BIR Ruling [DA-141-99]

March 9, 1999 BIR RULING [DA-141-99] SGV & Co. 6760 Ayala Avenue 1226 Makati City Attention: Atty . E . C . Alcantara Tax Division Gentlemen : This refers to your letter dated September 21, 1998 requesting clarification, on behalf of your client, United Paragon Mining Corporation (UPMC) , as to the capital gains tax and documentary stamp tax (DST) implications, if any, of the proposed conversion of UPMC's convertible preferred stock to common stock. It is represented that UPMC is a domestic mining corporation with present authorized capital stock of P3,027,000,000 consisting of the following: Class/Series of Shares Number of Shares Par Value per Share Common 2,500,000,000 P1.00 Preferred A 2,700,000,000 P0.01 Preferred B 5,000,000 P100.00 that UPMC's common shares (C/S) are registered and listed with the Philippine Stock Exchange (PSE) while the preferred shares (P/S) are neither registered nor traded; that in 1997, UPMC amended its Articles of Incorporation to provide, among others, that its P/S shall be non-participating but shall be convertible into any other stock or security of UPMC if authorized by the Board of Directors; that accordingly, UPMC now proposes to allow the conversion of the outstanding convertible P/S, together with their accumulated "interests" and dividends, to C/S at the conversion price of P1.00 (par value); that the conversion will entail the issuance of C/S in such a number as their total par value will equal the total par value of the P/S and the accumulated "interests" and dividends thereon; that UPMC likewise proposes to issue C/S in lieu of the unpaid accrued interests on convertible bonds and that, in this connection, UPMC shall issue P287.468 million C/S at P1.00 par value, itemized as follows: Preferred A (principal and "interests") P47.496 million Preferred B (principal and dividends) 147.631 million Accrued interest (bonds) 92.340 million Total P287.468 million ============ and that at present, UPMC has P765.156 million previously authorized and unissued C/S available to cover the above proposed conversion. Based on the foregoing, you request for clarification on the following: (a) Whether or not the conversion of the preferred shares into common shares will be subject to the capital gains tax on the part of the holders thereof; and (b) Whether or not the issuance of the common shares for the converted preferred shares will be subject to the documentary stamp tax. In reply thereto, please be informed as follows: (a The conversion of the P/S for C/S, at par for par, in line with the conversion feature of the P/S, shall not be subject to capital gains tax since the holders thereof merely change the form of their shareholdings from preferred to common shares and they do not realize any gain or economic benefit therefrom. Moreover, the exchange of P/S for C/S 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] However, while the conversions of the P/S into C/S are non-taxable, the issuance of C/S for accrued dividends on P/S is taxable as dividend distribution to the extent of the arrearages. [Mertens, ibid, p. 165] Moreover, the issuance of C/S for the discharge of accrued interest on the convertible bonds is also taxable as ordinary income on the part of the bondholders. [Mertens, supra, Section 43.107, p. 170] (b) The issuance of new C/S for the converted P/S, not being a sale or transfer of shares or certificates of stock, shall not be subject to the DST imposed under Section 176 of the Tax Code of 1997. The conversion of P/S into C/S, pursuant to a conversion feature of the P/S, which does not involve any transfer of ownership to another shareholder/(s), is not a transaction distinct from the subscription contract but a mere continuation thereof for which the required DST has been previously paid. Accordingly, the conversion of the shares is not therefore subject to DST. However, the issuance of C/S for the accrued dividends and interest, which presumably shall be sourced from unissued shares, shall be subject to DST at the rate of P2.00 for every P200 or fractional part thereof, of the par value of the C/S to be issued, pursuant to Section 175 of the Tax Code of 1997. (BIR Ruling No. 158-98 dated November 10, 1998) This ruling is being on the basis of the foregoing facts as represented. However, if upon investigation it be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) SIXTO ESQUIVIAS IV Deputy Commissioner (Legal and Enforcement Group)