BIR Ruling [DA-259-99]

April 29, 1999 BIR RULING [DA-259-99] Atty. Rene G. Baez 6th Floor, Ramon Cojuangco Building Makati Avenue, Makati City S i r : This refers to your letter dated February 15, 1999 requesting for a ruling that no gain or loss shall be recognized on the transfer of properties by Smart Communications, Inc. ("SMART") solely for the shares of stock of Philippine Long Distance Telephone Company ("PLDT") pursuant to a merger under Section 40(C)(2) and (6)(b ) of the Tax Code of 1997. cdtech It is represented that SMART is a domestic corporation duly organized and existing under the laws of the Philippines and duly licensed to operate an integrated telecommunications service in the Philippines pursuant to a legislative franchise under Republic Act No. 7294 which took effect on March 27, 1992; that PLDT is likewise a domestic corporation duly licensed to operate a telecommunications system in the Philippines by virtue of a legislative franchise issued on November 28, 1928 under Act No. 3436, as amended by Commonwealth Act No. 407 and further amended by Republic Act No. 6146 and Republic Act No. 7082; that pursuant to a corporate reorganization being implemented in PLDT and SMART and in order to achieve the following benefits in line with their common business purpose: 1. To maximize and enhance the use of resources by eliminating duplication of efforts, facilities and personnel relating to analogous activities and reducing overall business and administrative expenses; 2. To increase operating and administrative efficiencies and reduce capital expenditures and operating costs through the integration of telecommunications networks; 3. To enhance competitive position through improvement in services; 4. To expand financial strength, improve access to financing and credit facilities and reduce aggregate financing costs; 5. To be able to route increased long distance traffic on transmission networks, thus reducing utilization of facilities owned by third parties; 6. To intensify marketing of existing products and services; 7. To improve access to technological advances; 8. To improve quality of local exchange services through integration of fixed line operations; 9. To combine and share operating expertise in order to improve service levels and efficiencies; 10. To integrate service centers and business offices, reducing overhead expenses and offering subscribers a "one-stop shop" for all telecommunications requirements; 11. To be able to offer cellular subscribers a full range of cellular services to meet the demands of all types of cellular telephone users; and 12. To enable a broader, wider and more complete range of integrated telecommunication-related services to be offered to the public at a lower cost and thus better meet the increasing needs of the expanding Philippine economy. the two (2) companies shall enter into a de facto merger whereby most of the functions and operations of both companies shall be merged, namely, management finance and accounting, personnel, corporate and legal affairs, and operations, including the local exchange carriers (LEC), Mobile, International Gateway Facilities, (IGF), (POI)/Backbone, Information Technology, Domestic Fiber Optic Network and Customer Service; that the de facto merger is being undertaken for a bona fide business purpose and not for the purpose of avoiding the burden of taxation; that pursuant to the plan of de facto merger, a number of assets shall be transferred from SMART to PLDT; that the two companies shall enter into a stock transfer agreement whereby PLDT shall acquire all the shares of stock of SMART, thereby making SMART a 100% owned subsidiary of PLDT, in exchange solely for its own shares of stock; that the number of PLDT shares to be issued and allotted to each SMART shareholders will be determined in reference to the relative values of PLDT and SMART, hence, there shall be no change in the value of the shareholdings of each shareholder; that SMART shareholders who shall acquire PLDT shares in exchange for their SMART shares shall warrant that they shall not transfer, sell, or otherwise dispose of their PLDT shares for at least one (1) year following the stock transfer pursuant to the de facto merger; that SMART has the obligation under its legislative franchise, to make a public offering through the stock exchange of the shares representing at least thirty per centum (30%) of its authorized capital stock in any securities exchange in the Philippines; and that both PLDT and SMART were granted separate franchises to operate a telecommunication system in the Philippines; that while PLDT's franchise covers landline telephones, SMART's franchise covers cellular telephones. In reply, please be informed that pursuant to Section 40(C)(2) and (6)(b) of the Tax Code of 1997, no gain or loss shall be recognized if in pursuance of a plan of merger or consolidation (a) a corporation which is a party to the merger or consolidation exchanges property solely for stock in a corporation which is a party to the merger or consolidation and, (b) a shareholder exchanges stock in a corporation which is a party to a merger or consolidation solely for the stock, of another corporation also a party to the merger or consolidation. The term merger or consolidation shall be understood to mean: (1) the ordinary merger or consolidation or (2) the acquisition by one corporation of all or substantially all the properties of another corporation solely for stock: Provided, That for a transaction to be regarded as merger or consolidation within the purview of this section, it must be undertaken for a bona fide business purpose and not solely for the purpose of escaping the burden of taxation: Provided further, That in determining whether a bona fide business purpose exists each and every step of the transaction shall be considered and the whole transaction or series of transaction shall be treated as a single unit: Provided finally, That in determining whether the property transferred constitutes a substantial portion of the property of the transferor, the term "property" shall be taken to include the cash assets of the transferor. prll In addition, "substantially all" was defined in BIR General Circular No. V-253 dated July 16, 1957 to mean "the acquisition by one corporation of at least 80% of the assets, including cash, of another corporation," which "has the element of permanence and not merely momentary holding." Considering the foregoing, your opinion to the effect that the above reorganization is a merger within the contemplation of Section 40(C)(2) and (6)(b) of the Tax Code of 1997, because a corporation (PLDT) acquired substantially all, (at least 80%) the assets and assumed the liabilities of another corporation (SMART), solely for PLDT shares of stock and the transaction undertaken being for a bona ride business purpose and not solely for the purpose of escaping the burden of taxation, is hereby confirmed. Accordingly, your opinion that no gain or loss shall be recognized both to the transferor and the transferee corporation on the transfer by SMART of substantially all its assets and liabilities to PLDT solely in exchange for the latter's shares of stock pursuant to a merger under Section 40 paragraphs (C)(2) and (6)(b) of the Tax Code of 1997, is hereby also confirmed. The basis of the assets received by PLDT shall be the same as it would be in the hands of SMART: The transfer of assets and liabilities by SMART solely in exchange for the shares of stock of PLDT will not be subject to the gift tax since there is no intention to donate on the part of either or both of the parties and the transaction is effected purely for business reasons. For value-added tax (VAT), purposes, the transfer of the assets, by SMART pursuant to the merger will not be subject to VAT. (BIR Ruling No. 106-89 dated May 16, 1989). The original issuance of certificates of stock by PLDT to SMART will be subject to the documentary stamp tax imposed by Section 175 of the Tax Code of 1997. The Agreement of merger execute between SMART and PLDT is not subject to documentary stamp tax. (BIR Ruling No. 472-93 dated December 3, 1993) It is understood, however that upon the subsequent sale or exchange of the assets or shares of stock acquired by the parties, the gain derived from such sale or exchange shall be subject to income tax. However, in order that the above-described re-organization can be considered as merger under Section 40(C)(2) and (6)(b) of the Tax Code of 1997, the parties to the merger should comply with the following requirements: A. The plan of reorganization should be adopted by each of the corporations, parties thereto, the adoption being shown by the acts of its duly constituted responsible officers and appearing upon the official records of the corporation, each corporation, which is a party to the reorganization, shall file, as part of the return for the taxable year within which the reorganization occurred a complete statement of all facts pertinent to the non-recognition of gain or loss in connection with the reorganization, including: LLpr (1) A copy of the plan of reorganization, together with a statement, executed under the penalties of perjury, showing in full the purposes thereof and in detail all transactions incident to, or pursuant to the plan. (2) A complete statement of the cost or other basis of all properties, including all stocks or securities, transferred incident to the plan. (3) A statement of the amount of stocks or securities and other properties or money received from the exchange, including a statement of all distribution or other disposition made thereof. The amount of each kind of stock or securities and other properties received shall be stated on the basis of the fair market value at the date of exchange; and (4) A statement of the amount and nature of any liabilities assumed upon the exchange, and the amount and nature of any liabilities to which any of the property acquired in the exchange is subject. B. Every taxpayer, other than a corporation, a party to the reorganization, who received stock or securities and other properties or money upon a tax-free exchange in connection with a corporate reorganization shall incorporate in his income tax return for the taxable year in which the exchange takes place a complete statement of all facts pertinent to the non-recognition of gains or loss upon such exchange including: (1) A statement of the cost or other basis of the stock or securities transferred in the exchange; and (2) A statement in full of the amount of stock or securities and other properties or money received from the exchange, and any liabilities to which property received is subject. The amount of each kind of stock or securities and other properties (other liabilities assumed upon the exchange) received shall be set forth upon the basis of the fair market value thereof at the date of the exchange. C. Permanent records in substantial form shall be kept by every taxpayer who participates in a tax-free exchange in connection with a corporate reorganization showing the cost or to her basis of the transferred property or money received (including any liabilities assumed on the exchange, or any liabilities in which any of the properties received were subject), in order to facilitate the determination of gain or loss from a subsequent disposition of such stock or securities and other properties received from the exchange (par. 9803-8, P-H 1963 ed., p. 9611). In addition to the foregoing requirements, permanent records in substantial form must be kept by the corporation participating in the merger showing the information listed above in order to facilitate the determination of gain or loss from a subsequent disposition of the stocks received as a consequence of the merger. 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, and/or any of the requirements imposed in this letter are not complied with, then this ruling shall be considered null and void. LLphil Very truly yours, (SGD.) BEETHOVEN L. RUALO Commissioner of Internal Revenue