BIR Ruling [DA-236-05]

May 31, 2005 BIR RULING [DA-236-05] 24 (C); DA-117-89 SGV & Co. 6760 Ayala Avenue 1226 Makati City Attention: Atty. Luis Ferrer Gentlemen : This refers to your letter dated October 7, 2004 requesting, in behalf of your client FMF Development Corporation (FMF),for a confirmation of your opinion that: 1. Pursuant to Section 24(C) of the 1997 Tax Code, a final tax of 5% or 10% on the net capital gains is imposed on the sale of FMF shares by the individual stockholders. In addition, a documentary stamp tax (DST) of P0.75 is due for every P200 of the par value of the stocks sold based on Section 175 of the 1997 Tax Code, as amended by Republic Act No. 9243; 2. Pursuant to BIR Ruling No. 117-89 dated June 5, 1989 and Pangilinan et al. v. Commissioner of Internal Revenue (CTA Case No. 4826 dated August 23, 1994),the Cost Method of Accounting should be applied, for tax purposes, in determining the book value per share for the acquisition of FMF shares; 3. Under the Cost Method of Accounting, the computation of the book value per share of FMF should exclude the following items: a. Share of FMF in the investments of its subsidiaries and an associate, namely: (1) Reserve for fluctuation in investments in shares of stock; (2) Revaluation increment in property; (3) Reserve for fluctuation in foreign exchange; and (4) Cumulative translation adjustment; and b. A portion of the unappropriated retained earnings computed as: (1) Accumulated equity in net earnings; and (2) Share in Net Assets of Ben-PNB 4. Accordingly, using the Cost Method of Accounting, the book value per share of FMF is computed at P4.60, as follows: Total Stockholder's Equity P1,158,965,535.00 Less: Share in a subsidiary's Reserve for fluctuation in investments in shares of a subsidiary P(7,183,845) Revaluation increment in property of a subsidiary 19,422,006 Reserve for fluctuation in foreign exchange of a subsidiary 9,352,198 Cumulative translation adjustment of subsidiaries 28,392,169 49,982,528.00 Unappropriated retained earnings Accumulated equity in net earnings 541,562,168 Share in net assets of Ben-PNB 245,138,487 786,700,655.00 Balance P322,282,352.0.0 No. of Shares Outstanding 70,000,000.00 Book Value per Share P4.60 It is represented that FMF, a domestic corporation, was established to own, invest or manage properties such as buildings or other structures and shares of stock and other types of securities (Note 1, Notes to Parent Company Financial Statements, Parent Company Financial Statements, December 31, 2002 and 2003);that its shares are not traded or listed in the stock exchange; that FMF has investments in the shares of stock of Future Capital Enterprises Limited (Future Capital),Beneficial-PNB Life Insurance Company, Inc. (Ben-PNB) and Philippine Koyo Bearing Corporation (PKBC),which are accounted for under the Equity Method of Accounting, with the following percentages of ownership (Note 5, Notes to Parent Company Financial Statements, December 31, 2002 and 2003): EaTCSA Percentage of Ownership Future Capital Enterprises Limited 100% Beneficial-PNB Life Insurance Company, Inc. 51% Philippine Koyo Bearing Corporation 30% that since FMF employs the Equity Method of Accounting for its investments in subsidiaries and an associate for financial reporting purposes, these investments are carried in the parent company balance sheet at cost plus post-acquisition changes in FMF's share in the net assets of the investees, less impairment in value (Note 2, Notes to Parent Company Financial statements, December 31, 2002 and 2003; that for calendar year 2003, FMF's financial statements show the current composition of the company's stockholder's equity: Stockholder's Equity Capital stock P70,000,000 Additional paid-in capital 45,680,725 Share in a subsidiary's: Reserve for fluctuation in investments in shares of stock (7,183,845) Revaluation increment in property 19,422,006 Reserve for fluctuation in foreign exchange 9,352,198 Cumulative translation adjustment 28,392,169 49,982,528 Retained earnings Appropriated for capital development projects 102,500,000 Unappropriated 890,802,282 Total Stockholder's Equity 1,158,965,535 that in addition, a portion of the company's unappropriated retained earnings in the amount of P890,802,282 consists of the following items: Unappropriated retained earnings Accumulated equity in net earnings P541,562,168 Share in net assets of Ben-PNB 245,138,487 P786,700,655 that the amount of P786,700,655 represents retained earnings not currently available for distribution as dividends until actually received by FMF; that the amount consists of FMF's share in undistributed earnings of the subsidiaries and an associate accounted for under the Equity Method and the increase in net assets of Ben-PNB, a subsidiary; that the increase in the net assets of Ben-PNB is FMF's unrealized income from the increase in the value of its investments in Ben-PNB resulting from PNB's acquisition of Benlife shares at a premium (Note 5, Notes to Parent Company Financial Statements, Parent Company Financial Statements, December 31, 2002 and 2003);that at present, FMF plans to reacquire its outstanding shares from its shareholders, who are individual investors scattered all over the country and that upon acquisition from the individual shareholders, the shares shall be booked by FMF as treasury shares. EDCIcH In reply, please be informed that in computing the book value per share, the stockholder's equity must first be determined. Generally, the elements constituting stockholder's equity are: 1. Capital Stock 2. Subscribed capital stock 3. Additional paid in capital 4. Retained earnings 5. Treasury stock (if there is any, the same should be deducted from the subscribed capital stock.) In the case of Pangilinan, et al. vs. Commissioner of Internal Revenue ,CTA Case No. 4826, August 23, 1994, it was ruled that the equity method of accounting is employed in the preparation of financial statements in accordance with the generally accepted accounting principles. However, it does not necessarily follow that in determining the book value, the same should be applied. They do not accurately reflect the retained earnings and the book value of shares because the same includes the share in the net earnings of its subsidiary. In BIR Ruling No. 117-89 dated June 5, 1989, it was ruled that the accumulated and current equity in the investees net earnings and the share in revaluation increments are not considered as income and should not therefore be included in the determination of the book value of the shares. Hence, considering that FMF uses the equity method of accounting for financial reporting, the total stockholders equity will not be correctly determined if the investments in its subsidiaries will not be deducted therein. Therefore, FMF's share in its subsidiary, viz : Share in a subsidiary: Reserve for fluctuation in investments in shares of stock of a subsidiary P(7,183,845) Revaluation increment in property of a subsidiary 19,422,006 Reserve for fluctuation in foreign exchange of a subsidiary 9,352,198 Cumulative translation adjustment of subsidiaries 28,392,169 49,982,528 Unappropriated retained earnings Accumulated equity in net earnings 541,562,168 Share in net assets of Ben-PNB 245,138,487 786,700,655 P836,683,183 ========== in the amount of P836,683,183 should be deducted from P1,158,965,535.00 in order to determine the correct balance of stockholders equity, which is P322,282,352.00. The next step is to determine the total issued and outstanding shares of stock which is 70,000,000. Then divide the balance of stockholders' equity by the total issued and outstanding shares of stock, viz : Stockholders equity 322,282,352.00 Total issued and outstanding shares 70,000,000 = Book Value per Share P4.60 ============== Accordingly, under the cost method of accounting, this Office is of the opinion as it hereby holds that the book value per share in the instant case is P4.60. Likewise, pursuant to Section 24(C) of the 1997 Tax Code, a final tax of 5% or 10% on the net capital gains is imposed on the sale of FMF shares by the individual stockholders. In addition, a documentary stamp tax (DST) of P0.75 is due for every P200 of the par value of the stocks sold based on Section 175 of the 1997 Tax Code, as amended by Republic Act No. 9243; 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, Commissioner of Internal Revenue By: (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group