BIR Ruling [DA-278-05]

June 23, 2005 BIR RULING [DA-278-05] DA-064-04; Sec. 56 Reg. 2 Baniqued & Baniqued Suite 803, 8/F Jollibee Center San Miguel Avenue Pasig City Attention: Attys. Carlos G. Baniqued Terence Conrad H. Bello Suzette A. Celicious Gentlemen : This refers to your letter dated April 11, 2005 requesting on behalf of your clients, Unocal Philippines, Inc. (UPI) [formerly Philippine Geothermal, Inc. or PGI] and Philippine Geothermal Production Company, Inc. (PGPC), for confirmation of your opinion on the tax implications of the assignment by UPI of the Geothermal Resources Sales Contract (GRSC) and, as a necessary consequence, the right to enter into the New Service Contracts, in favor of PGPC by way of additional capital contribution, but without the issuance of additional PGPC shares. It is represented that UPI is a corporation organized and existing under the laws of the State of California, USA; that it is engaged in the exploration, development and production of geothermal resources for power generation services in the Philippines and is licensed to do business in the Philippines through a Philippine branch, which holds office at the 12th Floor, Citibank Tower, 8741 Paseo de Roxas, Salcedo Village, Makati City; that on the other hand, Philippine Geothermal Production Company, Inc. (PGPC) is in the process of changing its corporate name to Unocal Philippines Geothermal, Inc., a corporation organized and existing under Philippine laws and similarly holds office at the 12th Floor Citibank Tower, 8741 Paseo de Roxas, Salcedo Village, Makati City; that UPI currently owns, directly or beneficially, all of the outstanding stock of PGPC. Old Service Contract On September 10, 1971, the National Power Corporation (NPC) and PGI (now UPI) entered into a service contract (the Old Service Contract) whereby NPC engaged the services of UPI for the development, operation, and utilization of geothermal resources found within the vicinity of Tiwi, Albay, Mt. Makiling in Laguna, and Mt. Banahao in Quezon (the Tiwi and Mak-Ban Geothermal Fields). Pursuant to Proclamation Nos. 739 and 1111, the area of geothermal resources subject matter of the exploration, exploitation, and development by UPI under the Old Service Contract covered the Tiwi and Mak-Ban Geothermal Fields, where NPC, as its own expense installed such plants, machinery, and auxiliary works (collectively, the Tiwi-Mak-Ban Geothermal Complexes) as may be necessary for the conversion of geothermal energy into electric power and distribution of such power. THAICD Renewability Provision, Dispute, and Compromise Agreement Section 3.1 of the Old Service Contract provided that the term of this contract shall be twenty-five (25) years renewable for another twenty-five (25) years upon the option of UPI under the same terms and conditions set forth herein (the Renewability Provision). After the first 25 years of the Service Contract, UPI attempted to renew the Old Service Contract for another 25 years. However, a dispute arose on the proper interpretation of the Renewability Provision of the Old Service Contract, which led to the filing of arbitration and court cases between UPI and NPC sometime in 1996. UPI filed an arbitration case with the International Chamber of Commerce, while NPC sought declaratory relief with the Regional Trial Court. In March 2003, a Compromise Agreement was entered into by and between NPC, Power Sector Assets & Liabilities Management Corporation (PSALM), and UPI with the conformity of the Department of Energy (DOE), to effect a full and final settlement of the arbitration case and court case pending between NPC and UPI since 1996. NPC-PSALM and UPI submitted the Compromise Agreement to Branch 84 of the Regional Trial Court of Quezon City for approval, which, in a Decision dated June 11, 2004, resolved to approve the Compromise Agreement and enjoined the parties to strictly abide by its terms. GRSC, Filipinization, and New Service Contracts Pursuant to Section 5.0 of the Court-approved Compromise Agreement, NPC-PSALM and UPI entered into a GRSC on June 17, 2004 for the supply of steam to the Tiwi-Mak-Ban Geothermal Complexes. The GRSC shall take effect on the completion date of the rehabilitation of the Tiwi-Mak-Ban Geothermal Complexes (the GRSC Effective Date). The rehabilitation of the geothermal facilities being undertaken by PSALM is still ongoing and is expected to be completed in the first quarter of 2006. As part of the settlement of the dispute between NPC and UPI, and as a concession agreed to by UPI under the Compromise Agreement so that the parties can enter into two new service contracts, one for Tiwi Geothermal Complex and another for the Mak-Ban Geothermal Complex, replacing the Old Service Contract (the New Service Contracts), UPI undertook to form before the GRSC Effective Date a Philippine company at least 60 percent of which shall be owned by Philippine nationals. (Filco). UPI intends to use PGPC as Filco for the purpose of transferring the GRSC and entering into the transactions described below and in the Compromise Agreement. As agreed upon under Sections 5.0 and 6.0 of the Compromise Agreement, Filco (i.e., PGPC) shall eventually take over from UPI the development and operation of the Tiwi-Mak-Ban Geothermal Complexes by entering into the New Service Contracts. As a preliminary to the eventual take-over by PGPC from UPI of the development and operation of the Tiwi-Mak-Ban Geothermal Complexes, under Section 5.1 of the Compromise Agreement, UPI shall assign the GRSC to Filco (i.e., PGPC) before the GRSC Effective Date. Thereafter, once PGPC becomes "Filipinized", PGPC and PSALM will execute the New Service Contracts pursuant to Section 6.2 of the Compromise Agreement. HAIaEc For this purpose, UPI intends to assign the GRSC to PGPC by way of an additional capital contribution but without the issuance of additional PGPC shares. Upon completion of the series of transactions described above (i.e., assignment of the GRSC, "Filipinization" of PGPC, and execution of the New Service Contracts, in that order), PGPC would have stepped into the shoes of UPI as the new contractor under both the GRSC and the New Service Contracts. As the new contractor, PGPC shall extract geothermal resources (i.e., steam) from the Tiwi and Mak-Ban Geothermal Fields for commercial utilization in accordance with the New Service Contracts; and supply and deliver such geothermal resources to the Tiwi-Mak-Ban Geothermal Complexes pursuant to the GRSC. Based on the foregoing representations, you now request confirmation of your opinion that "1. The assignment by UPI of the GRSC to PGPC and, as a necessary consequence, the right to enter into the New Service Contracts, by way of additional capital contribution, but without the issuance of additional PGPC shares, would qualify as a non-taxable capital contribution under Section 56 of Revenue Regulations No. 2 such that no taxable gain or loss shall be recognized both to the transferor and the transferee since the transfer would be made as a capital contribution; 2. No documentary stamp tax (DST) shall be due upon the assignment by UPI to PGPC of all its rights and interests in the GRSC and the right to enter into the New Service Contracts; 3. No donor's tax shall be due upon the assignment by UPI of all its rights and interests in the GRSC, and the right to enter into the New Service Contracts, as there is no intention to donate on the part of UPI; and 4. The assignment by UPI to PGPC of all its rights and interests in the GRSC and the right to enter into the New Service Contracts is not subject to value-added tax (VAT)." In reply thereto, please be informed that your opinion is hereby confirmed as follows: 1. Section 56 of Revenue Regulations No. 2 provides as follows: "Sec. 56. Contribution by shareholders. Where a corporation requires additional funds for conducting its business and obtains such needed money through voluntary process payments by its shareholders, the amounts so received being credited to its surplus account or to a special capital account, will not be considered income, although there is no increase in the outstanding shares of stock of the corporation. The payments in such circumstances are in the nature of voluntary assessments upon, and represent an additional price paid for, in shares of stock held by the individual shareholders, and will be treated as an addition to and as part of the operating capital of the company." DaIACS In BIR Ruling No. DA046-04 dated February 5, 2004 which is a reiteration of BIR Ruling No. DA221-02 dated November 25, 2002, this Office ruled that "xxx xxx xxx "Accordingly, no taxable gain or loss shall be recognized both to the transferor and the transferee on the transfer by the individual stockholders of their shares of stock in favor of JHN since the transfers were made as capital contributions in JHN where by the transferees in the transfer of the shares to JHN do not realize taxable income and therefore are not subject to Philippine income tax. "Moreover, the capital infusion shall effect no change in the equity shareholdings of the stockholders of JHN. The transfer will merely increase the basis of the stockholders' stock but not their proportionate equity in the corporation. Hence, the transaction not subject to income or gift taxes. "Finally, considering that the infusion of the APIC will not result in the issuance of shares of stock by JHN, the same shall not be subject to documentary stamp tax imposed under Section 175 of the Tax Code of 1997. However, the transfer of the subject shares of stock to JHN shall be subject to documentary stamp tax under Section 176 of the Tax Code of 1997." Considering that the above-cited case is in all fours similar to the instant case, this Office holds that the assignment by UPI of all its rights and interests in the GRSC in favor of PGPC, and, as a necessary consequence, the right to enter into the New Service Contracts, in the form of additional paid-in capital, without the issuance of additional PGPC shares, would not result in the recognition of taxable income both to UPI and PGPC pursuant to Section 56 of Revenue Regulations No. 2. 2. The transfer of rights in a contract, e.g., assignment of rights and interests in the GRSC as well as the right to enter into the New Service Contracts, is not among the transactions subject to the documentary stamp tax under the Tax Code of 1997. Moreover, Section 185 of Revenue Regulations No. 26, otherwise known as the Documentary Stamp Tax Regulations, provides that "Sec. 185. Conveyances without consideration. Conveyances of realty, not in connection with a sale, to trustees or other persons without consideration are not taxable. Thus, in BIR Ruling No. DA-065-05 dated February 23, 2005 , it was ruled that "Considering that Condrado and Sergia Estrella transferred the above-listed real properties without the corresponding issuance of additional shares of stock in their favor, the foregoing will be considered as contribution of additional paid-in capital, not subject to documentary stamp tax as the above conveyances of realties are without any consideration and are not made in connection with a sale." Such being the case, the transfer of rights in a contract, e.g., assignment of rights and interests in the GRSC as well as the right to enter into the New Service Contracts is not subject to the documentary stamp tax. 3. The assignment by UPI of all its rights and interests in the GRSC and the right to enter into the New Service Contracts is not subject to donor's tax since the foregoing transfer and assignment of rights by UPI is a necessary consequence of the requirement imposed under the Court-approved Compromise Agreement and there is no donative intent on the part of UPI. CDAcIT 4. Finally, since the subject rights and interests in the GRSC and in the New Service Contracts are not held primarily for sale or lease in the ordinary course of trade or business of UPI, as the transfer of the aforesaid property rights is not being made "in the course of trade or business" of UPI. The assignment by UPI to PGPC of the GRSC, and, as a necessary consequence, the right to enter into the New Service Contracts, is a VAT-exempt isolated transaction. ( BIR Ruling No. DA139-04 dated March 26, 2004 ) 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.) JOSE MARIO C. BUAG Deputy Commissioner Legal & Inspection Group