Steel Asia Manufacturing Corporation

December 13, 2007 BIR RULING [DA-643-07] DA-419-2004 DA-593-2006 DA-260-2007 Steel Asia Manufacturing Corporation 2/F Building 2, Bonifacio High Street Bonifacio Global City Taguig City Attention: Mr. Renato A. Soriano President Gentlemen : This refers to your letter dated August 22, 2007, stating that Steel Asia Manufacturing Corporation is a corporation duly organized and existing under and by virtue of Philippine laws; that during the years ended December 31, 2004, 2005 and 2006, it continued to be in a capital deficit position; that the company's financial position is such that its auditors have expressed the existence of a material uncertainty which may cast doubt on the company's ability as a going concern; and that in order to address this problem, the company entered into debt restructuring agreements with its creditors. ESCTIA Based on the foregoing representations, you now request for confirmation of your opinion that the condonation by your company's creditors of its debts will not be subject to income tax since after the condonation, your company will remain to be in a capital deficit position; and that such condonation will not be subject to donor's tax since there is no donative intent of the part of your company's creditors. In reply thereto, please be informed that cancellation of indebtedness may not give rise to taxable income. In BIR Ruling No. DA-419-04 dated August 4, 2004 , this Office held that ''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." ASaTCE The same principle was reiterated in BIR Ruling No. DA-593-2006 dated October 5, 2006 , where this Office likewise ruled that "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. xxx xxx xxx 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." Finally, in BIR Ruling No. DA-260-2007 dated April 25, 2007 , this Office ruled that ". . . any gain resulting from the condonation of RCPI's debt is not taxable for income tax purposes; and that any conversion of debt into equity as a result of the debt restructuring plan is likewise not subject to income tax, it being in the nature of capital transaction." IN VIEW OF THE FOREGOING, this Office hereby confirms your opinion that the condonation by the creditors of Steel Asia Manufacturing Corporation of its debts is not subject to income tax since after the condonation, the company will remain to be in a capital deficit position; and that such condonation is not subject to donor's tax since there is no donative intent on the part of the creditor. 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. IcSEAH Very truly yours, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service