BIR Ruling [DA-371-06]

June 15, 2006 BIR RULING [DA-371-06] SGV & Co . 6760 Ayala Avenue 1226 Makati City Attention: Atty. J. A. Osana and Atty. A. C. Tionko Tax Services Gentlemen : This refers to your letter dated April 9, 2003 requesting on behalf of your clients, SAN MIGUEL PROPERTIES, INC. ("SMPI") and HOC REALTY, INC. ("HRI") for a confirmation of your opinion that pursuant to Section 40(C)(2) of the 1997 Tax code, no gain or loss shall be recognized on the transfer of assets and liabilities by HRI to SMPI as a consequence of their merger wherein SMPI shall be the surviving corporation. The facts, as represented, are as follows: a. SMPI, a corporation organized and existing under Philippine laws, is engaged in the development, sale and lease of real property. It has an authorized capital stock ("ACS") of P1,280,000,000.00 divided into 128,000,000 shares with a par value of P10.00 per share. As of June 30, 2002, of the total ACS of SMPI 115,919,850 shares are issued and outstanding with about 87% thereof owned and held by San Miguel Corporation ("SMC"). b. HRI, also organized and existing under Philippine laws, was organized to acquire, own, use, improve, develop, sell, mortgage, exchange, lease, develop and hold for investment or otherwise, real estate of all kinds. Its ACS consists of 100,000.000 Preferred Shares with par value of P1.00 per share and Common Shares of 300,000,000 with par value of P1.00 per share. As of June 30, 2002, of the ACS of HRI, 33,333,333 Preferred Shares and 300,000,000 Common shares are issued and outstanding of which approximately 90% is owned by SMPI while the remaining 10% of the shares are owned by SMC. c. Considering that both corporations are engaged in the same line of business, the shareholders of SMPI and HRI have determined that the merger of both corporations will result in benefits and various advantages from their combined operations such as, but not limited to, effective and optimum utilization of their resources, properties and facilities and rationalization of their respective structures. AaIDHS d. The merger has been effected pursuant to Sections 76 to 80 of the Corporation Code and has been approved by the Securities and Exchange Commission (SEC) on December 9, 2002, also the effective date of the merger. e. As a result of the merger, SMPI issued 6,091,090 shares to San Miguel Corporation (SMC) and not 609,109 shares as reflected in the above cited issued ruling, SMPI, on the other hand, did not issue shares to itself. Accordingly, each of the outstanding certificates of stock of HRI held by SMPI and SMC have been surrendered for cancellation and replacement, respectively. In connection, you now request for a confirmation that: 1. The merger between SMPI told HRI with SMPI as the surviving corporation is a merger within the contemplation of Section 40(C)(2) and 40 (C)(6)(b) of the Tax Code, considering that it is being undertaken for a bona fide business purpose and not for the purpose of escaping the burden of taxation. Therefore, no gain or loss shall be recognized by both SMPI and HRI on the transfer of all assets and assumption of liabilities pursuant to the Plan of Merger; 2. The tax-free exchange of the merger is not affected by the non-issuance by the surviving company, SMPI, of shares of stock to itself (but only to SMC to the extent of 6,091,090 shares in exchange for the assets and liabilities of the absorbed company) pursuant to sound business practice; 3. Since original SMPI shares of stock were issued to SMC, as a consequence of the merger, the documentary stamp tax (DST) on the original issuance of shares under Section 175 of the Tax Code will be due. However, no DST shall be due on the surrender of HRI shares for cancellation; 4. The transfer to SMPI of real properties owned by HRI pursuant to the merger shall be subject to DST imposed under Section 196 of the Tax Code; 5. The merger is not subject to donor's tax as there is not intention to donate on the part of either SMPI or HRI; and 6. The transfer of the assets of HRI to SMPI pursuant to the merger will not be subject to the value-added tax (VAT). Any unused input tax of HRI as of the effective date of the merger, will be absorbed by SMPI as the surviving corporation pursuant to Revenue Regulations No. 7-95 (RR No. 7-95). In reply thereto, please be informed as follows: 1. The merger between SMPI and HRI whereby all the assets and liabilities of HRI was transferred to SMPI as the surviving corporation, qualifies for non-recognition of gain or loss for income tax purposes in accordance with Section 40(C)(2) of the Tax Code, as amended, to wit: "(2) Exceptions. No gain or loss shall be recognized if in pursuance of a plan of merger or consolidation (a) A corporation, which is a party to a merger or consolidation, exchanges property solely for the stock of another corruption which is a party to the merger or consolidation; or (b) A shareholder exchanges stock in a corporation, which is a party to the merger or consolidation, solely for the stock of another corporation, which is a party to the merger or consolidation; or (c) A security holder of a corporation, which is a party to the merger or consolidation, exchanges his securities in another corporation, a party to the merger or consolidation." TcCDIS In this connection, Section 40(C)(6)(b) of the Tax Code defines the term "merger" as follows: TaCEHA "(b) The term "merger" or consolidation", when used in this Section, shall be understood to mean: (1) the ordinary merger or consolidation or (2) the acquisition by one corporation of all or substantially all the properties of another corporation solely for stock; provided that for a transaction to be regarded as a merger or consolidation within the purview of this Section, it must be undertaken for a bona fide business purpose and not solely for the purposes of escaping the burden of taxation; provided, further, that in determining whether a bona fide business purpose exists, each and every step of the transaction shall be considered and the whole transaction or series of transaction shall be treated as a single unit, provided, finally, that in determining whether the property transferred constitutes a substantial portion of the business of the transferor, the term "property" shall be taken to include the cash assets of the transferor." Based on the foregoing, the following are the elements of a tax-free exchange merger under Section 40(c)(2) in relation to Section 40(c)(6)(b) of the Tax Code: 1. There must be a merger and a plan of merger; 2. The parties to the merger must, as a general rule, exchange property solely for stock, pursuant to the plan of merger; and 3. The merger must be undertaken for a bona fide business purpose and not solely for purpose of escaping the burden of taxation. The above provisions of law was applied by the BIR in several rulings including BIR Ruling No. 210 dated May 13, 1993, where the BIR ruled that the merger between GMCR and its wholly owned subsidiary, CRS qualifies as a tax-free merger under Section 34(c)(2) [now Section 40(c)(2)] of the Tax Code, as amended. The BIR ruled that: "1. The above re-organization is a merger within the contemplation of Section 34(c)(2)(c) and 5(b) of the Tax Code, as amended because a corporation (GMCR) will acquire all the assets and assume all the liabilities of CRS, although no GMCR shares shall be issued to GMCR, since on the effective merger date, CRS is wholly owned by GMCR, the transaction undertaken being for a bona fide business purpose and not solely for the purpose of escaping from the burden of taxation." Following the requirements under Section 40(c)(2) of the 1997 Tax Code, HRI transferred all assets and liabilities to SMPI in exchange for shares of stock pursuant to the provisions of the Plan of Merger. In addition, the merger is being undertaken for a bona fide business purpose as stated above and not merely for the purpose of escaping the burden of taxation. Consequently, the merger between SMPI and HRI qualifies as a tax-free merger. Under ordinary circumstances, the surviving corporation would issue shares of stock to the stockholders of the absorbed corporation in exchange for the net assets transferred by the absorbed corporation. Thus, the stockholders of the absorbed corporation will become the stockholders of the surviving corporation. 2. In the case of the merger between SMPI and HRI, sound corporate practice dictates that the surviving corporation, SMPI, having 90% shareholdings in HRI, waive its right to receive shares of stocks pursuant to the merger. Otherwise, SMPI would be issuing its own shares to itself. However, 6,091,090 SMPI shares of stock shall be issued to SMC, being a 10% shareholder in HRI. TDaAHS The fact that no shares were issued to SMPI, being 90% shareholder in HRI, will not prevent the merger of SMPI and HRI from qualifying for the non-recognition of gain or loss under Section 40(C)(2) of the Tax Code. In BIR Ruling No. 030-99, dated March 12, 1999 , this Office ruled that the merger between a parent company, Roche (Philippines), Inc. (Roche), with its subsidiary, Boehringer Mannheim (Philippines), Inc. (BMPI) where Roche acquired all the assets and assumed all the liabilities of BMPI, qualifies as a tax-deferred merger under Section 40(C)(2) and (6)(b) of the 1997 Tax Code. In that ruling, this Office noted that: "The tax-deferred character of the merger under Section 40(C)(2) and (6)(b) of the Tax Code of 1997, is not affected by the non-issuance by the surviving corporation of its share in exchange for the assets and liabilities of the absorbed corporation in cases of merger of a parent and its subsidiary (par. 4305, Vol. II, Mertens Law of Federal Income Taxation 1986)." This ruling was reiterated in BIR Ruling S-40-221-2001 dated November 5, 2001 . 3. The issuance of 6,091,090 SMPI shares to SMC shall be subject to DST imposed on the original issuance of shares under Section 175 of the Tax Code at a rate of P2.00 on each P200.00 or fractional part thereof, of the par value, of such shares of stock. Moreover, considering that all the outstanding shares of HRI will be retired/cancelled as a consequence of the merger, no DST shall be due upon the surrender by the stockholders of the shares to HRI for retirement/cancellation (BIR Ruling S-40-121-2001 dated October 5, 2001). TSacCH 4. The transfer to SMPI of the real properties owned by HRI shall likewise be subject to DST under Section 196 of the Tax Code at the rate of P15.00 for every P1,000.00 of the consideration for such realty or fair market value thereof, whichever is higher. 5. The merger is not subject to donor's tax as there is no intention to donate on the part of any of the parties to the merger, the latter being undertaken for a legitimate business purpose and not out of the pure liberality. 6. No VAT should be imposed on the transfer of the assets by HRI to SMPI pursuant to the plan of merger. This is in accordance with Section 4.100-5(b) of Revenue Regulations No. 7-95, an amended by Section 4.106-8 of Revenue Regulations No. 16-2005 dated November 1, 2005, viz: "(b) Not subject to output tax. The VAT shall not apply to goods or properties existing as of the occurrences of the following: (1) Change of control of a corporation by the acquisition of the controlling interest of such corporation by another stockholder or group of stockholder, Example: transfer of property to a corporation in exchange for its shares of stock under Section 34(c)(2) and (6)(c) of the Code; (2) Change in trade or corporate name of the business; (3) Merger or consolidation of corporations. The unused input tax of the dissolved corporation as of the date of merger or consolidation shall be absorbed by the surviving or new corporation. In view of the above, SMPI as the surviving corporation shall likewise absorb any unused input tax of HRI as of the effective date of merger. The basis of the assets to be received by SMPI shall be the same as it would be in the hands of HRI. The basis of SMPI's stocks received by the stockholders of HRI shall be the same as the basis of the HRI's stocks surrendered in exchange therefore. Thus, if the transferors later sell or exchange the shares of stock they acquired in the exchange, they shall be subject to income tax on the gains they derived from such sale or exchange, taking into consideration that the cost basis of the shares shall be the same as the original acquisition cost or adjusted cost basis to the transferors of the shares of stocks exchanged therefore; and that the cost basis to the transferee of the property exchanged for stocks shall be the same as it would be in the hands of the transferors. [Section 40(c)(5)(a) and (b) of the 1997 Tax Code] It is understood, however, that upon the subsequent sale or exchange of the assets and shares of stock acquired by the parties, the gain derived from such sale or exchange shall be subject to income tax. Property Transferred Substituted Basis Current Assets Cash and Cash Equivalents Cash In Banks P1,213,102,827.00 Short Term Placements 26,100,000.00 Advances to Parent Company 146,518,279.00 Receivables 648,557.00 Property and Equipment Land and Land Improvements 166,612,829.00 Buildings 116,387,712.00 Land held for Future Development 144,494,753.00 Machinery & Equipment 2,428,216.00 Non-Current Assets Withholding Tax Certificates 2,170,465.00 Deposits with a local bank under Receivership 1,857,036.00 Tax Credits 1,548,539.00 TOTAL P1,821,869,213.00 Shares Liabilities Aggregate ASSETS Allocated Allocated Substituted Basis (SMC) (SMC) (SMC) Current Assets Cash and Cash Equivalents Cash In Banks 4,055.790 -0- P121,310,282.70 Short-Term Placements 87,261 P326,749.33 2,283,250.67 Advances to Parent Company 489,857 1,834,281.61 12,817,546.29 Receivables 2,168 8,119.37 56,736.33 Property and Equipment Land and Land Improvements 557,040 2,085,847.93 14,575,434.97 Buildings 389,121 1,457,073.08 10,181,698.12 Land Held for Future Development 483,092 1,808,948.82 12,640,526.48 Machinery & Equipment 8,118 30,399.16 212,422.44 Non Current Assets Withholding Tax Certificates 7,257 27,172.34 189,874.16 Deposits with a local bank under Receivership 6,209 23,248.48 162,455.12 Tax Credits 5,177 19,386.36 135,467.54 TOTAL 6,091,090 P7,621,226.48 P174,565,694.82 Moreover, in order that the above-described re-organization can be considered as merger under Section 40(c)(2) of the 1997 Tax Code, the parties to the merger should comply with the following requirements: A. The plan of re-organization should be adopted by each corporation, parties thereto, the adaptation being shown by the acts of its duly constituted responsible officers and appearing upon the official records of the corporation. Each corporation, which is a party to the reorganization, shall file, as part of its return for the taxable year within which the reorganization occurred, a complete statement of all facts pertinent to the non-recognition of gain or loss in connection with the reorganization including: (1) A copy of the plan of reorganization, together with a statement executed under the penalties of perjury, showing in full the purposes thereof, and in detail all transactions incident to, or pursuant to the plan; (2) A complete statement of the cost or other basis of all properties including all stocks or securities, transferred incident to the plan; IcaHCS (3) A statement of the amount of stock or securities and other property or money received from the exchange including a statement of all distribution or other disposition made thereof. The amount of each kind of stock or securities and other property received shall be stated on the basis of the fair market value thereof at the date of the exchange; and (4) A statement of the amount and nature of any liabilities assumed upon the exchange, and the amount and nature of any liabilities to which any of the property acquired in the exchange is subject. B. Every taxpayer, other than a corporation who is a party to the reorganization, who received stock or securities and other property or money upon a tax free exchange in connection with a corporate reorganization shall incorporate in his income tax return for the taxable year in which the exchange takes place a complete statement of all facts pertinent to the non-recognition of gain or loss upon such exchange including: (1) A statement of the cost or other basis of the stock or securities transferred in the exchange; and (2) A statement in full of the amount of the stock or securities and other property or money received from the exchange, including any liability assumed upon the exchange, and any liability to which property received is subject. The amount of each kind of stock or securities and other property (other liabilities assumed upon the exchange) received shall be set forth upon the basis of the fair market value thereof at the date of exchange. C. Permanent records in substantial form shall be kept by every taxpayer who participates in a tax free exchange in connection with a corporate reorganization showing the cost or other basis of the transferred property or money received (including any liability assumed on the exchange, or any liability to which any of the properties received were subject), in order to facilitate the determination of gain or loss from a subsequent disposition of such stock or securities and other property received from the exchange (par. 9803-8, Prentice Hall 1963., p. 9611) In addition to the foregoing requirements, the parties shall enclose with their respective income tax returns for the taxable year in which the merger occurred a copy of the request for ruling, with, and the corresponding ruling issued by, the Bureau of Internal Revenue (BIR), both duly stamp-received by the appropriate office of the BIR. Such parties shall include as a note to their respective audited financial statements for the taxable year in which the merger occurred a statement to the effect that they hold such assets/shares acquired in a merger and the year in which such merger occurred, and in the taxable years until the subject properties are subsequently transferred to another transferee. Finally, the surviving corporation shall cause the annotation at the back of the newly issued Certificates of Stock and Transfer Certificates of Title, the substituted basis of the transferred shares of stock, and the fact that no gain or loss was recognized as a result of such merger. It is further required that within ninety (90) days from receipt of this ruling, the parties to the transaction must submit to the Law Division, Bureau of Internal Revenue (BIR), a certified true copy of the duly annotated Certificates of Stock, in respect of the issued shares of the transferee corporation. This ruling supersedes BIR Ruling No. S-40-010-2005 dated June 1, 2005. cSCTEH 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 as null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service