Santiago & Santiago Law Offices

November 20, 2009 BIR RULING [DA-(C-274) 689-09] Sec. 56, RR 2; BIR Ruling No. 076-89; DA 269-08; DA-028-05; DA-260-07; DA-444-05 Santiago & Santiago Law Offices Ground Floor, Ortigas Building Ortigas Avenue cor MERALCO Avenue 1605 Pasig City Attention: Atty. Manuel C. Carlos Gentlemen : This refers to your letter dated October 28, 2009 requesting, on behalf of your client, NEGROS NAVIGATION CO., INC. ("NENACO"), confirmation of your opinion that the various transactions that NENACO shall undertake pursuant to an Equity Restructuring are not subject to income tax and donor's tax. The facts, as represented, are as follows: NENACO is a domestic corporation organized and existing under and by virtue of the laws of the Republic of the Philippines, with address at Pier 2, North Harbor, Port Area, Tondo, Manila, and registered with the Securities and Exchange Commission (SEC) as evidenced by SEC Registration No. 1275 dated 26 July 1932. NENACO is under corporate rehabilitation, which is the subject of Special Proceedings No. 04-109532, before Branch 46 of the Regional Trial Court (RTC) of Manila. The authorized capital stock of NENACO is Four Billion Pesos (P4,000,000,000.00) divided into four billion (4,000,000,000) common shares with a par value of One Peso (P1.00) per share. The subscribed, issued and outstanding capital stock of NENACO is Three Billion Twenty Five Million Seven Hundred Thirty-Three Thousand One Hundred Twenty-Three Pesos (P3,025,733,123.00) divided into three billion twenty five million seven hundred thirty-three thousand one hundred twenty-three (3,025,733,123) common shares with a par value of One Peso (P1.00) per share. IACDaS In the Audited Financial Statements of NENACO ending 31 December 2008, the equity consists of the following: Issued and Outstanding Shares P3,025,733,123.00 Less: Subscription Receivables 64,923,371.00 Share Capital P2,960,809,752.00 Additional Paid in Capital 890,932,189.00 Deposit for Future Subscription 280,310,000.00 Change in fair value on available for sale investments 291,925.00 Deficit (4,171,747,126.00) Total Capital Deficiency (P39,403,260.00) ============== KGLI-NM Holdings, Inc. (KGLI-NM), the majority stockholder of NENACO, holding ninety nine point zero four percent (99.04%), more or less, of the issued and outstanding capital stock of NENACO intends to cause NENACO to undertake an equity restructuring program for the purpose of improving the equity of NENACO by removing from the financials of NENACO its capital deficit (accumulated negative retained earnings). In a meeting held on November 26, 2008, the Board of Directors passed a resolution, which was later approved by its stockholders, authorizing the corporation to (i) cause NENACO to convert into Additional Paid-In Capital (APIC), without the issuance of additional shares, the credits against and advances to NENACO, at its acquisition cost; and write-off condone the difference between the face value and acquisition cost of its credits; and (ii) to cause NENACO to offset the APIC and difference with the equity deficit (accumulated negative retained earnings) of NENACO in order to wipe out the same. The said credits and advances are as follows: i. Secured credits against NENACO in the total amount of Four Hundred Nine Million One Hundred Eighty Three Thousand Seven Hundred Six Pesos and Thirty Five Centavos (P409,183,706.35), more or less, representing forty four percent (44%), more or less, of the outstanding secured obligations of NENACO subject of the rehabilitation proceedings; ii. Unsecured credits in the total amount of One Hundred Four Million Five Hundred Seventy Eight Thousand Five Hundred Ten Pesos and Sixty Three Centavos (P104,578,510.63), more or less, representing twenty one percent (21%), more or less, of the outstanding unsecured obligations of NENACO subject of the rehabilitation proceedings; DaTISc iii. Shareholder advances in the total amount of Two Hundred Fifty Eight Million Two Hundred Sixty Thousand Seven Hundred Ninety Four Pesos and Six Centavos (P258,260,794.06); iv. Notes payable in the total amount of One Hundred Nineteen Thousand Three Hundred Ninety Four Thousand Six Hundred Sixty Two Pesos and Ninety Four Centavos (P119,394,662.94); and v. Advances for future stock subscriptions in the amount of One Hundred Million Pesos (P100,000,000.00) out of the above-mentioned amount of Two Hundred Ninety Million Three Hundred Ten Thousand Pesos (P290,310,000.00). KGLI-NM acquired the above-mentioned credits, advances and notes payable as follows: Acquired From Face Value Acquisition Cost (1) Secured Development Bank of the Phils. 367,917,922.37 183,989,000.00 Credits Cameron Granville Asset Management (SPV-AMC), Inc. 30,221,391.06 11,181,914.69 Meridian (SPV-AMC) Corp. 11,044,392.92 4,080,000.00 409,183,706.35 199,250,914.69 (2) Unsecured Tsuneishi Heavy Credit Industries (Cebu), Inc. 104,578,510.63 44,462,656.00 (3) Advances Metro Pacific Corp. 258,260,794.06 75,320,169.00 (4) Notes payable Metro Pacific Corp. 119,394,662.94 55,407,584.00 (5) Advances for Future Subscription Metro Pacific Corp. 100,000,000.00 33,141,536.00 TOTAL P991,417,673.98 P407,582,859.69 ============ ============ In a special meeting held on 29 March 2004, the Board of Directors of NENACO passed a resolution, approved and adopted by the stockholders on even date, authorizing the corporation to "take all actions or matters necessary and desirable to rehabilitate the Corporate, including, but not limited to . . . the conversion of its obligations to equity . . . the amendment of its Articles of Incorporation . . . the increase or decrease of its authorized capital stock . . .". Upon securing the approval of the RTC and the SEC as regards the above resolutions, the above-mentioned equity restructuring of NENACO shall be implemented as follows: 1. KGLI-NM shall cause NENACO to convert into additional paid-in capital (APIC), without the issuance of additional shares of stock, the secured credits of KGLI-NM against NENACO at its acquisition cost in the amount of One Hundred Ninety Nine Million Two Hundred Fifty Thousand Nine Hundred Fourteen Pesos and Sixty Nine Centavos (P199,250,914.69); 2. KGLI-NM shall cause NENACO to convert into APIC, without the issuance of additional shares of stock, the unsecured credits of KGLI-NM against NENACO at its acquisition cost in the amount of Forty Four Million Four Hundred Sixty Two Thousand Six Hundred Fifty Six Pesos (P44,462,656.00); 3. KGLI-NM shall cause NENACO to convert into APIC, without the issuance of additional shares of stock, the advances of KGLI-NM against NENACO at its acquisition cost in the amount of Seventy Five Million Three Hundred Twenty Thousand One Hundred Sixty Nine Pesos (P75,320,169.00); IaESCH 4. KGLI-NM shall cause NENACO to convert into APIC, without the issuance of additional shares of stock, the notes payable of KGLI-NM against NENACO at its acquisition cost in the amount of Fifty Five Million Four Hundred Seven Thousand Five Hundred Eighty Four Pesos (P55,407,584.00); 5. KGLI-NM shall cause NENACO to convert into APIC, without the issuance of additional shares of stock, the advances for future subscription of KGLI-NM in NENACO at its acquisition cost in the amount of Thirty Three Million One Hundred Forty One Thousand Five Hundred Thirty Six Pesos (P33,141,536.00); 6. KGLI-NM shall cause NENACO to convert into APIC, without the issuance of additional shares of stock, the other advances/deposits for future subscription in the amount of One Hundred Eighty Million Three Hundred Ten Thousand Pesos (P180,310,000.00); 7. KGLI-NM shall condone in favor of NENACO the collection of the difference between the face value and acquisition cost of the items stated in paragraphs (1) to (5), above, in the total amount of Five Hundred Eighty Three Million Eight Hundred Thirty Four Thousand Eight Hundred Fourteen Pesos and Twenty Nine Centavos (P583,834,814.29); 8. KGLI-NM shall cause NENACO to amend its Articles of Incorporation to decrease the par value of its capital stock from One Peso (P1.00) per share to Twenty Centavos (P0.20) per share, thereby reducing its issued and outstanding capital to Six Hundred Million One Hundred Forty Six Thousand Six Hundred Twenty Four Pesos and Sixty Centavos (P605,146,624.60); 9. KGLI-NM shall cause NENACO to offset the APIC created pursuant to clauses (1) to (6), above in the total amount of Four Hundred Seven Million Five Hundred Eighty Two Thousand Eight Hundred Fifty Nine Pesos and Sixty Nine Centavos (P407,582,859.69), and the pre-existing APIC of NENACO in the amount of Eight Hundred Ninety Million Nine Hundred Thirty Two Thousand One Hundred Eighty Nine Pesos (P890,932,189.00), with the above-mentioned equity deficit (accumulated negative retained earnings); 10. KGLI-NM shall cause NENACO to offset with the above-mentioned equity deficit (accumulated negative retained earnings) the difference between the face value and acquisition cost of the items stated in paragraphs (1) to (5), above, in the total amount of Five Hundred Eighty Three Million Eight Hundred Thirty Four Thousand Eight Hundred Fourteen Pesos and Twenty Nine Centavos (P583,834,814.29); and IDTSaC 11. KGLI-NM shall cause NENACO to offset the surplus created in the total amount of Two Billion Four Hundred Twenty Million Five Hundred Eighty Six Thousand Four Hundred Ninety Nine Pesos and Forty Centavos (P2,420,586,499.40) as a result of the decrease in the capital stock of NENACO pursuant to paragraph (7), above, with the above-mentioned equity deficit (accumulated negative retained earnings)." After undertaking the equity restructuring, the equity of NENACO shall be as follows: Issued and Outstanding Shares P605,146,624.60 Less: Subscription Receivables 64,923,371.00 Share Capital 540,223,253.60 Change in fair value on available for sale investments 291,925.00 Retained Earnings 311,499,236.38 Total Capital P852,014,414.98 ============ It is your opinion that the foregoing transactions comprising the equity restructuring program of NENACO are not subject to income and donor's taxes because the transactions (i) are solely for business consideration; (ii) are in the nature of capital transactions; (iii) do not generally give rise to a taxable event; and (iv) will be undertaken pursuant to the approval of the rehabilitation court and the SEC. In reply, please be informed that this Office has issued several rulings confirming that the condonation of indebtedness and the conversion and/or contribution of the condoned debt into APIC constitutes a capital transaction that does not give rise to either income or donor's tax. The more notable of said rulings are quoted in part below: In BIR Ruling No. DA-028-05 dated January 24, 2005, where Bayan Telecommunications, Inc. ("Bayantel") similarly applied for "corporate rehabilitation" with the court, this Office confirmed that any gain resulting from the condonation of Bayantel's debt through a court-approved restructuring plan is not taxable for income tax purposes. This Office furthermore confirmed that any conversion of debt into equity as a result of the debt restructuring plan is likewise not subject to income tax. Thus, this Office stated in [DA-028-05], to wit "Considering that in the case of your client, Bayantel, it was through court action that the debt rehabilitation plan was approved and is now being implemented. In other words, the restructuring was not a result of the mutual agreement of the debtors and creditors, but of judicial action. Accordingly, the gain resulting from condonation of the Bayantel's debt to its various creditors shall not be subject to income tax nor to gift tax since there is no donative intent on the part of its various creditors but is solely for business consideration." EACTSH This Office further ruled that: ". . . the conversion of Bayantel's debt into equity as a result of the debt restructuring plan shall not give rise to a taxable income and shall only be considered as an additional capital investment which likewise is not subject to donor's tax since there is no donative intent in the aforesaid transaction." Likewise, in BIR Ruling No. DA-260-07 dated April 25, 2007, where Radio Communications of the Philippines, Inc. ("RCPI") entered into a debt restructuring plan with its creditor-shareholders under which plan a portion of its debt were to be converted into equity, the BIR ruled that any gain resulting from the condonation of RCPI's debt is not taxable for income tax purposes; and that any conversion of debt into equity as a result of the debt restructuring plan is likewise not subject to income tax, it being in the nature of a capital transaction. Furthermore, BIR Ruling No. DA-444-05 dated October 27, 2005 which involved the conversion of accrued interest expense into equity in the form of APIC and the condonation or suspension of interest not accrued. The BIR extensively ruled on the non-taxability of said transactions, as follows: "In reply thereto, please be informed that your opinion is hereby confirmed as follows: "I. Accrued Interest Converted into Additional Paid in Capital Not Subject To Income Tax and Donor's Tax. "GBCI will not realize any taxable income arising from the conversion into APIC of the accrued interest for the period covering October 2, 2000 to March 31, 2003 amounting to Php83,138,289.00. "The contribution of paid-in surplus in the form of money or property without the issuance of additional shares by GBCI's major stockholders is not subject to any income tax. Capital contribution generally does not give rise to a taxable event pursuant to Section 56 of Revenue Regulations No. 2, otherwise known as the Income Tax Regulations, which provides that 'Section 56. Contributions by shareholders. Where a corporation requires additional funds for conducting its business and obtains such needed money through voluntary process payments by its shareholders, the amounts so received being credited to its surplus account or to a special capital account, will not be considered income, although there is no increase in the outstanding shares of stock of the corporation. The payments in such circumstances are in the nature of voluntary assessments upon, and represent an additional price paid for, in shares of stock held by the individual shareholders, and will be treated as an addition to and as part of the operating capital of the company.' SDIaHE The above rulings were also applied in BIR Ruling DA-269-08 dated April 25, 2008 involving the rehabilitation of Maynilad Water Services, Inc. ("MWSI") where it was held that the condonation of MWSI's indebtedness to its stockholders Benpres Holdings Corporation ("Benpres") and the Suez Group pursuant to a court-mandated/approved Restructuring Agreement, and likewise approved by the SEC, did not result in taxable income on the part of MWSI. On the basis of the foregoing rulings, and considering further that the transactions pursuant to the equity restructuring program, which will be implemented after NENACO has secured the approval of the RTC and SEC, are considered as additional capital investments and undertaken solely for business consideration, this Office hereby confirms your opinion as follows: 1. The conversion of KGLI-NM secured and unsecured credits against and advances to NENACO into APIC as a result of the equity restructuring program, without the issuance of additional shares of stock, shall not give rise to a taxable income on the part of NENACO; and 2. The write-off/condonation of the difference between the face value and acquisition costs of such credits shall not be subject to donor's tax, there being no donative intent on the part of KGLI-NM. Further, the said condonation of NENACO shall not be subject to income tax since NENACO is in a capital deficiency position. 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