Centennial Savings Bank

May 4, 2009 BIR RULING [DA-(C-063) 216-09] Sec. 27; BIR Ruling 076-89; DA-419-2004; DA-463-2007 Centennial Savings Bank 15/F Prestige Tower Emerald Avenue, Ortigas Center Pasig City Attention: MGen. Avelino L. Abiol (Ret.) President & CEO Gentlemen : This refers to your letter dated January 5, 2009 requesting confirmation of your opinion that the condonation in favour of Centennial Savings Bank (CSB) by one of its creditors is not subject to income tax and other applicable taxes. It is represented that CSB is a corporation duly organized and existing under and by virtue of Philippine laws. It is registered with the Securities and Exchange Commission as a domestic thrift bank and was authorized by the Bangko Sentral ng Pilipinas to operate as thrift bank on February 13, 1998. Its principal office is located at the 15th Floor, Prestige Tower, Don Francisco Ortigas, Jr. Road, Ortigas City. CSB is an 86%-owned subsidiary of Armed Forces and Police Savings and Loan Association, Inc. (AFPSLAI). It is further represented that for taxable years ended December 31, 2007 and 2008, CSB has reflected a capital deficit position to the extent of P960,000,000 and P890,000,000, respectively. The said capital deficiency arose from the financial difficulties suffered by CSB. Among the reasons attributed to CSB's business downturn are attributed to its loan accounts and aggressive investment in real properties. CSB incurred huge losses when majority of these accounts graduated into non-performing loans. This situation was aggravated by certain changes in the policy of the BSP to provide higher loan loss provisions. Eventually, CSB's ROPA (Real and Other Properties Acquired) increased and contributed to its liquidity problem. As of November 30, 2008, CSB's ROPAs stand at P157,108,000, net of impairment losses and its investment properties, consisting of condominium units and parking lots, stand at P78,747,000. HcSCED It is also represented that a huge part of CSB's liabilities pertain to deposit liabilities of AFPSLAI amounting to P774,240,000.00. In order to contain the further losses of the bank, the AFPSLAI Board of Directors intends to cancel and condone a portion of its deposit amounting to P235,855,000 which is equivalent to the value of the Bank's ROPAs and investment properties. After the proposed condonation, CSB will still be in a capital deficit position of P646,372,000. The Audited Financial Statements of CSB as of December 31, 2007 and its interim financial statements for year 2008 reflect that the Bank continually sustained the following business downturn summarized as follows: FY 2007 FY 2008 Net Income (losses) (P166,757,295) (P46,785,000) Capital deficiency (P959,898,442) (P882,227,142) In reply, please be informed that in BIR Ruling No. DA-419-04 dated August 4, 2004, this Office had occasion to state that the cancellation of indebtedness will not give rise to taxable income where the debtor will remain in a capital deficiency position after the condonation, thus: DAESTI ". . ., the condonation of the CPI's debt to SJ shall not be subject to income tax considering that the 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 tax, 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 therefor cancels the debt, the amount of the debt is a gift from the creditor to the debtor and need to be included in the latter's gross income. If a corporation to which a stock holder is indebted forgives the debt, the transaction has the effect of the payment of a dividend. (Sect. 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 reduced 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 Corp. 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, 13 AFTR 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 efficiency position. The condonation is likewise not subject to gift tax since there is no donative interest 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." aHADTC It is clear from the foregoing that the condonation of indebtedness is not subject to income tax if nothing of exchangeable value comes to or is received by the debtor. This is based on the basic and generally accepted principle of taxation that taxable income is created from the inflow of wealth. Therefore, if after the condonation of the liability, the debtor will remain insolvent or in a capital deficit position, then cancellation of the indebtedness is not subject to any tax. Moreover, if the said condonation does not indicate donative intent on the part of the creditor, the condonation is also not subject to donor's tax. Applying the above principles, this Office hereby confirms your opinion that the condonation in favor of CSB by AFPSLAI of a portion of CSB's deposit liabilities in the amount of P235,855,000 is not subject to income tax considering that after the condonation CSB will remain to be in a capital deficit position. Moreover, such condonation is not subject to donor's tax inasmuch as there is no donative intent on the part of AFPSLAI but the same is pursued solely for business consideration. 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 as represented 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