BIR Ruling [DA-346-06]

June 5, 2006 BIR RULING [DA-346-06] DA 407-05 V.C. Mamalateo & Associates Unit 6C, 20 Lansbergh Place 170 T. Morato Avenue Quezon City Attention: Atty. Vic C. Mamalateo Managing Partner Gentlemen : This refers to your letter dated April 25, 2006 stating that your client, United Coconut Planters Bank (UCPB), is a universal bank registered with the Securities and Exchange Commission (SEC); that on various prior dates, Uniwide Sales and Warehouse Club, Inc. (USWCI). Uniwide Sales, Inc. (USI), and Uniwide Sales and Realty and Resources Corporation (USRRC) [collectively referred to as UNIWIDE] obtained various loans from the UCPB, using as collaterals certain real properties; that on December 29, 1999, UNIWIDE and UCPB entered into a Memorandum of Agreement (MOA): that in the said MOA, it is stated that "UNIWIDE has outstanding obligations due in favor of the BANK, in the aggregate amount of P1,043,963,162.13, inclusive of all interest, charges and fees"; that UNIWIDE has offered to assign, transfer and convey to UCPB all the rights to, title and interest of UNIWIDE in certain real properties located in Naic, Cavite, Baclaran, and Caloocan, registered in the name of and owned by UNIWIDE, to satisfy in full and settle the obligation, and UCPB has accepted the offer, subject to certain terms and conditions; that in consideration for the assignment, transfer and conveyance of the property in favor of UCPB, all outstanding obligations of UNIWIDE as of date shall be deemed fully paid and extinguished; that the MOA further stated that "all friction costs related to the dacion and creation of the special purpose corporations shall be shouldered by UNIWIDE"; that however, since UNIWIDE was cash-strapped at the time of the dacion , UCPB agreed to pay for all expenses and UNIWIDE will reimburse UCPB through the dacion of additional Naic lots; that on January 10, 2001, UNIWIDE and UCPB signed an Amendatory Agreement whereby the assignment, transfer and conveyance of certain properties shall be made through the establishment of special purpose corporations; that in this connection, two (2) special purpose corporations (SPC) have been organized, to wit: I. Autumn Hills Realty Corporation (AHRC), which owns the Baclaran, Paraaque property, was organized on August 14, 2001 by five individual stockholders and United Sales Realty and Resources Corporation (USRRC). USRRC owns 99.9% of the subscribed capital stock, or 373,895 shares with par value of P100 per share, by paying P37,389,500 (amount subscribed) and P414,406,523.25 (premium), or a total amount of P451,796,923.25; and 2. Unice Realty Corporation (URC), which owns the various Naic, Cavite lots, was organized on January 19, 2001 by five individual stockholders and USRRC. USRRC owns 99.9% of the subscribed capital stock, or 746,832 shares with par value of P100 per share, by paying paid-up capital of P74,682,700 and premium of P800,023,487.21, or a total amount of P874,706,187.21. 2006cdasia that in compliance with existing issuances, USRRC, a corporation within the UNIWIDE group that owns the real properties, secured the necessary rulings from the BIR, confirming that the exchange of said real properties by USRRC for shares of stock of AHRC and URC are exempt from income tax and capital gains tax, VAT and donor's tax in accordance with Section 40(C)(2) of the Tax Code of 1997; that implementing the MOA, USRRC and AHRC executed a Deed of Absolute Assignment, assigning the Baclaran, Paraaque property, on August 14, 2001, while USRRC and URC executed another Deed of Absolute Assignment, assigning the Naic, Cavite properties, on October 26, 2000 and June 25, 2001; that the corresponding Certificates Authorizing Registrations for the above-described real properties were issued by the appropriate Revenue District Officers on August 24, 2001 and December 3, 2001, respectively; that on April 8, 2005, to settle the outstanding obligations in the total amount of P1,043,963,162.13, USRRC executed three (3) Deeds of Assignment covering the following shares of stocks: Name of Company Value AHRC P314,549,780.12 URC 608,957,008.64 HVDC 120,426,373.42 that on April 12, 2005, UCPB executed a MOA with Odyssey Capital Ventures (SPV-AMC), Inc., a special purpose vehicle corporation, whereby the AHRC shares would be conveyed to the latter, for a valuable consideration, subject to certain terms and conditions, and SPV-AMC would thereafter convey such shares to Cobankiat Hardware, Inc., for valuable consideration, subject also to certain terms and conditions; that under Republic Act (R.A.) No. 9182, otherwise known as the "Special Purpose Vehicle Law of 2002'', as implemented by Revenue Regulations No. 06-04, as amended, the transfer of assets by a debtor-mortgagor in settlement of its liabilities to a bank-mortgagee through dacion en pago within two years from April 12, 2005 as well as the sale of NPA/NPL by a bank to an SPV and by the SPV to a buyer is entitled to tax exemptions, provided that the necessary Certificate of Eligibility is issued by the appropriate regulatory agency, such as the Bangko Sentral ng Pilipinas (BSP) or the Securities and Exchange Commission (SEC); that with the implementation of the SPV Law of 2002, UCPB filed in January 2005 its application with the BSP that UCPB is a qualified financial institution and that the loans of UNIWIDE are recognized as Non-Performing Assets; that on July 4, 2005, BSP approved UCPB's application and issued Certificate of Eligibility (of Non-Performing Assets) on June 23, 2005; that the BSP also recognized the transfer/sale of the identified non-performing assets of UCPB to SPV-AMC as a "true sale" and issued a Certificate of Eligibility (of Non-Performing Assets) on June 26, 2005; that on July 11, 2005, UCPB filed capital gains tax return and documentary stamp tax return, covering the AHRC shares transferred through dacion en pago by UNIWIDE with the Large Taxpayers Audit and Investigation Division I, and claimed exemption from such taxes pursuant to the provisions of R.A. No. 9182; and that on July 26, 2005, UCPB filed capital gains tax return and documentary stamp tax return, covering the URC shares, and claimed exemption from such taxes under R.A. No. 9182. CSIHDA In connection therewith, you now request for opinion as to whether or not 1. UNIWIDE, as seller (through dacion en pago ) of unlisted shares of stock of special purpose corporations, is the person liable to pay capital gains tax, if any; 2. The sale or transfer through dacion en pago of unlisted shares of stock of special propose corporations by UNIWIDE to UCPB is exempt from capital gains tax and documentary stamp tax pursuant to R.A. No. 9182; and 3. Donor's tax accrues on the sale of unlisted shares of stock of a domestic corporation classified as capital assets for less than full and adequate consideration." In reply thereto, please be informed that 1. Section 27(D)(2) of the Tax Code of 1997 provides that "xxx xxx xxx "(2) Capital Gains from the Sale of` Shares of Stock Not Traded in the Stock Exchange. A final tax at the rates prescribed below shall be imposed on net capital gains realized during the taxable year from the sale, 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 5% "Amount in excess of P100,000 10% From the above-cited provisions, it is undisputed that the capital gains tax is imposed upon the seller or transferor of unlisted shares of stock of domestic corporations based on its net capital gains. Since the seller of the unlisted shares in the dacion en pago is UNIWIDE, which is under receivership, it is the person liable to the aforesaid tax, if any, on the transaction. 2. Section 15 of R.A. No. 9182 provides that "Section 15. Tax Exemption and Fee Privileges . Any existing law to the contrary notwithstanding, the transfer of NPAs from the FI to an SPV, and from an SPV to a third party or dation in payment ( dacion en pago ) by the borrower or by a third party its favor of an FI or in favor of an SPV shall be exempt from the following taxes: (a) Documentary stamp tax on the above-mentioned transfer of NPAs and dation in payment ( dacion en pago ) as may be imposed under Title VII of the National Internal Revenue Code or 1997; (b) Capital gains tax imposed on the transfer of lands and/or other assets treated as capital assets as defined under Section 39(A)(1) of the National Internal Revenue Code of 1997; (c) Creditable withholding income taxes imposed on the transfer of land and/or buildings treated as ordinary assets pursuant to Revenue Regulations No. 2-98, as amended; (d) Value-added tax on the transfer of NPAs as may be imposed under Title IV of the National Internal Revenue Code of 1997 or gross receipts tax under Title V of the same Code, whichever is applicable. Corollarily, Section 3, supra , defines the following terms: "xxx xxx xxx "(g) Non-Performing Assets or NPAs consists of the Non-Performing Loans and Real and Other Properties Owned or Acquired by FIs (ROPOA); "(h) Non-Performing Loans or NPLs refers to loans and receivables such as mortgage loans, unsecured loans, consumption loans, trade receivables, credit card receivables and all registered and unregistered security and collateral instruments, including but not limited to, real estate mortgages, chattel mortgages, pledges, and antichresis, whose principal and/or interest have remained unpaid for at least one hundred eighty (180) days after they have become past due or any of the events of default under the loan agreement has occurred; "(i) ROPOAs refers to real and other properties owned or acquired by an FI in settlement of loans and receivables, including real properties, shares of stocks, and chattels formerly constituting collaterals for secured loan, which have been acquired by way of dation in payment ( dacion en pago ) or juridical or extra-judicial foreclosure or execution of judgment. Moreover, Section 3 of Revenue Regulations No. 06-04 provides "xxx xxx xxx "(d) Dation in payment ( dacion en pago ) refers to a payment whereby property, whether real or personal, tangible or intangible, is alienated in favor of the creditor, which could either be an FI or an SPV, in satisfaction of a non-performing loan: Provided, That the term does not include other forms of transfer such as judicial or extra-judicial foreclosure and execution of judgment. "xxx xxx xxx "(g) Non-Performing Loan or NPL refers to loans and receivables, such as mortgage loans, unsecured loans, consumption loans, trade receivables, lease receivables, credit card receivables and all registered and unregistered security and collateral instruments, including, but not limited to, real estate mortgages, pledges, and antichresis whose principal and/or interest has remained unpaid for at least one hundred eighty (180) days after they have become past due or any of the events of default under the loan agreement has occurred, as of June 30, 2002, as certified by the Appropriate Regulatory Authority. DcHaET "(h) ROPOA refers to real and other properties owned or acquired by an FI in settlement of its loans and receivables, including, but not limited to real properties, shares of stock, and chattel formerly constituting collateral for secured loans, by way of dation in payment ( dacion en pago ), judicial or extra-judicial foreclosure, or execution of judgment, as of June 30, 2002; and to such real and other properties acquired by an FI after June 30, 2002, through the same modes in settlement of a loan or receivable classified as NPL as of June 30, 2002; in either case as certified by the Appropriate Regulatory Authority: Provided, That, only for the purpose of this definition, a property is deemed acquired on: (1) The date of notarization of the "Deed of Dacion" in case of dation in payment ( dacion en pago ); (2) The date of the entry of judgment in case of judicial foreclosure; or (3) The date of notarization of the "Sheriff's Certificate" in case of extra-judicial foreclosure, Provided, further, That this definition does not include real and other properties owned or acquired by an SPV in settlement of its loans and receivables acquired from an FI or otherwise. A careful scrutiny of the above provisions disclosed that the shares of stock of the special purpose corporations are within the contemplation of the said provisions. It is safe to conclude that the dation in payment by UNIWIDE of shares of stock of the special purpose corporations, like AHRC, URC and HVDC, in favor of UCPB in settlement of its outstanding obligations is exempt from the capital gains tax on the net capital gains realized from the sale of shares of stock not traded in the local stock exchange imposed under Section 27(D)(2) of the Tax Code of 1997 and the corresponding documentary stamp tax on the transfer of shares imposed under Section 196, supra . This is fortified in BIR Ruling No. DA407-05-dated October 3, 2005 , where this Office ruled that "Such being the case and on the basis of the aforementioned COEs issued by the BSP that the foregoing obligations are NPLs, the dation in payment thereof executed between the Liquidator of the NSC and GIHI (SPV-AMC), and between the Liquidator of NSC and GSII, within the covered period from April 12, 2003 to April 12, 2005 are exempt from the above enumerated taxes. "xxx xxx xxx" 3. Section 100 of the Tax Code of 1997 provides that "Sec. 100. Transfer for Less Than Adequate and Full Consideration . Where property, other than real property referred to in Section 24(D), is transferred for less than an adequate and full consideration in money or money's worth, then the amount by which the fair market value of the property exceeded the value of the consideration shall, for the purpose of the tax imposed by this Chapter, be deemed a gift, and shall be included in computing the amount of gifts made during the calendar year." The rationale of the above-cited provisions in excluding the sale of real property classified as capital asset from donor's tax is that since the capital gains tax is computed on the higher amount between the fair market value and gross selling price, to impose the donor's tax on the excess of the fair market value over the gross selling price would be tantamount to double taxation on the same amount first, in the form or capital gains tax, and second, in the form of donor's tax. The above principle is likewise true with respect to the sale or transfer of unlisted shares of stock of a domestic corporation that is not a dealer in securities. Revenue Regulations No. 2-82 provides that the gain from the sale shall be the difference between the cost or adjusted basis and the gross selling price. Considering that the net capital gain from the sale of unlisted shares of stock of a domestic corporation is based and computed on gross selling price, which is the fair market value of the shares of stock sold at the time of sale, no donor's tax arising from the sale of unlisted shares of stock for less than adequate consideration provided for in Section 100 of the Tax Code of 1997 should be imposed. In other words, there would be no occasion where there would be a sale or transfer of unlisted shares of stock for less than adequate consideration where the seller is not a dealer in securities. In the instant case, the Deed of Assignment dated April 8, 2005 provides in the first 'WHEREAS Clause' that UNIWIDE has outstanding obligations due to UCPB in the aggregate amount of P1,043,963,162.18; and in the third 'WHEREAS Clause' that the shares of the special purpose corporations owned by UNIWIDE transferred to UCPB have a total issued value of P1,326,502,210.46 (i.e., P451,796,023.25 for AHRC and P874,706,187.21 for URC). Thus, the facts alone are insufficient to conclude that there was a donation made by UNIWIDE in favor of UCPB, on account of the transfer of shares of stock with a total listed value of P1,326,502,210.46 for a valuable consideration only of P1,043,963,162.18. It is highly unusual for a debtor experiencing financial difficulties in paying its maturing loan obligations and incurring substantial yearly operating losses to even make a donation to its creditor-bank. Thus, Revenue Regulations No. 2-82 do not apply to the dation in payment of UNIWIDE and UCPB because of the following: 1. The unlisted shares of stock of AHRC and URC owned by USRRC are capital assets, since USRRC is not a dealer in securities and said shares are held by USRRC for investment purposes. This finds support in Section 39(A)(1) of the Tax Code of 1997, which defines the term "capital assets" to mean property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property used in the trade or business, of a character which is subject to the allowance for depreciation provided in Subsection (F) of Section 34, or real property used in trade or business of the taxpayer. 2. The same principle of law applies to sale of real property classified as capital asset and shares of stock of a domestic corporation classified as capital asset. The similarities in the application of the legal principle have been adequately explained above, and this Office sees no legal reason for treating unlisted shares of stock differently from real property, which are both subject to final income taxes computed on the gross selling price or fair market value, whichever is higher. cIDHSC 3. The figures shown as outstanding obligations of UNIWIDE to UCPB (P1,043,963,162.18) and total issued value of the shares of stock (P1,326,502,210.46 = P451,796,023.25 for AHRC and P874,706,187.12 for URC) are misleading and not accurate, for the following reasons: a. The outstanding loan obligation mentioned in the MOA and Deed of Assignment dated December 29, 1999 is broken down as follows: Principal P995,500,000.00 Interest 30,846,590.29 Bills purchased 17,616,571.89 TOTAL P1,043,963,162.18 ============== On the other hand, the total issued value of the shares of stock as of the date of incorporation in 2001 of the special purpose corporations are: Unice Realty P16,509,400.00 Autumn Hills 874,706,187.21 Hyper Villas 451,796,023.25 TOTAL P1,343,011,610.46 ============== b. The UNIWIDE loan accounts consist of twelve (12) separate loans extended by UCPB at different dates with a total principal amount of P995,500,000.00 as of December 31, 1999. Since these loans have become past due as of December 31, 1999, additional interests in the total amount of P764,287,500.44 have accrued from January 1, 2000 to April 8, 2005, when the Deeds of Assignment were executed by UNIWIDE and UCPB. These additional interests are not, however, recorded in the books of UCPB in accordance with BSP Manual Regulations of Banks issued on December 31, 1996, which prohibits further accrual of interest income in the books of the bank after the loan of a debtor has become past due, although these accrued interests are reflected in the subsidiary ledger account of the bank and continuously monitored for collection purposes. Considering that the total amount of principal, interest and bills purchased as of April 8, 2005 was P1,808,250,662.62 (P1,043,963,162.18 + 764,287,500.44), which amount is higher than the P1,043,963,162.18 outstanding obligation mentioned in the Deeds of Assignment or the total issued value of the shares of stock in the amount of P1,343,011,610.46, it is clear that the correct amount of obligation being settled as of April 8, 2005 by the contracting parties through dacion en pago is greater than the fair market value of the shares of stock assigned by UNIWIDE to UCPB. c. The breakdown of the book value of the shares of stock is as follows: Autumn Hills Realty Corporation P244,893,747 Unice Realty Corporation 225,735,929 TOTAL P470,629,676 =========== Moreover, Section 6(a)(3)(ii) of Revenue Regulations No. 2-82 provides that "Section 6. Determination of Tax Base . In determining the tax base, the following rules shall apply: "(a) Determination of selling price . The selling price of the shares of stock shall be the fair market value of the shares of stock transferred or exchanged and not the fair market value of the property received in exchange. If the total consideration of the sale or disposition consists partly in cash or money and partly in kind, the selling price shall be the fair market value of the shares disposed. xxx xxx xxx "(ii) In case the shares are valued on a basis lower than their book values, a justification for the deviation from the book value, together with the evidences in support thereof, should be submitted. The following factors are considered relevant in the valuation of shares of stock of closed corporations. xxx xxx xxx "If such lower fair market valuation is not clearly established and documented, the book value of the unlisted shares of stock shall be adopted. If there have been previous sales/exchanges of the unlisted shares of stock, the price at which those shares exchanged hands should be taken/considered as its fair market value." Said regulations clearly provides that "the book value of these unlisted shares of stock shall be prima facie considered as their fair market value, and in case the shares are valued on a basis lower than their book values, a justification for the deviation from the book value, together with the evidences in support thereof, should be submitted. In the case at bar, the book values of the unlisted shares of stock as of June 30, 2005 are computed as follows: I. Autumn Hills Realty Corporation Total liabilities and stockholders' equity P244,995,636 Less: Advances from stockholders 100,000 Stockholders' equity P244,895,636 Breakdown of equity: Capital stock P37,390,000 Additional paid-in capital 414,412,065 Revaluation increment on land (206,906,429) TOTAL P244,895,636 Formula: Stockholders' equity divided by the number of shares issued and outstanding equals the book value per share Thus: Stockholders' Equity P244,895,636 Divided by No. of Shares 373,900 Book value per share P654.98 Multiplied by No. of Shares owned by UNIWIDE 373,895 Book value of shares owned by UNIWIDE P244,893,747 2. Unice Realty Corporation Total liabilities and stockholders' equity P255,738,293 Less: Advances from stockholders - Stockholders' equity P255,738,293 Breakdown of equity: Capital Stock P74,683,200 Additional paid-in capital 800,028,843 Impairment on revaluation of land (648,973,750) TOTAL P255,738,293 Thus: Stockholders' equity P255,738,293 Divided by No. of Shares 746,832 Book value per share P302.26 Multiplied by No. of shares owned by UNIWIDE 746,827 Book value of shares owned by UNIWIDE P255,735,929 On the basis of the figures in the tentative audited financial statements (stockholders' equity section) as of June 30, 2005, it would appear that the fair market value of the shares of stock is P470,629,676 (P244,893,747 + P255,735,929) IDSaTE It should be noted that on October 24, 2005, the same external auditor, Wilfred Oliver L. Dolosa finalized the tentative audited balance sheet of Unice Realty Corporation. This amended balance sheet shows that the stockholders equity as of June 30, 2005 was P225,738,293, after reflecting the impairment of the value of land, based on the appraisal report submitted by Sallsmans Phil., Inc. dated March 29, 2004, in accordance with the applicable 2005 Philippine Accounting Standard approved by the SEC. For purposes of computing the correct amount of capital gains tax payable and remitting in the process prima facie rule laid down by the regulations as discussed above, it is important that what should be determined is the true fair market value of the property being transferred. It is but proper that the correct value of the property be determined for purposes of computing the capital gains tax. In this regard, the international accounting standards adopted for use in the Philippines could be instructive. After recognition of an asset, an item of property whose fair value can be measured reliably shall be carried at a revalued amount. Revaluation shall be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date. The fair value of land and building is usually determined from market-based evidence by appraisal that is normally undertaken by professionally qualified valuers. The fair value of items of plant and equipment is usually their market value determined by appraisal (International Accounting Standard No. 16 on Property, Plant and Equipment, paragraphs 31 & 32; BIR Ruling No. DA413-04 dated July 30, 2004). If an asset's carrying amount is decreased as a result of a revaluation, the decrease shall be recognized in profit or loss. However, the decrease shall be debited directly to equity under the heading of revaluation surplus to the extent of any credit balance existing in the revaluation surplus in respect of that asset (International Accounting Standard No. 16 on Property, Plant and Equipment, paragraph 40). Considering that the true fair market values of the shares of stock of the special purpose corporations and their underlying real properties (P470,629,676) are lower than the total amount of outstanding obligations (P923,536.79) as of date of execution of the Deed of Assignment, there is a loss (rather than a gain) from the sale or transfer of such shares of stock. Accordingly, this will therefore serve as the authority and guide for the Large Taxpayers Service concerned to issue the corresponding Certificate Authorizing Registration (CAR) relating to the shares of stocks of AHRC and URC on the aforementioned transactions. WHEREFORE, in view of the foregoing , this Office holds that since there is no capital gain (but rather a capital loss) from the sale or transfer of the unlisted shares of stock of the special purpose corporations by UNIWIDE in favor of UCPB, the assignment of the unlisted shares of stock is exempt from the following taxes: (a) capital gains tax imposed under Section 27(D)(2); (b) donor's tax imposed under Section 99; and (c) documentary stamp tax imposed under Section 176, all of the Tax Code of 1997 in relation to R.A. No. 9182. 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