BIR Ruling [DA-312-06]

May 10, 2006 BIR RULING [DA-312-06] R.A. 9243; 28; 175; 179; DA-029-2002 SGV & Co. 6760 Ayala Avenue 1226 Makati City Attention: Attys. C. P. Noel Vice-Chair and Deputy Managing Partner and W. U. Villanueva Principal, Tax Services Gentlemen : This refers to your letter dated April 25, 2006 requesting for confirmation of your opinion on the tax consequences of the sale by the shareholders of Mirant Philippines Corporation (MPC) of their respective shareholdings in MPC in favor of Mirant Sual Investments Corporation (MSIC), said sale being part of a corporate restructuring plan for the Mirant Group of Companies which will include, among others, the merger of MSIC, MPC and Mirant Pagbilao Corporation (MPAG ) , with MPAG as the surviving corporation. The facts, as represented, are as follows: MPC is a domestic corporation duly registered with the Securities and Exchange Commission (SEC) primarily to invest in and hold shares in the capital stock, bonds and other securities of companies engaged in the construction, installation, erection, commissioning, repair, rehabilitation, operation and maintenance of power stations, transmission lines, distribution systems, highways, ports, reclamation, water and sewerage projects, and other infrastructure, public, and related works to the full extent permitted by law, and to exercise in respect thereof, all rights, powers and privileges of ownership. cHTCaI MPC has an authorized capital stock of Nine Billion Four Hundred Seventy Eight Million Three Hundred Thousand Pesos (P9,478,300,000.00), divided into Four Billion Nine Hundred Seventy Eight Million Three Hundred Thousand (4,978,300,000) Preferred (Class A) shares with features such as 0.01% non-cumulative, voting, convertible, participating and redeemable shares, and with a par value of One Peso (P1.00) per share, and Four Billion Five Hundred Million (4,500,000,000) Common shares with a par value of One Peso (P1.00) per share. MPC's total issued and outstanding capital stock amounts to Four Billion Three Hundred Nineteen Million One Hundred Seventy Three Thousand One Hundred Fifty Eight Pesos (P4,319,173,158.00), consisting of Sixty Million Twenty Three Thousand Seven Hundred Thirty (60,023,730) Preferred (Class A) shares and Four Billion Two Hundred Fifty Nine Million One Hundred Forty Nine Thousand Four Hundred Twenty Eight (4,259,149,428) Common shares. The total issued and outstanding capital stock of MPC is distributed as follows: Stockholder % of Ownership Navotas II Holdings (BVI) Corporation (NAVIIH) 4.10% MAP Mobile Power Systems (MAPMPS) 4.33% MAP Pangasinan Ltd. (MAPPL) 48.75% MAP Pagbilao Ltd. (MAPPAGL) 40.27% MAP Navotas I Ltd. (MAPNL) 2.55% NAVIIH, MAPMPS, and MAPPL are corporations organized and existing under the laws of the British Virgin Islands, while MAPPAGL and MAPNL are corporations organized and existing under the laws of Hong Kong. Based on the Audited Financial Statements (AFS) of MPC as of December 31, 2005, MPC has total assets in the amount of Nine Hundred Forty Two Million Four Hundred Eighty Thousand Two Hundred Fifty Four United States (US) Dollars (US$942,480,254.00), total liabilities in the amount of Eighty One Million Six Hundred Fourteen Thousand Seven Hundred Eighty Two US Dollars (US$81,614,782.00), and stockholders' equity in the amount of Eight Hundred Sixty Million Eight Hundred Sixty Five Thousand Four Hundred Seventy Two US Dollars (US$860,865,472.00). Its assets consist mostly of cash and cash equivalents, accounts receivables, receivables from subsidiaries, associates and joint venture, pre-paid expenses and other current assets, notes receivable, investments and other non-current assets while its liabilities consist of accounts payable and accrued expenses, payables (due) to affiliates, and deferred income tax. AaSIET On the other hand, MSIC is a domestic corporation duly registered with the SEC, primarily to invest in and hold shares in the capital stock, bonds and other securities of companies engaged in the construction, installation, erection, commissioning, repair, rehabilitation, operation and maintenance of power stations, transmission lines, distribution systems, highways, ports, reclamation, water and sewerage projects, and other infrastructure, public, and related works to the full extent permitted by law, and to exercise in respect thereof, all rights, powers and privileges of ownership. MSIC has an authorized capital stock of Two Billion Three Hundred Nineteen Million Six Hundred Thirty Five Thousand Seven Hundred Sixty Five Pesos (P2,319,635,765.00), divided into Two Billion Three Hundred Nineteen Million Six Hundred Thirty Five Thousand Seven Hundred Sixty Five (2,319,635,765) Common shares with a par value of One Peso (P1.00) per share. MSIC's authorized capital stock is fully issued and outstanding and wholly owned by MAPPL. Based on the AFS of MSIC as of December 31, 2005, it has total assets in the amount of Two Hundred Thirty Six Million Twenty One Thousand Two Hundred Twenty Eight US Dollars (US$236,021,228.00), total liabilities in the amount of Sixteen Thousand Five Hundred Twenty Two US Dollars (US$16,522.00) and stockholders' equity in the amount of Two Hundred Thirty Six Million Four Thousand Seven Hundred Six US Dollars (US$236,004,706.00). Its assets consist mostly of cash and cash equivalents, receivables (due) from affiliates, and shares of stocks in Mirant Sual Corporation while its liabilities consist of accounts payable and accrued expenses. On April 21, 2006 a Memorandum of Understanding (MOU) was executed by and among MPC, MSIC, and their respective stockholders (the parties to the MOU are collectively referred to as ("the Parties"). The Parties, in pursuance of a proposed corporate restructuring plan for the Mirant Group of Companies that is aimed at consolidating their resources, capabilities, business and operations to achieve economies of scale, cost savings, efficiency in management reporting of financial information, effectiveness in cash management procedures, and efficiency necessary to carry on the business in the power industry, have agreed to undertake the following transactions: a. The MPC shares are to be consolidated in MSIC. Thus, it is intended that MSIC will purchase the MPC shares for a price not lower than the current book value of the said shares; b. In consideration for the said sale of the MPC shares, it is intended that MSIC will issue an interest-bearing note payable to each of the MPC shareholders, namely, NAVIIH, MAPMPS, MAPPL, MAPPAGL and MAPNL; c. After the sale of the MPC shares, MSIC and MPC will be subsequently merged into MPAG, with the latter as the surviving corporation. MPAG will acquire all the assets and assume all the liabilities of MSIC and MPC. MPAG will issue shares of stock to MAPPL and the stockholder of MSIC in exchange for the MSIC and MPC shares that will be surrendered to MPAG. aITECD Moreover, MPAG is also a domestic corporation duly registered with the SEC to principally engage in the business of power generation services and the subsequent sale thereof to the National Power Corporation under a Build, Operate, Transfer scheme. MPAG has an authorized capital stock of Six Hundred Forty Four Million Five Hundred Fifty Eight Thousand Three Hundred Eighty Pesos (P644,558,380.00), divided into Sixty Four Million Four Hundred Fifty Five Thousand Eight Hundred Thirty Eight (64,455,838) Common shares with a par value of Ten Pesos (P10.00) per share. Its total capital stock issued and outstanding is Six Hundred Thirty Eight Million Nine Hundred Forty Eight Thousand Three Hundred Eighty Pesos (P638,948,380.00), divided into Sixty Three Million Eight Hundred Ninety Four Thousand Eight Hundred Thirty Eight (63,894,838) common shares, all of which are owned by MPC. In view of the foregoing, you now request for confirmation of your opinion that: 1. The gain that may be realized by NAVIIH, MAPMPS, MAPPL, MAPPAGL, and MAPNL on the transfer of their MPC shares to MSIC shall be subject to capital gains tax (CGT) in accordance with Section 28 (B) (5) (c) of the 1997 Tax Code, as amended by Republic Act (RA) No. 9337; 2. The net capital gain to be realized from the said sale of the MPC shares shall be computed by determining the difference between the selling price of the MPC shares, or its book value, whichever is higher, and the acquisition costs of said shares; TAaHIE 3. The cost basis of the MPC shares of stock that will be disposed of or conveyed by NAVIIH, MAPMPS, MAPPL, MAPPAGL, and MAPNL to MSIC shall be: (a) the historical costs of the MPC shares of stock that were previously acquired under a series of "tax-free" exchanges under Section 40 (C) (2) of the 1997 Tax Code [then Section 34 (C) (2) of the Tax Code] and were the subject of BIR Ruling Nos. S-40-75-98, S-40-230-99 and S-40-096-00 or, (b) the actual purchase price of the MPC shares of stock as original subscriptions by NAVIIH, MAPMPS, MAPPL, MAPPAGL and MAPNL, or acquired by NAVIIH, MAPMPS, MAPPL, MAPPAGL and MAPNL from previous stockholders; 4. The sale or transfer of the MPC shares to MSIC shall be subject to documentary stamp tax (DST) at the rate prescribed under Section 175 of the 1997 Tax Code, as amended by RA No. 9243; 5. The interest-bearing notes payable that MSIC will issue each to the shareholders of MPC are subject to DST at the rate prescribed under Section 179 of the 1997 Tax Code, as amended by RA No. 9243; and, 6. The interest that will be incurred and paid by MSIC on the said notes payable will be subject to twenty percent (20%) final withholding tax (FWT) pursuant to Section 28 (B) (5) (a) of the 1997 Tax Code, as amended by RA No. 9337. In reply thereto, please be informed as follows: 1. Section 28 (B) (5) (c) of the 1997 Tax Code, as amended by RA No. 9337, provides, viz: "Sec. 28. Rates of Income Tax on Foreign Corporation . (A) . . . (B) Tax on Nonresident Foreign Corporation . xxx xxx xxx (5) Tax on Certain Incomes Received by a Nonresident Foreign Corporation . ETHSAI xxx xxx xxx (c) Capital Gains from Sale of Shares of Stock not Traded in the Stock Exchange . A final tax at the rates prescribed below is hereby imposed upon the net capital gains realized during the taxable year from the sale, barter, exchange or other disposition of shares of stock in a domestic corporation, except shares sold, or disposed of through the stock exchange: Not over P100,000.00 5% On any amount in excess of P100,000.00 10%" In BIR Ruling No. DA-029-02 dated March 5, 2002, this Office ruled that the net capital gains derived by a nonresident foreign corporation seller on the sale of shares of domestic corporation not traded in the local stock exchange realized during the taxable year shall be subject to capital gains tax under Section 28 (B) (5) (c) of the Tax Code of 1997 at the rate of 5% of the net capital gains not exceeding P100,000, and 10% on the net capital gains in excess of P100,000. Considering that NAVIIH, MAPMPS, MAPPL, MAPPAGL, and MAPNL are nonresident foreign corporations not engaged in trade or business in the Philippines, as evidenced by the Certificates of Incorporation of NAVIIH, MAPMPS, MAPPL, MAPPAGL, and MAPNL, and the SEC Certifications that NAVIIH, MAPMPS, MAPPL, MAPPAGL, and MAPNL are not registered and engaged in business in the Philippines, this Office hereby confirms your opinion that the net capital gains to be realized by NAVIIH, MAPMPS, MAPPL, MAPPAGL, and MAPNL from the sale or disposition of their MPC shares to MSIC, which shares are classified as capital assets and which are not listed or traded in the stock exchange, shall be subject to CGT at the rates prescribed above. (BIR Ruling No. DA-029-2002 dated March 5, 2002) 2. In a sale of shares, the CGT is applied on the net capital gain. Net capital gain is defined as the difference between the gross selling price or fair market value (FMV) of the shares, whichever is higher, and the acquisition cost of the shares (Revenue Regulations (RR) No. 2-82) Section 40 (A) of the 1997 Tax Code provides that: TICaEc "SEC. 40. Determination of Amount and Recognition of Gain or Loss . (A) Computation of Gain or Loss . 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;" Furthermore, pursuant to RR No. 2-82, for purposes of determining the selling price, in case of sale, transfer or exchange of shares of stock not listed in the stock exchange, the same shall be valued at their book value nearest the valuation date. The book value of the unlisted shares of stock shall be prima facie considered as their FMV. However, if there have been previous bonafide sales/exchanges of the unlisted shares of stock, the price at which these shares exchange hands should be taken/considered as its FMV [ Section 6 (a) (3) of RR No. 2-82 ]. Accordingly, this Office hereby confirms your opinion that the net capital gains to be realized from the sale of the MPC shares shall be computed by determining the difference between the selling price, or the book value, whichever is higher, and the original or adjusted cost basis of said shares. 3. Section 40 (B) of the 1997 Tax Code provides that: "SEC. 40. Determination of Amount and Recognition of Gain or Loss . (B) Basis for Determining Gain or Loss from Sale or Disposition of Property . The basis of property shall be (1) The cost thereof in the case of property acquired on or after March 1, 1913, if such property was acquired by purchase; or xxx xxx xxx (5) The basis as defined in paragraph (C)(5) of this Section, if the property was acquired in a transaction where gain or loss is not recognized under paragraph(C)(2) of this Section." CIETDc In this regard, Section 6 (b) of RR No. 2-82 states that: "SEC. 6. Determination of Tax Base . In determining the tax base, the following rules shall apply: xxx xxx xxx (b) Determination of cost . The cost basis for determining the capital gains or losses shall be the basis as determined in accordance with the provisions of Section 35 of the National Internal Revenue Code, as amended, and its implementing regulations applied in the following manner: (1) If the stocks can be identified, then the cost shall be the actual purchase price plus all costs of acquisition such as commission, documentary tax, transfer fees, etc. (2) If the stocks cannot be properly identified, then the cost to be assigned shall be computed on the basis of the first-in, first-out (FIFO) method. However (3) If books of accounts are maintained by the seller where every transaction of a particular stock are recorded, then the moving average method shall be applied rather than the first-in, first-out, (FIFO) method. (4) In all cases, stock dividend received must be assigned a corresponding cost by allocating the original cost of acquisition to the total number of shares composed of the original shareholdings plus the number of shares of stocks received as stock dividend." Furthermore, when the shares being disposed were previously acquired by the transferor pursuant to a tax-free exchange transaction under Section 40 (C) (2) of the 1997 Tax Code, the acquisition cost of said shares, for purposes of determining the net capital gain, shall be equivalent to the substituted basis of said shares. The " substituted basis ", as determined by this Office, is significant in determining the tax basis of the properties acquired pursuant to a tax-free exchange transaction under Section 40 (C) (2) of the 1997 Tax Code for purposes of computing the gain or loss on the subsequent disposition of such properties or shares. The term "substituted basis" is used in reference to the value of the property in the hands of the transferee and the shares received by the transferor from the transferee [ Paragraph IV (A) (2) (2.1) of Revenue Memorandum Ruling No. 2-2002 ]. DHacTC In determining the substituted basis, the basis of the properties transferred in the hands of the transferee shall be the same as it would be in the hands of the transferor increased by the amount of the gain recognized to the transferor on the transfer while the basis of the shares of stock received by the transferor shall be the original basis of the property transferred decreased by money received or fair market value of the other property received, if any, and increased by the amount treated as dividend of the shareholder and the amount of gain recognized on the exchange, if any [ Section 40 (C) (5) (b) of the Tax Code ]. In BIR Ruling No. UN-250-95 dated July 7, 1995, this Office confirmed that the gain realized by Procter & Gamble Philippines, Inc. (PGPI) from the subsequent transfer of its Star & Dari, Inc. (SDI) shares acquired through a tax-free exchange transaction under Section 34 (c) (2) and (6) (c) of the Tax Code, in favor of San Miguel Corporation (SMC) is subject to 10%-20% capital gains tax pursuant to Section 24 (e) (2) (A) of the Tax Code and that in computing the net capital gain, the cost basis to PGPI of the SDI shares to be transferred to SMC shall be their original acquisition/historical cost, which is the book value of the assets transferred by PGPI to SDI in exchange for SDI shares. Thus, ". . . In reply, please be informed that this Office has consistently ruled, and specifically in BIR Ruling No. 6-34-127-95 dated May 16, 1995 that Section 34(c)(2) & (6)(c) of the Tax Code, as amended merely defers recognition of gain or loss from the exchange transaction, and in determining the gain or loss from a subsequent transaction of the properties of the stocks involved in the exchange, the original or historical cost of the properties or stocks is considered. Thus, if the transferor later sells or exchanges the shares of stock acquired by it in the exchange, it shall be subject to income tax on the gains derived from such sale or exchange, taking into consideration that the cost basis of the shares of stock shall be the same as the original acquisition cost or adjusted cost basis to the transferor of the properties exchanged therefor; and that the cost basis to the transferee of the properties exchanged for stocks shall be the same as it would be in the hands of the transferor. [Sec. 34 (c)(5)(a) and (b), NIRC as amended by P.D. 1773]. It is to be noted that tax-free exchanges under Section 34(c)(2) and (6)(c) of the Tax Code merely defer recognition of gain or loss from such transactions, not the tax due. In other words, as of the time of the exchange which is tax-free, there is actually no gain or loss to tax or deduct, as the case may be. The gain or loss, if ever, is recognized only upon subsequent transaction which may be a sale or exchange or disposition of the properties or of the stocks involved in the exchange. Consequently, the law providing for the taxability or prescribing the applicable tax rate at the time of actual sale or exchange or disposition of the properties or shares shall govern and not the law which is effective at the time of the tax-free exchange. It is axiomatic that the law in force as of the time of the taxable event shall govern. . . ." Accordingly, this Office hereby confirms your opinion that the cost basis of the MPC shares of stock that will disposed of or conveyed by NAVIIH, MAPMPS, MAPPL, MAPPAGL and MAPNL to MSIC shall be based, as the case may be, on the following: (a) the historical cost/substituted basis of the MPC shares of stock, insofar as said shares were previously acquired under a "tax-free" exchange transaction, pursuant to Section 40(C)(2) of the 1997 Tax Code [then Section 34(C)(2) of the Tax Code], and which the records of this Office show were the subject of BIR Ruling Nos. S-40-75-98 , S-40-230-99 and S-40-096-00 dated June 5, 1998, November 12, 1999 and May 4, 2000, respectively; or aHSCcE (b) the actual purchase price of the MPC shares of stock and all other costs of acquisition of the MPC shares of stock, insofar as they were original subscriptions by NAVIIH, MAPMPS, MAPPL, MAPPAGL, and MAPNL, or were acquired from previous stockholders (BIR Ruling No. DA-222-96 dated July 3, 1996; BIR Ruling UN-250-95 dated July 7, 1995) . 4. The sale of the MPC shares to MSIC shall be subject to DST at the rate of Seventy Five Centavos (P0.75) on each Two Hundred pesos (P200.00), or fractional part thereof, of the par value of such stock ( Section 175 of the 1997 Tax Code, as amended by RA No. 9243 ). 5. A DST is imposed on every original issue of debt instruments and the tax shall be based on the issue price thereof (Section 179 of the 1997 Tax Code, as amended by RA No. 9243). The term "issue price" shall refer to the face value of the debt instrument. If the debt instrument has a term of less than one (1) year, the DST due shall be computed taking into consideration the number of days that the instrument is outstanding as a fraction of 365 days. On the other hand, if the debt instrument has a term of one year or longer, the DST due shall be computed based on the issue price of the debt instrument ( Section 5 of RR No. 13-04 ). In view of the above, this Office hereby confirms your opinion that the interest-bearing Notes Payable that MSIC will issue in favor of NAVIIH, MAPMPS, MAPPL, MAPPAGL and MAPNL, are subject to DST at the rate prescribed under Section 179 of the 1997 Tax Code, as amended by RA No. 9243. 6. Section 28 (B) (5) (a) of the 1997 Tax Code, as amended by RA No. 9337, provides that: "Sec. 28. Rates of Income Tax on Foreign Corporations . xxx xxx xxx (B) Tax on Nonresident Foreign Corporation . (5) Tax on Certain Incomes Received by Nonresident Foreign Corporation. (a) Interest on Foreign Loans . A final withholding tax at the rate of twenty percent (20%) is hereby imposed on the amount of interest on foreign loans contracted on or after August 1, 1986;" (Emphasis supplied) aHSAIT Accordingly, considering that NAVIIH, MAPMPS, MAPPL, MAPPAGL, and MAPNL are nonresident foreign corporations not engaged in trade or business in the Philippines, this Office hereby confirms your opinion that MSIC is required to withhold 20% final withholding tax on the interest that will accrue and be payable on the Notes Payable that MSIC will issue to NAVIIH, MAPMPS, MAPPL, MAPPAGL, and MAPNL in consideration for the sale of the MPC shares. As to when the obligation to withhold the tax arises, reference is made to Section 2.57.4 of RR No. 02-98, as amended, which reads: "SEC. 2.57.4. Time of Withholding . The obligation of the payor to deduct and withhold the tax under Section 2.57 of these Regulations arises at the time an income is paid or payable, or the income payment is accrued or recorded as an expense or asset, whichever is applicable, in the payor's books, whichever comes first. The term "payable" refers to the date the obligation become due, demandable or legally enforceable. Provided, however, where income is not yet paid or payable but the same has been recorded as an expense or asset, whichever is applicable, in the payor's books, the obligation to withhold shall arise in the last month or the return period in which the same is claimed as an expense or amortized for tax purposes. . . ." This ruling is issued on the basis of the facts as represented. However, if upon investigation, it shall be disclosed that the facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. ATCaDE Very truly yours, (SGD.) JOSE MARIO C. BUAG Commissioner of Internal Revenue