BIR Ruling [DA-511-03]

December 18, 2003 BIR RULING [DA-511-03] Sec. 50, RR No. 2 UN-195-94 Siguion Reyna Montecillo & Ongsiako 4th & 6th Floors, Citibank Center 8741 Paseo de Roxas, Makati City Attention: Attys. Jose Lis C. Leagoco, Leonardo Siguion Reyna, Jr. Nicanor N. Padilla & Ajee A. Tiu Gentlemen : This refers to your letter dated November 14, 2003 requesting in behalf of your client, Tuls Industries, Inc. (hereinafter "Tuls"), for a ruling confirming your opinion that: (1) the substitution of AB Electrolux of Sweden (hereinafter "ABE") in the place of Citibank as creditor of Tuls is not subject to income tax or donor's tax; the (2) subscription of shares of Tuls by ABE is subject to documentary stamp tax (DST); and the (3) subsequent conversion of the debt with ABE to shares of stock of Tuls is not subject to income or donor's tax. It is represented that Tuls, formerly known as Electrolux Industrial, Inc., is a corporation organized and existing under Philippine laws. It is primarily engaged in the manufacturing of goods, wares and merchandise; the marketing of general merchandising, on a wholesale basis of goods, wares, merchandise, products of all kinds; and for this purpose, to carry on the business of manufacturers, importers and exporters as principal, factors, representatives, agents or commission merchants in respect of manufacturing, buying, selling, trading or dealing in any and all kinds of goods and wares, including, but not limited to goods, wares and merchandise manufactured, sold or traded by ABE. ABE, on the other hand, is a non-resident corporation organized and existing under the laws of Sweden. It is similarly engaged in the manufacturing, selling, trading, or dealing in any and all kinds of goods, wares and merchandise. In 1999, Tuls, had debts with Security Bank Corporation (SBC) amounting to Php30M. This debt was later paid by Citibank pursuant to a Letter of Awareness (LOA) with ABE and Citibank taking the place of SBC as the creditor of the Company. As the debt had remained unpaid, it is now increased to Php56M inclusive of interests. During the period of the loan, Tuls signed several promissory notes to reflect the increase in the amount of the debt. ABE also signed successive LOAs, with each LOA replacing immediately the preceding one. The latest LOA was signed on November 3, 2003 for Php56M. On the basis of ABE's latest LOA addressed to Citibank, the latter now wishes to collect on Tuls Php56M debt and ABE has expressed its willingness to pay the same. The payment of Tuls Php56M debt shall be transmitted by ABE to the Citibank Makati City Office by way of inward remittance of funds from Sweden. Thereafter, Citibank shall cease to be a creditor of Tuls and ABE shall be the company's new creditor. The debt shall continue to remain in the books of Tuls. ABE shall subscribe to the shares of stock of Tuls. Thereafter, ABE shall convert the loan into equity and paid-in surplus of Tuls without the corresponding issuance of additional shares. Eventually, Tuls shall be dissolved and liquidated. In reply, please be informed that your above opinions are hereby confirmed as follows: (1) The payment by ABE of the loan of Tuls with Citibank and the substitution of ABE as Tul's creditor is not subject to income or donor's tax . AcDHCS The payment by ABE of Tuls loan with Citibank is not subject to either income tax or donor's tax. The transaction, which involves a mere substitution of creditors in the loan contract between Tuls and Citibank, does not generate income on account of either Tuls or ABE. The entire amount of the loan, plus interests, will be paid by the creditor of Tuls. Tuls, on the other hand, will continue to have a loan obligation in the amount of Php56M, no portion thereof being condoned or written off by Citibank or ABE. Thus, no income tax or donor's tax shall be due on the transaction. (2) The subscription of the shares of stock of Tuls by ABE is subject to documentary stamp tax under section 175 of the Tax Code . The subscription and the original issuance of shares of stock of Tuls to ABE is subject to the documentary stamp tax under Section 175 of the Tax Code at the rate of Two pesos (P2.00) for every Two hundred pesos (P200.00) par value, or fractional part thereof. The DST due shall be paid within five (5) days after the close of the month when the shares of stock are issued. (3) The conversion of the loan with ABE into additional capital or paid-in surplus is not subject to income or donor's tax . Unlike the forgiveness or condonation of a debt by the creditor/stockholder which is subject to either income or donor's tax, 1 the conversion of debt to equity is not subject to either donor's tax or income tax. In BIR Ruling Nos. UN-195-94, 193-87 and 300-88, 2 the BIR opined that the conversion of the loan into paid-in surplus without the corresponding issuance of additional shares is not subject to either income tax or donor's tax. It is noted herein that the issues in the instant case are almost identical with the issues in the above rulings, thus, the above opinion of this Office can be made applicable to the instant case. Accordingly, the conversion of the loan with ABE into equity without the corresponding issuance of shares of stock by Tuls is a capital transaction not subject to either donor's tax or income tax. 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.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group Footnotes 1. Section 50, Revenue Regulations No. 2, otherwise known as the Income Tax Regulations. 2. Dated July 1, 1994, July 7, 1987 and July 6, 1988, respectively.