BIR Ruling [DA-593-06]

October 5, 2006 BIR RULING [DA-593-06] 27; DA-419-2004 Aranas Consunji & Barleta Law Offices Unit 106 Le Metropole Building Tordesillas Corner Dela Costa Streets Salcedo Village, Makati City Attention: Atty. Jesus Clint O. Aranas Gentlemen : This refers to your letter dated September 20, 2006 requesting for confirmation of your opinion that the condonation by Growluck Limited (hereinafter "Growluck") of the debt of Prime Orion Philippines, Inc. (hereinafter "POPI") is not subject to income or donor's tax if after the condonation, the same remains to be in capital deficit position. However, if after the condonation it is shown that POPI derived income from the transaction, then the said amount shall be subject to the corporate income tax accordingly. It is represented that POPI is a corporation duly organized and existing under and by virtue of Philippine laws; that it is a publicly listed company with principal address at 20/F LKG Tower, Ayala Avenue, Makati City; that Growluck is a non-resident foreign corporation organized under the laws of British Virgin Islands; that for taxable year ended June 30, 2005, POPI has reflected a capital deficit position to the extent of P4,237,484,104; that this is due to the financial difficulties suffered by the company; that considering that the liabilities have remained unpaid, Growluck believe that it cannot fully collect its advances and that accordingly, Growluck has lost interest in collecting in full its advances to POPI and condoned the amount of P624,020,637.88 sometime in November 2005; that the Audited Financial Statements of POPI reflects that the company continually sustained the following business downturn summarized as follows: FY2004 FY2005 Net income/(losses) 858,298,595 (1,004,141,769) Capital deficiency 4,237,484,104 5,114,943,371 that the unaudited Balance Sheet of POPI after the condonation, or as of December 31, 2005 is as follows: At Cost Basis Total Assets 6,037,955,366 Total Liabilities 5,995,807,597 Total Capital Deficiency 42,147,769 On the basis of the foregoing, you now request for confirmation of your opinion that the condonation by Growluck of the debt of POPI is not subject to income or donor's tax if after the condonation, the same remains to be in capital deficit position. However, if after the condonation it is shown that POPI derived income from the transaction, then the said amount shall be subject to the corporate income tax accordingly. ACTESI In reply, please be informed that in BIR Ruling No. DA-419-04 dated August 4, 2004, this Office held as follows: "Thus, the condonation of the CPI's debt to SJ shall not be subject to income tax considering that CPI is in a capital deficiency position and will remain insolvent before and after the said condonation considering that the amount to be condoned would only be P84,198,555.20. Moreover, the condonation is likewise not subject to gift tax since there is no donative intent on the part of SJ but solely for business consideration." The above ruling was issued by this Office on the basis of the discussions stated in BIR Ruling No. 076-89 dated April 17, 1989 which states as follows: "Cancellation and forgiveness of indebtedness may amount to a payment of income, to a gift, or to a capital transaction, dependent upon the circumstances. If for example, an individual performs services for a creditor who, in consideration thereof cancels the debt, income to that amount is realized by the debtor as compensation for his services. If, however, a creditor merely desires to benefit a debtor and without any consideration therefrom cancels the debt, the amount of the debt is a gift from the creditor to the debtor and need not be included in the latter's gross income. If a corporation to which a stockholder is indebted forgives the debt, the transaction has the effect of the payment of a dividend. (Sec. 50 Revenue Regulations No. 2) The waiver of interest by the banks on non-trade and trade related indebtedness of GMPI is not subject to income tax considering that the deduction of said interest as expense in prior years did not offset nor reduce the taxable income of GMPI since it was in a financial loss position even without the deduction. (See Barnhart-Marrow Consolidated v. Commissioner of Internal Revenue , 47 BTA 590) Moreover, when a creditor cancels a debt as part of a business transaction, the debtor is enriched or its net assets has been increased and, therefore, he realized taxable income ( Philippine Fiber Processing Co. v. CIR , CTA Case No. 1407 Dec. 29, 1966). However, a transaction whereby nothing of exchangeable value comes to or is received by a taxpayer does not give rise to or create taxable income. (See Dallas Transfer and Terminal Warehouse Co. v. Commissioner of Internal Revenue 5 Cir. 70 F 2d 95 13AFTR 930) Accordingly, the condonation of GMPI's indebtedness by GM-US is not subject to income tax since before and after the condonation GMPI remains insolvent, i.e ., in a capital deficiency position. The condonation is likewise not subject to gift tax since there is no donative intent on the part of GM-US but solely for business consideration since Isuzu will only acquire the GMPI shares from GM-US if GMPI has a "clean" balance sheet with no outstanding liabilities except those to Isuzu." It is clear from the foregoing that the condonation of POPI advances by Growluck is not subject to income tax if nothing of exchangeable value comes to or is received by POPI. This is based on the basic and generally accepted principle of taxation that taxable income is created from the inflow of wealth. Therefore, the extent of any tax benefit derived after the condonation will be subject to income tax, if any. Accordingly, we hereby confirm your opinion that the condonation by Growluck of the liability of POPI is not subject to income or donor's tax if after the condonation, the same remains to be in capital deficit position. However, if after the condonation it is shown that POPI derived income from the transaction, then the said amount shall be subject to the corporate income tax accordingly. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation it is discovered that the facts are different from that represented, then this ruling shall be null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service