BIR Ruling [DA-323-06]

May 17, 2006 BIR RULING [DA-323-06] 29 (B) (2) (a); DA-232-2003 Quisumbing Torres 12th Floor, Net One Center 26th St. cor. 3rd Avenue, Crescent Park West Bonifacio Global City Taguig, Metro Manila Attention: Attys. Dennis G. Dimagiba and Franklin A. Prestousa Gentlemen : This refers to your letter dated February 2, 2006 requesting on behalf of your clients, Schering-Plough Corporation (SPC) and Essex Pharmaceuticals, Inc. (Essex and collectively, referred to as the Philippine Companies) for a confirmation that they are exempt from the 10% Improperly Accumulated Earnings Tax (IAET) because they qualify as publicly-held corporations under Section 29(B)(2) of the 1997 Tax Code and Revenue Regulations (RR) No. 2-2001. The facts as you represented are as follows: SPC is a domestic corporation duly registered with the Philippine Securities and Exchange Commission (SEC) on March 31, 1987 with SEC Reg. No. 15945. At present, SPC is a registered Large Taxpayer with the BIR National Office. Under its Articles of Incorporation, the primary purpose of SPC is to manufacture, prepare, compound, purchase, sell, import and export, advertise, promote, develop or otherwise deal in all articles of any kind and description including but not limited to pharmaceutical, medical biological, chemical, industrial and other preparations, proprietary articles, toilet articles, perfumeries, cosmetics, and by-products thereof, as may be allowed under existing laws of the Philippines. SPC is a wholly-owned subsidiary of SOL Limited (SOL), a company organized and existing under the laws of the British Virgin Islands. At present, SOL is the stockholder of record of 499,986 shares of the capital stock of SPC, with the remaining shares held by individuals acting as its nominees. CSaHDT Essex is a domestic corporation duly registered with the SEC on October 10, 1997 with SEC Reg. No. A1997-17540. At present, Essex is a registered Large Taxpayer with the BIR National Office. Under its Articles of Incorporation, the primary purpose of Essex is to manufacture, prepare, compound, purchase, sell, import and export, advertise, promote, develop or otherwise deal in all articles of any kind and description including but not limited to pharmaceutical, medical biological, chemical, industrial and other preparations, proprietary articles, toilet articles, perfumeries, cosmetics, and by-products thereof, as may be allowed under existing laws of the Philippines. Essex is a wholly-owned subsidiary of SOL, a company organized and existing under the laws of the British Virgin Islands. At present, SOL is the stockholder of record of 49,999,500 shares of the capital stock of Essex, with the remaining shares held by individuals acting as its nominees. SOL is an indirect wholly-owned subsidiary of Schering-Plough Corporation in the U.S.A. (SPC-US). The shares of SPC-US, the ultimate parent company of the Philippine Companies, are listed and traded on the New York Stock Exchange (NYSE). As of January 31, 2005, SPC-US has 41,000 stockholders of record, with the 20 largest beneficial shareholders owning less than 50% of SPC-US issued and outstanding shares. In reply, please be informed that Section 29 (A) and (B) of the 1997 Tax Code on the imposition of IAET, states that: "(A) In General . In addition to other taxes imposed by this Title, there is hereby imposed for each taxable year on the improperly accumulated taxable income of each corporation described in subsection B hereof, an improperly accumulated earnings tax equal to ten percent (10%) of the improperly accumulated taxable income. (B) Tax on Corporations Subject to Improperly Accumulated Earnings Tax (1) In General . The improperly accumulated earnings tax imposed in the preceding Section shall apply to every corporation formed or availed for the purpose of avoiding the income tax with respect to its shareholders or the shareholders of any other corporation, by permitting earnings and profits to accumulate instead of being divided or distributed. (2) Exceptions . The improperly accumulated earnings tax as provided for under this Section shall not apply to: (a) Publicly-held corporations;" This kind of tax is being imposed in the nature of a penalty to the corporation for the improper accumulation of its earnings, and as a form of deterrent to the avoidance of tax upon shareholders who are supposed to pay dividends tax on the earnings distributed to them by the corporation. However, the IAET shall not apply to, among others, publicly-held corporations. Furthermore, Section 4 of Revenue Regulations No. 2-2001, "Implementing the Provision on Improperly Accumulated Earnings Tax under Section 29 of the Tax Code of 1997", provides: "For purposes of these Regulations, closely-held corporations are those corporations at least fifty percent (50%) in value of the outstanding capital stock or at least fifty percent (50%) of the total combined voting power of all classes of stock entitled to vote is owned directly or indirectly by or for not more than twenty (20) individuals. Domestic corporations not falling under the aforesaid definition are, therefore, publicly-held corporations." For purposes of determining whether the corporation is a closely-held corporation, it is provided that stock owned directly or indirectly by or for a corporation, partnership, estate or trust shall be considered as being owned proportionately by its shareholders, partners or beneficiaries. cACEaI In BIR Ruling No. 025-2002 dated June 25, 2002 and later in BIR Ruling No. DA-085-03 dated March 20, 2003, this Office ruled that such shares will be considered as being owned proportionately by the shareholders. The ownership of a domestic corporation for purposes of determining whether it is closely held corporation or a publicly held corporation is ultimately traced to the individual shareholders of the parent company. Thus, where at least 50% of the outstanding capital or at least 50% of the total combined voting power of all classes of stock entitled to vote in a corporation is owned directly or indirectly by at least 21 or more individuals, the corporation is considered publicly-held corporation as the term is defined under the cited Revenue Regulations 2-2001. Thus, the ownership of a domestic corporation (like SPC and Essex) for purposes of determining whether it is a closely-held corporation or a publicly-held corporation is ultimately traced to the individual shareholders of the parent company. Since SPC and Essex is practically a wholly-owned subsidiary of SOL, and which is an indirect wholly-owned subsidiary of SPC-US, the shares of SPC and Essex will be considered as being owned proportionately by SPC-US shareholders. Applying the foregoing principles, it is clear that SPC and Essex are publicly-held corporations. The Philippine Companies are indirect wholly-owned subsidiary of their ultimate parent (SPC-US) on account of the following: a) 99.99% of the capital stock of the Philippine Companies is owned by SOL; b) 100% of the capital stock of SOL is ultimately owned by SPC-US and because the shares of SPC-US, the Philippine Companies ultimate parent company are listed and traded on the NYSE, with the top 20 beneficial shareholders owning not more than 50% of its total outstanding capital stock, the Philippine Companies cannot therefore be considered closely-held corporation. Under the premises, the Philippine Companies qualify instead as publicly-held corporations not subject to the improperly-accumulated earnings tax. In view of the foregoing, SPC and Essex cannot be considered a closely held corporation but rather a publicly-held corporation, and therefore, is exempt from the imposition of IAET pursuant to Section 29 (B)(2)(a) of the 1997 Tax Code. 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, then this ruling shall be considered as null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service