Baniqued & Baniqued

August 17, 2009 BIR RULING [DA-(C-177) 460-09] 32 (A); 34; 105; RR 2; RR 2-98; #020-99; DA-641-04; #211-88; #641-04; DA-162-07; #641-04; DA-162-07; #510-03; DA 452-04; DA-143-05 Baniqued & Baniqued Suite 803, 8/F Jollibee Centre San Miguel Avenue Pasig City Attention: Atty. Carlos G. Baniqued Atty. Laura Victoria A.S. Yuson-Layug Gentlemen : This refers to your letter dated May 12, 2009 requesting on behalf of your client, Pilipino Telephone Corporation ("Piltel"), for confirmation of your opinion on the tax consequences of the intended sale and transfer of Piltel's Talk n' Text business and assets to its parent company, Smart Communications, Inc. ("Smart"). ACTISE Background Prior to 2000, Piltel provided cellular telecommunications services using various technologies. In response to market demands for value-based services, particularly short message or texting services, in April 2000, Piltel began offering prepaid cellular services under the Talk n' Text trademark using the Global System for Mobile Communications ("GSM") platform of Smart. Since then, Piltel's prepaid cellular services have become the main component of its business. To consolidate Piltel's cellular business under Smart, in March and April of 2009, the Board of Directors of Piltel approved the proposal to sell and transfer the company's Talk n' Text business and assets to Smart. The sale and transfer of the Talk n' Text business and assets is expected to, among others, enhance efficiency and economy in the provision of cellular telecommunications services, simplify operations and promote cost efficiency improvements, create wider market coverage and consolidation of established brands. The proposed sale of the Talk n' Text business and assets is intended to be undertaken through: TcSICH (i) the assignment of the Talk n' Text trademark covered by Trademark Certificate No. 4-2000-001326 issued by the Philippine Intellectual Property Office on December 16, 2005; (ii) the transfer of Talk n' Text subscriber base for a consideration equivalent to what Smart would have spent had it acquired its own subscriber base. The Talk 'N Text subscriber base (based on the number of Talk 'N Text Subscriber Identity Modules ("SIMs") was around 16.5 million as of July 31, 2009. On closing date, Piltel shall transfer to Smart the holders of the Talk 'N Text SIMs (the "Subscribers") as of closing date and Smart shall agree to take over and provide the Talk 'N Text Services to the Subscribers in accordance with the terms offered by Piltel to said Subscribers. Piltel offers voice and data services such as text, MMS and value added services (the "Talk 'N Text Services") via value-driven packages, which include top-up services providing a fixed number of messages with prescribed validity periods and call packages which allow a fixed number of calls of preset duration; and (iii) the sale at net book value of assets consisting of land, buildings and improvements, telecommunications equipment, transportation equipment, furniture and tools, installation materials, parts and supplies and inventories. In support to your request, you submitted the following documents: 1. Proposed Equipment Sale and Purchase Agreement 2. Notarized Contract to Sell of Real Properties between Pilipino Telephone Corporation and Smart Communications, Inc. 3. Proposed Deed of Absolute Sale 4. Proposed Deed of Assignment of Trademark 5. List of Real Properties to be transferred 6. Agreement to acquire the subscribers of the Talk 'N Text prepaid GSM service 7. Consolidated Financial Statements as of December 31, 2008 On the basis of the foregoing, you now request for confirmation that the sale by Piltel of its Talk n' Text business and assets to Smart shall have the following tax implications: SADECI 1. On the assignment of the Talk n' Text trademark 1.1. Any income on the part of Piltel from the assignment of the Talk n' Text trademark constitutes an item of gross income ( i.e., gain derived from dealings in property) under Section 32 (A) of the 1997 NIRC, as amended, subject to 30% regular corporate income tax. The transaction shall not be subject to creditable withholding tax ("CWT"), notwithstanding that Smart is a large taxpayer, as the transaction is considered a sale of intangibles, not a sale of goods or a sale of services subject to withholding tax. 1.2. The consideration to be paid by Smart for the acquisition of the trademark may be amortized over the remaining life of the trademark and claimed as a deduction for income tax purposes for such period. 2. On the transfer of the Talk n' Text subscriber base 2.1. Any income on the part of Piltel from the transfer of the Talk n' Text subscriber base constitutes an item of gross income ( i.e., gain derived from dealings in property) under Section 32 (A) of the 1997 NIRC, as amended, subject to 30% regular corporate income tax. The transaction shall not be subject to CWT, notwithstanding that Smart is a large taxpayer, as the transaction is considered a sale of an intangible, not a sale of goods or a sale of services subject to withholding tax. 2.2. The consideration to be paid by Smart for the acquisition of the subscriber base may be amortized over the average period customers usually retain their business and claimed as a deduction for tax purposes. 3. On the sale of assets relating to the Talk n' Text business 3.1. Any income on the part of Piltel from the sale of assets relating to the Talk n' Text business constitutes an item of gross income ( i.e., gain derived from dealings in property) under Section 32 (A) of the 1997 NIRC, as amended, subject to 30% regular corporate income tax. As Piltel shall sell the assets at net book value, Piltel shall not realize any gain on the sale of assets. However, Smart shall withhold 6% CWT on the purchase of real property used in business based on the highest of zonal value, fair market value or gross selling price of the real property and 1% CWT on the purchase of other tangible assets based on the proceeds thereof, which CWT Piltel may apply against its regular corporate income tax. 3.2. Smart may depreciate the acquisition cost of the assets acquired other than land over the remaining life thereof and claim the same as a deduction for tax purposes. We reply, as follows: 1. The assignment of the Talk n' Text trademark shall be subject to 30% regular corporate income tax or 2% MCIT, whichever is higher, on the part of Piltel but shall not be subject to CWT. Any income on the part of Piltel from the sale of the Talk n' Text trademark for a fixed consideration constitutes an item of gross income ( i.e., gain derived from dealings in property) under Section 32 (A) of the 1997 NIRC, as amended, subject to the 30% regular corporate income tax. 1 In BIR Ruling No. DA-641-04, dated December 17, 2004, this Office recognized that an agreement involving the transfer of ownership over a trademark is subject to the 32% [now 30%] regular corporate income tax. STADIH The sale of the Talk n' Text trademark by Piltel to Smart is not subject to CWT as such sale does not constitute a sale of goods subject to 1% CWT or a sale of services subject to 2% CWT. Since the sale of a trademark constitutes a sale of an intangible, 2 not a sale of goods or a sale of services, it is not subject to CWT. In BIR Ruling No. DA-641-04, this Office confirmed that the sale of a trademark is not subject to CWT. The consideration to be paid by Smart for the acquisition of the trademark may be amortized over the remaining life of the trademark and claimed as a deduction for income tax purposes for such period. On the part of Smart, the acquisition cost for the Talk n' Text trademark may be amortized over the remaining life of the trademark and may be claimed as a deduction for purposes of computing taxable income. The amortization or depreciation of intangible assets or property is expressly allowed under certain conditions as provided in Section 107 of Rev. Regs. No. 2, otherwise known as the "Income Tax Regulations", to wit: "SEC. 107. Depreciation of intangible property. Intangibles, the use of which in the trade or business is definitely limited in duration, may be the subject of a depreciation allowance. Examples are patents, copyrights, and franchises. Intangibles, the use of which in the business or trade is not so limited, will not usually be a proper subject of such an allowance. If however, an intangible asset acquired through capital outlay is known from experience to be of value in the business for only a limited period, the length of which can be estimated from experience with reasonable certainty, such intangible asset may be the subject of a depreciation allowance, provided the facts are fully shown in the return or prior thereto to the satisfaction of the Commissioner of Internal Revenue." (Emphasis supplied) Thus, in BIR Ruling No. 211-88, dated May 20, 1988, this Office confirmed that intangibles, the use of which in trade or business is definitely limited in duration, may be the subject of depreciation allowance as provided in Section 107 of the Income Tax Regulations. It was ruled that the acquisition cost of trademarks, which is computed on the basis of future sales discounted to its present value at the time of acquisition, can be amortized for tax purposes over the average remaining life of the different trademarks purchased. Subsequently, in BIR Ruling No. DA-641-04, this Office again ruled that the price paid for the purchase of trademarks may be claimed as a deduction from taxable income as periodic charges to amortization pursuant to Section 34 (F) of the 1997 NIRC. EIcSDC In BIR Ruling No. DA-162-07, dated March 20, 2007, it was reiterated that intangible assets such as trademarks may be considered depreciable assets upon showing that their use in trade or business is definitely limited in duration in accordance Section 107 of Rev. Regs. No. 2. It was further added that since the trademarks acquired have a remaining life of 10 years, they are regarded as intangibles subject to depreciation. The taxpayer was thus allowed to amortize the cost of the trademarks acquired over their remaining life from the date of sale. 2. The transfer of the Talk n' Text subscriber base shall be subject to 30% regular corporate income tax or 2% MCIT, whichever is higher, on the part of Piltel but shall not be subject to CWT. On the part of Piltel, any income from the transfer of Piltel's subscriber base for a consideration equivalent to what Smart would have spent if it were to acquire its own subscriber base constitutes an item of gross income ( i.e., gain derived from dealings in property) under Section 32 (A) of the 1997 NIRC, as amended, subject to 30% regular corporate income tax. 3 The sale of Piltel's subscriber base to Smart, a large taxpayer, is not subject to CWT as such sale does not constitute a sale of goods subject to 1% CWT or a sale of services subject to 2% CWT. This is because the sale of subscriber base constitutes a sale of an intangible, not a sale of goods or a sale of services. cAEDTa In BIR Ruling No. DA-452-04, this Office considered a customer list, which is akin to a subscriber base, an intangible asset. In BIR Ruling No. DA-641-04, this Office considered the sale of an intangible asset, particularly Health Registration Data and Know-How, as not subject to CWT. The consideration to be paid by Smart for the acquisition of the subscriber base may be amortized over the average period customers usually retain their business and claimed as a deduction for tax purposes. The consideration to be paid by Smart to Piltel for the acquisition of subscriber base may be amortized over the period the customers usually retain their business relationship and may be claimed as a deduction for purposes of computing income tax. Historically, Talk n' Text subscribers retain their business relationship for a period of 21 months. Hence, Smart may amortize the consideration to be paid for Piltel's subscriber base over a period of 21 months and claim the same as a deduction for tax purposes. In BIR Ruling No. DA-452-04, this Office allowed the taxpayer to depreciate the acquisition cost for a customer list over a period of 5 years considering that this was the average period customers retain their business relationship. The BIR considered a two-pronged test to allow a depreciation allowance to be taken on an intangible, that is, the intangible must have: (i) an ascertainable cost basis; and (ii) a limited useful life the duration of which can be ascertained with reasonable accuracy. It was concluded that since the sale of the customer list has an ascertainable cost basis under the parties' Asset Purchase Agreement and inasmuch as, based on the experience of the taxpayer, it is reasonable to approximate the limited useful life of the customer list for amortization purposes at 5 years since this was the average period customers retain their business relationship, the taxpayer was allowed to amortize the acquisition cost of the customer list. ADSIaT As the acquisition by Smart of the subscriber base entails a capital outlay and would have an ascertainable cost basis, and the average period customers usually retain business may be determined with reasonable accuracy, the consideration to be paid by Smart to Piltel for the subscriber base may be amortized over the period cellular phone subscribers retain their business ( i.e., 21 months) and claimed as a deduction for purposes of computing income tax. 3. Piltel shall not realize any gain on the sale of assets at net book value. However, Smart shall withhold 6% CWT on the purchase of real property used in business and 1% CWT on the purchase of other tangible assets based on the proceeds thereof, which CWT Piltel may apply against its regular corporate income tax. Generally, any gain from the sale of assets used in business constitutes an item of gross income ( i.e., gain derived from dealings in property) under Section 32 (A) of the 1997 NIRC, as amended, subject to 30% regular corporate income tax. 4 If the assets consist of real properties, the sale of real properties used in business shall be subject to an upfront 6% CWT. The sale of assets not considered real property, on the other hand, shall be subject to 1% CWT on the sale of goods if the payor is a large taxpayer. Since the assets related to the Talk n' Text business shall be sold by Piltel to Smart at net book value, no gain shall be realized on the sale and the transaction will not be subject to 30% corporate income tax. However, the sale of real property used in business shall, nonetheless, be subject to 6% CWT based on the zonal value, fair market value or selling price, whichever is highest, of the real property which tax must be withheld by Smart from the selling price paid to Piltel. 5 On the other hand, the sale of tangible assets other than real property shall be subject to 1% CWT on the sale of goods considering that Smart is a large taxpayer. 6 The taxes withheld by Smart from Piltel may be used by Piltel as tax credit against its income tax liability. CcHDaA Smart may depreciate the acquisition cost of the assets acquired over the remaining life thereof and claim the same as a deduction for tax purposes. Upon acquisition, Smart may depreciate its acquisition cost for the assets other than land over the remaining useful life of the assets and claim the same as an expense in computing its income tax liability. 7 In view thereof, this Office confirms your opinion that the sale of the Talk n' Text business and assets shall have the following tax implications: 1. On the assignment of the Talk n' Text trademark 1.1. Any income on the part of Piltel from the assignment of the Talk n' Text trademark constitutes an item of gross income ( i.e., gain derived from dealings in property) under Section 32 (A) of the 1997 NIRC, as amended, subject to 30% regular corporate income tax. The transaction shall not be subject to CWT, notwithstanding that Smart is a large taxpayer, as the transaction is considered a sale of an intangible, not a sale of goods or a sale of services subject to withholding tax. 1.2. The consideration to be paid by Smart for the acquisition of the trademark may be amortized over the remaining life of the trademark and claimed as a deduction for income tax purposes. 2. On the transfer of the Talk n' Text subscriber base 2.1. Any income on the part of Piltel from the transfer of the Talk n' Text subscriber base constitutes an item of gross income ( i.e., gain derived from dealings in property) under Section 32 (A) of the 1997 NIRC, as amended, subject to 30% regular corporate income tax. The transaction shall not be subject to CWT, notwithstanding that Smart is a large taxpayer, as the transaction is considered a sale of an intangible, not a sale of goods or a sale of services subject to withholding tax. 2.2. The consideration to be paid by Smart for the acquisition of the subscriber base may be amortized over the average period customers usually retain their business and claimed as a deduction for tax purposes. 3. On the sale of assets relating to the Talk n' Text business 3.1. Any income on the part of Piltel from the sale of assets relating to the Talk n' Text business constitutes an item of gross income ( i.e., gain derived from dealings in property) under Section 32 (A) of the 1997 NIRC, as amended, subject to 30% regular corporate income tax. As Piltel shall sell the assets at net book value, Piltel shall not realize any gain on the sale. However, Smart shall withhold 6% CWT on the purchase of real property used in business based on the highest of zonal value, fair market value or gross selling price of the real property and 1% CWT on the purchase of other tangible assets based on the proceeds thereof, which CWT Piltel may apply against its regular corporate income tax. 3.2. Smart may depreciate the acquisition cost of the assets other than land acquired over the remaining life thereof and claim the same as a deduction for tax purposes. Finally, this covers only the income tax implications of the foregoing transactions as requested by the taxpayer, and shall not include other taxes that may be due on the sale by Piltel of its Talk n' Text business and assets to Smart, such as but not limited to land, buildings and improvements, telecommunications equipment, transportation equipment, furniture and tools, installation materials, parts and supplies and inventories, trademark and subscriber base. 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. DaTICc Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. Section 27 (A) in relation to Sections 31 and 32 of the 1997 NIRC. 2. BIR Ruling No. 211-88, dated May 20, 1988. 3. Section 27 (A) in relation to Sections 31 and 32 of the 1997 NIRC. 4. Section 27 (A) in relation to Sections 31 and 32 of the 1997 NIRC. 5. Section 2.57.2 (J) of Rev. Regs. No. 2-98, as amended by Rev. Regs. No. 6-01 and Rev. Regs. No. 17-03. 6. Section 2.57.2 (M) of Rev. Regs. No. 2-98, as amended by Rev. Regs. Nos. 6-01, 17-03 and 14-08. 7. Section 34 (F), 1997 NIRC.