BIR Ruling [DA-449-04]

August 23, 2004 BIR RULING [DA-449-04] Punongbayan & Araullo 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue Makati City Attention: Atty. Romeo H. Duran Tax Principal Gentlemen : This refers to your letter dated August 10, 2004 seeking further confirmation that the change in the cost of Investment in Trust Fund as well as the reclassification of the short-term placements would not affect the qualification of the transfer of the assets and liabilities by Pacific Plans, Inc. (PPI) to Lifetime, Inc. (Lifetime) under Section 40(C)(2) of the 1997 Tax Code and its tax consequences as we earlier ruled in BIR Ruling S-40-018-2004, dated July 21, 2004, and as amended by BIR Ruling DA-425-2004, dated August 06, 2004. It is represented that in BIR Ruling S-40-018-2004, dated July 21, 2004, and as amended by BIR Ruling DA-425-2004, dated August 06, 2004, which we issued in response to your request for confirmation of your opinion that the transfers of assets and liabilities of Pacific Plans, Inc. (PPI) to Lifetime, Inc. (Lifetime) qualify under Section 40(C)(2) of the 1997 Tax Code and therefore subject to tax under said provision and related tax laws and regulations, we ruled, among others, that: "Pursuant to Section 40(C)(2) and (6)(c) of the Tax Code of 1997, no gain or loss shall be recognized if property is transferred to a corporation by a person in exchange for stock or unit of participation in such a corporation of which as a result of such exchange said person, alone or together with others, not exceeding four persons, gains control of said corporation. The term " control " shall mean ownership of stocks in a corporation possessing at least 51% of the total voting power of all classes of stock entitled to vote. Control is determined by the amount of stocks received, i.e. , total subscribed by the transferors. In determining the 51% ownership, only those persons who transferred property for stocks in the same transaction may be counted up to a maximum of five. "Accordingly, no gain or loss shall be recognized both on the transferor and transferee corporation on the transfer by PPI of their assets and liabilities in exchange for the shares of stock of Lifetime, considering that as a consequence of the exchange, PPI gained control of the transferee corporation by owning 100% of its total voting stocks. aCTcDS "However, if pursuant to the exchange transaction and as part of the consideration, the transferee corporation assumes the liability of the transferors or acquires from the transferors property subject to liability, such assumed or acquired liability shall not be treated as money and/or other property, and shall not prevent the exchange from being tax free [ Sec. 40(C)(4)(a) of the Tax Code of 1997 ]. If the amount of the liabilities assumed plus the amount of the liabilities to which the property is subject, exceed the total of the adjusted basis of the property transferred pursuant to such exchange, then such excess shall be considered as a gain from the sale or exchange of a capital asset or of property which is not a capital asset, as the case may be. [ Sec. 40(C)(4)(b) of the Tax Code of 1997 ] "Applying the foregoing to the instant case, and since the liabilities to be transferred to Lifetime exceed its original basis, a taxable gain therefore, shall be recognized in the aggregate amount of TWO BILLION NINE HUNDRED SIX MILLION FIVE HUNDRED TWENTY SIX THOUSAND FIVE HUNDRED THIRTEEN PESOS (P2,906,526,513.00). "The taxable gain resulting from the excess of the liabilities over the original basis of the assets shall be subject to 32% corporate income tax and shall be entitled to the deductible corporate costs and expenses as provided under Section 34 of the 1997 Tax Code." "In as much as a gain of P2,906,526.51 has already been recognized upon the transfer of assets, the same shall be added to the difference between the assets transferred and the liabilities assumed. Accordingly, the substituted basis of the shares of stock received by PPI from Lifetime shall be as follows: "Property Allocated Shares Substituted Basis Cash 2,887 P48,331,683 Short-term bank placements 20,424 341,923,936 Other assets 976,689 0 TOTAL 1,000,000 P390,257,619" This ruling was issued based on the representation that the costs of assets and liabilities to be transferred by PPI to Lifetime in exchange for shares of stock to be issued by the latter, are as follows: Assets Cash and Cash Equivalents Cash on hand and in banks 48,331,683 Short-term bank placements 341,925,936 Total 390,257,619 Assets Other Than Cash and Cash Equivalents Investment in trust funds 5,589,634,448 Installment contract receivable 7,692,856,011 Other receivables 40,611,973 Property and equipment net 44,575,655 Deferred charges 184,226,321 Prepaid expenses and other assets 77,378,445 Total 13,629,282,853 Liabilities Accounts payable/accrued expenses 518,590,305 Actuarial reserve liability 8,064,560,859 Insurance premium reserve 259,802,192 Estimated provision for benefit in installment contracts receivable 4,918,995,622 Unrealized gross income in installment contracts receivable 2,773,860,388 16,535,809,366 Excess of liabilities over costs of assets (excluding cash) 2,906,526,513 ============ It is further represented that based on a subsequent audit conducted by an external auditor on the assets and liabilities of PPI as of May 31, 2004, the following would be the changes in the costs and composition of the assets to be transferred by PPI to Lifetime: a) Cost of Investment in Trust Fund, which forms part of the total assets to be transferred to Lifetime, amounts to P6,335,603,086, not P5,589,634,448 as earlier represented; and b) The short-term placements amount to a total of P297,756,307, not P341,925,936 as earlier represented. The difference of P44,169,628 represents long-term securities and should therefore be classified as long-term investment. IESDCH Other than the change in the cost of Investment in Trust Fund and the reclassification of short-term placements into long-term investments, there are no other substantial changes from your earlier representations. With these changes, final balances of the costs of assets and liabilities to be transferred by PPI to Lifetime in exchange for shares of stock to be issued by the latter are as follows: Assets Cash and Cash Equivalents Cash on hand and in banks 48,331,684 Short-term bank placements 297,756,307 Total 346,087,991 Assets Other Than Cash and Cash Equivalents Investment in trust funds 6,335,603,086 Installment contract receivable 7,692,856,011 Other investments 44,169,637 Other receivables 40,611,973 Property and equipment net 44,575,655 Other assets 261,604,766 Total (excluding cash and cash equivalents) 14,419,421,127 Liabilities Accounts payable/accrued expenses 518,590,305 Actuarial reserve liability 8,064,560,859 Insurance premium reserve 259,802,192 Estimated provision for benefit in installment contracts receivable 4,918,995,622 Unrealized gross income in installment contracts receivable 2,773,860,388 16,535,809,366 Excess of liabilities over costs of assets (excluding cash) 2,116,388,239 ============ Based on the foregoing, you now request for a further confirmation that the above changes would not affect the qualification of the transfer under Section 40(C)(2) of the 1997 Tax Code and its tax consequences as earlier ruled in BIR Ruling S-40-018-2004, dated July 21, 2004, and as amended by BIR Ruling DA-425-2004, dated August 06, 2004. In reply thereto, please be informed that your opinion is hereby confirmed. Accordingly, the change in the cost of Investment in Trust Fund and the reclassification of a portion of the short-term placements into long-term investments would not affect the qualification of the transfer under Section 40(C)(2) of the 1997 Tax Code and its tax consequences as earlier ruled in BIR Ruling S-40-018-2004, dated July 21, 2004, and as amended by BIR Ruling DA-425-2004, dated August 06, 2004. However, because the total original basis of the assets to be transferred to Lifetime increased, the excess of the liabilities to be assumed over the adjusted bases of the assets to be transferred decreased to P2,116,388,239. Accordingly, the taxable gain to be recognized upon the transfer of assets and liabilities shall be in the aggregate amount of TWO BILLION ONE HUNDRED SIXTEEN MILLION THREE HUNDRED EIGHTY-EIGHT THOUSAND TWO HUNDRED THIRTY NINE PESOS (P2,116,388,239). Likewise, in as much as a gain of P2,116,388,239 has already been recognized upon the transfer of assets, the same shall be added to the difference between the assets transferred and the liabilities assumed in determining the substituted basis of the shares of stock received. Accordingly, the substituted basis of the shares of stock received by PPI from Lifetime shall be as follows: Property Allocated Shares Substituted Basis Cash 2,887 P48,331,684 Short-term bank placements 17,786 297,756,307 Other assets 979,323 0 TOTAL 999,996 P346,087,991 =========== Accordingly, this ruling hereby further amends BIR Ruling No. S-40-018-2004, dated July 21, 2004, as amended by BIR Ruling DA-425-2004, dated August 06, 2004, with regard to the phrase that "the taxable gain resulting from the excess of the liabilities over the original bases of the assets shall be in the aggregate amount of TWO BILLION ONE HUNDRED SIXTEEN MILLION THREE HUNDRED EIGHTY EIGHT THOUSAND TWO HUNDRED THIRTY-NINE PESOS (P2,116,388,239)" and that the substituted basis of the shares received from Lifetime shall amount to P346,087,991. 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 the ruling shall be considered null and void. IcESDA Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service