SGV & Co.

November 18, 2008 BIR RULING [DA-(S40M-018) 436-08] 40 (C) (2) (6) (c); S-40-109-2002 SGV & Co. 6760 Ayala Avenue 1226 Makati City Attention: Atty. W.U. Villanueva Principal, Tax Services Gentlemen : This refers to your letter dated April 30, 2008 requesting for confirmation of your opinion that pursuant to Section 40 (C) (2) and (C) (6) (b) of the Tax Code of 1997, no gain or loss shall be recognized on the proposed merger of Orca Energy, Inc. [now Rolls-Royce Philippines, Inc. (OEI)], Orca Plant Operations, Inc. (OPO) and Rolls-Royce Power Ventures Philippines, Inc. (RRPVPI) where OEI shall be the surviving corporation. The facts, as represented, are as follows: 1. OEI is a corporation duly registered with the Securities and Exchange Commission with authorized capital stock of P5,000,000.00 divided into fifty thousand (50,000) common shares with a par value of P100.00 per share. Rolls-Royce Power Ventures Limited (RR-UK), a foreign corporation organized under the laws of the United Kingdom, is the legal and beneficial owner of 100% of the total equity of OEI; 2. OEI is authorized to engage, construct, erect, assemble, commission, operate, maintain and rehabilitate gas turbine and other power generating plans and related facilities for the conversion into electricity of coal, distillate and other fuel provided by and under contract with the government of the Philippines or any subdivision, instrumentality or agency thereof, or any government-owned or controlled corporation or other entity; 3. Based on its Audited Financial Statements (AFS) as of May 31, 2007, OEI has total assets of Two Hundred Twelve Million Two Hundred Forty Seven Thousand Six Hundred Eighty Seven Pesos (P212,247,687.00), total liabilities in the amount of Forty Two Million Eight Hundred Eighty Four Thousand Two Hundred Fifty Nine Pesos (P42,884,259.00), and stockholders' equity in the amount of One Hundred Sixty Nine Million Three Hundred Sixty Three Thousand Four Hundred Twenty Eight Pesos (P169,363,428.00). Its assets consists of cash due from related parties, creditable withholding taxes and input taxes, while its liabilities consist of trade and other payables, amounts owed to related parties and deferred income tax liability; SEHTIc 4. OPO is a corporation duly registered with the SEC with an authorized capital stock of P20,000,000.00 divided into Two Hundred Thousand (200,000) shares with a par value of P100.00 per share. RR-UK is likewise the legal and beneficial owner of 100% of the total equity of OPO; 5. OPO is authorized to operate, maintain and rehabilitate, power, steam, and gas generating plants, including their related facilities for the conversion of coal, distillate, steam, water and gases into other forms of energy and commodities, namely, electricity, steam, water and gases and to render advise and consultancy service in connection with the construction, erection, assembly, commissioning, operation, maintenance and rehabilitation of such plants; 6. Based on its AFS as of May 31, 2007, OPO has total assets of Thirty Eight Million Four Hundred Eighty Nine Thousand Five Hundred Sixty Four Pesos (P38,489,564.00), total liabilities in the amount of One Hundred Thousand Pesos (P100,000.00), and stockholders' equity in the amount of Thirty Eight Million Three Hundred Eighty Nine Thousand Five Hundred Sixty Four Pesos (P38,389,564.00). Its assets consist of cash due from related parties, prepaid taxes and other current assets; 7. RRPVPI is a corporation duly registered with the SEC with an authorized capital stock of P8,550,000.00 divided into Eighty Five Thousand Five Hundred (85,500) shares with a par value of P100.00 per share. RR-UK is also the legal and beneficial owner of 100% of the total equity of RRPVPI; cSDHEC 8. RRPVPI is authorized to conduct research on and to investigate and pursue business opportunities for, the development, construction, operation and maintenance of reciprocating engine, steam turbine, water turbine and other power generating plants and related facilities for the conversion of natural gas, heavy fuel oil, coal, distillate, steam, water and other gases into electricity, steam, and other forms of energy and commodities including carbon dioxide, in the Philippines, in order to secure information and data for capital investment, both for its own account and as agent for other, to buy and sell power projects, opportunities and developments for its own account and as agent for others; to maintain executive and operating personnel for the purpose of consulting with and advising others in all matters relating to investments in, and management plans and programs for, power generating plants, and generally, to advise and assist others, under contract or otherwise, in the management, operation and maintenance of all kinds of power generating plants; 9. Based on its AFS as of May 31, 2007, RRPVPI has total assets of Twenty Three Million Eight Hundred Seventy Four Thousand Forty Three Pesos (23,874,043.00), total liabilities in the amount of One Hundred Fifty One Million Nine Hundred Seventy Five Thousand Three Hundred Forty Eight Pesos (P151,975,348.00). RRPVPI has a capital deficiency in the amount of One Hundred Twenty Eight Million One Hundred One Thousand Three Hundred Five Pesos (P128,101,305.00). Its assets consist mostly of cash, creditable withholding tax, input value-added tax, property and equipment and other non-current assets, while its liabilities consist of trade and other payables, amounts owed to related parties and deferred income tax liability; 10. OEI, OPO and RRPVPI desired to merge for the following bona fide business reasons: a. The constituent corporations are engaged in similar and related types of businesses and have common stockholders; IHSTDE b. The merger shall achieve efficiency and economy of business operations, and the integration of the administrative facilities of the constituent corporations will result in simplifying business processes, improving operational efficiency, reducing operating costs and avoiding conflicts of interest among the constituent corporations; and c. The consolidation of the capital base of the constituent corporations will improve the competitive position and financial strength of the surviving corporation, resulting in increased leverage in the procurement of materials and services, and reduction in overall financing costs; 11. The fair market value, acquisition cost (excluding cash) of the assets and liabilities to be transferred by OPO, the value of the shares of stock to be received by OEI from OPO, in consideration of such transfers are as follows: Assets Acquisition Cost Fair Market Value Cash P257,763.00 Amounts owed by related parties P14,964,720 14,964,720.00 Prepayments and other current assets 23,267,081 23,267,081 P38,231,801 P38,489,564.00 Liabilities Trade and other payables P100,000 P100,000 Net Assets Transferred P38,389,564 (Value of Shares Received) 12. The fair market value, acquisition cost (excluding cash) of the assets and liabilities to be transferred by RRPVPI, the value of the shares of stock to be received by OEI from RRPVPI, in consideration of such transfers are as follows: SAHIaD Assets Acquisition Cost Fair Market Value Cash 4,971,603 Prepayments and other current assets 18,259,090 18,259,090 Transportation & other equipment 472,350 472,350 Other non-current assets 171,000 171,000 18,902,440 23,874,043 Liabilities Trade and other payables 7,093,074 7,093,074 Amounts owed to related parties 141,215,057 141,215,057 Deferred income tax liability 3,667,217 3,667,217 151,975,378 151,975,348 Net Assets Transferred (P128,101,305) (Value of Shares Received) 13. On November 28, 2007, the SEC approved the merger among OPO, RRPVPI and OEI with the latter as surviving corporation and with January 1, 2008 as Effective Date of Merger, with the issuance of a Certificate of Filing of the Articles and Plan of Merger; acITSD 14. Based on the foregoing, you now request for a confirmation of your opinions as follows: a. The transactions described above, including the transfer and conveyance of all the assets and liabilities of OPO and RRPVPI, the net value of which shall be recorded as Additional Paid In Capital (APIC) in the books of OEI, constitute a "tax-free merger" within the meaning of Sections 40 (C) (2) (a) and (b) and 40 (C) (6) (b) of the 1997 Tax Code. Therefore, no gain or loss shall be recognized by: i. OPO and RRPVPI, the absorbed corporations, as the transferors, on their assignment of all their assets and liabilities to OEI, pursuant to the Plan of Merger; ii. OEI, the surviving corporation, as the transferee, on its receipt of the assets and liabilities of OPO and RRPVPI without issuing stock in exchange therefore; b. The above-mentioned transactions and exchanges pursuant to the merger of OPO and RRPVPI into OEI are not subject to donor's tax; ECaSIT c. The transfer of the OPO and RRPVPI assets pursuant to the Plan of Merger is not subject to the Value-Added Tax (VAT) as provided under Section 4.106-8 (b) (3) of Revenue Regulations No. 16-05, as amended by RR No. 04-07. Any unused input VAT of OPO and RRPVPI will be transferred for the use or tax credit against the output VAT liabilities of OEI; d. The excess and unutilized creditable withholding taxes of OPO and RRPVPI as of the effective date of the merger which form part of the assets to be transferred by OPO and RRPVPI to OEI as a consequence of the merger, may be applied as a tax credit by OEI against its income tax due for the taxable year in which the merger takes effect and in the succeeding taxable years, or may be the subject of a claim for refund or issuance of a tax credit certificate; e. The excess Minimum Corporate Income Tax (MCIT) of OPO and RRPVPI, if any, will be transferred and vested in OEI as of the effective date of the merger and hence, OEI may carry forward and credit said excess MCIT of OPO and RRPVPI against its regular corporate income tax liability for the three (3) immediately succeeding taxable years; f. The Net Operating Loss Carry Over (NOLCO) of OPO and RRPVPI, if any, will be transferred to and vested in OEI on the effective date of the merger. Consequently, the aggregate NOLCO balances of OPO and RRPVPI, if any, may be claimed by OEI as a deduction from its gross income; and aDHCAE g. The transfer of properties of OPO and RRPVPI to OEI shall not be subject to documentary stamp tax pursuant to Section 199 (m) of the 1997 Tax Code, as amended by R.A. 9243. Moreover, since no new shares will be issued by OEI to the stockholders of OPO and RRPVPI upon the merger, no DST shall also be due thereon. Moreover, the surrender of the shares of stock held by the stockholders of OPO and RRPVPI, respectively, pursuant to the merger is likewise not subject to DST. In reply thereto, please be informed as follows: 1. The above reorganization between OPO, RRPVPI and OEI is a merger within the contemplation of Section 40 (C) (2) and (6) (b) of the Tax Code of 1997 since OEI acquired/assumed all the assets and liabilities of OPO and RRPVPI, the transaction being for a bonafide business purpose and not intended to escape the burden of taxation. The tax deferred character of the merger under Section 40 (C) and (6) (b) of the Tax Code of 1997 is not affected by the non-issuance of the surviving corporation of its shares of stock in exchange for the assets and liabilities of the absorbed corporation in cases of merger of a parent corporation and its subsidiary. Therefore, no gain or loss shall be recognized by: A. OPO and RRPVPI, the absorbed corporations, as the transferors, on its assignment of all assets and liabilities to OEI pursuant to the Plan of Merger; and B. OEI, the surviving corporation, as the transferee, on its receipt of the assets and liabilities of OPO and RRPVPI without issuing stock in exchange therefore. OPO and RRPVPI will not be subject to income tax, capital gains tax, or creditable withholding tax on the transfer of their properties to OEI since no gain or loss will be recognized to OPO and RRPVPI upon the transfer and conveyance of their properties to OEI by virtue of the merger. It is understood however, that upon the subsequent sale or exchange of the assets acquired by OEI, the gain derived from such sale or exchange shall be subject to income tax. 2. The basis of the assets that will be recognized by OEI shall be the same as it would be in the hands of OPO and RRPVPI. 3. Since no shares of stock were issued pursuant to the Plan of Merger, Section 174 of the Tax Code of 1997, as amended by Republic Act No. 9243, imposing documentary stamp tax (DST) on original issuance of shares of stock, is inapplicable to the present case. No DST shall also be due on the surrender by the stockholders of their shares in RRPVPI for cancellation. Since RRPVPI had no shares of stock or real property in its name to transfer to OEI pursuant to the merger, neither party shall be liable for DST on transfers or exchanges of shares of stock and real property, under Section 175 and 196 of the Tax Code of 1997, respectively. Moreover, Section 199 (m) of the Tax Code of 1997 exempts from DST transfers of property pursuant to Section 40 (C) (2) of the Tax Code of 1997. 4. The merger is not subject to donor's tax as there is no intention to donate on the part of OEI, OPO and RRPVPI. 5. The transfer of the assets by OPO and RRPVPI to OEI pursuant to the plan of merger will not be subject to value-added tax (VAT). Any unused input tax of OPO and RRPVPI as of the effective date of merger will be absorbed by OEI, as the surviving corporation, pursuant to Revenue Regulations No. 16-2005. 6. The excess and unutilized creditable withholding taxes of RRPVPI and OPO, if any, as of the effective date of Merger, which form part of the assets to be transferred by RRPVPI and OPO to OEI as a consequence of the merger, may be applied as a tax credit by OEI against its income tax due for taxable year 2006 and succeeding taxable years or may be the subject of a claim for refund or issuance of a tax credit certificate. 7. If on the Effective Date of Merger, RRPVPI and OPO has excess Minimum Corporate Income tax ("MCIT"), such excess MCIT of RRPVPI and OPO shall be deemed transferred to and vested in OEI on the Effective Date of Merger, and OEI may carry-over and credit the excess MCIT amount against its regular income tax liability. [BIR Ruling No. 137-99]; In a merger, the surviving corporation succeeds to the rights and liabilities of the absorbed corporation and merely carries on the identity of the latter. (BIR Ruling No. 112-96 dated October 25, 1996) Thus, the excess minimum corporate income tax or MCIT which formed part of the assets transferred to and vested in the surviving corporation effective upon the date of the merger, shall be carried forward and credited to the excess MCIT of the surviving corporation which will be applied against its normal tax liability for the three immediately succeeding taxable years pursuant to Section 27 (E) (2) of the 1997 Tax Code, as amended, which provides, viz. : "(2) Carry Forward of Excess Minimum Tax. Any excess of the minimum corporate income tax over the normal income tax as computed under Subsection (A) of this Section shall be carried forward and credited against the normal income tax for the three (3) immediately succeeding taxable years." CSIDEc Accordingly, the excess MCIT of RRPVPI and OPO shall, on the effective date of the merger, be transferred to and vested in OEI. The excess MCIT of RRPVPI and OPO shall be carried forward and credited against the normal income tax due of OEI for the three immediately succeeding taxable years pursuant to Section 27 (E) (2) of the 1997 Tax Code, as amended. (BIR Ruling No. 137-99 dated August 31, 1999) 8. OEI, as the surviving corporation, is entitled to carry-over the accumulated net operating loss of RRPVPI and OPO and claim the same as deduction from its gross income, pursuant to Section 34 (D) (3) of the Tax Code of 1997, as amended. Section 3.8 of Revenue Regulations No. 14-2001 (NOLCO Regulations) defines "Substantial Change in the Ownership of the Business or Enterprise" as "a change in the ownership of the business or enterprise as a result of or arising from its merger or consolidation or combination with another person in the manner as provided in subsection 2.4 of these Regulations. Any change in ownership as a result of or arising thereunder shall not be treated as a substantial change for as long as the stockholders of the party thereto, to whom the net operating loss is attributable, gains or retains 75% or more interest after such merger or consolidation or combination." The stockholders of RRPVPI and OPO collectively hold more than 75% interest in OEI after the merger. Thus, there was no substantial change in the ownership of the business or enterprise as a result of the merger. Accordingly, the NOLCO balance of RRPVPI and OPO should be deemed transferred to and vested in OEI and may be carried over and claimed by the latter as a deduction from it gross income. THCSAE However, in order that the above-described reorganization can be considered as merger under Section 40 (C) (2) of the Tax Code of 1997, the parties to the merger should comply with the following requirements: A. The plan of reorganization should be adopted by each of the corporations, parties, thereto, the adoption being shown by the acts of its duly constituted responsible officers and appearing upon the official records of the corporation. Each corporation, which is a party to the reorganization, shall file, as part of its return for the taxable year within which the reorganization occurred, a complete statement of all facts pertinent to the non-recognition of gain or loss in connection with the reorganization, including: 1. A copy of the plan of reorganization, together with a statement, executed under the penalties of perjury, showing in full the purposes thereof and in detail all transactions incident to, or pursuant to the plan; 2. A complete statement of the cost or other basis of all properties, including all stocks or securities, transferred, incident to the plan; 3. A statement of the amount of stock or securities and other property or money received from the exchange including a statement of all distribution or other disposition made thereof. The amount of each kind of stock or securities and other property received shall be stated on the basis of the fair market value thereof at the date of the exchange; and cCESaH 4. A statement of the amount and nature of any liabilities assumed upon the exchange, and the amount and nature or any liabilities to which any of the property acquired in the exchange is subject. B. Every taxpayer, other than a corporation, who is a party to the reorganization, who received stock or securities and other property or money upon a tax-free exchange in connection with a corporate reorganization shall incorporate in his income tax return for the taxable year in which the exchange takes place a complete statement of all facts pertinent to the non-recognition of gain or loss upon such exchange including: 1. A statement of the cost or other basis of the stock or securities transferred in the exchange; and 2. A statement in full of the amount of the stock or securities and other property or money received from the exchange, including any liability assumed upon the exchange, any liability to which property received shall be set forth upon the basis of the fair market value thereof at the date of exchange. C. Permanent records in substantial form shall be kept by every taxpayer who participates in a tax-free exchange in connection with a corporate reorganization showing the cost or other basis of the transferred property or money received (including any liability assumed on the exchange, or any liability to which any of the properties received were subject), in order to facilitate the determination of gain or loss from a subsequent disposition of such stock or securities and other property received from the exchange. (par. 9803-8, Prentice Hall 1963, ed., p. 9611) TIDcEH Finally, the parties shall likewise cause the annotation at the back of the Certificates of Stock of the shares owned by OPO and RRPVPI transferred to OEI pursuant to the merger, the fact that no gain or loss was recognized as a result of the merger, the date the transaction (merger) takes place and the historical cost of acquisition of the shares transferred. 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 are not complied with, then this ruling shall be considered null and void. aEcDTC Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service