BIR Ruling [DA-033-05]

January 27, 2005 BIR RULING [DA-033-05] Global Brands Co., Inc. Penthouse, 35th Floor Raffles Corporate Center Emerald Avenue, Ortigas Pasig City Attention: Mr. Roy Theodore G. Villafuerte Managing Director Chemical Formulations Division and Mr. Ray Silvestre N. Canilao Managing Director Fashionable Goods Division Gentlemen : This refers to your letter dated January 5, 2005 stating that your company, Global Brands Company, Inc. (GBCI) owns 99.99% of Global Brands Products, Inc. (GBPI) while the five (5) qualifying shares are owned by the individual stockholders; that on December 15, 2004, the board of directors of GBPI with the approval of its stockholders has decided to dissolve GBPI and thereafter liquidate and distribute its assets to its parent company by shortening its corporate term effective December 31, 2004; that in the course of its preparation for liquidation, GBPI noted that the present book value of its assets consisting of patents and trademarks (all collectively known as "brands") no longer reflect the true present value thereof; that accordingly, it engaged the professional services of a firm to appraise and determine their true and fair market value; and that following the completion of the valuation report, GBPI agreed that after paying off its liabilities, the brands be distributed to its parent company as liquidating dividends using the average between the low and high ranges of its appraisal fair market value, which is higher than the book value thereof. Based on the foregoing representations, you now request for a ruling that "1. The appraisal value of the brands made by an independent firm may be used as a basis for determining their fair market value for purposes of distributing them as liquidating dividends by GBPI to its parent company, GBCI, and for purposes of determining gain or loss to its parent company; "2. The said value shall be used as the basis for depreciation or amortization and/or determining gain or loss on the subsequent sale or disposition of the brands in the hands of the parent company, "3. GBPI is not liable for income tax either on its receipt of the surrendered shares, or for its transfer of the distributed assets to its parent company as liquidating dividends; AaITCS "4. No documentary stamp tax is due on the surrender and cancellation of the GBPl shares; and "5. The transfer of the brands as liquidating dividends is not subject to the 10% value-added tax." In reply thereto, please be informed that this Office in BIR Ruling No. 039-02 dated November 11, 2002 resolved and characterized liquidating gain as gain from sale or exchange of shares and thus, subject to ordinary income tax, cited the case of Wise & Co., Inc. et al. vs. Bibiano L. Meer, Collective of Internal Revenue , G.R. No. 48231, June 30, 1947 . Accordingly, the gain, if any, is measured by the difference between the fair market value of the assets received and the adjusted cost to the stockholders of their respective shares. Thus, in the case of Nachod & United States Signal Co. v. Commissioner of Internal Revenue , 74 F. 2d 164, the US Supreme Court ruled that the Commissioner acted arbitrarily in finding no value in group of patents owned by the United States Signal Co. (Signal Co.) on the ground that the appraisal of a patent not yet fully exploited is speculative and of no probative value. In this case, Signal Co. is a corporation whose entire capital stock of US$100,000 was issued to Carl Nachod, who had been engaged in the manufacture and sale of signal devices invented by him for use upon electric railroads. His assets taken over by Signal Co. consisted of machine shop, tools and dies, patents and patent applications, contracts and goodwill. The tangible assets had a book value of US$18,712.22 and the balance of Signal Co.'s stock, of the par value of US$81,287.89, was issued in consideration for intangibles, of which patents and patent rights were the most important. In using US$81,287.78 as the value of the patents, Signal Co. relied upon the evidence of five expert witnesses, among others. However, the Commissioner discarded the opinion evidence on the ground that this was speculative. The US Supreme Court in sustaining the valuation of the expert witnesses ruled that: "At times the only evidence available may be that supplied by testimony of experts as to the state of the art, the character of the improvement, and the probable increase of efficiency or savings of expense." Corollarily, in BIR Ruling No. 413-04 dated July 30, 2004 , this Office had already the occasion to rule on the matter when it said that ". . . Solid Shipping Lines Corporation, is hereby allowed to use the appraisal fair market values of their property, plant and equipment used in business as determined and reported by an independent appraiser and depreciate the same based on their remaining useful life as re-estimated in the light of the subsequent facts or the straight-line method of depreciation pursuant to Section 109 of Revenue Regulations No. 2." DHEcCT 1 & 2. Accordingly, it is submitted that the average of the low and high values of the valuation of an independent professional firm may be used as a basis for determining the fair market value of the brands for purposes of distributing them as liquidating dividends by GBPI to its parent company and for purposes of determining gain or loss to its parent company. Furthermore, the same valuation may likewise be used as the basis for depreciation or amortization and/or determining gain or loss on the subsequent sale or disposition of the brands in the hands of the parent company because the properties received in liquidation should be recorded in the books of the stockholders at their fair market value. ( BIR Ruling No. 014-85 dated February 7, 1985 ) 3. The transfer by the liquidating corporation of its remaining assets to its stockholders is not considered a sale of these assets. Thus, a liquidating corporation does not realize gain or loss in partial or complete liquidation. ( W.P. Fox & Sons, Inc. Petitioner, v. Commissioner of Internal Revenue, Respondent, 15 BTA 115; Jordan Petroleum Company, 13 AFTR 2d 1692; 227 F. Supp. 174; J.T.S. Brown & Son Company v. Commissioner of Internal Revenue, 10 TC 840, cited in BIR Ruling No. 196-010-90-059-90 dated April 17, 1990 ) ( BIR Ruling No. 039-02 dated November 11, 2002 ) Such being the case, GBPI should not be liable for income tax either on its receipt of the surrendered shares, or its transfer of the distributed assets as liquidating dividends. 4. No documentary stamp tax is due on the surrender and cancellation of shares as it does not constitute a sale, assignment or transfer of shares of stock since GBPI is not taking title to the surrendered shares and the shares are retired as a consequence of the liquidation. In effect, GBPI does not realize any benefit, as owner or otherwise, from the receipt of the said shares. ( BIR Ruling No. 039-02 dated November 11, 2002 ) 5. Finally, the transfer of the brands by GBPI to its parent company as liquidating dividends is not subject to the 10% value-added tax. ( BIR Ruling No. DA164-04 dated April 5, 2004 ) cSaCDT 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