Feliciano & Khan

June 20, 2008 BIR RULING [DA-376-08] 076-89 Feliciano & Khan Law Offices 3rd Floor EMF Building 7426 Santillan Street Makati City Attention: Atty. Myrna Cruz-Feliciano and Atty. Maria Lourdes C. Feliciano-Khan Gentlemen : This refers to your letter dated February 15, 2008 stating that your client, Don Bosco Academy of Pampanga, Inc. (DBAPI), is a non-stock, non-profit educational institution registered with the Securities and Exchange Commission (SEC) under SEC Registration No. 13921; that it is organized for the purpose of and actually offering pre-elementary, elementary and secondary courses for the religious, moral, academic, technical, industrial and vocational education of students and training the youth in the scholastic and ecclesiastical field of knowledge in accordance with up-to-date and modern educational theories and methods; that on the dates specified below, DBAPI was issued the following government permits/recognitions/certificates: Permit/Recognition/Certificate Issued by Coverage 1. Government Recognition No. Department of Education Pre-Elementary Course E-053, Series of 2005 dated (DepEd) April 14, 2005 2. Government Recognition No. DepEd Grades I-VI of the E-038 Series of 2004 dated Elementary Course March 9, 2004 3. Government Recognition No. Dep-Ed Complete Secondary SES-01, Series of 2005 dated Course April 7, 2005 (First to Fourth Year) 4. Certificate of TVET Program Technical Education and Fifteen (15) Month Registration Skills Development Industrial Electricity Authority (TESDA) Course 5. Certificate of TVET Program TESDA Fifteen (15) Month Registration Industrial Electronics Course TaDSHC 6. Certificate of TVET Program TESDA Fifteen (15) Month Registration Mechanical Technology Course 7. Certificate of TVET Program TESDA Fifteen (15) Month Registration Garments Technology Course That DBAPI's constitutional documents provide that (i) no member shall have any interest or participation in the assets or income of the corporation (ref. Article VIII, Amended Articles of Incorporation); (ii) no part of its net income shall inure to the benefit of any member, trustee, officer or private individual nor shall any member, officer or trustee have any pecuniary right or interest in the profit of the corporation or to any of its assets (Article VIII, Amended AOI); (iii) this non-stock and non-profit corporation, is not organized, nor shall it be operated for pecuniary gain or profit (Article VII, Amended By-Laws); (iv) the corporation does not contemplate the distribution of gains, profits or dividends to its members and is organized solely for non-profit purposes (Art. VII, Amended By-Laws); (v) the property, assets, profits and net income of the corporation are irrevocably dedicated to social welfare and charitable purposes, and no part of its profits or net income shall inure to the benefit of any person, whomsoever, but that all its income, properties, real or personal, shall be used and expended in carrying out into effect the aims and objectives of the school/corporation or of corporations devoted exclusively for charitable and social welfare purposes as the Board of Trustees may determine (Art. VII, Amended By-Laws); that since its incorporation, trustees, all of whom are religious brothers or priests who are bound by their vows of poverty, do not receive any compensation by virtue of their position as trustees. That on the other hand, St. John Bosco, Manila Province, Inc. (SSJB) is a non-stock, non-profit religious corporation sole registered with the SEC under SEC Registration No. 7179; that it is organized for the purpose of holding title to the properties, whether real or personal, collecting income therefrom and turning over the entire amount, less expenses to churches, convents, retreat houses, colleges, schools, house of studies, relief or charitable houses, parsonages, youth centers, hospitals, seminaries, cemeteries, religious missions owned or to be owned in connection with its religious purposes, as well as for undertaking community development, scientific and sociological projects, youth development, health, social welfare, cultural and charitable activities. TSIDEa That SSJB is part of a world-wide religious congregation of the Roman Catholic Church of Pontifical right consisting of religious priests and brothers who are engaged in the dissemination of the Catholic faith through the establishment and operation of parishes, establishment and operation of seminaries, retreat houses, schools, charitable houses, youth centers and religious missions; that DBAPI, being one of the instrumentalities of SSJB, through which SSJB undertakes its religious and educational mission, receives funding from SSJB and is assisted by the religious priests and brothers of the SSJB who contribute their time and effort for the operation of the school; that except for 2001 wherein DBAPI had a net income from operations of P388,978.00, from the years 1999 to 2006, DBAPI sustained losses from its operations in the following amounts: 1999 P457,832 2000 1,277,964 2002 2,433,691 2003 4,604,265 2004 2,700,191 2005 4,677,242 2006 3,665,206 that in addition to sustaining losses in the course of its operations as a non-profit educational institution, additional funding was sought by DBAPI from SSJB to fund the transfer of its school site from Bacolor to Mabalacat, and the construction of new school buildings made necessary after the eruption of Mt. Pinatubo which caused the Bacolor site to be buried under "lahar" and rendering the same unusable as a school site; that in 1999, SSJB advanced P17,186,989 for the pre-fabrication of DBAPI's school building; and in 2003, SSJB made another advance of P25,125,582 for the construction of a new building; that to date, SSJB's total advances in favor of DBAPI amounted to P42,312,571; and that in January 2008, in order to assist in DBAPI's operations by reducing its liabilities, SSJB agreed to convert its advances of P42,312,571 into donated capital. DaTEIc Based on the foregoing representations, you now request confirmation of your opinion that the conversion of the advances made to DBAPI by SSJB into donated capital does not give rise to a taxable event on the part of DBAPI nor shall such conversion of debt into donated capital be subject to donor's tax and documentary stamp tax. In reply thereto, please be informed that in BIR Ruling No. 076-89 dated April 17, 1989, this Office ruled, that ". . . before the condonation or forgiveness of indebtedness will give rise to a taxable income, there must be an increase in the assets of the debtor thereby enriching the latter. A transaction whereby nothing of exchangeable value comes to or is received by a taxpayer does not give rise to or create a taxable income. Gain or profit is essential to the existence of taxable income." This Office, in setting forth the above pre-condition for imposing income tax on the condonation of indebtedness, adopted the principle laid down by the US Supreme Court in Dallas Transfer & Terminal Warehouse v. Commissioner of Internal Revenue, 70 F. 2d 95, which held that there must be an increase in assets for there to be income realized from the reduction or extinguishment of liability. In this case, Dallas was renting an office building from its lessor. Due to the lease, Dallas incurred a debt of US$107,880.77 rendering it insolvent. In order to enable Dallas to remain in business and to have a chance to pay the reduced future rental agreed upon, and also to keep its building from being vacant and unprofitable, the lessor accepted as partial payment Dallas' Alamo street property with the appraised value of US$17,507.20 and cancelled the balance of that debt, charging it off as worthless. The US Supreme Court in ruling that Dallas did not realize taxable income explained that: "The transaction was not in form or substance a sale for US$107,880.77 of property which has an appraised value of US$17,507.20. In effect the transaction was similar to what occurs in an insolvency or bankruptcy proceeding when, upon a debtor surrendering, for the benefit of his creditors, property insufficient in value to pay his debts, he is discharged from liability for his debts. This does not result in the debtor acquiring something of exchangeable value in addition to what he had before. There is a reduction or extinguishment of liabilities without any increase in assets. There is an absence of such a gain or profit as is required to come within the accepted definition of income. . . That the increase in clear assets so brought about constituted taxable income is not applicable to the factors of the instant case, as the cancellation of Dallas' past due debt to its lessor did not have the effect of making the Dallas' assets greater than they were before that transaction occurred. Taxable income is not acquired by a transaction which does not result in the taxpayer getting or having anything he did not have before. Gain or profit is essential to the existence of taxable income." aIcDCA The above situation may be applied to DBAPI. The extinguishment of DBAPI's liability as a result of the condonation did not increase DBAPI's assets. It did not have the effect of making DBAPI's assets greater than they were before. Its liabilities still exceed its assets. Moreover, DBAPI did not realize any taxable income as a result of the suspension or waiver or condonation. SUCH BEING THE CASE, this Office holds that DBAPI is not subject to income tax on the amount P42,312,571 condoned by SSJB. Furthermore, the condonation is not subject to donor's tax under Section 101 (A) (3) of the Tax Code of 1997 considering that DBAPI is a non-stock, non-profit educational and charitable institution and as such donation made in its favor, including that in the form of donated capital, is exempt from donor's tax. Finally, the conversion of advances into contributed capital for which no shares were issued is not subject to documentary stamp tax since the said transaction does not fall within the purview of Section 175 of the Tax Code of 1997, as amended by R.A. No. 9243. 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