BIR Ruling [DA-174-98]

April 30, 1998 BIR RULING [DA-174-98] SyCip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: Atty . C . P . Noel Tax Division Gentlemen : This refers to your letter dated January 14, 1998 requesting for our opinion on the following, viz : "(1) the transfer by PepsiCo, Inc., Philippine Branch ( Branch ), of the recording in its books of all its shares in Pepsi-Cola Far East Trade Development Co. Inc. ( Far East ) to PepsiCo, Inc. Head Office ( Head Office ) is not a taxable transaction and hence, not subject to any Philippine tax; LibLex "(2) gains that may be realized by the Head Office on the exchange of all its shares of stock in Far East, including the Far East shares received from the Branch to Beverage, Food and Service Industries, Inc. (BFS) solely in exchange for BFS shares are not subject to Philippine income tax in accordance with Article 14(2) of the RP-US Tax Treaty (Treaty) and Section 34(c) of the Tax Code; and "(3) gains that may be realized by BFS on the transfer of all its Far East shares to Seven Up Netherlands, B.V. (SUN) solely in exchange for SUN shares are not subject to income tax in accordance with Article 14(2) of the Tax Treaty and Sec. 34(c)(2) of the Tax Code." It is represented that PepsiCo, Inc. is a corporation organized and existing under the laws of the State of North Carolina, U.S.A.; that it is licensed to do business in the Philippines through a branch office; that PepsiCo, Inc.'s Head Office in the U.S.A. directly owns 99,946 common shares with a par value of P100 per share, and which represents 77% of the outstanding common shares of Far East; that PepsiCo, Inc.'s Philippine Branch also holds 29,572 common shares of Far East which represents 23% of the outstanding common shares of Far East; that the shares held by the Philippine Branch are in the process of being consolidated with the Head Office, and as a result thereof, 129,518 shares representing 100% of the total equity of Far East will be held by the Head Office; that Far East is a domestic corporation duly organized under the laws of the Philippines with office address at Fusion Street, Bo. Diezmo, Light Industry & Science Park, Cabuyao, Laguna; that it is engaged in the manufacture of softdrink concentrates which it sells to the franchised bottler; that BFS is a corporation duly organized under the laws of the State of Delaware, U.S.A. which is 100% owned and controlled by PepsiCo and is essentially the holding company for various affiliates and subsidiaries; that SUN is a corporation organized and existing under and by virtue of the laws of the Netherlands; that it is engaged in the business of providing services to the PepsiCo international bottling network and at the same time act as the holding company for many of PepsiCo's international investments; that it is 100% owned and controlled by BFS; that due to certain corporate policies adopted by the Head Office, all the shares in various affiliates and subsidiaries are to be consolidated in certain Netherlands holding companies; and that in accordance with these worldwide corporate restructuring policies, the proposed transactions are as follows : "1) All the stockholdings in Far East must be consolidated in the Head office. The Branch will therefore transfer the recording of all its Far East shares to the Head Office. "2) The Head Office will transfer all its Far East shares including those acquired from the Branch to BFS solely in exchange for shares of BFS. "3) BFS will transfer all its Far East shares acquired from the Head Office to SUN solely in exchange for shares of SUN. "4) All the transfer of shares will be done at book values. LLjur that the audited financial statements of the Branch for the year ended December 31, 1996, revealed that it has a capital deficit of P640,453,218.00; that the book value of its Far East's shares is P269,615,800.00; that considering its size, the Branch's capital deficit position will remain for quite sometime, if not indefinitely, hence, it cannot constructively remit any profit as there are no profits to remit; and that, a copy of the Branch's latest audited financial statements were likewise submitted. In reply, please be informed as follows, viz : a. Ordinarily, the transfer of property by a branch to its head office is subject to branch profit remittance tax pursuant to Section 28(A)(5) of the Tax Code of 1997 [then Section 25(a)(5) of the Tax Code, as amended], except profits earned from those activities which are registered with the Philippine Economic Zone Authority. However, since the financial position of the Branch as shown in its audited financial statements of 1996 revealed that its capital deficit position will likely remain for quite sometime, and therefore the feasibility to remit profits, even constructively, to the Head Office is remote in this case, then neither a branch profit remittance tax can be presumed to be due . Thus, the above transaction is not subject to any Philippine tax. b. Gains, if any, of the Head Office and BFS on the various transfers are exempt from tax under the RP-US Tax Treaty . Article 14 of the RP-US Tax Treaty provides that "ARTICLE 14 "Capital Gains "1. Gains from the alienation of tangible personal (movable) property forming part of the business property of a permanent establishment which a resident of a Contracting State has in the other Contracting State or of tangible personal (movable) property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or together with the whole enterprise) or of such a fixed base, may be taxed in the other State. However, gains derived by a resident of a Contracting State from the alienation of ships, aircraft or containers operated by such resident in international traffic shall be taxable only in that State, and gains described in Article 13 (Royalties) shall be taxable only in accordance with the provisions of Article 13. "2. Gains from the alienation of any property other than those mentioned in paragraph 1 or in Article 7 (Income from real property) shall be taxable only in the Contracting State of which the alienator is a resident." LLphil Moreover, the Reservation Clause of the RP-US Tax Treaty provides in part : " Notwithstanding the provisions of Article 14 of the Convention relating to capital gains, both the Philippines and the United States may tax gains from the disposition of an interest in a corporation if its assets consists principally of a real property interest located in that country . Likewise, both countries may tax gain from the disposition of an interest in a partnership, trust or estate to the extent the gain is attributable to a real property interest in one of the countries. The term "real property interest" is to have the meaning it has under the law of the country in which the underlying real property is located." In this connection, Section 2 of Revenue Regulations No. 4-86 defines the terms "wholly" or "principally" as more than 50% of the entire assets in terms of value. Thus, considering that Far East's real property interest in the Philippines consists of less than 50% of its total assets, then Far East's total assets do not consist "principally" of real property located in the Philippines. (See BIR Ruling Nos. 135-94 dated September 1, 1994, 136-92 dated April 28, 1992, 351-92 dated December 8, 1992, 082-91 dated May 14, 1991) Based on the foregoing, gains, if any, from the transfer by the Head Office of all its Far East shares including the shares acquired from the Branch to BFS, and BFS of all its Far East shares to SUN are not subject to Philippine income tax pursuant to Article 14(2) of the RP-US Tax Treaty. c. No gain or loss on the transfer of Far East shares by the Head Office to BFS and the transfer of the Far East shares by BFS to SUN under Section 40(C)(2) of the Tax Code of 1997 . 1. No gain or loss shall be recognized both on the part of the Head Office , the transferor, and BFS, the transferee, on the transfer by the former of all its Far East shares solely in exchange for shares of stock in BFS and the second transfer by BFS of the Far East shares to SUN solely in exchange for shares of SUN considering that after the exchange and as a result thereof, Head Office will continue to control BFS, and BFS will also continue to control SUN, in accordance with Section 40(c)(2) of the Tax Code of 1997, which provides that "No gain or loss shall be recognized if property is transferred to a corporation by a person in exchange for stock in such corporation of which as a result of such exchange, said person, alone or together with others, not exceeding four persons, gains control of said corporation : . . ." Section 40(C)(6)(2) of the Tax Code of 1997, defines "control" as follows : "The term "control" when used in this section shall mean ownership of stocks in a corporation possessing at least fifty-one percent of the total voting power of all classes of stock entitled to vote." cdll This Office had consistently ruled that additional transfers of property already controlled by the transferor will qualify as tax-free exchange under then Section 34(c)(2) of the Tax Code, as amended [now Section 40(C)(2) of the Tax Code of 1997] (BIR Ruling No. 018-94 dated January 13, 1994; No. 003-94 dated January 6, 1994) Under BIR Ruling No. UN-202-95 dated May 31, 1994, this Office has ruled that where a company which is a resident of Japan, and which pursuant to its policy decision to centralize in its wholly-owned subsidiary corporation incorporated and resident of Singapore, had exchanged all its shares in a Philippine company for shares in the company in Singapore, and still retained 100% ownership in the latter, the same is exempt from capital gains tax prescribed under then Section 34(c)(2) of the Tax Code since there is no effective transfer of beneficial ownership. 2. On the transfer by the Head Office to BFS, the basis of the Far East shares in the hands of BFS shall be the same as their basis in the hands of the Head Office ; and the basis of the BFS shares received by the Head Office shall be the same as the basis of the Far East shares it transferred. 3. On the transfer by BFS to SUN, the basis of the Far East shares in the hands of SUN shall be the same as their basis in the hands of BFS; and the basis of SUN shares in the hands of BFS shall be the same as its basis in Far East shares transferred. 4. The Deeds of Assignment covering the transfer by the Head Office of the Far East shares to BFS; and the transfer by BFS of the Far East shares to SUN are subject to the documentary stamp tax imposed by Section 176 of the Tax Code of 1997. d. Furthermore, since the transfers were primarily for business considerations, for which no donative intent can be attributed to the transferors, the same shall not be subject to the donor's tax. 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. llcd Very truly yours, (SGD.) LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue