Metro Pacific Corporation

November 24, 2009 BIR RULING [DA-(C-282) 702-09] 27; 98; 179; #076-89; DA-376-2008; DA-419-2004; #146-95; DA-381-2008; DA-(C-005) 023-2008; DA-342-2008 Metro Pacific Corporation 10/F, MGO Building, Legazpi cor. Dela Rosa Streets Legaspi Village, 0721 Makati City Attention: Ms. Joy Fernandez Controller Gentlemen : This refers to your letter dated December 22, 2008 requesting for confirmation of your opinion that the condonation in favor of Metro Pacific Corporation ("MPC") by its creditor of the loan amount of P63,723,182.16 out of the total loan obligation in the amount of P109,468,682.16 is not subject to income tax and donor's tax; and that the execution of a settlement agreement to document and effect the terms of such condonation is not subject to documentary stamp tax. Background Metro Pacific Corporation ("MPC") is a domestic corporation duly organized and existing under the laws of the Philippines with principal office at 10/F MGO Bldg., Legaspi corner Dela Rosa Streets, Legaspi Village, Makati City. It is duly-registered with the Securities and Exchange Commission ("SEC") under SEC Registration No. 135748 dated August 23, 2006. MPC has been suffering from capital deficiency arising from financial difficulties, and that one of the primary reasons of MPC's business downturn is the continuing incurrence of interest and penalties on the substantial amount of outstanding liabilities in MPC's books. A portion of said liabilities pertains to a loan taken from a third-party creditor with a maturity value amounting to P109,468,682.16 consisting of principal and interest which remains unpaid up to date. Moreover, said capital deficiency is comprised of liabilities of the company, which, in the opinion of its auditors, "indicate the existence of a material uncertainty which may cast substantial doubt about the company's ability to continue as a going concern." SaCDTA The accrued interests from the said loan were incurred by MPC way back 2002. During those taxable years, MPC was in a loss position, thus, it was not able to claim tax deduction benefits from said interests and penalties. In view of the fact that the liabilities have remained unpaid, MPC has offered settlement with the said third party creditor, and out of the total liability, MPC offered to pay PHP45,745,500.00 and requested the cancellation and condonation of the remaining portion of the principal value of the loans plus accrued interests amounting to PHP63,723,182.16. As and by way of documenting and effecting the approved condonation, the parties have executed a settlement agreement which specified the terms of payment. MPC has reflected a capital deficit position and continually sustained losses as shown by its Audited Financial Statements, as follows: 2007 2006 Net income (losses) (244,372,000) 2,106,593,000 Capital deficiency (425,629,000) (181,257,000) After the proposed condonation, MPC will still be in a capital deficit position as reflected in the unaudited Balance Sheet as of September 30, 2008 as follows: Total Assets 1,251,655,562.10 Total Liabilities 1,376,734,490.25 Capital Deficiency (125,078,928.15) Based on the foregoing, you now request for confirmation on the following that: 1. The condonation in favor of MPC by its creditor is not subject to income tax and donor's tax; and 2. The execution of a settlement agreement to effect the terms and conditions of the condonation is not subject to the documentary stamp tax. We reply, as follows: On Income Tax In several BIR rulings, 1 this Office has ruled that before the condonation or forgiveness of indebtedness will give rise to a taxable income, there must be an increase in the assets of the debtor thereby enriching the latter. A transaction whereby nothing of exchangeable value comes to or is received by a taxpayer does not give rise to or create a taxable income. Gain or profit is essential to the existence of taxable income. ECaHSI In setting forth the above pre-condition for imposing income tax on the condonation of indebtedness, adopted the principle laid down by the US Supreme Court in Dallas Transfer & Terminal Warehouse v. Commissioner of Internal Revenue, 70 F. 2d 95 , which held that there must be an increase in assets for there to be income realized from the reduction or extinguishment of liability. In this case, Dallas was renting an office building from its lessor. Due to the lease, Dallas incurred a debt of US$107,880.77 rendering it insolvent. In order to enable Dallas to remain in business and to have a chance to pay the reduced future rental agreed upon, and also to keep its building from being vacant and unprofitable, the lessor accepted as partial payment Dallas' Alamo street property with the appraised value of US$17,507.20 and cancelled the balance of that debt, charging it off as worthless. The US Supreme Court in ruling that Dallas did not realize taxable income explained that: "The transaction was not in form or substance a sale for US$107,880.77 of property which has an appraised value of US$17,507.20. In effect the transaction was similar to what occurs in an insolvency or bankruptcy proceeding when, upon a debtor surrendering, for the benefit of his creditors, property insufficient in value to pay his debts, he is discharged from liability for his debts. This does not result in the debtor acquiring something of exchangeable value in addition to what he had before. There is a reduction or extinguishment of liabilities without, any increase in assets. There is an absence of such a gain or profit as is required to come within the accepted definition of income . . . That the increase in clear assets so brought about constituted taxable income is not applicable to the factors of the instant case, as the cancellation of Dallas' past due debt to its lessor did not have the effect of making the Dallas' assets greater than they were before that transaction occurred. Taxable income is not acquired by a transaction which does not result in the taxpayer getting or having anything he did not have before. Gain or profit is essential to the existence of taxable income." Thus, the cancellation of indebtedness may not give rise to taxable income. This has been the consistent stance by this Office in our long line of BIR rulings 2 which pronounced, to wit: "Thus, the condonation of the CPI's debt to SJ shall not be subject to income tax considering that CPI is in a capital deficiency position and will remain insolvent before and after the said condonation considering that the amount to be condoned would only be P84,198,555.20." The above ruling was issued on the basis of the discussions stated in BIR Ruling No. 076-89 dated April 17, 1989 which stated as follows: "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." SAHaTc The same principle was reiterated in BIR Ruling No. DA-593-2006 dated October 5, 2006 , where it was held that: "It is clear from the foregoing that the condonation of POPI advances by Growluck is not subject to income tax if nothing of exchangeable value comes to or is received by POPI. This is based on the basic and generally accepted principle of taxation that taxable income is created from the inflow of wealth. xxx xxx xxx" The above situation may be applied to MPC. The extinguishment of MPC's liability as a result of the condonation did not increase MPC's assets. It did not have the effect of making MPC's assets greater than they were before. Its liabilities still exceed its assets. Moreover, MPC did not realize any taxable income as a result of the suspension or waiver or condonation. It is clear from the foregoing that the condonation of MPC's indebtedness is not subject to income tax if nothing of exchangeable value comes to or is received by MPC. This is based on the basic and generally accepted principle of taxation that taxable income is created from the inflow of wealth. Therefore, if after the condonation of the liability, MPC will remain insolvent or in a capital deficit position, then the cancellation of the indebtedness is not subject to income tax. Accordingly, the condonation by the creditor of MPC of its debt in the amount of P133,723,182 is not subject to income tax considering that after the condonation, the company will remain to be in a capital deficit position. On Donor's Tax In BIR Ruling No. DA-419-04 dated August 4, 2004 , it was held that: ". . . Moreover, the condonation is likewise not subject to gift tax since there is no donative intent on the part of SJ but solely for business consideration." Applying the foregoing, the condonation of the liability of MPC is not subject to donor's tax if after the condonation, the same remains to be in capital deficit position. Accordingly, it can be said that the condonation by the creditor of MPC of its debt in the amount of P133,723,182 is not subject to donor's tax since there is no donative intent on the part of the creditor but is solely for business consideration. On Documentary Stamp Tax Section 179 of the Tax Code of 1997, as amended by Republic Act (RA) No. 9243 3 provides: DCISAE "Sec. 179. Stamp Tax on All Debt Instruments. On every original issue of debt instruments, there shall be collected a documentary stamp tax on One Peso (PHP1.00) on each two hundred pesos (PHP200), or a fraction thereof, of the issue price of any such debt instruments: Provided, That for such debt instruments with terms of less than one (1) year, the documentary stamp tax to be collected shall be of a proportional amount in accordance with the ratio of its term in number of days to three hundred sixty-five (365) days: Provided, further, That only one documentary stamp tax shall be imposed on either loan agreement, or promissory notes issued to secure such loan." The above-quoted provision enumerates the type of documents subject to DST on loan agreements. Revenue Regulations (RR) No. 9-94, as amended, defined such documents as follows: "Loan agreement refers to a contract in writing where one of the parties delivers to another money or other consumable thing, upon the condition that the same amount of the same kind and quality shall be paid. The term shall include credit facilities, which may be evidenced by credit memo, advice or drawings." In the case of MPC, the settlement agreement is not in the nature of a loan agreement, but is executed precisely to effect the payment of terms embodied in a loan agreement. Since MPC did not execute any document that may be considered as a loan agreement to which the tax under Section 179 of the Tax Code, as amended, is imposed, and since a settlement agreement is not one among those instruments falling under any of the documents enumerated under the Tax Code that are subject to a specific documentary stamp tax, then the said settlement agreement which provides for the new terms and conditions of payment of an original loan, shall not be subject to said tax. 4 Accordingly, the execution of a settlement agreement to document and effect the terms of said condonation of MPC's loan by its creditor, is not subject to documentary stamp tax. 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 and/or any of the requirements imposed in this letter is not complied with, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. BIR Ruling No. DA-376-08 dated June 20, 2008; BIR Ruling No. 076-89 dated April 17, 1989. 2. BIR Ruling Nos. DA-(C-005)-023-08 dated July 10, 2008; BIR Ruling No. DA-342-08 dated June 4, 2008; BIR Ruling No. DA-643-07 dated December 13, 2007; BIR Ruling No. DA-593-06 dated October 5, 2006; BIR Ruling No. DA-419-04 dated August 4, 2004. 3. As implemented by Revenue Regulations (RR) No. 13-04. 4. BIR Ruling Nos. DA-(C-005)-023-08 dated July 10, 2008; and DA-378-2008 dated June 24, 2008 citing BIR Ruling No. 146-95 dated September 19, 1995 and BIR Ruling No. DA-381-08-24-98 dated August 24, 1998.