Sebastian Liganor Galinato & Alamis

July 10, 2008 BIR RULING [DA-(S40M-005) 027-08] 40 (C) (2) (6) (c); S40-20-2003 Sebastian Liganor Galinato & Alamis 1409 East tower, Philippine Stock Exchange Centre Exchange Road, Ortigas Center, Pasig City Attention: Avelino M. Sebastian Jr. Partner Gentlemen : This refers to your letter dated June 30, 2008 requesting on behalf of your client, Interphil Laboratories, Inc. (Interphil), for a ruling on the tax consequences of the following proposed transactions of Interphil: 1. Transfer of land from Interphil to Lancashire Realty Holding Corporation (Lancashire) in exchange for shares of stocks of the latter. 2. Transfer of Fixed Assets, Inventory and excess Creditable Withholding Tax (CWT) from Interphil to First Pharma Industries Philippines, Inc. (First Pharma) in exchange for shares of stock of the latter. The facts, as represented, are as follows: Interphil is a corporation duly organized, validly existing and in good standing under the laws of the Republic of the Philippines. Its principal business is to toll manufacture pharmaceutical products. Its shares are listed at the Philippine Stock Exchange. As of 31 December 2007, its total issued and outstanding capital stock is 412,064,596 1 shares each with a par value of Php1.00 as follows: TDAHCS 272,696,551 class "A" shares 139,368,045 class "B" shares. 412,064,596 Out of 272,696,551 class "A" shares, Interpharma Holdings & Management Corporation (hereafter "Interpharma"), a Philippine company, owns 255,264,483 shares. 2 Out of 139,368,045 class "B" shares, Khatibi Holdings Limited (hereafter "Khatibi"), a BVI company, owns 128,208,993 shares. 3 Interpharma and Khatibi are companies related through the ultimate common ownership of the brothers Stephen and Gilbert Zuellig, both Filipino nationals. On a combined basis, Interpharma and Khatibi own 93.06% of the total issued and outstanding capital stock of Interphil, while the minority shareholders collectively own the remaining 28,591,120 shares representing 6.94%. The operations of Interphil over the years had been less than satisfactory. Its operating expenses are high, but its capacity utilization is low. Its volume has steadily declined over the years. In 2002, Interphil implemented a share buy-back program that was intended to improve share value. While 150,435,404 shares representing approximately 26.74% of the then issued and outstanding shares were converted to treasury shares, 4 the objective of the share buy-back program was not realized largely due to the persistently declining volume. Thus, in 2004, 2005 and 2006, Interphil reported substantial losses. In 2007, Interphil reported total revenues of Php2.106 billion with a net profit of Php53.6 million. This modest performance was achieved primarily through price increases, deferment of major capital expenditure, and radical cost reduction. However, with the unabated decline in volume and the limited opportunity to increase prices and defer capital expenditure, management is convinced that this performance is not sustainable in the medium or long-term. For which reason, it was agreed that Interphil must look for other business opportunities. Unfortunately, Interphil, under its current corporate structure, can hardly entertain business opportunities other than those related to pharmaceuticals because of the legal principle that every corporation should have only one principal corporate purpose. Thus the decision to reorganize Interphil by entering into the following transactions, to wit: First Transaction: To transfer and assign a certain parcel of land situated at Canlubang Industrial Estate, Bo. Pittland, Municipality of Cabuyao, Province of Laguna, covered by Transfer Certificate of Title No. T-115286 (hereafter the "Cabuyao Property") to Lancashire, a Philippine corporation, in exchange for originally issued shares of stock of the latter (hereafter the "Lancashire Shares"). Following the completion of the land transfer, Interphil will gain control of Lancashire. ISDCHA Second Transaction: To transfer and assign the Fixed Assets, 5 Inventory 6 and the excess CWT 7 of Interphil to First Pharma, a Philippine corporation, in exchange for originally issued shares of stock of the latter (hereafter the "First Pharma Shares"). Following the completion of the transfer of the Fixed Assets, Inventory, and excess CWT, Interphil will gain control of First Pharma. Lancashire and First Pharma have currently identical capital and ownership structures as follows. Each share has a par value of Php100.00. Subscriber No. of Shares Amount Subscribed Amount Paid Avelino M. Sebastian, Jr. 39 Php3,900.00 Php3,900.00 Jesus A. Liganor 20 Php2,000.00 Php2,000.00 Jon Michael P. Alamis 20 Php2,000.00 Php2,000.00 Fernando S. Maronilla 20 Php2,000.00 Php2,000.00 Andrelina G. Monis 1 Php100.00 Php100.00 Total 100 Php10,000.00 Php10,000.00 ==== =========== =========== Following the completion of the transfer and assignment of the Cabuyao Property to Lancashire, 8 the capital and shareholding structure of Lancashire shall be as follows: Subscriber No. of Shares Amount Subscribed Amount Paid Interphil Laboratories, Inc. 280,000 Php28,000,000.00 Php28,000,000.00 Avelino M. Sebastian, Jr. 39 Php3,900.00 Php3,900.00 Jesus A. Liganor 20 Php2,000.00 Php2,000.00 Jon Michael P. Alamis 20 Php2,000.00 Php2,000.00 Fernando S. Maronilla 20 Php2,000.00 Php2,000.00 Andrelina G. Monis 1 Php100.00 Php100.00 Total 280,100 Php28,010,000.00 Php28,010,000.00 ====== ============= ============= Following the completion of the transfer and assignment of the Fixed Assets, Inventory and excess CWT to First Pharma, 9 the capital and shareholding structure of First Pharma shall be as follows: Subscriber No. of Shares Amount Subscribed Amount Paid Interphil Laboratories, Inc. 1,300,000 Php130,000,000.00 Php130,000,000.00 Avelino M. Sebastian, Jr. 39 Php3,900.00 Php3,900.00 Jesus A. Liganor 20 Php2,000.00 Php2,000.00 Jon Michael P. Alamis 20 Php2,000.00 Php2,000.00 Fernando S. Maronilla 20 Php2,000.00 Php2,000.00 Andrelina G. Monis 1 Php100.00 Php100.00 Total 1,300,100 Php130,010,000.00 Php130,010,000.00 ======= ============== ============== In connection with these transactions, you now request confirmation of your opinion that: HDTSCc A. In respect of the First Transaction: (1) No gain or loss shall be recognized by Interphil on the transfer and assignment of the Cabuyao Property to Lancashire in exchange for the originally issued Lancashire Shares in accordance with Revenue Memorandum Order No. 32-01 and Revenue Regulations No. 18-01 and falling under Section 40 (C) (2) and (6) (c) of the Tax Code of 1997, as amended. (2) The cost basis of the Lancashire Shares which Interphil shall acquire pursuant to the exchange shall be the same as the original acquisition cost or adjusted cost basis of the Cabuyao Property to Interphil; while the cost basis to Lancashire of the Cabuyao Property that it shall acquire in exchange for the Lancashire Shares shall be the same as it would be in the hands of Interphil pursuant to Section 40 (C) (5) of the Tax Code. (3) The transfer and assignment of the Cabuyao Property by Interphil in exchange for the Lancashire Shares is not subject to value-added tax (VAT) pursuant to Section 4.106-8 of Revenue Regulations No. 16-05, as amended. (4) No documentary stamp tax (DST) shall be imposed on Interphil's transfer and assignment of the Cabuyao Property to Lancashire because this transaction is not among those subject to DST under Revenue Regulations No. 13-04. B. In respect of the Second Transaction: (1) No gain or loss shall be recognized by Interphil on the transfer and assignment of the Fixed Assets, Inventory and excess CWT to First Pharma in exchange for originally issued First Pharma Shares in accordance with Revenue Memorandum Order No. 32-01 and Revenue Regulations No. 18-01 and falling under Section 40 (C) (2) and (6) (c) of the Tax Code, as amended. EDHTAI (2) The cost basis of the First Pharma Shares which Interphil shall acquire pursuant to the exchange shall be the same as the original acquisition cost or adjusted cost basis of the Fixed Assets and Inventory to Interphil; while the cost basis to First Pharma of the Fixed Assets and Inventory that it will acquire in exchange for the First Pharma Shares shall be the same as it would be in the hands of Interphil pursuant to Section 40 (C) (5) of the Tax Code. (3) The transfer and assignment of the Fixed Assets, Inventory and excess CWT by Interphil in exchange for the First Pharma Shares is not subject to VAT pursuant to Section 4.106-8 of Revenue Regulations No. 16-05, as amended. (4) No DST shall be imposed on Interphil's transfer and assignment of the Fixed Assets, Inventory and excess CWT to First Pharma because this transaction is not among those subject to DST under Revenue Regulations No. 13-04. In reply, please be informed that pursuant to Section 40 (C) (2) and (6) (c) of the Tax Code of 1997, no gain or loss shall be recognized if property is transferred to a corporation by a person, in exchange for stock in such a corporation of which as a result of such exchange, said person, alone or together with others, not exceeding four persons, gains control of said corporation. The term "control" shall mean ownership of stocks in a corporation possessing at least 51% of the total voting power of all classes of stocks entitled to vote. Control is determined by the amount of stocks received i.e., total subscribed by the transferors. In determining the 51% stock ownership, only those persons who transferred property for stocks in the same transaction may be counted up to a maximum of five. Accordingly, no gain or loss shall be recognized on the transfer by Interphil of the Cabuyao Property in exchange for shares of stock of the transferee corporation, Lancashire, considering that as a consequence of the exchange, Interphil gained control of the transferee corporation by owning more than 51% of its total voting stocks. In respect of the second transaction, this Office hereby confirms your opinion that the transfer by Interphil of its Fixed Assets, Inventory and excess CWT in exchange for shares of stock of First Pharma likewise qualifies for non-recognition of gain or loss since the transfer of said properties will result in Interphil gaining control of the transferee corporation. EDSAac It should be emphasized, however, that Section 40 (C) (2) and (6) (c) of the Tax Code of 1997 merely defers recognition of the gain or loss from such transaction, for in determining the gain or loss from a subsequent transaction of the properties or of the stocks involved in the exchange, the original or historical cost of the properties or stocks is considered. Thus, if Interphil later sells or exchanges the shares of stock it acquired in the exchange, it shall be subject to income tax on the gains it derived from such sale or exchange, taking into consideration that the cost basis of the shares shall be the same as the original acquisition cost or adjusted cost basis to the transferor of the properties exchanged therefor; and that the cost basis to the transferees of the properties exchanged for stocks shall be the same as it would be in the hands of the transferor. [Sec. 40 (C) (5) (a) and (b) of the Tax Code of 1997] On the issue of whether the transfers are subject to value-added tax, this Office confirms your opinion that the transfer by Interphil of its properties to Lancashire and First Pharma pursuant to Section 40 (C) (2) are not subject to value-added tax imposed under Section 105 of the Tax Code as amended by Republic Act 9337. Section 4.106-8 (b) (1) of Revenue Regulations No. 16-05, as amended by Revenue Regulations No. 04-07, in part provides that: "(b) Not subject to output tax The VAT shall not apply to goods or properties existing as of the occurrence of the following: (1) Change of control of a corporation by the acquisition of the controlling interest of such corporation by another stockholder or group of stockholders. The goods or properties used in business or those comprising the stock-in-trade of the corporation, having a change in corporate control, will not be considered sold, bartered or exchanged despite the change in the ownership interest in the said corporation. Illustration: Abel Corporation is a merchandising concern and has an inventory of goods for sale amounting to Php1 million. Nel Corporation, a real estate developer, exchanged its real estate properties for the shares of stock of Abel Corporation resulting to the acquisition of corporate control. The inventory of goods owned by Abel Corporation (Php1 million worth) is not subject to output tax despite the change in corporate control because the same corporation still owns them. This is in recognition of the separate and distinct personality of the corporation from its stockholders. However, the exchange of real properties held for sale or for lease, or shares of stocks, whether resulting to corporate control or not, is subject to VAT subject to exceptions provided under Section 4.106-3 hereof. On the other hand, if the transferee of the transferred real property by a real estate dealer is another real estate dealer, in an exchange where the transferor gains control of the transferee-corporation, no output VAT is imposable on the said transfer." (Emphasis supplied.) CDAHIT In the instant case, the transfer and assignment of the Cabuyao Property by Interphil to Lancashire is not subject to VAT because the Cabuyao Property is not held by Interphil primarily for sale or for lease, in accordance with the above provision of Revenue Regulations No. 16-2005, as amended. Moreover, the transfer of Fixed Assets, Inventory and excess CWT by Interphil to First Pharma, in exchange for the latter's shares is not subject to VAT for the following reasons: 1. The transfer is not a transfer in the regular course of business. In Section 4.105-3, the phrase "in the course of trade or business" was defined as "the regular conduct or pursuit of a commercial or economic activity, including transactions incidental thereto, by any person regardless of whether or not the person engaged therein is a non-stock, non-profit private organization (irrespective of the disposition of its net income and whether or not it sells exclusively to members or their guests) or government entity". The proposed transfer of the Fixed Assets and Inventory is a one-off transaction that is not meant to be undertaken on a regular basis. In the same way, the transfer of these assets by Interphil to First Pharma cannot be construed as a "transaction incidental" to the regular conduct of business, because this transfer is an incident of a corporate reorganization. In BIR Ruling 024-05 dated December 23, 2005, this Office held that: ". . . the word 'incidental' contemplates an activity that necessarily follows the carrying out of the primary function. Since the sale of vessels is not necessary in the carrying out NDC's primary function of leasing personal properties, it should not be subject to VAT. In the instant case, the transfer by PSPC of the Fixed Assets of its LPG business to SGLPI in exchange for the latter's shares of stock pursuant to a tax-free exchange under Section 40 (C) (2) of the Tax Code of 1997 is by reason of a reorganization, a transaction which is not done with regularity and would no longer be repeated. The assignment of the Fixed Assets is not undertaken in the course of PSPC's regular conduct of trade or business or in pursuit of a commercial or an economic activity, nor is it incidental thereto." 2. The transfer will not result in a real sale, barter or exchange because there will be no real change in the ownership of the properties considering that the corporate reorganization is a simple case of Interphil pursuing its toll manufacturing business through the interposition of a private non-listed corporate subsidiary. HATEDC 3. The transfer is not within the context of a "deemed sale" transaction. 10 Section 4.106-7 (a) (4) of Revenue Regulations No. 16-2005 partly provides that: "(4) retirement from or cessation of business with respect to all goods on hand, whether capital goods, stock in trade, supplies or materials as of the date of such retirement or cessation, whether or not the business is continued by the new owner or successor. The following circumstances shall, among other things, give rise to transactions "deemed sale": (i) change of ownership of business. There is a change in the ownership of a business when a single proprietorship incorporates; or the proprietor of a single proprietorship sells his entire business. (ii) Dissolution of a partnership and creation of a new partnership which takes over the business." The corporate reorganization of Interphil does not fall within the meaning of retirement from or cessation of business inasmuch as the corporate reorganization of Interphil is merely a strategy to expand to other businesses. Pursuant to Section 196 of the Tax Code of 1997, a conveyance or deed whereby land is assigned or transferred to another person is subject to documentary stamp tax based on the consideration or value received or contracted to be paid for such realty or on its fair market value determined in accordance with Section 6 (E) of the same Code, whichever is higher. However, under Republic Act (R.A.) No. 9243 which took effect on March 20, 2004, transfer of property pursuant to Section 40 (C) (2) of the 1997 Tax Code, as amended, is now exempt from the payment of documentary stamp tax (DST) under Section 196 of the Tax Code of 1997. Accordingly, the transfer by Interphil of the Cabuyao Property to Lancashire, as in this case, is not subject to DST under said section. Moreover, the transfer by Interphil of its properties to First Pharma is likewise not subject to DST since the transfer is made pursuant to Section 40 (C) (2) of the 1997 Tax Code. The shares to be issued by Lancashire and First Pharma, however, are original issues subject to the documentary stamp tax imposed by Section 175 of the Tax Code of 1997, as amended, which shall attach upon acceptance by the corporation of the stockholder's subscription regardless of the actual delivery of the certificates of stock. SaCIAE In fine, this Office confirms your opinion as follows: In respect of the First Transaction (1) No gain or loss shall be recognized by Interphil on the transfer and assignment of the Cabuyao Property to Lancashire in exchange for the originally issued Lancashire Shares pursuant to Section 40 (C) (2) and (6) (c) of the Tax Code of 1997, as amended. (2) The cost basis of the Lancashire Shares which Interphil shall acquire pursuant to the exchange shall be the same as the original acquisition cost or adjusted cost basis of the Cabuyao Property to Interphil; while the cost basis to Lancashire of the Cabuyao Property that it shall acquire in exchange for the Lancashire Shares shall be the same as it would be in the hands of Interphil pursuant to Section 40 (C) (5) of the Tax Code. (3) The transfer and assignment of the Cabuyao Property by Interphil in exchange for the Lancashire Shares is not subject to value-added tax (VAT); (4) No documentary stamp tax (DST) shall be imposed on Interphil's transfer and assignment of the Cabuyao Property to Lancashire. In respect of the Second Transaction (1) No gain or loss shall be recognized by Interphil on the transfer and assignment of the Fixed Assets, Inventory and excess CWT to First Pharma in exchange for originally issued First Pharma Shares in accordance with Section 40 (C) (2) and (6) (c) of the Tax Code, as amended. (2) The cost basis of the First Pharma Shares which Interphil shall acquire pursuant to the exchange shall be the same as the original acquisition cost or adjusted cost basis of the Fixed Assets and Inventory to Interphil; while the cost basis to First Pharma of the Fixed Assets and Inventory that it will acquire in exchange for the First Pharma Shares shall be the same as it would be in the hands of Interphil pursuant to Section 40 (C) (5) of the Tax Code. SDAaTC (3) The transfer and assignment of the Fixed Assets, Inventory and excess CWT by Interphil in exchange for the First Pharma Shares is not subject to VAT; (4) No DST shall be imposed on Interphil's transfer and assignment of the Fixed Assets, Inventory and excess CWT to First Pharma. However, in order that the parties to the exchange transaction can avail of the non-recognition of gains provided for in Section 40 (C) (2) and (6) (c) of the Tax Code of 1997, you are hereby advised to comply with the requirements hereunder mentioned: A. The transferor must file with its income tax return for the taxable year in which the exchange transaction was consummated, a complete statement of all facts pertinent to the exchange, including: 1. A description of the property they transferred, or of their interest in such property, with a statement of the original acquisition cost/adjusted cost basis or other basis thereof at the time of the transfer; 2. The kinds of stocks received and preferences, if any; 3. The number of shares of each class received; and 4. The fair market value per share of each class at the date of the exchange. B. On the other hand, the transferee corporations must file with their income tax return for the taxable year in which the exchange was consummated the following: 1. A complete description of the property received from the transferors; 2. A statement of the original acquisition cost or other basis of the property in the hands of the transferors and the adjusted cost basis thereof at the time of the transfer; and 3. Information with respect to the capital stock of the corporation including: HIAEcT a. The total issued and outstanding capital stock immediately prior to and immediately after the exchange with a complete description of each class of stock; b. The classes of stocks and number of shares issued to the transferors in the exchange; and c. The fair market value as of the date of the exchange of the capital stock issued to the transferors. In addition to the foregoing requirements, the parties shall enclose with their respective income tax returns for the taxable year in which the tax-free exchange occurred a copy of the request for ruling filed with, and the corresponding ruling issued by the Bureau of Internal Revenue, both duly stamped received by the appropriate office of the Bureau of Internal Revenue. Such persons shall include as a note to their respective audited financial statements for the taxable year in which the exchange occurred a statement to the effect that they hold such assets/shares acquired in a tax-free exchange and the year in which such exchange occurred, and in the taxable years until the subject properties are subsequently transferred to another transferee. The parties shall, pursuant to Section 58 (E) of the Tax Code of 1997, also cause the Register of Deeds to annotate on the Transfer Certificates of Title and/or the Corporate Secretary to annotate at the back of the Certificates of Stock, the date the deed of exchange was executed, the original or historical cost of acquisition of the properties or shares of stock involved, and the fact that no gain or loss was recognized as a result of such exchange; provided however, that any violation by the Register of Deeds of this condition shall be penalized under Section 269 of the same Code. It is further required that within ninety (90) days from receipt of this ruling, the parties to the transaction must submit to the Law Division, Bureau of Internal Revenue, a certified true copy/ies by the Register of Deeds or Corporate Secretary, as the case may be, of duly annotated Transfer Certificates of Title/Certificates of Stock, in respect of the transferred properties and shares of stock of transferee corporation. The fair market value and the zonal valuation as stated above shall be subject to verification by the RDO concerned. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be ascertained that the facts are different, and/or any of the requirements imposed in this letter are not complied with, then this ruling shall be considered as null and void. CaHcET Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. This number is net of 150,435,404 shares which are held in treasury. 2. This represents 93.6% of total issued and outstanding Class "A" shares. 3. This represents 92% of total issued and outstanding Class "B" shares. 4. See footnote 1. 5. The Fixed Assets comprise those assets identified in Interphil's Balance Sheet as at 31 December 2007 which is attached hereto as Annex "1" excluding the Cabuyao Property. 6. The Inventory is included among the current assets of Interphil valued at Php349.143 million in Interphil's Balance Sheet as at 31 December 2007 which is attached hereto as Annex "1". 7. The unused CWT of Interphil as at 31 December 2007 is Php136.282 million. This represents the 2% creditable withholding tax deducted by customers of Interphil from their payments net of the 2% MCIT. Because of accumulated losses, the CWT have not been applied to tax payments. 8. The articles of incorporation shall be amended to increase the authorized capital. 9. Ibid. Additionally, the name of First Pharma will be changed to "Interphil Laboratories, Inc." while Interphil shall change its corporate name to one that is suitable for a holding company. 10. Ibid. See also Section 4.106-1, Revenue Regulations No. 16-2005. cHaADC