SGV & Co.

April 25, 2007 BIR RULING [DA-260-07] DA-028-05 SGV & Co. 6760 Ayala Avenue Makati City Attention: R. C. Vinzon Tax Service Gentlemen : This refers to your letter dated February 15, 2007 stating that your client, Radio Communications of the Philippines, Inc. (RCPI), is a corporation duly organized and existing under the laws of the Philippines; that RCPI is the holder of a legislative franchise to provide telecommunications services of all types; that the National Telecommunications Commission (NTC) has authorized RCPI to provide and operate the following major services: local exchange carrier, international gateway facility, leased line service, and cellular mobile telephone systems; that during the years ended December 31, 2005 and 2006, respectively, RCPI continued to be in a capital deficit position; that the company's financial position is such that its auditors have expressed the existence of a material uncertainty which may cast doubt on RCPI's ability to continue operations normally; that in order to address this problem, RCPI requested its creditors for the restructuring of its bank loans and bonds payable; that the debt restructuring plan includes, among others, the extension of the repayment of terms of RCPI's outstanding loans and bonds, reduction in interest rates and conversion of certain debt into equity; that pursuant to a rehabilitation plan duly approved by RCPI's creditors, there will be a change in the payment scheme which does not include the reduction of the principal liability but only the reclassification of the debt into sustainable (68.933% of the total debt) and unsustainable debt (31.067% of the total debt), recalculation of interest expense based on lower interest rates provided by the court, which also form part of the unsustainable debt, and the waiver of penalties; and that pursuant to the rehabilitation plan agreed upon, a portion of the debt, specified as unsustainable debt, will be settled only when there are available excess cash, and any outstanding amount at the end of the 19 year rehabilitation period will be converted to equity to a maximum limit of 40% outstanding shares. Based on the foregoing representations, you now request confirmation of your opinion that the gain resulting from condonation of its debt to various creditors is not subject to income tax; and that any conversion of debt into equity as a result of the debt restructuring plan is also not subject to income tax. aDSIHc In reply thereto, please be informed that cancellation of indebtedness may not give rise to taxable income. In BIR Ruling No. 076-89 dated April 17, 1989 , this Office ruled that " 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, 13 AFTR 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 deficiency 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." (emphasis supplied) The same principle was reiterated in BIR Ruling No. DA 419-04 dated August 4, 2004 and BIR Ruling No. DA222-05 dated May, 9, 2005 , where this Office likewise ruled that ". . . 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 . . . . Moreover, the condonation is likewise not subject to gift tax since there is no donative intent on the part of SJ but is solely for business consideration. Finally, in BIR Ruling No. DA028-05 dated January 24, 2005 , this Office ruled that ". . . the conversion of Bayantel's debt into equity as a result of the debt restructuring plan shall not give rise to a taxable income and shall only be considered as an additional capital investment which likewise is not subject to donor's tax since there is no donative intent in the aforesaid transaction." IN VIEW OF THE FOREGOING, this Office hereby confirms your opinion that any gain resulting from the condonation of RCPI's debt is not taxable for income tax purposes; and that any conversion of debt into equity as a result of the debt restructuring plan is likewise not subject to income tax, it being in the nature of capital transaction. SaHIEA 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, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service