BIR Ruling [DA-178-96]

May 24, 1996 BIR RULING [DA-178-96] Polines & Caguioa Law Offices 2003 Cityland 10, Tower 1 6815 Ayala Avenue Makati City Attention: Atty. Jonathan M. Polines Gentlemen : This refers to your letter dated April 25, 1996 requesting for a ruling as to whether or not your client Acoje Mining Company, Inc. (AMC) can consider its capital deficiency as reflected in its audited financial statements eliminated and/or substantially reduced as a result of the condonation made and effected by its principal creditor, Minimax Mineral Exploration Corporation (Minimax) of AMC's indebtedness to Minimax. It is represented that AMC is a domestic mining corporation organized under Philippine laws; that it is a publicly listed company in the Philippine Stock Exchange (PSE); that AMC is 84.82% owned by Minimax and the balance of 15.18% is owned by the buying public; that by reason of business reverses, AMC in 1987 applied with the Securities & Exchange Commission (SEC) for approval of suspension of payments to all its existing creditors including Minimax; that the SEC approved said request and accordingly suspended AMC's payments to its creditors; that to date, AMC has remained dormant and insolvent; that based on its latest audited financial statements as of December 31, 1995, AMC has an outstanding liability/indebtedness to Minimax in the amount of P334,744,960.99; that the capital deficiency of AMC amounts to P451,248,249.00; that Minimax is the biggest creditor of AMC having assumed most of the debts of AMC from various (other) creditors; that Minimax thru its Board of Directors for the purpose of giving AMC a "new lease on life" and in order that AMC can have a clean balance sheet to start with, passed a resolution condoning the debt of AMC in the amount of P334,744,960.00; and that this action of the Board was unanimously approved by the stockholders of Minimax. In reply thereto, please be informed that Section 50 of Revenue Regulations No. 2, otherwise known as the Income Tax Regulations, provides that "the cancellation and forgiveness of indebtedness may amount to a payment of income, to a gift, or to a capital transaction, dependent upon the circumstances. If for example, an individual performs services for a creditor who, in consideration thereof cancels the debt, income to that amount is realized by the debtor as compensation for his services. If, however, a creditor merely desires to benefit a debtor and without any consideration therefor cancels the debt, the amount of the debt is a gift from the creditor to the debtor and need not be included in the latter's gross income. If a corporation to which a stockholder is indebted forgives the debt, the transaction has the effect of the payment of a dividend." Thus, in BIR Ruling No. 076-89 dated April 17, 1989 involving similar set of facts, this Office ruled that the waiver of interest by the banks on non-trade and trade related indebtedness of a taxpayer 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 said taxpayer since it was in a financial loss position even without the deduction. 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. vs. CIR ; CTA Case No. 1407, December 29, 1966). However, a transaction whereby nothing of exchangeable value comes to or is received by a taxpayer does not give rise to nor create taxable income (Dallas Transfer & Terminal Warehouse vs. Commissioner of Internal Revenue , 5 Cir. 70 F 2d 95, 13 AFTR 930 ) . Accordingly, the condonation of AMC's indebtedness to Minimax is not subject to income tax since before and after the condonation AMC remains insolvent, that is, in its capital deficiency position. Likewise, the condonation is not subject to donor's tax since there is no donative intent on the part of Minimax but solely for business consideration in that its purpose is to give AMC a fresh start by having a "clean" balance sheet with minimal liabilities as much as possible. Finally, AMC's return to solvency, if ever, due to a possible future capital infusion by willing investors and/or subsequent profitability in a different taxable year will not affect the non-taxability of the condonation. 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.) ALICIA P. CLEMENO Assistant Commissioner (Legal Service)