BIR Ruling [DA-701-06]

December 13, 2006 BIR RULING [DA-701-06] 40 (C) (2) & (6) (b) Merger Divina and Uy Law Offices 8/F, Pacific Star Building Sen. Gil Puyat, Makati City Attention: Attys. Nilo T. Divina & Marian Joanne K. Go Gentlemen : This refers to your letter dated December 8, 2006 requesting a confirmatory ruling that the proposed merger of your client, Banco De Oro Universal Bank (BDO) with Equitable PCI Bank (EPCIB), with BDO as the surviving corporation, is a tax-free merger under Section 40(C)(2) and 6(b) of the 1997 Tax Code, as amended. The facts, as represented, are as follows: BDO and EPCIB are universal banking institutions duly organized and existing under Philippine laws and licensed to do business as universal banks by Bangko Sentral ng Pilipinas (BSP). BDO has an authorized capital stock of Fifteen Billion Pesos (P15,000,000,000.00) divided into: (a) One Billion Fifteen Million (1,015,000,000) common shares with a par value of Ten Pesos (P10.00) per share, Nine Hundred Sixty Two Million Twenty Three Thousand Forty Eight (962,023,048) of which are subscribed, fully-paid and outstanding as of October 31, 2006; and (b) Four Hundred Eighty Five Million (485,000,000) preferred shares with a par value of Ten Pesos (P10.00) per share, Twenty Five Million (25,000,000) of which are subscribed, fully-paid and outstanding as of October 31, 2006. Simultaneous to and pursuant to the proposed merger, BDO will request for approval by its stockholders of proposed increase of its authorized capital stock to Sixty Five Billion Pesos (P65,000,000,000.00) divided into Five Billion Five Hundred Million (5,500,000,000) common shares with a par value of Ten Pesos (P10.00) and One Billion (1,000,000,000) preferred shares with a par value of Ten Pesos (P10.00) per share. The corresponding amendment to the Articles of Incorporation of BDO which would reflect the aforesaid increase shall likewise be subject to approval by its stockholders during its Special Stockholders' Meeting scheduled on December 27, 2006. As of December 31, 2005 audited financial statement, BDO has total resources of P233,764,786,000.00, total liabilities of P213,530,481,000.00 and stockholders' equity of P20,234,305,000.00. IDaCcS On the other hand, EPCIB has an authorized capital stock of Ten Billion Pesos (P10,000,000,000.00) divided into One Billion (1,000,000,000) common shares with a par value of Ten Pesos (P10.00) per share of which Seven Hundred Twenty Seven Million Three Thousand Three Hundred Forty Five (727,003,345) shares are subscribed, fully-paid and outstanding as of October 31, 2006. As of December 31, 2005 audited financial statement, EPCIB has total resources of P316,363,041,000.00, total liabilities of P278,865,627,000.00 and stockholders' equity of P37,497,414,000.00. Consistent with the declared policy of the Government to strengthen the banking system achieved through merger and consolidation, the respective Board of Directors of BDO and EPCIB deemed it in the best interest of each bank and their respective stockholders that these institutions merge through a share-swap arrangement, whereby stockholders of EPCIB exchange their shares solely for the shares of stock of BDO. The merger was duly approved by majority vote of the respective Board of Directors of BDO and EPCIB, upon the terms and subject to the conditions set forth in the Plan of Merger and the banks' Board of Directors recommended that the stockholders of BDO and EPCIB adopt the Plan of Merger and that the same is expected to be approved by their respective stockholders holding not less than two thirds (2/3) of their outstanding capital stock in their Special Stockholders' Meeting scheduled on December 27, 2006. In connection therewith, you are requesting confirmation of your opinion on the tax consequences thereof, to wit: 1) No gain or loss shall be recognized by EPCIB as transferor, on the transfer of all its assets and liabilities to BDO pursuant to the merger. Likewise, no gain or loss shall be recognized by BDO, as the transferee, on its receipt of the assets and liabilities of EPCIB pursuant to and as a consequence of the merger; 2) The transfer of all property, real or personal, from EPCIB to BDO, as a result of the merger, is a tax-free transfer of property under Section 40(C)(2) and (6)(b) of the Tax Code of 1997; 3) The transfer of property by EPCIB in exchange for the shares of stock of BDO and the surrender of shares of stock of EPCIB and the subsequent retirement thereof, pursuant to the merger, is not subject to the documentary stamp tax (DST) in accordance with Section 199(m) of the Tax Code of 1997, as amended by Republic Act No. 9243; 4) The transfer of property by EPCIB to BDO pursuant to the merger is not subject to output tax and the unused input tax of EPCIB as of the date of the merger will be absorbed by BDO; and 5) The transfer of property by EPCIB to BDO is likewise not subject to donor's tax as there is no intention on the part of EPCIB to donate its assets to BDO since the transaction is being undertaken for purely business purposes. In reply thereto, please be informed as follows: 1. Tax-Free Exchange The proposed merger between EPCIB and BDO is a tax-free exchange under Section 40(C)(2) of the 1997 Tax Code, as amended, which provides that: "Section 40. Determination of the amount of gains or loss. (C) Exchange of property. (2) Exception. No gain or loss shall be recognized if in pursuance of a plan of merger or consolidation (a) A corporation, which is a party to a merger or consolidation, exchanges property solely for stock in a corporation, which is a party to the merger or consolidation; or (b) A shareholder exchanges stock in a corporation, which is a party to the merger or consolidation, solely for the stock of another corporation also a party to the merger or consolidation; or (c) A security holder of a corporation, which is a party to the merger or consolidation, exchanges his securities in such corporation solely for stock or securities in another corporation, a party to the merger or consolidation." The term "merger" as used in this provision is defined by Section 40(C)(6)(b) of the same Code, to wit: "The term 'merger or consolidation', when used in this Section, shall be understood to mean: (i) the ordinary merger or consolidation, or (ii) the acquisition by one corporation of all or substantially all the properties of another corporation solely for stock; Provided , That for a transaction to be regarded as a merger or consolidation within the purview of this Section, it must be undertaken for a bona fide business purpose and not solely for the purpose of escaping the burden of taxation: Provided, further , That in determining whether a bona fide business purpose exists, each and every step of the transaction or series of transactions shall be treated as a single unit; Provided, finally , That in determining whether the property transferred constitutes a substantial portion of the property of the transferor, the term 'property' shall be taken to include the cash assets of the transferor." On the basis of the foregoing, the proposed reorganization involving BDO and EPCIB is a merger within the contemplation of Section 40(C)(2) and (6)(b) of the 1997 Tax Code, as amended, because BDO shall acquire all the assets and assume all the liabilities of EPCIB, and the same being for a bona fide business purpose and not for the purpose of escaping the burden of taxation. HCSEIT Likewise, no gain or loss shall be recognized by BDO, as the transferee, on its receipt of the assets and liabilities of EPCIB pursuant to and as a consequence of the merger. It is understood, however, that upon subsequent sale or exchange of the assets acquired by BDO in the merger transaction, the gain it derived, if any, from such sale or exchange shall be subject to income tax. The gain, if any, shall be computed by taking into consideration the basis of EPCIB of the properties it transferred as against the fair market value of the same at the time of sale or disposition. On the other hand, pursuant to Section 40(C)(5)(a) and (b) of the Tax Code of 1997, as amended, the basis of the assets to be received in the hands of the transferee shall be the same as it would be in the hands of the transferor increased by the amount of the gain recognized to the transferor on the transfer. Accordingly, since BDO neither received money or any other property from EPCIB nor BDO recognized any gain on the exchange, the basis of the properties to be received by BDO upon the exchange shall be the same as the basis of the properties in the hands of EPCIB. Further, if the total liabilities to be assumed by BDO upon the effective merger date exceed the historical or original acquisition cost or cost basis of the assets transferred by EPCIB, the excess shall be recognized as gain to EPCIB subject to income tax. (Section 40(C)(4)(b), Tax Code of 1997, as amended). 2. Transfer of property not subject to DST No DST shall be due on the transfer of properties by EPCIB made pursuant to the Plan of Merger in accordance with Section 199 (m) of the Tax Code, as amended by Republic Act No. 9243, in relation to Section 40(C)(2) of the Tax Code, as amended. However, the original issuance of BDO shares in exchange for the EPCIB shares shall be subject to DST at the rate of P1.00 per P200.00, or fractional part thereof, of the par value of such shares of stock as impose under Section 174 of the Tax Code of 1997, as amended. 3. Transfer not subject to VAT Section 105 of the Tax Code of 1997, as amended, identifies the persons liable for the Value-Added-Tax. Thus, "SEC. 105. Persons Liable . Any person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, renders services, and any person who imports goods shall be subject to the value-added-tax (VAT) imposed in Sections 106 to 108 of this Code. . . . ." However, Section 4.106-8(b)(3) of RR No. 16-2005, specifically excepts mergers from being subject to output tax. Hence, "SEC. 4.106-8. Change or Cessation of Status as VAT-registered Person . xxx xxx xxx (b) Not subject to output tax The VAT shall not apply to goods or properties existing as of the occurrences of the following: xxx xxx xxx. (3) Merger or consolidation of corporations. The unused input tax of the dissolved corporation, as of the date of merger or consolidation, shall be absorbed by the surviving or new corporation." Thus, the transfer of property as a consequence of the merger of BDO and EPCIB shall not be subject to value-added-tax under Section 4.106-8(b)(3) of Revenue Regulations No. 16-2005, the said transfer being considered a transaction "not subject to output tax" under the said Section. Consequently, the unused input tax EPCIB, if any, will be absorbed by BDO in accordance with Section 4.106-8(b)(3) of Revenue Regulations No. 16-2005. 4. Transfer not subject to Donor's Tax The transfer by EPCIB of its assets to BDO shall not be subject to donor's tax. EPCIB and its stockholders have no intention to donate the assets of EPCIB to BDO since the said transfer shall be effected purely for business reasons [ BIR Ruling No. DA-037-02, BIR Ruling No. DA 039-02, BIR Ruling No. DA 184-02 ] Moreover, in order that the above-described reorganization can be considered as merger under Section 40(C)(2) of the Tax Code of 1997, as amended, the parties to the merger should comply with the following requirements: A. The plan of reorganization should be adopted by each of the corporations, parties thereto, the adoption being shown by the acts of its duly constituted responsible officers and appearing upon the official records of the corporation. Each corporation, which is a party to the reorganization, shall file, as part of its return for the taxable year within which the reorganization occurred, a complete statement of all facts pertinent to the non-recognition of gain or loss in connection with the reorganization, including: (1) A copy of the plan of reorganization, together with a statement, executed under the penalties of perjury, showing in full the purposes thereof and in detail all transactions incident to, or pursuant to the plan; (2) A complete statement of the cost or other basis of all properties, including all stocks or securities, transferred/received incident to the plan; EHSADc (3) A statement of the amount of stock or securities and other property or money received from the exchange including a statement of all distribution or other disposition made thereof. The amount of each kind of stock or securities and other property received shall be stated on the basis of the fair market value thereof at the date of the exchange; and (4) A statement of the amount and nature of any liabilities assumed upon the exchange, and the amount and nature of any liabilities to which any of the property acquired in the exchange is subject. B. Every taxpayer, other than a corporation, who is a party to the reorganization, who received stock or securities and other property or money upon a tax-free exchange in connection with a corporate reorganization shall incorporate in his income tax return for the taxable year in which the exchange takes place a complete statement of all facts pertinent to the non-recognition of gain or loss upon such exchange including: (1) A statement of the cost or other basis of the stock or securities transferred in the exchange; and (2) A statement in full of the amount of the stock or securities and other property or money received from the exchange, including any liability assumed upon the exchange, and any liability to which property received is subject. The amount of each kind of stock or securities and other property (other liabilities assumed upon the exchange) received shall be set forth upon the basis of the fair market value thereof at the date of exchange. C. Permanent records in substantial form shall be kept by every taxpayer who participates in a tax-free exchange in connection with a corporate reorganization showing the cost or other basis of the transferred property or money received (including any liability assumed on the exchange, or any liability to which any of the properties received were subject), in order to facilitate the determination of gain or loss from a subsequent disposition of such stock or securities and other property received from the exchange. In addition to the foregoing requirements, the parties shall enclose with their respective income tax returns for the taxable year in which the merger occurred a copy of the request for ruling filed with, and the corresponding ruling issued by, the Bureau of Internal Revenue, both duly stamp-received by the appropriate office of the Bureau of Internal Revenue. Such parties shall include as a note to their respective audited financial statements for the taxable year in which the merger occurred a statement to the effect that they hold such assets/shares acquired in a merger and the year in which such merger occurred, and in the taxable years until the subject properties are subsequently transferred to another transferee. The parties shall, pursuant to Section 58 (E) of the Tax Code of 1997, as amended, also cause the Register of Deeds to annotate on the Transfer Certificate of Title, the date the deed of transfer or the document of merger, as in this case, was executed, the original or historical cost of acquisition of the properties involved, and the fact that no gain or loss was recognized as a result of such merger. It is further required that the parties to the transaction must submit to the Law Division, Bureau of Internal Revenue, a certified true copy by the Register of Deeds, of duly annotated Transfer Certificates of Title for the real properties involved in the merger transaction and proof of annotation of the substituted basis of the shares of stock involved therein, as well as, the shares of stock to be issued to the stockholders of the transferor corporation within ninety (90) days from the effective date of merger. Violation of the above requirements is subject to the penalties provided under Section 269 and/or Section 275 of the Tax Code of 1997, as amended, whichever is applicable. 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, and/or any of the requirements imposed in this letter is not complied with, 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