest by the banks on non-trade and trade related indebtedness of GMPI is not subject to income tax considering that the deduction of said interest as expense in prior years did not offset nor reduce the taxable income of GMPI since it was in a financial loss position even without the deduction. (See Barnhart-Marrow Consolidated vs. Commissioner of Internal Revenue, 47 BTA 590) Moreover, when a creditor cancels a debt as part of a business transaction, the debtor is enriched or its net assets has been increased and, therefore, he realized taxable income. (Philippine Fiber Processing Co. vs. CIR, CTA Case No. 1407 December 29, 1966) However, a transaction whereby nothing of exchangeable value comes to or is received by a taxpayer does not give rise to or create taxable income. (see Dallas Transfer and Terminal Warehouse Co. vs. Commissioner of Internal Revenue 5 Cir. 70 F 2d 95, 13AFTR 930) Accordingly, the condonation of GMPI's indebtedness by GM-US is not subject to income tax since before and after the condonation GMPI remains insolvent, i.e., in a capital deficiency position. The condonation is likewise not subject to gift tax since there is no donative intent on the part of GM-US but solely for business consideration since Isuzu will only acquire the GMPI shares from GM-US if GMPI has a "clean" balance sheet with no outstanding liabilities except those to Isuzu." DCSTAH Likewise, in BIR Ruling No. DA419-04 dated August 4, 2004 , this Office also ruled that "the condonation of the CPI's debt to SJ shall not be subject to income tax considering that CPI is in a capital deficiency position and will remain insolvent before and after the said condonation . . . Moreover, the condonation is likewise not subject to gift tax since there is no donative intent on the part of SJ but is solely for business consideration." Considering that in the case of your client, Bayantel, it was through court action that the debt rehabilitation plan was approved and is now being implemented. In other words, the restructuring was not a result of the mutual agreement of the debtors and creditors, but of judicial action. Accordingly, the gain resulting from condonation of the Bayantel's debt to its various creditors shall not be subject to income tax nor to gift tax since there is no donative intent on the part of its various creditors but is solely for business consideration. On the other hand, in BIR Ruling No. 045-92 dated February 13, 1992 which was reiterated in BIR Ruling No. DA419-04 dated August 4, 2004 , this Office citing Section 55 of the Income Tax Regulations implementing then Section 29(a) [now Section 28(a) of the Tax Code as amended, pertinent portion of which provides that "Section 55. Acquisition or Disposition by a Corporation of its Own Capital Stock . Whether the acquisition or disposition by a corporation of share of its own capital stock gives rise to taxable gain or deductible loss depends upon the real nature of the transaction, which is to be ascertained from all its facts and circumstances. The receipt by a corporation of the subscription price of shares of its capital stock upon their original issuance gives rise to neither taxable gain nor deductible loss, whether the subscription or issue price be in excess of, or less than, the par or stated value of such stock. "Nonoc shall not be subject to income tax on the difference between the receivables of P15,063,178,815.00 and the total par value of the converted shares of P7,586,032,760.00 because the receipt by Nonoc of the receivables constituting the subscription price for said shares (converted shares) upon the original issuance thereof did not give rise to taxable income or gain on the part of Nonoc even if the subscription or issue price consisting of the receivables is in excess of the total par value of the converted common and preferred shares. "Moreover, the stockholder's equity is the sum of the paid-in capital and retained earnings. The conversion of APT's receivables in the amount of P15,063,178,815.00 into shares of stock with par value of P7,586,032,760 only is indicative of the fact that the difference of P7,477,146,055 (15,063,178,815 less 7,586,032,760 = 7,477,146,055) is applied to increase Nonoc's retained earnings and equity from a negative total of P5,954,932,484.00 to a positive total of P7,611,032,760. The difference of P7,477,146,055 is not taxable income to Nonoc because they are not earnings from the use of capital; neither are they earnings from the exertion of physical or mental effort. On the other hand, such receivables would constitute additional capital investment of APT in Nonoc which is not included within the purview of the term "taxable income" as defined in Section 28 of the Tax Code, as amended. "Likewise, such additional capital investment shall not be subject to the donor's tax because there is no donative intent in a debt-to-equity conversation transaction . . ." SUCH BEING THE CASE, the conversion of Bayantel's debt into equity as a result of the debt restructuring plan shall not give rise to a taxable income and shall only be considered as an additional capital investment which likewise is not subject to donor's tax since there is no donative intent in the aforesaid transaction. 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, (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal & Inspection Group