BIR Ruling [DA-222-96]

July 3, 1996 BIR RULING [DA-222-96] Sycip Gorres Velayo & Co. 6760 Ayala Avenue, Makati City Attention: Atty . E . C . Alcantara Tax Division Gentlemen : This refers to your letter dated May 20, 1996 stating that Guoco Holdings (Philippines) Inc. (formerly Philippine Orion Properties, Inc.; hereinafter referred to as GHPI), a corporation duly organized and existing under and by virtue of the laws of the Philippines, with principal office at 17th Floor, BA-Lepanto Bldg., 8747 Paseo de Roxas Avenue, Makati City, is an investment holding company with interests in real estate and property development, manufacturing and distribution, financial services and infrastructure and utilities; that Guoco Land (Philippines) Inc. (formerly First Lepanto Corporation; hereinafter referred to as GLPI), a corporation duly organized and existing under and by virtue of the laws of the Philippines with principal place of business at 17th Floor, BA-Lepanto Bldg., 8747 Paseo de Roxas Avenue, Makati City, 74.62% of the outstanding capital stock of which is owned by GHPI, is engaged in the business of real estate development; that GLPI has investments in the following companies (SUBSIDIARIES): Subsidiary Percentage No. of Shares Total Par Book/Net Historical/ of Ownership subscribed Value Asset Value Acquisition Cost 1. Tutuban 100% 200,000,000 P200,000,000 P421,708.000 P572,125.696 Properties, Inc. 2. Mandaue Realty & Resources Corp. 30% 150,000,000 P150,000,000 P154,486,000 P153,339,578 3. Guoco Property Dev't. Inc. 100% 214,000,000 P214,000,000 P214,748,000 P219,550,737 4. Manila South-Coast Dev't. Corporation 40% 180,000,000 P180,000,000 P220,762,000 P220,761,881 5. Luck Hock Venture Holdings, Inc. 20% 25,000 P25,000 P4,734,000 P25,000 6. First Lepanto Realty, Inc. 100% 500,000 P500,000 P549,000 P500,000 7. First Lepanto Ceramic Wares, Inc. 100% 500,000 P500,000 P535,000 P500,000 TOTAL: 745,025,000 P745,025,000 P1,017,522,000 P1,166,802,892 that of the above investments, the following shares of stock were previously acquired by GLPI from GHPI pursuant to a "tax-free exchange" under Section 34 (c)(2) and (6)(c) of the Tax Code, as amended. (BIR Ruling No. S-34-145-94 dated June 20, 1994). No. of Historical Shares Cost 1. Tutuban Properties, Inc. 100,000,000 P320,372,500 2. Mandaue Realty and Resources Corporation 75,000,000 P75,000,000 3. Guoco Property Development, Inc. 214,000,000 P213,578,901 TOTAL: P608,951,401 =========== that ORION LAND, INC. (OLI), a corporation organized and existing under the laws of the Philippines with principal office address at 17th Floor, BA-Lepanto Bldg., Paseo de Roxas Avenue, Makati City, whose total outstanding capital stock is owned by GHPI, is a real estate company; that as part of the re-alignment of the investment of GHPI in its subsidiaries (i.e., GLPI and OLI), these three companies will execute a Deed of Assignment of shares of stock; that under the Deed of Assignment, GLPI will assign, transfer and convey to GHPI its aforesaid investments in the said SUBSIDIARIES in consideration of the total amount of P1,017,522,000.00 payable as follows: 1. Cash P267,522,000.00 2. 120,000,000 shares of stock (original issue) of GHPI valued at P6.25 per share 750,000,000.00 TOTAL: P1,017,522,000.00 ============== that although the issued and outstanding stock of GHPI are listed and traded through the stock exchange, the 120,000,000 GHPI shares to be issued to GLPI will come from the unsubscribed portion of its authorized capital stock; that this transaction is in the nature of a block at a price which is negotiated outside of the local stock exchange; that in determining the selling price in this case, the par value, net asset value, and market price of the GHPI shares of stock as well as other business reasons, were taken into consideration; that the amount of P6.25 per share should be considered as the fair market value of the (120,000,000) shares, regardless of the trading value of the listed shares of GHPI on closing date of the transaction; that this agreed price/fair value is higher than its par value of P1.00 per share and book value of P1.65 per share as of March 31, 1996, that the market price of GHPI shares fluctuated from about P3.00 in October 1995 to about P6.50 in April 1996; that the market price for most of the period from October 1995 to April 1996 was P5.00; that immediately after the said transaction, GHPI will transfer the shares of stock in the SUBSIDIARIES, with a book/net asset value of P1,017,522,000.00 to OLI as partial payment of its additional subscription to OLI's shares of stock amounting to P1,130,580,000.00; that after the transfer GHPI will own 100% of the outstanding capital stock of OLI; and that the corresponding certificate of stocks will be issued by the SUBSIDIARIES directly in the name of OLI upon full payment of its subscription. In connection therewith, you are requesting confirmation of your opinion that "1. The net capital gains/losses to be realized by GLPI from the disposition of its shares of stock in the SUBSIDIARIES to GHPI shall be computed by considering that the selling/transfer price thereof shall be the amount of money received plus the fair market value of the P120,000,000 GHPI shares received in exchange; "2. The fair market value of the said 12,000,000 GHPI shares shall be based on the price agreed upon by the parties to the transaction of P6.25 per share, which is higher than the book value thereof amounting to P1.65 per share as of 31 March 1996, regardless of the trading value of the GHPI shares which are listed and traded through the stock exchange; "3. The cost basis of the shares of stock disposed of or conveyed by GLPI to GHPI shall be based on the historical cost of the shares of stock acquired under a "tax-free" exchange under Section 34 (c)(2) of the Tax Code, as amended, and the actual purchase price of the shares of stock which were originally acquired by GLPI from the SUBSIDIARIES, plus all cost of acquisitions, such as, commissions, documentary stamp tax, transfer fees, etc.; "4. The transfer by GHPI of its shares of stock in the above SUBSIDIARIES to OLI qualifies as a "tax-free" exchange under Section 34 (c)(2) of the Tax Code, as amended; and that "5. There will be only one documentary stamp tax due on the subsequent transfer of the shares of stock in the SUBSIDIARIES from GLPI directly to OLI as part of the reorganization/restructuring of certain businesses and assets of the aforenamed companies." In reply thereto, please be informed as follows: (1) Your opinion to the effect that the net capital gains/losses to be realized by GLPI from the disposition of its shares of stock in the SUBSIDIARIES to GHPI shall be computed by considering that the selling/transfer price thereof shall be the amount of money received plus the fair market value of the 120,000,000 GHPI shares received in exchange in hereby confirmed. (Sec. 34 (a) Tax Code, as amended) [BIR Ruling No. 143-95 dated September 14, 1995] (2) Pursuant to then Section 35 (a) [now Section 34 (a)] of the Tax Code, as amended, the gain (tax base) from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis or adjusted basis for determining gain and the loss shall be the excess of the basis or adjusted basis for determining loss over the amount realized. The amount realized from the sale or other disposition of property shall be the sum of money received plus the fair market value of the property (other than money) received . (As amended by E.O. No. 37) For purposes of determining the selling price in the case of sale, transfer or exchange of shares not listed in the stock exchange, the same shall be valued at their book value nearest the valuation date. The book value of the unlisted shares of stock shall be prima facie considered as their fair market value. However, if there have been previous bonafide sales/exchanges of the unlisted shares of stock, the price at which these shares exchanged hands should be taken/considered as its fair market value (Sec. 6 (a)(3), Revenue Regulations No 2-82). Moreover, under Section 6 (b) of Revenue Regulations No. 2-82, the cost basis for determining the capital gains or losses shall be the basis as determined in accordance with the provisions of Section 35 (now Section 34) of the Tax Code, as amended, and its implementing regulations applied in the following manner: 1. If the stocks can be identified, then the cost shall be the actual purchase price plus all costs of acquisition such as commission, documentary stamp tax, transfer fees, etc. 2. If the stocks cannot be properly identified, then the cost to be assigned shall be computed on the basis of the first-in, first-out (FIFO) method. However, 3. If books of accounts are maintained by the seller where every transaction of a particular stocks is recorded, then the moving average method shall be applied rather than the first-in, first-out (FIFO) method. 4. In all cases, stock dividend received must be assigned a corresponding cost by allocating the original cost of acquisition to the total number of shares composed of the original shareholdings plus the number of shares of stock received as stock dividend. In other words, the gain or loss from a sale or other disposition of property is measured by the difference between the amount realized and the adjusted basis of the property disposed of (par. 1703, p. 425, Chap. 17, (1989) U.S. Master Tax Guide). Such being the case, if as represented, the fair market value of the said 120,000,000 GHPI shares of stock that are not traded and listed in the stock exchange is based on a fair value of P6.25 per share as agreed upon by the parties to the transaction which is higher than the book value thereof amounting to P1.65 per share as of March 31, 1996, regardless of the trading value of portions of GHPI shares which are listed and traded through the stock exchange, then the difference between the selling price of a total of P1,017,522,000.00 and the original acquisition cost or adjusted cost basis of the GLPI shares shall constitute the net capital gain subject to the 10% 20% capital gains tax imposed under Section 24 (e)(2)(A) of the Tax Code, as amended (BIR Ruling No. 046-90 dated March 29, 1990; BIR Ruling No. 143-95 dated September 14, 1995). (3) The cost basis of the shares of stock disposed of or conveyed by GLPI to GHPI shall be based on the historical cost of the shares of stock acquired by the former as a result of a "tax-free" exchange under Section 34 (c)(2) and (6)(c) of the Tax Code, as amended (BIR Ruling No. S-34-145-94 dated June 20, 1994) which shall be the same historical/acquisition cost of the shares from GHPI, the transferor. (4) Your opinion that the transfer by GHPI of its shares of stock in the abovementioned SUBSIDIARIES to OLI in exchange for OLI's shares of stock qualifies as a "tax-free" exchange under Section 34 (c)(2) and (6)(c) of the Tax Code, considering that after the transfer GHPI will own 100% of the outstanding capital stock of OLI is hereby confirmed. It should be emphasized, however, that Section 34 (c)(2) and (6)(c) of the Tax Code merely defers recognition of the gain or loss from such transaction, for in determining the gain or loss from a subsequent transaction of the properties or of the stocks involved in the exchange, the original or historical cost of the properties or stocks is considered. Thus, if the transferor later sells or exchanges the shares of stock acquired by it in the exchange, it shall be subject to income tax on gains derived from such sale or exchange, taking into consideration that the cost basis of the shares shall be the same as the original acquisition cost or adjusted cost basis to the transferor of the properties (shares) exchanged therefor; and that the cost basis to the transferee of the properties (shares) exchanged for stocks shall be the same as it would be in the hands of the transferor. (Section 34 (c)(5)(a) and (b) of the Tax Code, as amended by Presidential Decree No. 1773). In this connection, you are further advised that in order that the parties to the exchange can avail of the non-recognition of gains provided for in Section 34 (c)(2) and (6)(c) of the Tax Code, as amended, they should comply with the requirements hereunder mentioned: a. The transferor must file with its income tax return for the taxable year in which the exchange transaction was consummated, a complete statement of all facts pertinent to the exchange, including: 1. A description of the properties transferred, or of its interest in such properties, together with a statement of the original acquisition cost/adjusted cost basis or other basis thereof at the time of the transfer; 2. The kind of stocks received and preferences, if any; 3. The number of shares of each class received, and 4. The fair market value per share of each class at the date of the exchange. b. On the other hand, the transferee corporation must file with its income tax return for the taxable year in which the exchange was consummated the following: 1. A complete description of all properties received from the transferor; 2. A statement of the original acquisition cost or other basis of the properties in the hands of the transferor and the adjusted cost basis thereof at the time of the transfer; and 3. Information with respect to the capital stock of the corporation including: a. The total issued and outstanding capital stock immediately prior to and immediately after the exchange with a complete description of each class of stock; b. The classes of stocks and number of shares issued to the transferor in the exchange; and c. The fair market value as of the date of the exchange of the capital stock issued to the transferor. In addition to the foregoing requirements, permanent records in substantial form must be kept by the taxpayers participating in the exchange, showing the information listed above in order to facilitate the determination of gain or loss from a subsequent disposition of stocks/properties received in the exchange. The parties shall also cause to be annotated at the back of the Certificate of Stocks, the date the deed of exchange was executed, the original or historical cost of acquisition of the shares of stock involved, and the fact that no gain or loss was recognized as a result of such exchange. Finally, the certificate of stocks to be issued by OLI are, in all probability original issues, which are subject to the documentary stamp tax imposed by Section 175 of the Tax Code, as amended. (5) Since there are two transactions involved in this case, i.e., (1) the transfer by GLPI of its investments in the SUBSIDIARIES to GHPI in exchange for cash of P267,522,000 and 120,000,000 shares of stock (original issue) of GHPI; and (2) the transfer by GHPI of its shares of stock in the subsidiaries with book/net asset value of P1,017,522,000 as partial payment of its additional subscription of OLI's shares amounting to P1,130,580,000 under Section 34 (c)(2) and (6)(c) of the Tax Code, as amended, the two Deeds of Assignments shall be subject to the documentary stamp tax respectively prescribed under Sections 176 and 175 of the Tax Code, as amended. (BIR Ruling No. 071-92 dated February 27, 1992). cdll Very truly yours, ALICIA P. CLEMENO Assistant Commissioner (Legal Service)