BIR Ruling [DA-117-03]

April 14, 2003 BIR RULING [DA-117-03] AFP Retirement and Separation Benefits System Camp General Emilio Aguinaldo Quezon City Attention: BGen. Francisco M. Paredes Senior Vice President Corporate Services Gentlemen : This refers to your letter dated April 26, 2001 requesting for a ruling on the tax consequences to the contracting parties of (a) the conversion of loan receivables into equity (additional paid-in capital) without the issuance of new shares of stocks and (b) the subsequent swap of shares of stocks of domestic corporations. cECaHA It is represented that Chinatown Steel Towers Corporation (CSTI) is a domestic corporation organized on May 29, 1989 with an authorized capital stock of P150 million; that it was established for the purpose of undertaking the construction and marketing of Chinatown Steel Towers Condominium, a 28-storey structure located at San Nicolas, Manila; that the condominium building was completed in 1992 with 230 units; that as of December 31, 1998, CSTI had total assets of P846,548,798, total liabilities of P935,725,991 and negative stockholders' equity of P89,177,194; that the entire capital stock of CSTI is owned by the AFP-Retirement and Separation Benefits System (AFP-RSBS), a qualified pension plan within the contemplation of Republic Act No. 4917, created under Presidential Decree No. 361, as amended; that on the other hand, Monterrosa Development Corporation (MDC) is another domestic corporation organized on August 25, 1998 and owned 100% by RGV Development Corporation (RGVDC); that as of December 31, 1998, MDC had total assets of P351,449,419, total liabilities of P251,449,419, and stockholders' equity of P100 million; that on February 5, 1998, CSTI (with the approval and conformity of the AFP-RSBS) and RGVDC entered into a Memorandum of Agreement, whereby the contracting parties shall swap shares of stock under a debt-free arrangement, and accordingly, AFP-RSBS which owns CSTI, and RGVDC which owns MDC, will convert their loans receivable from their respective subsidiaries into equities (as additional paid-in capital and without new shares being issued) and thereafter shall swap CSTI and MDC shares, such that after the swap transaction AFP-RSBS will be the owner of MDC while RGVDC will be the owner of CSTI; that to implement the provisions of the Memorandum of Agreement, RGVDC converted on February 5, 1999, its loans receivable from MDC amounting to P208,722,172 into equities (as additional paid-in capital without issuing new MDC shares; that on March 16, 1999, CSTI and RGVDC confirmed the contents of the Memorandum of Agreement and re-documented, re-stated and amplified their mutual intentions and covenants through a new document "Addendum to the Memorandum of Agreement" executed and signed by them; that the conversion of the loans payable to RGVDC was not, however, timely presented by MDC to its external auditor and in the original audited financial statements and income tax return of MDC for the year 1999 which were filed on April 17, 2000, the loans payable was not shown as additional paid-in capital; that on the same day, MDC noting the error, immediately filed an amended audited financial statements and income tax return; that in accordance with the Memorandum of Agreement, AFP-RSBS converted its loans receivable from CSTI amounting to P868,976,847 into equities (as additional paid-in capital without issuing new CSTI shares); that when the original tax return and audited financial statements were filed on April 17, 2000, the conversion of the loan receivables into equity (additional paid-in capital) was not reflected; that the error was promptly discovered, and an amended income tax return and audited financial statements were later filed by CSTI; that on September 17, 1999, CSTI and RGVDC executed a Deed of Assignment whereby CSTI shall submit the Deeds of Assignment executed by the stockholders of CSTI with the duly endorsed stock certificates as well as the Condominium Certificates of Title, tax declarations and other relevant documents over 120 condominium units, while RGVDC shall submit the Deeds of Assignment with the corresponding duly endorsed MDC stock certificates and the owner's duplicate copy of the Transfer Certificate of Title No. T-82447, covering the Batulao property and other relevant documents; and that the contracting parties also warranted and assumed all liabilities and indebtedness of the corporations incurred prior to the actual and final transfer and conveyance of the shares of stock. Based on the foregoing representations, you now request for a ruling that "1. The conversion by the AFP-RSBS of its loans receivable from its subsidiary, CSTI, for the subsidiary's equity without the issuance of new shares of stock is exempt from income tax, donor's tax, and documentary stamp tax; "2. The conversion by the RGVDC of its loans receivable from its subsidiary, Monterrosa Development Corporation (MDC), for the subsidiary's equity without the issuance of new shares of stock is exempt from income tax, donor's tax and documentary stamp tax; "3. The gain, if any, from the subsequent exchange by AFP-RSBS of its CSTI shares with RGVDC of its MDC shares is exempt from capital gains tax; "4. The gain or loss from the subsequent exchange by RGVDC of its MDC shares with AFP-RSBS of its CSTI shares is subject to capital gains tax or deductible from capital gains during the taxable year; and "5. The Deed of Assignment involving the swap of CSTI shares for MDC shares shall be subject to documentary stamp tax on the part of RGVDC since AFP-RSBS is exempt from said tax." We reply in the order that the issues were presented, as follows: 1. Section 56 of Revenue Regulations No. 2, otherwise known as the "Income Tax Regulations" reads "Sec. 56. Contributions by shareholders. Where a corporation requires additional funds for conducting its business and obtains such needed money through voluntary process payments by its shareholders, the amounts so received being credited to its surplus account or to a special capital account, will not be considered income, although there is no increase in the outstanding shares of stock of the corporation. The payments in such circumstances are in the nature of voluntary assessments upon, and represent an additional price paid for, in shares of stock held by the individual shareholders, and will be treated as an addition to and as part of the operating capital of the company." Accordingly, the amounts so received being credited to its surplus account or to a special capital account ( i.e. , additional paid-in capital), being a capital investment, is not within the purview of the term "taxable income" as defined in Section 32 of the Tax Code of 1997. Consequently, the stockholder's contribution consisting of the converted loans receivable will not be subject to income tax. In BIR Ruling No. 193-87 dated July 7, 1987 which was later reiterated in BIR Ruling Nos. 270-87 dated September 8, 1987; 586-88 dated December 19, 1988 and 127-89 dated June 13, 1989, this Office had the occasion to rule on the matter, when it said that ". . . that the conversion of a loan into equity represents additional capital contribution to the debtor in the form of donated surplus or additional paid-in capital without the necessity of issuing additional shares of stock. As such, it is a capital investment which is not included within the purview of the term "taxable income" as defined in the Tax Code." Accordingly, it is the opinion of this Office as it hereby holds that the conversion by AFP-RSBS of its loans receivable from its subsidiary, CSTI, for the latter's equity without the issuance of new shares of stock is exempt from income tax and donor's tax. Moreover, considering that the loans receivable were credited to additional paid-in capital and no new shares of stock were issued by CSTI to AFP-RSBS, it is not subject to documentary stamp tax imposed under Sections 175 and 176 both of the Tax Code of 1997 as the original issuance and the transfer of shares of stock of domestic corporations are based on the par value of such shares. 2. Already discussed in No. 1 above. 3. Section 60(B) of the Tax Code of 1997 reads "Sec. 60(B) Exception . The tax imposed by Title II shall not apply to employee's trust which forms part of a pension, stock bonus or profit-sharing plan of an employer for the benefit of some or all of his employees (1) if contributions are made to the trust by such employer, or employees, or both for the purpose of distributing to such employees the earnings and principal of the fund accumulated by the trust in accordance with such plan, and (2) if under the trust instrument it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees under the trust, for any part of the corpus or income to be (within the taxable year or thereafter) used for or diverted to, purposes other than for the exclusive benefit of his employees: Provided, That any amount actually distributed to any employee or distributee shall be taxable to him in the year in which so distributed to the extent that it exceeds the amount contributed by such employee or distributee." Inasmuch as the AFP-RSBS is a qualified pension plan within the contemplation of R.A. No. 4917 and is exempt from income tax under Presidential Decree (PD) No. 361, as amended by PD No. 1656 and under the aforecited section of the Tax Code, any gain that AFP-RSBS may realize from the exchange of its CSTI shares for MDC shares shall be exempt from the payment of capital gains tax imposed under Section 24(C) of the Tax Code of 1997. ( BIR Ruling No. DA673-99 dated December 9, 1999 ) 4. Section 27(D)(2) of the Tax Code of 1997 reads "Sec. 27. (D) Rates of Tax on Certain Passive Incomes . (2) Capital Gains from the Sale of Shares of Stock Not Traded in the Stock Exchange . A final tax at the rates prescribed below shall be imposed on net capital gains realized during the taxable year from the sale, exchange or other disposition of shares of stock in a domestic corporation except shares sold or disposed of through the stock exchange: Not over P100,000 5% Amount in excess of P100,000 10% The term "net capital gain" means the excess of the gains from the sales or exchanges of capital assets over the losses from such sales or exchanges. On the other hand, "net capital loss" means the excess of the losses from sales or exchanges of capital assets over the gains from such sales or exchanges. ( Sec. 39(A)(2) & (3) of the Tax Code of 1997 ) Thus, the gain or loss from the subsequent exchange by RGVDC of its MDC shares with AFP-RSBS of its CSTI shares is subject to the capital gains tax or capital loss during the taxable year. Revenue Regulations No. 2-82 dated March 29, 1982, provides for the following rules in determining the tax base: (a) . . . (b) In the case of sale, transfer or exchange of shares not listed in the stock exchange, the following rules are observed: (i) In general, the unlisted shares shall be valued at their book value nearest the valuation date. The book value of these unlisted shares of stock shall be considered as their fair market value. (ii) In case the shares are valued on a basis lower than their book values, a justification for the deviation from the book value together with the evidences in support thereof should be submitted. Accordingly, the net capital gains, if any, shall be subject to 5% for the first P100,000 and 10% for the amount in excess of P100,000. 5. Considering that AFP-RSBS is a qualified pension plan under R.A. No. 4917, the exchange of its CSTI shares for MDC shares shall be exempt from the payment of capital gains tax. However, the exchange of said shares shall be subject to the payment of documentary stamp tax of P1.50 for every P200 of the par value of such stock as imposed under Section 176 of the Tax Code of 1997 which shall be paid by RGVDC pursuant to Section 173 of the same Code. 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