BIR Ruling [DA-030-05]

January 24, 2005 BIR RULING [DA-030-05] Secs. 174 & 175 DA-141-99; 496-2003; 511-03 Platon Martinez Flores San Pedro & Leao Law Offices 6th Floor Tuscan Building, 114 Herrera Street Legaspi Village, Makati City Attention: Atty. Carlos G. Platon Gentlemen : This refers to your letter dated January 13, 2005, requesting on behalf of your client, Golden Arches Development Corporation, (hereinafter "GADC") for confirmation of your opinion that: 1) The reclassification/conversion of a portion of the common stock of GADC owned by McDonald's Restaurants Operations, Inc.'s (hereinafter "MRO") to preferred stock does not give rise to a taxable transaction and, therefore, not subject to income tax on the part of MRO and GADC nor to the documentary stamp tax (DST);and 2) The subscription by and issuance to MRO of preferred stock of GADC at a price equal to the par value of the preferred shares plus a premium to be paid out of GADC's outstanding payables to MRO is a capital transaction and, therefore, not subject to donor's tax nor to income tax. The issuance of the preferred stock is, however, subject to DST. It is represented that GADC is a domestic corporation duly registered with the Securities and Exchange Commission (SEC),the primary purpose of which is to establish, maintain, operate and manage, for its own account or for the account of other entities or individuals, restaurants, cafes, bars and general food catering services; that it has an authorized capital stock of One Hundred Fifty Million Pesos (P150,000,000.00) divided into One Hundred Fifty Thousand (150,000) shares with a par value of One Thousand Pesos (P1,000.00) per share; that One Hundred Forty Seven Thousand One Hundred (147,100) shares are issued and outstanding; that MRO is a non-resident foreign corporation duly organized and existing under the laws of the State Delaware, USA, with office address at 2711 Centerville Road, Suite 400, Wilmington, Delaware 19801, USA; that it has not been licensed to do business in the Philippines as evidenced by the Certificate of Non-Registration issued by the Securities and Exchange Commission dated September 16, 2004; that as of December 31, 2004, GADC has an outstanding debt due to MRO in the amount of P4,140,770,111 which is reflected in the balance sheet of GADC as "Advances from a stockholder";that GADC will now undertake the following corporate restructuring: 1. Reduce the authorized capital stock (ACS) of GADC from P150,000,000.00 divided into 150,000 shares with a par value of P1,000.00 per share to P146,953,348.00 divided into 99,444 common shares with a par value of P1,000 per share and 778 class A preferred shares with a par value of P61,066.00 per share, that the class A preferred shares will be allocated to MRO; that of the 92,191 shares owned by MRO in GADC 47,656 shares with par value of P1,000.00 per share will be reclassified/converted into 778 class A preferred shares with par value of P61,066.00 per share; that all other outstanding shares will remain as common shares; and 2. Increase the authorized capital stock from P146,953,348.00 divided into 99,444 common shares with a par value of P1,000.00 per share and 778 class A preferred shares with a par value of P61,066.00 per share to P1,673,603,348.00 divided into 99,444 common shares with a par value of P1,000.00 per share and 2,500,105 class B preferred shares with a par value of P61,066.00 per share. CDESIA that the 25,000 class B preferred shares shall be subscribed by MRO at a price equal to its par value of P1,526,650,000.00 plus a premium or additional paid-in capital of P1,939,480,111.00 or a total aggregate subscription price of P3,466,130,111.00; that MRO shall pay for said subscription price of P3,466,130,111.00 out of GADC's outstanding debt due to MRO reflected in the balance sheet of GADC as "Advance from a stockholder";that class A preferred shares shall be non-voting; that dividends declared by the board of directors of GADC, if any, on said preferred shares shall have the priority over dividends declared by the board of directors of GADC, if any, on the common shares, but in no event shall the dividends on the preferred shares outstanding exceed One Philippine Peso (P1.00) per share; that the holder of class A preferred shares has the option to require GADC to purchase back/redeem the preferred shares at any time after the beginning of the 19th year from the date of the issuance of such preferred shares for a total redemption or purchase price equivalent to the Philippine Peso value of the preferred shares on the date that the preferred shares were issued; that the class B preferred shares shall be voting; that dividends declared by the board of directors of GADC, if any, on said preferred shares shall have the priority over dividends declared by the board of directors of GADC, if any, on the common shares but in no event shall the dividends on the preferred shares outstanding exceed One Philippine Peso (P1.00) per share; that the holder of class B preferred shares at any time after the beginning of the 19th year from the date of the issuance of such preferred shares for a total redemption or purchase price equivalent to the Philippine Peso value of the preferred shares on the date that the preferred shares were issued; and that the corporate restructuring is subject to the approval of the SEC which GADC anticipates within the year 2005. In reply thereto, please be informed as follows: 1. The conversion of the common shares into preferred shares shall not be subject to capital gains tax since the holders thereof merely change the form of their shareholdings from common shares to preferred shares and they do not realize any gain or economic benefit therefrom. (BIR Ruling No. DA-141-99 dated March 9, 1999) The exchange of common shares into preferred shares qualifies as a mere recapitalization and no gain or loss is recognized therefrom. Recapitalization has been defined as a "readjustment of existing interests in the rearrangement of the capital structure" of the company, which generally are non-taxable to both, the holders and the issuing corporation. (Mertens, Law of Federal Income Taxation, Section 43.105, pp. 164-166) Moreover, the conversion of the subject common shares into equivalent preferred shares does not partake of the issuance of original shares of stock, hence, the same is not subject to the documentary stamp tax imposed under Section 175 of the Tax Code of 1997. Likewise, the reclassification of the shares from common shares into preferred shares of the stockholders in corporation is not subject to the documentary stamp tax provided the new certificates are issued to the same stockholders and the par value is not higher than the replaced certificates. (BIR Ruling No. DA-406-2003 dated November 10, 2003). AHCTEa Such being the case, since the new certificates will also be issued to the same shareholders of MRO, and the aggregate par value is not higher than the replaced certificate, the same shall not be subject to the documentary stamp tax. 2. The subscription by and issuance to MRO of GADC's of preferred shares plus a premium is a capital transaction and, therefore, not subject to donor's tax, as well as to income tax. The issuance of the preferred shares, however, will be subject to documentary stamp tax pursuant to Section 174 of the Tax Code of 1997. (BIR Ruling No. DA-511-03 dated December 18, 2003) 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 and Inspection Group