BIR Ruling [DA-652-06]

November 6, 2006 BIR RULING [DA-652-06] Section 100; BIR Ruling No. 033-02 & DA-398-95 Itochu Corporation Manila Branch 16th Floor, 6788 Ayala Avenue Oledan Square, Makati City Attention: Mr. Seiichi Kimoto and Atty. Gerardo T. Buan Gentlemen : This refers to your letter dated September 30, 2005 requesting for confirmation of your opinion that the sale of shares of stocks and the assignment of receivables by the head office of Itochu Corporation (Itochu) are not subject to Philippine donor's tax as provided under Section 100 of the Tax Code of 1997. As represented, Itochu is a corporation organized and existing under Japanese laws, with principal office located at 5-1, Kita-Aoyama 2-chome, Minato-ku, Tokyo, Japan. It has obtained from the Securities and Exchange Commission a license to establish a branch office in the Philippines. Itochu owns 39,060.000 common shares of Petrochemical Corporation of Asia Pacific (Petrocorp), representing 1.69% of the outstanding capital stock of Petrocorp. The common shares have a par value of PhP1.00 per share. Petrocorp is engaged in the manufacture and processing of downstream petrochemical products. Petrocorp is heavily indebted to various creditors. Due to cash flow problems, Petrocorp defaulted on nearly PhP2,000,000,000.00 in loan payments in 2000 and 2001. As a result of the default, in 2001, Itochu was required to pay one of Petrocorp's creditors, Hong Kong and Shanghai Banking Corporation (HSBC) under a Guaranty Agreement and a Guaranty Payment Agreement which Itochu issued in favor of HSBC. By performing under the Guaranty, Itochu became subrogated to the rights of HSBC and assumed the position of a lender to Petrocorp. As of December 2003, the indebtedness of Petrocorp amounted to PhP8,861.623,000.00. DCcHIS As a lender to Petrocorp, Itochu became entitled to a claim with a face value of PhP125,000,000.00. This claim is secured on a pro-rata, pari-passu basis by a mortgage on land (mortgaged property), through a Mortgage Trust Indenture (MTI). The MTI secures an aggregate obligation of PhP2,020,000,000.00. In November 2003, the mortgaged property was applied at PhP65,793,000.00 only. Unfortunately, in the years after Itochu's investment, Petrocorp's petrochemical business steadily worsened due to a variety of factors, including high costs of imported feedstock, liquidity shortages, low product prices and severe import competition. Due to the foregoing factors, the value of the Petrocorp business plummeted, as its financial statements clearly show: (a) On December 31, 2000, Petrocorp had a net positive shareholder's equity (total assets minus total liabilities) of PhP1,700,000,000.00. (b) From 2000 to 2003, Petrocorp incurred net losses of PhP6,360,000,000.00. (c) By December 31, 2003, Petrocorp had negative shareholders' equity of PhP3,280,000,000.00 Compounding the problems of Petrocorp is the decision of the Provincial Government of Bataan to levy Petrocorp's plant and equipment in Bataan for overdue unpaid real property taxes. Petrocorp's plant and equipment were thereby sold off by the Provincial Government of Bataan in a public auction, further dwindling the assets of the company. Due to its serious business losses and its inability to finance its operations, Petrocorp was forced to close and stop its operations on November 11, 2001. The investment of Itochu in Petrocorp has proven to be bad and its shares in Petrocorp have become worthless on account of ensuing serious financial and business condition of Petrocorp. As expected, Petrocorp failed to pay its creditors. In fact, it could not even pay for the salaries and benefits of its employees, which as of September 28, 2004, amounted to approximately PhP8,800,000.00. Due to the bleak prospect of Petrocorp, Itochu decided to dispose of its entire interest in Petrocorp by selling all its shares and assigning all its receivables to third parties. The divestment will allow Itochu to remove from its balance sheet assets or receivables which are already considered worthless. With respect to the assignment of the receivables from Petrocorp, the same was offered for sale to various companies. After a prolonged period, Itochu was able to find one company, JP Morgan, which agreed to buy the receivables at the price of PhP20,000,000.00. The shares in Itochu were sold after following the right of first refusal provisions of the Articles of Incorporation of Petrocorp. The shares were eventually bought by Basic Diversified Holdings, Inc. (Basic), also a stockholder of Petrocorp. It agreed to acquire the entire block of shares of Itochu in Petrocorp, after all other stockholders of Petrocorp and Petrocorp itself declined to buy the shares of Itochu. The entire block of shares of Itochu in Petrocorp were sold at the price of US$1.00. IcCATD The corresponding documentary stamp tax thereon was paid on the sale of the Petrocorp shares and the capital gains tax return was filed. In reply thereto, please be informed that under Section 100 of the Tax Code of 1997, it is provided that: "Section 100. Transfer for Less Than Adequate and full Consideration . Where property, other than real property referred to in Section 24(D), is transferred for less than an adequate and full consideration in money or money's worth, then the amount by which the fair market value of the property exceeded the value of the consideration shall, for the purpose of the tax imposed by this Chapter, be deemed a gift, and shall be included in computing the amount of gifts made during the calendar year." Section 100 of the same Tax Code imposes donor's tax on transfers made for less than an adequate and full consideration. This "adequate and full consideration" is deemed to be the fair market value of the property, such that donor's tax is imposed on the amount by which the fair market value of the property exceeded the value of the consideration. In BIR Ruling No. 033-02, dated 16 August 2002, this Office, citing the decision of the Supreme Court in Commissioner of Internal Revenue vs. BF Goodrich Phils., Inc. (now Sime Darby International Tire Co., Inc.) and the Court of Appeals (G.R. No. 104171, 24 February 1999), held that the rule provided for in Section 100 of the Tax Code is not absolute, viz: "In the case of Commissioner ofInternal Revenuevs. B.F.GoodrichPhils., Inc. [now Sime DarbyInternational Tire co., Inc.] and the Court of the Appeals G.R. No. 104171, February 24, 1999, the Supreme Court ruled that: 'It is possible that real property may be sold for less than adequate consideration for a bona fide business purpose; in such event, the sale remains as "arm's length" transaction. In the present case, the private respondent was compelled to sell the property even of a price less than its market value, because it would have lost all ownership rights over it upon the expiration of the parity amendment. In other words, private respondent was attempting to minimize its losses. At the same time, it was able to lease the property for 25 years, renewable for another 25. This can be regarded as another consideration on the price.' Judging from the facts, there is no showing of donative intent on the part of the York. . . . jurisprudence recognizes those instances where there is no gratuity intended these are dealings done in the 'ordinary course of business.' Although it is true that these dealings per se is not sufficient to rule out existence of donative intent, it is equally true that donative intent is not synonymous with a disparity in consideration. (PAUL, Federal Estate and Gift Taxation). Therefore, considering that York's transaction with GNQ is an arm's length transaction and a bona fide business arrangement, the same negates the 'fiction' which treats the effect as a donation. Accordingly, it is not subject to donor's tax ordinarily imposed on gift or donation under Section 98 in relation to Section 100 of the Tax Code of 1997." (Emphasis supplied) From the foregoing ruling, this Office also concluded that as long as the transaction is conducted at arm's length, such that a bona fide business arrangement or the dealings are done in the ordinary course of business, a sale for less than an adequate consideration is not subject to donor's tax. CcSEIH Moreover, in BIR Ruling DA-398-95 dated 14 November 1995, this Office further held that the transfer of 1,000,000 shares in a Philippine corporation for US$1.00 is not subject to donor's tax because there was no intent on the part of the seller to donate. Premises being considered, it is the opinion of this Office that Section 100 of the Tax Code is not applicable to the above-described sale of shares of stocks and assignment of receivables for the following reasons: 1. The consideration for the sale of the shares of stocks was greater than the fair market value of the shares. This Office finds that the consideration for the above-described sale, which included the amount of US$1.00 and the opportunity for Itochu to remove from its financial statements an investment that is considered worthless, is higher and more than adequate to compensate for the shares of stocks which, as of December 2001 were reported to have a nil book value. Under Section 6 (a) of Revenue Regulations 2-82, the book value of the shares of a company is presumed to be its market value. Since the Petrocorp shares have a negative value, the fair market value of the shares of stocks of Petrocorp is not higher than PhP1.00. 2. The assignment by Itochu to JP Morgan of its receivables from Petrocorp also shows that the price of Php 20,000,000.00 paid by JP Morgan was adequate consideration. The receivables of Itochu from Petrocorp, in the face value of Php 125,000,000.00, was secured on a pro-rata, pari-passu basis by a mortgage on land, through a Mortgage Trust Indenture, owned by Petrocorp that is subject to 2.02 Billion Pesos in encumbrances of Petrocorp's lenders. However, the mortgaged land, which is the only available asset to creditors of Petrocorp, including Itochu, was appraised at the value of only Php 65,793,000.00 in November 2003. The appraised value represents only 3.26% of the total obligation secured by the said mortgage, which is the amount of Php 2,020,000,000.00. In view of this, the mortgaged property will satisfy only a miniscule portion of Itochu's receivables from Petrocorp. Such miniscule portion recoverable from the mortgaged land is less than the price of Php 20,000.000.00 paid by JP Morgan to Itochu for the receivables. 3. Both the sale of shares of stocks and the assignment of receivables were conducted at arm's-length and for a legitimate business purpose, as shown by Itochu's observance of the requirement of Petrocorp's Articles of Incorporation regarding the right of first refusal and its offers to several third parties who may be interested in acquiring the shares and receivables. 4. The acts of Itochu in actively looking for a more suitable buyer and/or assignee for its shares of stocks and receivables, respectively, prove the lack of donative intent on the part of Itochu. It is to be noted that, Itochu did not condone but instead assigned to JP Morgan its receivables from Petrocorp. Since there has been no cancellation and forgiveness of Petrocorp's liabilities, Itochu is not also liable for donor's taxes under Section 50 of the Income Tax Regulations. To this Office's mind, imposing a donor's tax has no legal or factual basis. Accordingly, your opinion that when Itochu sold its 39,060,000 shares of stock in Petrocorp to Basic for the price of US$1.00 and assigned its PhP125,000,000.00 receivables from Petrocorp to JP Morgan for PhP20,000,000.00, neither of these transactions is subject to donor's tax under Section 100 of the Tax Code, is hereby confirmed. 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. HacADE Very truly yours, (SGD.) JOSE MARIO C. BUAG Commissioner of Internal Revenue