BIR Ruling [DA-244-05]

June 7, 2005 BIR RULING [DA-244-05] 40 (C) (2) & (3); 115-98 National Home Mortgage and Finance Corporation Filomena Building III Amorsolo St., Legaspi Village Makati City Attention: Mr. Celso delos Angeles President Gentlemen : This refers to your letters dated 14 December 2004 and 18 May 2005 requesting for our confirmation that no gain or loss shall be recognized by the National Home Mortgage Finance Corporation (NHMFC) upon the transfer of its mortgage loan receivables in favor of the BALIKATAN HOUSING, INC. (the "Corporation") in exchange for the latter's shares of stock and other debt instruments under Section 40(C)(2) of the Tax Code. It is represented that the NHMFC is a corporation created by virtue of Presidential Decree No. 1267 (1977); that among its objectives are to: (a) develop and provide for a secondary market for home mortgages granted by public and/or private home financing institutions [Pres. Decree No. 1267 (1977)]; (b) act as the major government home mortgage institution [Exec. Order No. 90 (1986)]; and (c) develop and provide a secondary mortgage market to finance mortgage take and fast track the disposition of existing mortgages [Exec. Order No. 195 (1999)]; that in line with its objectives, NHMFC provided financing for various low-cost housing projects and took over the various loan mortgage accounts of the buyers of houses and lots and that over the years, many of these loan mortgage accounts defaulted and NHMFC began to accumulate a portfolio of non-performing loans ("NPLs"); that in order to liquefy some fifty-five thousand (55,000) of its highly delinquent NPLs, NHMFC obtained approval from the Office of the President of the Philippines to incorporate the Corporation as a vehicle for holding on to the NPLs and to serve as an eventual entry point for other investors; that in light of the Presidential approval, the Corporation was incorporated with the Securities and Exchange Commission with an authorized capital stock of Two Hundred Million Pesos (P200,000,000.00) divided into Two Hundred Thousand (200,000) common shares with a par value of One Hundred Pesos (P100.00) per share and One Hundred Eighty Thousand (180,000) redeemable preferred shares with a par value of (P1,000.00) per share; that out of the Corporation's authorized capital stock of Two Hundred Million Pesos (P200,000,000.00), Forty-Nine Thousand (49,000) common shares with a par value of Four Million Nine Hundred Thousand Pesos (P4,900,000.00) and Fifty-Eight Thousand (58,000) redeemable preferred shares with a par value of Fifty-Eight Million Pesos (P58,000,000.00) have been subscribed and fully paid by NHMFC; that in full payment of its subscription, NHMFC executed a Deed of Assignment dated 13 December 2004 assigning the NPLs with an aggregate book value of approximately Thirteen Billion Four Hundred Fifty Three Million Eight Hundred Six Thousand Five Hundred Sixty Two Pesos and Sixty Centavos (P13,453,806,562.60) (hereinafter referred to as the "Receivables") at an aggregate transfer value of Five Billion One Hundred Twenty-Three Million Two Hundred Nine Thousand Five Hundred Thirty-Nine Pesos and Five Centavos (P5,123,209,539.05) in favor of the Corporation. On 18 May 2005, NHMFC and the Corporation executed an Amended Deed of Assignment of Receivables to reflect mathematical adjustments made with respect to the number and value of the mortgage loan receivables resulting in a reduction of the book value of the receivables from P13,453,806,562.60 to P12,837,966,661.00 and an increase in the transfer value of such mortgage loan receivables to PhP5,172,936,190.00 instead of PhP5,123,209,539.05. Thus, pursuant to the Deed of Assignment of Receivables dated as of 13 December 2004 and following the execution of the Amendment to Deed of Assignment of Receivables dated as of 18 May 2005, the Corporation issued the following equity and debt instruments in favor of NHMFC in exchange for the Receivables: a. Equity Type of Stock No. of Shares Par Value per Paid-in Premium share Preferred 58,000 1,000.00 P58,000,000.00 P688,450,747.55 Common 49,000 100.00 4,900,000.00 0 Total 107,000 P62,900,000.00 P688,450,747.55 b. Debt Instrument Issue Value Senior Debt Instruments + Additional Senior Debt Instruments 3,103,761,714.00 Series "A" Subordinated Debt Instrument + Additional Series "A" 1,055,278,982.76 Subordinated Debt Instrument Series "B" Subordinated Debt Instrument + Additional Series "B" 262,544,745.69 Subordinated Debt Instrument Total 4,421,585,442.45 After the transfer by the NHMFC of the Receivables in exchange for the above-described equity and debt instruments, the outstanding capital stock of the Corporation is as follows: Name of Shareholder No. of Par Value Amount Premium Voting Shares Per share Paid-Up Power Preferred Shares National Home 58,000 1,000.00 P58,000,000.00 P688,450,747.55 - Mortgage and Finance Corporation Common Shares National Home 48,995 100.00 P4,899,500.00 0 100% Mortgage and Finance Corporation 1 100.00 100.00 0 - 1 100.00 100.00 0 - 1 100.00 100.00 0 - 1 100.00 100.00 0 - 1 100.00 100.00 0 Total Common 49,000 4,900,000.00 0 100% Grand Total 107,000 P62,900,000.00 P688,450,747.55 100% That as a result of the above-described transfer, NHMFC gained control of the Corporation; that based on the above-mentioned transactions, you requested our confirmation of your opinion that: "1. No gain or loss shall be recognized on the transfer by the NHMFC of the Receivables to the Corporation in exchange for 100% of the outstanding voting stock of the Corporation, pursuant to Section 40(C)(2) and (C)(6) of the Tax Code; "2. The basis of the shares of stock or debt instruments NHMFC acquired in the exchange shall be the same as the original acquisition cost or adjusted cost basis to NHMFC of the Receivables exchanged therefor; and the cost basis to the Corporation of the Receivables exchanged for stocks shall be the same as it would be in the hands of NHMFC, pursuant to Section 40(C)(5)(a) and (b) of the Tax Code; "3. The transfer of the Receivables by NHMFC to the Corporation will not be subject to value-added tax (VAT); "4. The transfer of the Receivables by NHMFC to the Corporation in exchange for shares of stock and debt instruments shall not be subject to donor's tax; "5. The transfer by NHMFC to the Corporation of the Receivables is exempt from DST pursuant to Section 199(m) of the Tax Code, as amended by Republic Act No. 9243; "6. The issuance of shares by the Corporation to NHMFC in exchange of the Receivables will be subject to the DST imposed under Section 174 of the Tax Code, as amended by Republic Act No. 9243; and "7. The issuance of the debt instruments by the Corporation to NHMFC in exchange for the Receivables will be subject to the DST imposed under Section 179 of the Tax Code, as amended by Republic Act No. 9243. However, no DST shall be due on the subsequent assignment, transfer, or amendment thereof provided there is no increase in the amount or change in the maturity date from that of the original instrument pursuant to Section 199(f) of the Tax Code." and that in support of your request, you submitted to this office copies of the following documents: (1) BIR Form No. 0605 evidencing payment of the filing fees; (2) Deed of Assignment of the Receivables executed by and between NHMFC and the Corporation dated 13 December 2004; (3) Amended Deed of Assignment of Receivables executed by and between NHMFC and the Corporation dated 18 May 2005; (4) certified list of the Receivables to be transferred; (5) A certification as to the original or historical cost or acquisition/adjusted cost basis of the Receivables; (6) Articles of Incorporation and By-Laws of the Corporation as filed with the Securities and Exchange Commission; and (7) Audited Financial Statements of NHMFC as of December 31, 2003. In reply, please be informed that pursuant to Section 40(C)(2) and (6)(c) of the Tax Code of 1997, no gain or loss shall be recognized if property is transferred to a corporation by a person, in exchange for stock in such a 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. The term "control" shall mean ownership of stocks in a corporation possessing at least 51% of the total voting power of all classes of stocks entitled to vote. Control is determined by the amount of stocks received i.e., total subscribed, whether for property or for services by the transferors. In determining the 51% stock ownership, only those persons who transferred property for stocks in the same transaction may be counted up to a maximum of five. Section 40(C)(3)(a) of the 1997 Tax Code further states that if, in connection with the above-described exchange, an individual, a shareholder, security holder or corporation receives not only stock or securities permitted to be received without recognition of gain or loss, but also money and/or other property, the gain, if any, but not the loss, shall be recognized but in an amount not in excess of the sum of the money and the fair market value of such other property received. Pursuant to Section 40(A) of the same Tax Code, the gain 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. In an assignment of receivables, the gain shall be the excess of the amount realized therefrom over the cost or adjusted cost of the receivables and the loss to be recognized by the transferee from the assignment of receivables shall be the excess of the cost or adjusted cost of the receivables over the amount realized. The amount to be realized from the assignment of receivables is determined by considering the selling/transfer price of the receivables shall be the fair market value of the property received in exchange therefor and not the fair market value of the receivables transferred. (BIR Ruling No. 15-98 dated July 28, 1998) Accordingly, no gain or loss shall be recognized both to the transferors and the transferee corporation on the transfer by NHMFC of the Receivables in exchange for the common shares, redeemable preferred shares of stock and debt instruments issued by the transferee corporation, considering that as a consequence of the exchange, the transferor will gain control of the transferee corporation by owning 100% of its total voting stocks. Notwithstanding acceptance by NHMC of property consisting of debt instruments other than shares of stock to be issued by the Corporation in exchange for the Receivables, NHMFC will not realize any gains by virtue of the transaction since NHMFC will be transferring property consisting of the Receivables with a book value of approximately P12,837,966,661.00 in exchange for shares of stock and debt instruments with an aggregate par value of only P4,484,485,442.45. It should be emphasized, however, that Section 40(C)(2) and (6)(c) of the 1997 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 NHMFC later sells or exchanges the shares of stock or debt instruments it acquired 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 and debt instruments shall be the same as the original acquisition cost or adjusted cost basis to the NHMFC of the Receivables exchanged therefor, and that the cost basis to Balikatan of the Receivables exchanged for stocks and the debt instruments shall be the same as it would be in the hands of NHMFC. (Section 40(C)(5)(a) and (b) of the Tax Code) 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 40(C)(2) and (6)(c) of the Tax Code of 1997, 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, 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 or other properties 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 the 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 and other property 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. Furthermore, your opinion on the following are likewise hereby confirmed: (1) Pursuant to Section 4.100-5(b)(1) of Revenue Regulations No. 7-95, as amended, a change of control of a corporation by the acquisition of the controlling interest of such corporation by another stockholder or group of stockholders shall not be subject to output tax. Example: transfer of property to a corporation in exchange for its shares of stock under Section 40(C)(2) and (6)(c) of the 1997 Tax Code. Consequently, the transfer of the Receivables by NHMFC to Balikatan will not be subject to value added tax; (2) The transfer of the Receivables by NHMFC to Balikatan in exchange for common shares, redeemable preferred shares, and debt instruments shall not be subject to donor's tax since there is no donative intent involved in the transfer. (BIR Ruling No. 224-93 dated May 18, 1993) (3) The certificates of stocks to be issued by Balikatan are subject to the documentary stamp tax at the rate of P1.00 for every P200.00, or a fractional part thereof, of the par value of the shares issued pursuant to Section 174 of the Tax Code, as amended by Republic Act No. 9243, which shall attach upon issuance by the SEC of Balikatan's Certificate of Incorporation. (4) The documentary stamp tax due on the issuance of the Senior Debt Instrument, Series "A" Subordinated Debt Instrument, Series "B" Subordinated Debt Instrument and the Additional Senior and Subordinated Debt Instruments by Balikatan shall be subject to P1.00 for every P200.00, or a fractional part thereof, of the issue value of the debt instruments pursuant to Section 179 of the Tax Code, as amended by Republic Act No. 9243. However, the subsequent assignment, transfer or amendment of such debt instruments by NHMFC shall not be subject to DST provided that there is no increase in the amount or change in the maturity date from that of the original instrument pursuant to Section 199(f) of the Tax Code of 1997, as amended by Republic Act No. 9243. ADTCaI This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be ascertained that the facts are different and/or any of the requirements imposed in this letter is not complied with, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service