BIR Ruling [DA-459-06]

July 27, 2006 BIR RULING [DA-459-06] S40; 173; 174; 175; RR 16-2005; RR 13-2004; RR 26; 149-94; 052-99 DA-025-02; DA-144-03 Ayala Corporation 34/F Tower One Exchange Plaza Ayala Avenue, Makati City Attention: Mr. Renato O. Marzan Managing Director Gentlemen : This refers to your letter dated June 30, 2006 requesting a ruling on the tax consequences of the proposed transfer by Ayala Corporation of its 832,343,700 shares of stock in Integrated Microelectronics, Inc. (IMI) to AYC Holdings, Limited, ("AYC Holdings"), a corporation to be organized and registered under the laws of The British Virgin Islands (BVI), in exchange for about 100,117 AYC Holdings' shares of stock, resulting in Ayala Corporation owning more than fifty-one (51%) percent of AYC Holdings' outstanding capital stock entitled to vote, pursuant to Section 40(c)(2) of the 1997 Tax Code, as amended. TcHEaI The facts as represented are as follows: Ayala Corporation is a corporation duly organized and existing under Philippine laws. It is the registered owner of Eight Hundred Thirty-two Million Three Hundred Forty-three Thousand Seven Hundred (832,343,700) shares of stock of IMI, also a corporation duly organized and existing under Philippine laws. IMI is a leading regional electronics manufacturing service (EMS) provider and original design manufacturer (ODM). Its design solutions and manufacturing capabilities are widely respected by original equipment manufacturers from all over the world. IMI's work can be found in many electronics devices that form part of humanity's daily routine, from personal computers to mobile phones, battery charges, automotive sensor devices, bar code readers, and even electronic toothbrushes. IMI currently operates ten (10) manufacturing plants worldwide- 5 in the Philippines, 3 in China, 1 in Singapore and 1 in the US. IMI is aggressively pursuing an expansion strategy that will transform the company into a key global solutions provider and into a higher value global company. In anticipation of the plans of IMI to list its shares with the Philippine Stock Exchange and/or offshore where its shares could realize higher valuation, Ayala Corporation, plans to undertake a rationalization of its equity investment in IMI by undertaking a two-step integrated approach, as follows: a. As a first step, Ayala Corporation proposes to transfer its 832,343,700 shares of stock in IMI to AYC Holdings, a proposed BVI company, in exchange for the latter's shares of stock resulting in Ayala Corporation owning 99% of the total voting power of AYC Holdings outstanding capital stock entitled to vote, pursuant to Section 40 (c)(2) of the Tax Code, as amended. AYC Holdings will focus its investments in the electronic sector. b. Second step and as an integral part of the reorganization, Ayala Corporation proposes to transfer the AYC Holdings shares received in the exchange to its wholly-owned subsidiary, AC International Finance, Limited ("ACIFL"), a corporation duly organized and existing under Cayman Islands laws. The transfer of the AYC Holdings shares to ACIFL will result in Ayala Corporation gaining further control of ACIFL. ACIFL was organized as an offshore company to hold investments in all sectors offshore. AYC Holdings has a proposed authorized capital stock of Twenty Million US Dollars (US$20,000,000.00) divided into Two Hundred Thousand (200,000) shares with a par value of One Hundred US Dollars (US$100.00) per share. Ayala Corporation will undertake the above reorganization of its IMI equity investments to provide an appropriate corporate structure to maximize shareholders' value in IMI. Ayala Corporation's original acquisition cost for the 832,343,700 IMI shares of stock to be transferred to AYC Holdings is Five Hundred Twenty Million Six Hundred Eleven Thousand Three Hundred Nineteen Pesos (P520,611,319.00), Philippine Currency. In reply, please be informed as follows: A. INCOME TAX Pertinent portions of Section 40(C)(2) of the 1997 Tax Code, as amended, state: "No gain or loss shall also be recognized if property is transferred to a corporation by a person in exchange for stock or unit of participation in such corporation of which as a result of such exchange said person, alone or together with others, not exceeding four (4) persons, gains control of said corporation: Provided, that stocks issued for services shall not be considered as issued in return for property." xxx xxx xxx (c) The term ' control ' when used in this Section, shall mean ownership of stocks in a corporation possessing at least fifty-one percent (51%) of the total voting power of all classes of stocks entitled to vote." In BIR Ruling No. 149-94 dated September 29, 1994 , this Bureau affirmed that the tax-free' exchange provision of Section 40(C)(2) is applicable to transfers of Philippine domestic company shares by transferors who are organized and registered under foreign laws to a transferee likewise registered and incorporated under foreign laws. Applying the foregoing, the transferor, Ayala Corporation, therefore, will not recognize gain or loss on the transfer of its 832,343,700 IMI shares of stock to AYC Holdings in exchange for the latter's shares of stock resulting in Ayala Corporation gaining at least 51% of the total voting power of all classes of stock entitled to vote of AYC Holdings since this qualifies as a tax-free exchange pursuant to Section 40(C)(2) and (6)(c) of the 1997 Tax Code, as amended. It should be emphasized, however, that Section 40(C)(2) and (6)(c) of the Tax Code merely defers recognition of the gain or loss from such transaction, for in determining the gain or loss from a subsequent transaction of the properties or of the stocks involved in the exchange, the original or historical cost of the properties or stocks is considered. Thus, if the transferor later sells or exchanges the shares of stock it acquired in the exchange, it shall be subject to income tax on gains 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 transferor of the property exchanged therefor; 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 transferor. (Section 40(C)(5), 1997 Tax Code, as amended). 3. Ayala Corporation will also not recognize gain or loss when it transfers to ACIFL the AYC Holdings shares received in the previous exchange in exchange for ACIFL shares since there is no effective change of beneficial ownership of the AYC Holdings shares since the transfer thereof to ACIFL will result in Ayala Corporation merely gaining further control of its wholly-owned subsidiary, ACIFL. Thus, through its wholly-owned subsidiary, ACIFL, Ayala Corporation will still own, albeit indirectly, the AYC Holdings shares received in a tax-free exchange. ( BIR Ruling No. DA-025-02 dated February 20, 2002 and BIR Ruling No. DA-144-03 dated May 5, 2003 ) TcEDHa B. VALUE-ADDED TAX (VAT) Section 106 of the 1997 Tax Code, as amended, states: "Sec. 106. Value-added Tax on Sale of Goods or Properties . (A) Rate and Base of Tax . There shall be levied, assessed and collected on every sale, barter or exchange of goods or properties, a value-added tax equivalent to ten percent of the gross selling price or gross value in money of the goods or properties sold, bartered or exchanged, such tax to be paid by the seller or transferor: Provided, That the President, upon the recommendation of the Secretary of Finance, shall, effective January 1, 2006, raise the rate of value-added tax to twelve percent (12%) . . ." Moreover, pertinent portion of Section 4.106-8 of Revenue Regulations No. 16-2005, provides: "(a) Subject to output tax The VAT provided for in Sec. 106 of the Tax Code shall apply to goods or properties originally intended for sale or use in business, and capital goods which are existing as of the occurrence of the following . . . xxx xxx xxx (b) Not subject to output tax The VAT shall not apply to goods or properties existing as of the occurrence 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 stockholders . The goods or properties used in business or those comprising the stock-in-trade of the corporation, having a change in corporate control, will not be considered sold, bartered or exchanged despite the change in the ownership interest in the said corporation. Based on the foregoing, the transfer by Ayala Corporation of the IMI shares in exchange for AYC Holdings shares of stock is not subject to 12% VAT under Section 106 of the Tax Code, as amended by Republic Act No. 9337 and as implemented by Revenue Regulations No. 16-2005 [ Consolidated VAT Regulations of 2005 ] since the IMI shares are not held by Ayala Corporation primarily for sale, barter or exchange in the ordinary course of its trade or business. C. DOCUMENTARY STAMP TAX (DST) The transfer by Ayala Corporation of its IMI shares of stock to AYC Holdings in exchange for the latter's shares of stock is exempt from DST pursuant to Section 199(m) of the Tax Code, as amended by R.A. No. 9243 and as implemented by RR No. 13-2004, which states as follows: "Sec. 199. Documents and Papers Not Subject to Stamp Tax . The provisions of Section 173 to the contrary notwithstanding, the following instruments, documents and papers shall be exempt from the documentary stamp tax: xxx xxx xxx (m) Transfer of property pursuant to Section 40(c)(2) of the National Internal Revenue Code of 1997, as amended ." [Emphasis supplied] Thus, for DST purposes, a transfer of shares for shares pursuant to a tax-free exchange under Section 40(c)(2) of the Tax Code is an exempt transaction under Section 199(m) of the 1997 Tax Code, as amended. In this connection, Section 9 of Revenue Regulations No. 13-2004 states that "The exemption on transfer of property pursuant to Section 40(c)(2) of the National Internal Revenue Code of 1997, as amended, provided for under Section 199 (m) refers to the DST due on the deed transferring the property. However, the shares of stocks issued in exchange for said property is subject to DST due under Section 174 if they are original issues ." Although the shares of stock to be issued by AYC Holdings are original issuance, AYC Holdings, being the issuer, is not subject to DST on original issuance of shares under Section 174 of the Tax Code, as amended, because AYC Holdings is a corporation to be organized and registered under The British Virgin Islands laws, therefore, not within the Philippine taxing jurisdiction. Section 173 of the 1997 Tax Code, as amended, only imposes DST on obligations or rights arising from Philippine sources or property situated in the Philippines. aHcACT Similarly, when ACIFL issues shares of stock to Ayala Corporation in exchange for AYC Holdings shares to be exchanged by Ayala Corporation, ACIFL will also not be subject to DST under Section 174 of the Tax Code, as amended, since ACIFL is a Cayman Islands corporation. Hence, the ACIFL shares to be originally issued are not considered rights or obligations arising from Philippine sources subject to DST. On the other hand, when Ayala Corporation transfers the AYC Holdings shares to ACIFL in exchange for the latter's shares resulting in further control of ACIFL, Ayala Corporation is not subject to DST on the transfer thereof under Section 176 of the Tax Code, as amended, because the shares to be transferred are shares issued by a foreign corporation (i.e., AYC holdings- a BVI company) and to be transferred also to a foreign corporation (i.e., ACIFL- a Cayman Islands company). Section 176 of the Tax Code, as amended, only imposes DST on certificates of stock issued in any foreign country when the same are sold or transferred in the Philippines. ( BIR Ruling No. 052-99 dated April 19, 1999 ) Section 176 of the Tax Code states: "Sec. 176 Stamp tax on bonds, debentures, certificates of stock or indebtedness issued in foreign countries . On all bonds, debentures, certificates of stock , or certificate of indebtedness issued in any foreign country, there shall be collected from the person selling or transferring the same in the Philippines , such tax as is required by law or similar instruments when issued, sold or transferred in the Philippines ." On the other hand, Section 26 of Revenue Regulations No. 26 (Documentary Stamp Tax Regulations) provides: "Section 26. Sales of bonds, debentures, etc. issued in a foreign country . Under this paragraph, bonds, debentures, certificates of indebtedness or certificates of stock issued in a foreign country but sold in the Philippines Islands (now Philippines), are subject to tax imposed upon similar instruments when issued, sold or transferred in the Philippine Islands (now Philippines)." 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, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service