Quisumbing Torres

October 30, 2009 BIR RULING [DA-(C-249) 638-09] DA-136-05; 076-89; DA-419-04 Quisumbing Torres 12th Floor, Net One Center 26th Street corner 3rd Avenue Crescent Park West Bonifacio Global City Taguig City Attention: Attys. Dennis G. Dimagiba and Jose Jaime V. Cruz Gentlemen : This refers to your letter dated March 3, 2009 stating that your client, Suez Environnement (SE), is a company incorporated under the laws of France; that on the other hand, Ondeo Services Philippines, Inc. (OSPI) is a corporation organized and existing under the laws of the Philippines and is the wholly-owned subsidiary of SE in the Philippines; that OSPI is engaged in the business of conducting general consultancy, advisory, professional and technical services and assistance to its sole customer Maynilad Water Services, Inc. (MWSI), in respect to the maintenance, development, upgrading and operation of its water, wastewater and sewerage facilities; that in connection with the services that OSPI rendered to MWSI, OSPI (then known as Lyonnaise des Eaux Philippines, Inc.) entered into a Current Account Agreement with SE (then known as Suez Lyonnause des Eaux) in January 1998, pursuant to which SE agreed to provide financial support to OSPI (in the form of cash advances made from time to time) in order for OSPI to meet its financial commitments relative to the activities and operations of OSPI in the Philippines; that the cash advances made by SE were booked and reported in the Advances from Parent Company account in OSPI's financial statements; that OSPI has incurred significant losses over the years as a result principally of severe financial difficulties encountered by its sole customer, MWSI, which also forced the suspension of the technical services agreement between the parties; that based on OSPI's most recent audited financial statements for the calendar year ended December 31, 2007 and the period ended September 30, 2008, OSPI reported a capital deficiency, as follows: CcTHaD December 31, 2007 September 30, 2008 Capital stock P5,280,000.00 P5,280,000.00 Additional paid-in capital 364,000.00 364,000.00 Deficit (275,589,655.00) (314,873,001.00) Total Capital Deficiency (269,945,655.00) (309,229,001.00) ============= ============= that because of OSPI's financial problems and its inability to pay SE for the advances made by the latter, the balance of the Advances from Parent Company account of OSPI has also increased considerably; that based on OSPI's audited financial statements as of December 31, 2007 and as of September 30, 2008, the Advances from Parent Company account had a running balance of P273,720,061.00 and P311,979,866.00, respectively; that the notes to OSPI's audited financial statements also disclosed that the substantial losses incurred by OSPI and the suspension of its technical service agreement with MWSI indicate a material uncertainty, which casts significant doubt about OSPI's ability to continue as a going concern; that currently, OSPI has discontinued its operations and plans to go into dissolution and liquidation; that in view of the foregoing developments and the clear inability of OSPI to settle its outstanding liabilities to its parent company SE, SE is constrained and has decided to condone a portion of the amount of the advances and charges collectible from OSPI and cancel/write off the receivables from OSPI based on balances reported as of September 30, 2008; that SE advised OSPI about the write-off and stated that it will be in the best interest of both parties for SE to forego or waive its right to collect the sum of P309,229,001 from the unpaid accounts of OSPI, rather than to pursue further collection efforts which will turn out to be futile given the current financial condition of OSPI; that the balance of the Advances which will not be written off amounting to P2,750,865 will just be settled using the remaining cash of OSPI reported as of September 30, 2008; that in the latest audited financial statements of the Company as of September 30, 2008, the balance of the Company's Advances from Parent Company amounted to P311,979,866, while OSPI had a deficit with a balance of P314,873,001; that after the write-off of the sum of P309,229,001 from the Advances from Parent Company account, it is projected that OSPI's net assets will not improve and that it will not report a positive amount as capital, as follows: 09-30-08 Write-Off Adjusted Cash 3,298,677.00 3,298,677.00 Accrued expenses 547,812.00 547,812.00 Advances from Parent 311,979,866.00 (309,229,001.00) 2,750,865.00 Total liabilities 312,527,678.00 3,298,677.00 Capital stock 5,280,000.00 5,280,000.00 Additional paid-in 364,000.00 364,000.00 (Deficit) (314,873,001.00) 309,229,001.00 (5,644,000.00) Total Capital (309,229,001.00) 0.00 Deficiency Total 3,298,677.00 3,298,677.00 ============ ========== Based on the foregoing representation, you now request for confirmation of your opinion that 1. the cancellation or write-off by SE of a portion of the unpaid advances and charges collectible from OSPI will not be subject to donor's tax on the part of SE because the cancellation or write-off of the debt is motivated by a definite business consideration and is made without donative intent; and 2. the cancellation from OSPI will not subject OSPI to liability for income tax (whether regular corporate income tax or minimum corporate income tax) if OSPI will not realize an increase in its net assets after the cancellation or write-off. In reply thereto, please be informed as follows 1. The write-off of the accounts receivable should not be considered as donation subject to donor's tax since there is no donative intent on the part of SE. The write-off is purely for business consideration since OSPI has no more sufficient assets to cover its payables to SE. The above principle is not without authority. This Office in BIR Ruling No. DA-593-06 justified its stance by the following ratiocination: "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, 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 deficiency position. The condonation is likewise not subject to gift tax since there is no donative intent 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. " 2. The write-off should not be considered as income of OSPI subject to the regular income tax. A transaction whereby nothing or exchangeable value comes to or received by the taxpayer does not give rise to or create taxable income. Taxable income is not acquired by a transaction which does not result in the taxpayer getting or having anything the taxpayer did not have before (BIR Ruling No. 076-89 and BIR Ruling No. DA-419-04, citing Dallas Transfer, supra, BIR Ruling No. DA-206-97, citing Comm. V. Rail Joint Co. [C. CA.] 61 f 2D 751; Bowers vs. Kerbough Empire Co., 271 US 170). Accordingly, OSPI did not derive any income as a result of the write-off of the portion of the advances from SE in the amount of P309,229,001.00 and as such, it should not be subject to income tax. This is so because its net asset position, as represented, will not improve from negative to positive as a result of the write-off. ScHAIT WHEREFORE, in view of the foregoing, this Office hereby confirms your opinion that: 1. the cancellation or write-off by SE of a portion of the unpaid advances and charges collectible from OSPI will not be subject to donor's tax on the part of SE because the cancellation or write-off of the debt is motivated by a definite business consideration and is made without donative intent; and 2. the cancellation from OSPI will not subject OSPI to liability for income tax (whether regular corporate income tax or minimum corporate income tax) if OSPI will not realize an increase in its net assets after the cancellation or write-off. 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