SGV & Co.

December 22, 2009 BIR RULING [DA-(C-335) 815-09] Secs. 27, 98 & 179; DA-419-04; DA-(C-005) 023-08; DA-038-06 SGV & Co. 6760 Ayala Avenue 1226 Makati City Attention: Atty. W. U. Villanueva Principal, Tax Services Gentlemen : This refers to your letter dated December 18, 2009 requesting confirmation of your opinion that the partial condonation by Kimberly-Clark Luxembourg Finance S.a.r.l. (KCLF) of the debt of Kimberly-Clark Philippines, Inc. (KCPI) is not subject to income, donor's and documentary stamp taxes. It is represented that KCPI, with Tax Identification No. 000-162-194-000, is a domestic corporation engaged in the manufacture and sale of facial and bathroom tissues, paper towels and napkins for household and away-from-home use, disposable diapers, feminine pads/liners, and baby toiletries; that KCLF is a foreign corporation not doing business in the Philippines, with principal office located in 46A, Avenue J.F. Kennedy, L-1855 Luxembourg R.C.S. Luxembourg B122.039; that KCLF is a private limited liability company organized to enter into, assist or participate in financial, commercial and other transactions, and to grant to any holding company subsidiary or affiliated company, or any other company associated in any way with the Company, or any said holding company, subsidiary or affiliated company, in which the Company has a direct or indirect financial interest, any assistance, loans, advances or guarantees; that both KCPI and KCLF are subsidiaries of Kimberly Clark Corporation ("KCC"), a foreign corporation organized and existing in the United States of America; that on September 15, 2005, Kimberly-Clark Irish Finance Corporation Limited ("KCIFCL"), a corporation organized under the laws of England, and KCPI entered into a Credit Agreement whereby the former extended credit to the latter in the amount of Twenty Five Million US Dollars (US$25 Million); that in accordance with the Agreement, KCPI shall pay KCIFCL interest on the each advance at a USD-LIBOR rate plus one-eight percent (1/8%); that on June 21, 2007, KCIFCL and KCLF executed an Assignment Agreement whereby the former transferred and assigned its right, title, and interest in Credit Agreement in favor of the latter; that on December 31, 2008, KCPI closed its manufacturing facility in San Pedro, Laguna due to severe losses; that the influx of imported tissues, paper towels and napkins as well as diapers and other toiletries has resulted in a drop in the demand for KCPI products and consequently, its local market share; that as of December 31, 2008, KCPI has reflected a capital deficit position to the extent of P1,279,085,465.00; that the said capital deficiency arose from the financial difficulties suffered by KCPI; that due to its continued losses it suffered at least in the past three years, the Company has been unable to service its debt to KCLF; that the Audited Financial Statements of KCPI as of December 31, 2007 and December 31, 2008 reflect that the Company continually sustained capital deficiency amounting to 595,305,774.00 and P1,279,085,465.00, respectively; that given its insolvency, KCPI's loan has been designated by KCC and KCLF as not payable in the foreseeable future; that as part of the global mandate to restore KCPI's business into a viable operation and in order to minimize its capital deficiency, KCLF decided to partly condone the debt of KCPI; that of the outstanding debt of $23,226,364, $21,800,000 was proposed by the KCLF board of managers to be condoned in a special meeting on December 15, 2009; that the balance of $1,431,364 will be payable in a period of five (5) years beginning December 31, 2010; and that after the proposed condonation, KCPI will still be in a capital deficit position. IEHDAT In reply, please be informed that in BIR Ruling No. 076-89 dated April 17, 1989, it has been settled that before a 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. In BIR Ruling No. DA-(C-005) 023-08 dated July 10, 2008, this Office had the occasion to rule that debt condonation is not subject to income tax if the assets of the debtor has not been enriched and thus, does not realize any taxable income therefrom. It held as follows: "In reply, please be informed that in BIR Ruling No. DA-419-04 dated August 4, 2004, the BIR held as follows: '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. 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.' The above ruling was issued by the BIR on the basis of the discussions stated in BIR Ruling No. 076-89 dated April 17, 1989 which states 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 without any consideration therefore 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 a debt, the transaction has the effect of the payment of a dividend. (Section 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 GMPI shares from GM-US if GMPI has a "clean" balance sheet with no outstanding liabilities except those to Isuzu.' HAaECD It is clear from the foregoing that the condonation of LCI's indebtedness is not subject to income tax if nothing of exchangeable value comes to or is received by LCI. 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, LCI will remain insolvent or in a capital deficit position, then the cancellation of the indebtedness is not subject to any tax. The said condonation is also not subject to donor's tax in the hands of LCI, for lack of donative intent on the part of its creditors." The 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. [BIR Ruling DA-(C-091) 288-08 dated October 13, 2008, DA-(C-005) 023-08 dated July 10, 2008, DA-643-07 dated December 13, 2007, DA-419-04 dated August 4, 2004 and 076-89 dated April 17, 1989] In this case, KCPI will remain to be in a capital deficit position despite the partial condonation by KCLF. Hence, the Company will not derive any taxable gain from the condonation that is subject to income tax. The subject partial condonation is a mandate given by KCC, parent company of both KCLF and KCPI, as a business strategy and not to be construed as an act of liberality on the part of KCLF. The partial condonation is bereft of any generous and voluntary motive on the part of KLCF from which an intent to donate in favor of KCPI may be derived. Thus, the partial condonation by KCLF of KCPI's debt is not subject to donor's tax. [BIR Ruling No. (DA-038-06) dated February 9, 2006 citing 076-89, supra. ] Moreover, execution of an agreement to implement debt condonation is not subject to DST. In BIR Ruling No. DA-378-2008 dated June 24, 2008, this Office held as follows: "In reply, please be informed that Section 179 of the Tax Code of 1997, as amended by Republic Act (R.A.) No. 9243, provides: 'Sec. 179. Stamp Tax on all Debt Instruments. On every original issue debt instruments, there shall be collected a documentary stamp tax of One Peso (P1.00) on each two hundred pesos (P200), 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 terms 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.' AaECSH In the case of POPI, the compromise 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 POPI 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 compromise agreement is not one among those instruments falling under any of the documents enumerated under the Tax Code that are subject to a specific DST, then the said compromise agreement which provides for the new terms and conditions of payment of an original loan, shall not be subject to documentary stamp tax (BIR Ruling No. 146-95 dated September 19, 1995 and BIR Ruling No. DA-381-08-24-98 dated August 24, 1998). Accordingly, the execution of a compromise agreement to document and effect the terms of a previously agreement upon condonation of a loan by POPI from one of its creditors, is not subject to the documentary stamp tax.' In view of the foregoing, the execution of a compromise agreement to document and effect the terms of a previously agreed upon condonation of a loan between LCI and one of its creditors, is not subject to the documentary stamp tax imposed under Section 179 of the Tax Code, as amended." Based on the foregoing, this Office hereby confirms your opinion that the partial condonation by KCLF of the debt of KCPI is not subject to income, donor's and documentary stamp taxes. 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. Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service