Daicolor Philippines, Inc.

February 12, 2009 BIR RULING [DA-(C-023) 078-09] 23 (D) (1); DA-541-07 Daicolor Philippines, Inc. Lot 7-D-8 Canlubang Industrial Estate Canlubang, Calamba City Laguna Attention: Mr. Makoto Akiyama Executive Vice-President Gentlemen : This refers to your letter dated September 16, 2008 stating that Daicolor Philippines is a BOI registered company that was incorporated in 1997 with the Securities and Exchange Commission (SEC) primarily to manufacture and export plastic colorants. Unfortunately, most of its prospective customers during Daicolor's project planning stage chose to locate their factories elsewhere in Asia. However, despite the tough operating environment, your Japan-based parent company Dainichiseika Color & Chemicals Mfg., Co., Ltd., has always been supportive of Daicolor Philippines, Inc. waiting for a business turnaround and to continue providing employment to its Filipino staff. During the month of May 2008, the Bureau of Customs (BOC) issued a new Order/Circular immediately suspending duty-free and value-added tax free importation for plastic resin entering bonded warehouses. Instead, tax credits will be issued upon the plastic's direct or indirect export. Plastic resin is Daicolor's major raw material in terms of absolute value and new ruling would have severe impact to Daicolor's operating and financial ability. The estimated increase in monthly working capital as a result of the new order would amount to Php8,000,000.00 as advance payment or both duty (5%) and VAT (12%) payment. Should it take more than a year to convert the tax credit into cash, the working capital increase would total Php110,000,000.00. Furthermore, Daicolor would not be able to offset any of its advance VAT payment since 90% of its sales are exported. Faced with the new ruling, Daicolor had no other option except to immediately cease manufacturing operations and inform its major customers that it would not be able to supply plastic colorants without any clear recourse and timetable on how to recover the advance payment of value-added tax and duties. On August 19, 2008, the BOC issued an amendment on the aforementioned Order/Circular, creating a parameter as to who may continue to import resin under its tax-free import status with bonded warehouses. But unfortunately, Daicolor had already turned over its existing business to its competitors located within the Ecozone who were not affected by the BOC Circular/Order. Daicolor's painful decision had to be done so as not to disrupt operations of other major exporters who are also customers of your parent company Dainichiseika in other countries. EcTDCI It is with a heavy heart that you have to terminate your Philippine operations and seek assistance in requesting for the following BIR rulings as you are winding down your Philippine operations: 1. VAT exemption upon issuance of Daicolor Philippines of a Deed of Assignment in favor of Esta Fine Color, its Lessor, during the transfer of ownership of the factory/office building located at Lot 7-D-8, Silangan, Canlubang Industrial Park Extension (Airstrip) Road, Canlubang, Calamba, Laguna, as payment for liquidated damages in the pre-termination of its lease contract since Daicolor Philippines has never been and is not engaged in the real estate business. The contract was pre-terminated on the 11th year of the 15 year contract. Daicolor's primary business is to make, manufacture, assemble, export, wholesale, buy, trade or otherwise deal in plastic compounds, masterbatches, dry colors, colorants and compounds for plastic, pigment, products, chemical products, polymer products, general printing products and other related products of any kind of description. 2. Lowering the Fair Market Value of Machineries & Equipment to book value Php16,813,183.00 as recorded in the 2007 Audited Financial Statement. Machines and equipment are fully depreciated over 10 years and should only retain a residual value since the machines were imported in 1998. The current book value of Php16,813,183 as reflected in your December 2007 Financial Statement is more indicative of the current fair market value as opposed to the current tax declaration value of Php48,710,060.00. 3. Your Japan based parent Company, Dainichiseika Color & Chemicals Manufacturing Co., Ltd. will transfer funds in the form of a loan to Daicolor Philippines for the purpose of repaying the current debt of the same with financial institutions. Daicolor Philippines will repay the loan from whatever proceeds are collected from the liquidation of its assets. Daicolor Philippines would like to request for a ruling that the transfer of funds should not be treated as a capital gain and not considered a donation as the remaining funds will be returned after all its financial obligations will be settled. In reply, please be informed as follows: 1. The Deed of Assignment in favor of Esta Fine Color, involving the transfer of ownership of the factory/office buildings, as payment for liquidated damages in the pre-termination of its lease contract by way of dacion en pago is subject to the 12% VAT inasmuch as the said properties were ordinary assets of the transferor-Daicolor. Considering, however, that 90% of its products are exported, hence, zero-rated, the input VAT on the acquisition of the above properties, to the extent not offsetted against its output tax is available for refund, assuming that it did not previously file a claim for refund. If it was previously refunded the input VAT, the taxpayer has already benefited from the input VAT on the properties. RR 4-2007 was issued specifically to recoup/recover the input VAT that the taxpayer has used/offsetted against its vatable transactions. Moreover, damages from a breach of contract constitute a taxable income to the recipient thereof in the year received only to the extent that such damages constitute a loss of anticipated profits and non-taxable to the extent that the same represent a return of capital or investment. CITDES Hence, if the fair market value (FMV) of the properties is lower than the amount of damages satisfied, effectively, Daicolor will incur business expense attributable to the lease in an amount equivalent to the difference of the damages satisfied vis-a-vis FMV of the property. Consequently, the damages which are equivalent to FMV of the property paid to the other party are taxable income to the recipient. 2. When asset is disposed of, or is permanently withdrawn from use or no future economic benefits are expected from its disposal, the cost and accumulated depreciation and impairment losses, if any, are removed from the accounts and any resulting gain or loss arising from the retirement or disposal is recognized in the statement of operations. Non-financial assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If any such indication exists and where the carrying amount of an asset exceeds its recoverable amount, the asset or cash-generating unit is written down to its recoverable amount. The estimated recoverable amount is higher of an asset's fair value less cost to sell and value in use. The net selling price is the amount obtainable from the sale of an asset in an arm's length transaction less the cost of disposal while value in use of an asset is the present value of estimated cash flows expected to arise from the continuing use of an asset and from its disposal at the end of its useful life. 3. The transfer of fund from the parent Company, Dainichiseika Color & Chemicals Manufacturing Co., Ltd. To Daicolor Philippines, Inc. in the form of a loan, for the purpose of repaying the current debt of the same with financial institutions, wherein Daicolor Philippines will repay the loan from whatever proceeds to be collected from the liquidation of its assets, should not be treated as a capital gain or considered a donation considering that Daicolor Philippines, Inc. incurred no gain thereon nor was there any donative intent on the part of the parent Company. 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.) JAMES H. ROLDAN Assistant Commissioner Legal Service