SGV & Co.

September 26, 2008 BIR RULING [DA-(C-083) 265-08] 163-90 SGV & Co. 6760 Ayala Avenue Makati City Attention: Atty. Luis Jose P. Ferrer Partner, Tax Services and Atty. Cirilo P. Noel Vice Chairman & Deputy Managing Partner Co-Head, Tax Services Gentlemen : This refers to your letter dated August 21, 2007 requesting on behalf of your client, STEAG State Power, Inc. (SPI)[GmbH(STEAG)], confirmation of your opinion that the acquisition cost or cost basis of the SPI shares owned by STEAG includes the amounts actually paid by STEAG for the subscription price of all its shares, the premium or Participation Fee for the Power Project, and other incidental costs such as registration costs and legal fees incurred to acquire all of its shares in SPI. SPI (formerly known as State Power Development Corporation) is a corporation organized and existing under the laws of the Philippines with principal office address at 20/F Yuchengco Tower, RCBC Plaza, 2816 Ayala Avenue, Makati City. The Company is primarily engaged in the business of power generation and subsequent sale of said generated power to the National Power Corporation (NPC) under a Build, Operate and Transfer (BOT) Scheme; that at present, SPI is owned 89% by STEAG GmbH (STEAG formerly known as STEAG Aktiengesellschaft or STEAG AG), and 11% by State Investment Trust, Inc. (SITI); STEAG, an independent power producer, is a corporation duly organized and existing under the laws of Germany, with a registered office address at STEAG GmbH, Rellinghauser Strasse 1-11, 45128 Essen, Germany; that SITI is a corporation organized and existing under the laws of the Philippines with registered address at 4th Floor, State Center Building, 333 Juan Luna Street, Binondo, Manila. Originally, the consortium of SITI and Harbin Power Engineering Company, Limited (Harbin), from whom STEAG took over, won the bid to undertake the construction and operation of the 200MW coal-fired thermal power plant (Power Plant) in Villanueva, Misamis Oriental on a BOT basis. Subsequently, the consortium signed a Power Purchase Agreement (PPA) with the NPC for the implementation of the said Power Project. For the purpose of performing its undertakings, the consortium has caused the formation of SPI. Under the Accession Undertaking, SPI was designated as the Operator under the PPA; that SPI undertook to construct the power plant and operate the same during an agreed cooperation period of 25 years. aHADTC In July 2003, STEAG entered into a Share Subscription and Commercial Agreement (Subscription Agreement) with SITI and SPI. Under the Subscription Agreement, SPI shall initially have an authorized capital stock (ACS) of P50,000,000.00 divided into 5,000,000 shares with par value of P10.00 per share; that out of the P2,250,000.00 initial outstanding capital stock, 88.9% was owned by SITI, 11.1% was owned by Harbin. Pursuant to the agreement, the parties agreed to increase SPI's ACS to allow STEAG to subscribe for, and the Company to issue shares to STEAG, such that on completion of the subscription, STEAG shall own 89% of SPI's outstanding capital stock. Under the Subscription Agreement, STEAG agreed to pay SPI and SITI the following amounts: (a) Initial Subscription Price paid to SPI P182,045,460.00; and (b) Premium/Participation Fee for the Power Project paid to SITI US$22,775,400.00 In addition, STEAG incurred other incidental costs, specifically lawyer's fees and registration costs that were necessary for the purchase of SPI shares totaling US$627,672.68. From July 2003 to March 2007, additional subscription payments were made by STEAG to increase its share ownership in SPI while maintaining its 89% interest in the Company pursuant to the Subscription Agreement. As of March 31, 2007, STEAG is the legal and beneficial owner of 421,634,960 shares of stock equivalent to 89% of the current outstanding capital stock of SPI. On the other hand, SITI is the legal and beneficial owner of 52,112,186 shares of stock representing 11% of the outstanding capital stock of SPI. The Company's current capital structure is as follows: Authorized Capital Stock Issued Share Type Par No. of Aggregate Par No. of Aggregate Par Value Shares Value (PhP) Shares Value (PhP) (PhP) Common 10.00 335,000,000 3,350,000,000.00 308,747,146 3,087,471,460.00 Redeemable 10.00 165,000,000 1,650,000,000.00 165,000,000 1,650,000,000.00 Total 500,000,000 5,000,000,000.00 473,747,146 4,737,471,460.00 ========= ============ ========= ============ The Subscription Agreement provides the subscription price to be paid by STEAG for the SPI shares plus the premium/participation fee to be paid to SITI as premium or additional fee for STEAG participation in the Power Plant. Section 4.1 of the Subscription Agreement provides: "4.1. Amount of Consideration 4.1.1. Subject to Clause 4.1.4, the Subscriber shall pay to the Company on Completion for the subscription of the New Shares, ten (10) Peso per New Share amounting to a total of one hundred and eighty two million forty-five thousand four hundred and sixty (182,045,460) Peso in respect of all New Shares (the Subscription Price). CAIHTE 4.1.2. In addition, the Subscriber shall pay to SITI a total premium of twenty two million seven hundred and seventy-five thousand four hundred US Dollars (US$22,775,400) (the Fee), for, inter alia , the Subscriber's participation in the Project and SITI hereby confirms and acknowledges that an amount of four million three hundred thousand US Dollars (US$4,300.00) in partial payment of the Fee has already been received by it from the Subscriber as of the date of this Agreement and only the balance therefore (less the deduction by the Subscriber of the amount specified in paragraph 2.2 of Schedule 7 which SITI hereby agrees and confirms shall be in settlement of the amount due by it to the Subscriber in respect of any amounts payable by SITI to Harbin on or about Completion) of seventeen million and twenty-five thousand four hundred US Dollars (US$17,025,400) of the Fee shall be paid on Completion to SITI, subject to the other provisions of this Clause 4." The Subscription Price, Premium or Participation Fee, and other necessary costs were duly recorded in the books of accounts and audited financial statements of STEAG as part of its investment in SPI as indicated in the Audited Financial Statements of STEAG for the years 2002-2006 as well as the duly notarized and authenticated Certification by STEAG external auditor, KPMG, as to the recording of the foregoing amounts as part of STEAG's investment in SPI. Section 4.1 of the Subscription Agreement expressly provides that the Premium/Participation Fee will form part of the amount of consideration for the subscription by STEAG to 89% of SPI shares. STEAG's current shareholdings in SPI are as follows: Share Type Par Value No. of Shares Aggregate Par % of Total (PhP) Value (PhP) Outstanding Capital Common 10.00 274,784,960 2,747,849,600.00 Shares Redeemable 10.00 146,850,000 1,468,500,000.00 Shares Total 421,634,960 4,216,349,600.00 89% =========== ============= In computing for the acquisition cost of SPI shares, the Premium/Participation Fee should be allocated to the total SPI shares currently held by STEAG, derived as follows: ITcCaS Particulars Amount (PhP) STEAG's Subscription Price of SPI shares 4,210,690,050.59 as of March 2007 Add: Premium or Participation Fee 1,239,019,726.26 Other Costs (Registration Costs, Lawyer's 34,851,725.59 Fees) Total Acquisition Cost 5,484,561,502.44 Unit Cost/share = Total Acquisition 13.0078/share Cost/Total SPI Shares held by STEAG = P5,484,561,502.44/421,634,960 Shares to be Sold (34% of Total SPI shares 161,074,029 shares at 473,747,146 shares) Acquisition Cost = Unit cost/share x 34% of Total SPI shares at 473,747,146 shares = P13.0078 x 161,074,029 shares 2,095,218,754.42 Furthermore, as part of its desire to widen the participation and/or ownership of the Power Project, STEAG plans to sell as much as 161,074,029 or approximately 34% of its current shareholdings in SPI to a third party investor while retaining majority ownership of the Company; and that after the sale, STEAG's shareholdings in the Company shall then be reduced to 55% of total outstanding capital stock. In reply thereto, please be informed that Section 40 (A) of the Tax Code of 1997 provides that "SEC. 40. Determination of Amount and Recognition of Gain or Loss . (A) Computation of Gain or Loss. The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis or adjusted basis for determining gain, and the loss shall be the excess of the basis or adjusted basis for determining loss over the amount realized. The amount realized from the sale or other disposition of property shall be the sum of money received plus the fair market value of the property (other than money) received;" Corollarily, Section 136 of Revenue Regulations No. 2, otherwise known as the Income Tax Regulations, provides that "SEC. 136. Basis for determining gain or loss from sale of property. For the purpose of ascertaining the gain or loss from the sale or exchange of property, the basis is the cost of such property, or in the case of property which should be included in the inventory, its latest inventory value. . . . In any case proper adjustment must be made in computing gain or loss from the exchange or sale of property for any depreciation or depletion sustained and allowable as deduction in computing net income; the amount of depreciation previously charged off by the taxpayer shall be deemed to be true depreciation sustained unless shown by clear and convincing evidence to be incorrect. . . ." EHcaDT Moreover, Section 6 of Revenue Regulations No. 2-82 provides for the rules in determining the tax base which includes the selling price and the cost basis of the shares to be sold: "SEC. 6. Determination of Tax Base. In determining the tax base, the following rules shall apply: (a) Determination of selling price. The selling price of the shares of stocks shall be the fair market value of the shares of stocks transferred or exchanged and not the fair market value of the property received in exchange. If the total consideration of the sale or disposition consists partly in cash or money and partly in kind, the selling price shall be the fair market value of the shares disposed. xxx xxx xxx (b) Determination of cost. The cost basis for determining the capital gains or losses shall be the basis as determined in accordance with the provisions of Section 135 of the National Internal Revenue Code, as amended, and its implementing regulations applied in the following manner: (1) If the stocks can be identified, then the cost shall be the actual purchase price plus all costs of acquisition such as commission, documentary tax, transfer fees, etc. . . ." It is undisputed that the net capital gains is the difference between the gross selling price or fair market value of the shares, whichever is higher, and the acquisition cost of the shares. The cost shall be the actual purchase price plus all costs associated with the purchase of the shares. In this regard, the Commentaries to Article 13 of the OECD Model Tax Convention concerning the taxation of capital gains provide that "To arrive at cost all expenses incidental to the purchase and all expenditure for improvements are added to the purchase price." (Subsection 12 of the Commentaries to Article 13 (Capital Gains) of the OECD Model Tax Convention) Thus, in BIR Ruling No. 163-90 dated August 27, 1990, which is a reiteration of BIR Ruling No. 046-90 dated March 29, 1990 , this Office applied Revenue Regulations No. 2-82 in determining the cost of the shares and held that ". . . under Section 6(b) of RevenueRegulationsNo.2-82, the cost basis for determining the capital gains or losses shall be the basis as determined in accordance with the provisions of Section 35 (now Section 34) of the Tax Code, as amended, and its implementing regulations applied in the following manner: EITcaD (1) If the stocks can be identified, then the cost shall be the actual purchase price plus all costs of acquisition such as commission, documentary tax, transfer fees, etc. (2) If the stocks cannot be properly identified, then the cost to be assigned shall be computed on the basis of the first-in, first-out (FIFO) method. (3) If books of accounts are maintained by the seller where every transaction of a particular stock is recorded, then the moving average method shall be applied rather than the first-in, first-out (FIFO) method. (4) In all cases, stock dividend received must be assigned a corresponding cost by allocating the original cost of acquisition to the total number of shares composed of the original shareholdings plus the number of shares of stock received as stock dividend." Acquisition Cost of SPI Shares In the instant case, based on STEAG's audited financial statements, the consularized (duly authenticated and notarized) Certification by KPMG (STEAG's external auditor in Germany), as well as the supporting bank remittances evidencing proof of payments, STEAG paid the following amounts to acquire the SPI shares: a. US$78,227,944.78, as subscription price paid to SPI for 421,634,960 shares of stock representing 89% of the current outstanding capital stock of the Company; b. US$22,775,400.00 as premium or Participation Fee for the Power Project paid to SITI; and c. US$627,672.68, as legal fees and registration costs paid to SPI, which costs were necessary to acquire the SPI shares. The above payments were made by STEAG on various dates and in US Dollars. Thus, for purposes of determining the acquisition cost, the above payments were converted to Philippine Pesos on the day of the remittance/valuation. Under Revenue Memorandum Circular No. 26-85, the conversion rate to be applied shall be the prevailing interbank reference rate for the day of the transaction. The following US Dollar remittances as payment for the SPI shares are converted to Philippine Pesos at the exchange rate on the date of each remittance/valuation, to wit: HDITCS Classification Remittance Amount Exchange Rate on Amount (PhP) /Valuation (US$) Remittance/Valuation Date Date Subscription 12.10.2003 2,096,232.68 55.355 116,036,960.00 Price 11.27.2003 129,000.00 55.767 7,193,943.00 11.27.2003 180,000.00 55.767 10,038,060.00 12.9.2003 517,361.70 55.288 28,603,893.67 12.9.2003 367,350.40 55.288 20,310,068.92 12.17.2003 35,600,000.00 55.488 1,975,372,800.00 38,889,944.78 2,157,555,725.59 7.19.2005 2,225,000.00 55.684 123,896,900.00 9.20.2005 3,738,000.00 56.29 210,412,020.00 11.29.2005 6,230,000.00 53.999 336,413,770.00 12,193,000.00 670,722,690.00 1.17.06 5,740,000.00 52.615 302,010,100.00 1.17.06 45,000.00 52.615 2,367,675.00 6.1.06 890,000.00 52.912 47,091,680.00 7.19.06 2,225,000.00 52.675 117,197,425.00 8.16.06 6,675,000.00 51.336 342,667,800.00 10.19.06 7,565,000.00 50.013 378,348,345.00 23,140,000.00 1,189,683,025.00 3.26.2007 4,005,000.00 48.122 192,728,610.00 Total 78,227,944.78 4,210,690,050.59 Subscription Price Premium/ 11.28.03 1,000,000.00 55.719 55,719,000.00 Participation Fee for the Project 11.28.03 841,573.00 55.719 46,891,605.99 11.28.03 2,629,742.00 55.719 146,526,594.50 11.28.03 6,050,000.00 55.719 337,099,950.00 12.9.03 271,276.49 55.288 14,998,334.58 12.12.03 3,740,000.00 55.464 207,435,360.00 12.12.03 1,625,658.00 55.464 90,165,495.31 12.12.03 500,000.00 55.464 27,732,000.00 12.12.03 367,150.51 55.464 20,363,635.89 17,025,400.00 946,931,976.26 9.12.00 2,000,000.00 45.562 91,124,000.00 6.27.01 2,000,000.00 52.308 104,616,000.00 11.14.03 1,450,000.00 55.325 80,221,250.00 1.29.03 300,000.00 53.755 16,126,500.00 292,087,750.00 Total 22,775,400.00 1,239,019,726.26 Premium/ Participation Fee for the Project Other Costs Registration 9.10.03 72,000.00 55.057 3,964,104.00 Costs Lawyer's Fee 12.31.03 556,672.68 55.586 30,887,621.59 Total Other 627,672.68 34,851,725.59 Costs The premium or Participation Fee for the Project, which was paid by STEAG to SITI in installments over a period of several years, represents the premium for the SPI shares or the fee for STEAG's participation in the Power Project. Based on the contractual stipulation by the parties, STEAG is obligated to pay the Premium or Participation Fee as part of the consideration for the purchase of the SPI shares. Clearly, STEAG could not have acquired the SPI shares from SITI without payment of the Premium or Participation Fee. As such, the Premium or Participation Fee should form part of STEAG's cost basis or acquisition cost for the SPI shares. Accordingly, the Subscription Price in the amount of P4,210,690,050.59, the Premium or Participation Fee for the Project in the amount of P1,239,019,726.26, and other costs (registration costs and lawyers' fees) in the amount of P34,851,725.59, all of which amounts were actually incurred, paid and remitted by STEAG to acquire the SPI shares, should form part of the cost basis or the acquisition cost of STEAG for the said shares. To fortify the above position, the Supreme Court in affirming the CTA's decision, entitled Collector of Internal Revenue vs. Binalbagan Estate, Inc. (G.R. No. L-12752 dated January 30, 1965) , ruled that "The fair market value of Binalbagan's tangible assets as appraised by the Westly Committee in the amount of P2,541,134.69 augmented by the value of its sugar quota amounting to P1,482,629.28 is the correct acquisition cost of the 216,000 BISCOM shares. It is, however, contended by the Collector that the value of the sugar quota ought not to be accounted as part of the acquisition cost of the BISCOM shares for the simple reason that Binalbagan acquired them without cost. Under Subsection (c), Section 35, of the Tax Code, the acquisition cost of the shares of stock is equivalent to the fair market value of the property given in exchange therefor. The sugar quota, which had a fair market value of P5.00 per picul, was part and parcel of the property turned over by Binalbagan to BISCOM for the 216,000 shares. TCDcSE Under the terms of the contract of merger between Binalbagan and Isabela, we doubt if Binalbagan could have been allocated 216,000 shares without the sugar quota, or even with it, if the tangible assets of Binalbagan were valued at only P824,559.91. In plain language it cost Binalbagan P2,541,134.30 worth of tangible assets and P1,482,629.28 worth of sugar quota to acquire 216,000 shares of BISCOM." WHEREFORE, in view of the foregoing, this Office hereby confirms your opinion that the acquisition cost or cost basis of the SPI shares owned by STEAG includes the amounts actually paid by STEAG for the subscription price of all its shares, the Premium or Participation Fee for the Power Project, and other incidental costs such as registration costs and legal fees incurred to acquire all of its shares in SPI. 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, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service