BIR Ruling [DA-222-05]

May 9, 2005 BIR RULING [DA-222-05] DA-419-2004 Aranas Consunji & Barleta Law Office Unit 106 G/F Le Metropole Tordesillas Cor. Dela Costa Salcedo Village, Makati City Attention: Atty. Jesus Clint O. Aranas Partner Gentlemen : This refers to your letter dated April 19, 2005 requesting, on behalf of HLI HOLDINGS INC. (HLIH for brevity) for a clarificatory as to the tax consequences on the condonation of HLI Berhad (Malaysia) (HLIB for brevity) of the obligation of HLIH. It is represented that HLI Holdings Inc. (HLIH) is a holding company with principal address at 20/F LKG Tower, Ayala Avenue, Makati City, duly organized and existing under and by virtue of Philippine laws; that HLIH wholly owned subsidiary of HLI Berhad (Malaysia) (HLIB), a corporation organized under the laws of Malaysia; that for taxable year ended June 30, 2004, HLIH has reflected a capital deficit position to the extent of P908,392,533; that this is due to the financial difficulties suffered by HLIH; that considering that the liabilities have remained unpaid, HLIB has lost interest in collecting its loan from its subsidiary and intends to condone the amount of P928.8 million, more or less, out of the total liabilities of HLIH; and that after the proposed condonation, HLIH will still be in a capital deficit position as reflected in the attached Pro Forma Financial Statements. The Audited Financial Statements of HLIH reflects that the company continually sustained the following business downturn summarized as follows: FY2003 FY2004 Net losses 66,906,828 57,313,143 Capital deficiency 851,079,390 908,392,533 The unaudited Balance Sheet of HLIH as of March 31, 2005 is as follows: Total Assets 116,368 Total Liabilities 1,003,813,811 Due To Stockholders 1,001,896,853 Total Stockholders Equity (1,003,697,443) and that HLIB has already indicated its intention to partly cancel the above obligation in the amount of P928.8 million, more or less, and shows no further interest in collecting the said loan. In reply, please be informed that in BIR Ruling No. DA-419-04 dated August 4, 2004, this Office had occasion to rule 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 considering that the amount to be condoned would only be P84,198,555.20. Moreover, the condonation is likewise not subject to gift tax since there is no donative intent on the part of SJ but solely for business consideration." The above ruling was issued by the BIR on the basis of the discussions stated in BIR Ruling No. 076-89 dated April 17, 1989 which states as follows: "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. (Sec. 50 Revenue Regulations No. 2) 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 efficiency position. 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." Thus, the condonation of the HLIH's debt to HLIB shall not be subject to income tax considering that HLIH is in a capital deficiency position and will remain insolvent before and after the said condonation. Moreover, the said condonation is likewise not subject to gift tax since there is no donative intent on the part of HLIB but is solely for business considerations. ISTHED This ruling is being issued on the basis of the foregoing as represented. However, if upon investigation, it will be ascertained that the facts are different, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group