BIR Ruling [DA-038-06]

February 9, 2006 BIR RULING [DA-038-06] Write-off/Condonation 076-89; DA-419-04 SyCip Gorres Velayo & Co . SGV Building 6760 Ayala Avenue, Makati City Attention: Mr. Joel Tan-Torres Partner, Tax Services Gentlemen : This refers to your letters dated December 21, 2004 and August 15, 2005, requesting on behalf of Eagle Ridge Golf and Country Club, Inc., for confirmation that the write-off by Alsons Land Corporation and Sta. Lucia Realty Development Inc. of their receivables will not result in the imposition of income tax on the part of the Club nor of donor's tax on the part of ALC and SLRDI. The facts as represented are as follows: Eagle Ridge Golf and Country Club, Inc. (the "Club") is a non-profit organization incorporated on December 9, 1996 primarily to maintain, manage and carry on a social and recreation club for amusement, entertainment, instruction and recreation of its members, the core of which is the development and maintenance of golf courses and amenities. On October 10, 1994, Alsons Land Corporation ("ALC") and Sta. Lucia Realty Development Inc. ("SLRDI") signed a Memorandum of Agreement (MOA) whereby ALC and SLRDI formed a Joint Venture for the development of a golf course complex composed of four 18-hole golf courses and other amenities and facilities. The MOA was later amended on June 17, 1997. Pursuant to the MOA, ALC was obligated to contribute land with an area of 306.73 hectares to the Club, while SLRDI was tasked to develop the golf courses, clubhouses and other amenities/facilities. The MOA further provided that in exchange for the land and development work, ALC and SLRDI will receive the proceeds from the sale of the Club's shares based on defined percentages of work accomplished in the development of the golf course complex. SLRDI will have 60% of the proceeds while the remaining 40% will go to ALC. The MOA and the prospectus presented by the Club to the buying public provide that in the event that not all of the Offered Shares are subscribed by the public during the offering period, the Joint Venture partners are obliged to take all the unsubscribed shares as complete and final satisfaction of the obligations of the Club. In the course of the construction of the golf course complex, the Joint Venture has been billing the Club based on the projected proceeds from the sale of the Club of its shares. The total proceeds were originally computed using a projected average selling price of P1.266 Million per share. The Joint Venture's billings were set up by the Club by recognizing an asset account of "Project under Development" and recording a "payable to the landowner and developer." As the Club collects the sales proceeds, these are then paid to the SLRDI and ALC. On January 2002, the Club started operations and opened the facilities of the project for use even without formal turnover by the Joint Venture partners. The Project costs are being amortized over an estimated useful life of 30 years, commencing from 2002. cCaIET As of December 31, 2003, the Project under Development amounted to P3,443,021,543.00; the Payable to the landowner and developer amounted to P2,136,345,166.00, and accumulated amortization of the project cost amounted to P232,828,780.00. Due to the decline in the prices of golf club shares, the projected market value of Club shares was never realized. From the projected average price of P1,266,000.00 per share, the selling price averaged only P674,000.00 per share. As a result, the Club will not be able to pay outstanding liabilities amounting to P682,264,729.00 to the Joint Venture. Anticipating the forthcoming turn over of the facilities by the Joint Venture to the Club, and to comply with the condition indicated in the Prospectus and MOA, that the Joint Venture partners will take all unsubscribed shares as complete and final satisfaction of the obligations of the Club, SLRDI and ALC will write-off the uncollectible portion of its receivable from the Club, to the extent of P682,264,729.00. With this write off, the Club will record the following: reduce its payable to the landowner and developer by P682,264,729.00, reduce the project under development and input value added tax by P620,240,663.00 and P62,024,066.00, respectively, and reduce the accumulated amortization by P20,674,689.00. The Club's Financial Statements for 2003 shows the deficiency of revenues over expenses amounting to P115,559,160.00 for the year 2003, and P92,412,020.00 for the year 2002. Even if each of these are adjusted by P20,674,689.00 for the amortization corresponding to the amount written, the Club will still be in a financial loss position. In reply, please be informed that write-off or condonation of debt will not be subject to income tax if it does not result in the reduction of the taxable income of the debtor since it was in a financial loss position even without the deduction. In BIR Ruling No. 076-89 dated April 17, 1989, this Office held that: "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 v. 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. v. CIR, CTA Case No. 1407 Dec. 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. v. 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." Likewise, in BIR Ruling No. DA-419-04 dated August 4, 2004, involving the condonation of the indebtedness of COMSYS, Phils., Inc. to Sumitomo Japan, this Office held that: "Thus, 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." As represented, the Club's Financial Statements for 2003 shows the deficiency of revenues over expenses amounting to P115,559,160.00 for the year 2003, and P92,412,020.00 for the year 2002, and that even if each of these are adjusted by P20,674,689.00 for the amortization corresponding to the amount written, the Club will still be in a financial loss position. Therefore, following the two cited rulings, the write-off of the debts by the Joint Venture Partners should not result in a taxable gain on the part of the Club. Furthermore, the write-off will not result in anything of exchangeable value to be received by the Club, since in fact, the Club will have to reduce the value of its asset under "project under development" to take into account the effect of the write-off. In addition, the write-off is not subject to donors' tax since there was no donative intent on the part of the Joint Venture Partners. The write-off was undertaken solely for business consideration since the write-off is in fulfillment of the Joint Venture Partners' obligations in the MOA and the Prospectus, and therefore, part of the consideration for entering into the Joint Venture. Moreover, the write-off will also be needed prior to the full formal turn-over of the facilities. As held in BIR Ruling No. 076-89: "The condonation is likewise not subject to gift tax since there is no donative interest 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." And also as held in BIR Ruling No. DA-419-04: "Moreover, the condonation is likewise not subject to gift tax since there is no donative interest on the part of SJ but is solely for business consideration." 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. IcSEAH Very truly yours, (SGD.) JOSE MARIO C. BUAG Commissioner of Internal Revenue