Crown Communities

October 13, 2008 BIR RULING [DA-(C-091) 288-08] 27; 98; 105; #076-89; DA-643-2007; DA-038-2006; DA-342-2008; DA-269-2008 Crown Communities Suite 101, Dacay Building No. 72 Escario Street Capitol Site, Cebu City Attention: Ms. Loida D. Nacario Chief Accountant Gentlemen : This refers to your letter dated May 30, 2007 requesting for confirmation of your opinion that the payables written-off in the books of Crown Communities Holdings, Inc. is subject to income tax but not to donor's tax and value-added tax since the nature of such income is non-recurring and cannot be classified as ordinary income. TSIaAc Background Crown Communities Holdings, Inc. (the "Corporation") is a domestic corporation organized on December 12, 2002. Its source of revenues consists mainly of Management Fees for providing managerial and technical support services to its affiliated companies, Crown Communities (Cebu), Inc. ("Crown Cebu") and Crown Communities (Cagayan), Inc. ("Crown Cagayan"). Over the years, the Corporation had obtained non-interest bearing cash advances from Crown Cebu, which, based on the Corporation's records, as of December 31, 2005 amounted to P5,950,000.00. For the taxable year ending December 31, 2006, a portion of such advances were written off by the Corporation since upon reconciliation with Crown Cebu, only P3,000,000.00 was reflected in the latter's books of accounts as its outstanding due from the Corporation. Further, the afore-mentioned creditor (Crown Cebu) did not assert any claim against the Corporation with respect to the difference in the amount of P2,950,000.00. Consequently, the Corporation has written-off such payables in the taxable year ending December 31, 2006. The same amount was recorded in the books of accounts of the Corporation as "Other Income" and was likewise included in the said company's Income Statement for the same year. The total revenue of the Corporation for the taxable year ending December 31, 2006 consists of the following: Management fees P1,200,000 Other income 2,950,000 Interest on saving deposits 4,490 P4,154,490 ======== However, during the preparation of the audited financial statement for the said taxable year, the auditor's inadvertently included the "Other Income" as part of "Management fees". Hence, the audited income statement would reflect the amount of P4,150,000.00 as Management fees for the year, and the amount of P4,490.00 representing Interest income, which is already net of the final tax. aSIAHC Meantime, in its Annual Income Tax Return, the Corporation reported the amount of P4,150,000.00 as revenues for the taxable year December 31, 2008. Based on the foregoing, you now request for confirmation of your opinion that the payables written-off in the books of the Corporation may be subject to income tax, but the same is not subject to the value-added tax notwithstanding the fact that the sum written-off was booked as additional revenue of the Corporation, since the nature of such other income is non-recurring, and it cannot be classified as ordinary income of the company in the ordinary course of trade or business; and that the creditor (Crown Cebu) cannot be held liable for donor's tax. EHCaDS In reply, please be informed that write-off or condonation of debt will not be subject to income tax if it does not result in the reduction of the taxable income of the debtor or the debtor is in a capital deficit position after the condonation. Thus, in BIR Ruling No. 076-89 dated April 17, 1989, this Office held that: "Cancellation and forgiveness of indebtedness may amount to a payment of income, 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 not be included in the latter's gross income. If a corporation to which a stockholder is indebted forgives the debt, the transaction has the effect of the payment of a dividend. (Sec. 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 reduce 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 Co. 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, 13AFTR 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 deficiency 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. Moreover, a return to solvency due to a possible future additional capital infusion by Isuzu and/or subsequent profitability in a different taxable year will not affect the non-taxability of the condonation." CAcIES In the present case, the amount of P2,950,000.00 was recorded in the books of accounts of the Corporation as "Other Income" and was likewise included in the said Corporation's Income Statement for the same year. Consequently, the Corporation reported in its Annual Income Tax Return, the amount of P4,150,000.00 as revenues for the taxable year December 31, 2008. Due to the facts aforementioned, the Corporation is clearly not in a financial position after the write-off or condonation. Moreover, the debtor is enriched and its net assets have been increased due to the said condonation. Accordingly, the payables written-off in the books of the Corporation are subject to income tax. In addition, Section 105 of the Tax Code of 1997, as amended by Republic Act No. 9337, provides that the phrase 'in the ordinary course of trade or business' means the regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto. SCEDaT The facts being considered, the write-off or condonation is not subject to value-added tax notwithstanding the fact that the sum written-off was booked as additional revenue on the part of the Corporation, since the nature of such other income is non-recurring, and it cannot be classified as ordinary income of the company in the ordinary course of trade or business. Furthermore, the condonation is likewise not subject to gift tax or donor's tax on the part of the creditor (Crown Cebu) since there is no donative intent or interest on the part of Crown Cebu when it made the said condonation. (BIR Ruling Nos. DA-419-2004 dated August 4, 2004 and DA-038-2006 dated February 9, 2006) 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 as null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service