Reissuance of Treasury Shares Not Subject to Capital Gains or Income Tax

July 22, 2005 BIR RULING NO. 002-05 RR No. 2 000-00 Ponce Enrile Reyes & Manalastas Law Office 3rd Floor, VERNIDA IV Bldg., 128 Leviste St., Salcedo Village, Makati City Attention: Attys. Jesus M. Manalastas and Emelyn Corpus-Martinez Gentlemen : This refers to your letter dated January 12, 2005 requesting, on behalf of your client, JAKA INVESTMENTS CORPORATION (JIC for brevity) for a confirmatory ruling that the reissuance of treasury shares, given the circumstances in this particular instance, will not give rise to a taxable transaction. The facts, as you represent, are as follows: In May 2003, JIC reissued its entire 26,000 treasury common shares to one of its stockholders, Juan Ponce Enrile. These common treasury shares were originally owned by Juan Ponce Enrile who had to sell them to JIC in order to relinquish control of the corporation while he was serving as cabinet secretary in government. Juan Ponce Enrile sold the same to JIC for a nominal consideration of P3,000,000. Since he no longer holds such position in government, Juan Ponce Enrile sought the reissuance to him of said common shares. In view of the present financial situation of the corporation; the said shares were resold to him at P12,045,000.00 or P9,045,000.00 more than the acquisition cost. Simultaneous with the repurchase, Juan Ponce Enrile likewise subscribed to the remaining 4,695 unissued common capital stock of JIC (with P100 par value) for the amount of P10,355,000 or at a premium of P9,885,500. The circumstances in this instance clearly show that the intent of the parties is for Juan Ponce Enrile to regain controlling interest in JIC. The gross receipts of JIC from the resale of the treasury shares were credited to its capital account. The 2003 Financial Statement of JIC reflects this as follows: CIcTAE STOCKHOLDERS' EQUITY 2003 2002 Capital stock [A] 142,078,000 141,608,500 Additional paid-in-capital [B] 18,930,500 - Cumulative translation adjustment 8,469,905 4,913,537 Net unrealized loss on decline in value of Noncurrent marketable equity securities (56,805,420) (64,261,602) Retained earnings 1,669,317,699 1,590,860,478 Treasury stock [C] (37,078,000) (40,078,000) 1,744,912,684 1,633,072,913 [A] CAPITAL STOCK (P100 par value) Preferred, 14% cumulative and nonparticipating Authorized 450,000 shares Issued 370,780 P37,078,000 P37,078,000 Common Authorized 1,050,000 shares Issued 1,045,305 shares 104,530,500 104,530,500 Subscribed 4,695 shares in 2003 142,078,000 141,608,500 Note: The remaining authorized but unissued shares of JIC is 4,695. In 2003, this was subscribed to by Juan Ponce Enrile . ADDITIONAL PAID-IN CAPITAL 18,930,500 Note: This consists of the excess of the purchase price over the cost of the common treasury shares purchased by Juan Ponce Enrile (P9,045,000.00 and the premium paid for the additional subscription (P9,885,500.00) TREASURY STOCK Preferred 370,780 shares at par (37,078,000) (37,078,000) Common 26,000 shares at cost in 2002 - (3,000,000) Balance at end of year (37,078,000) (40,078,000) P1,744,912,684 P1,633,042,913 In reply, please be informed that Sec. 55 of Revenue Regulations No. 2 provides that: "Whether the acquisition or disposition by a corporation of share of its own capital stock gives rise to taxable gain or deductible loss depending upon the real nature of the transaction, which is to be ascertained from all its facts and circumstances". JIC is not a dealer in securities nor does it regularly buy or sell, or deal in the shares of stock. It is a "family owned" holding corporation of the Ponce Enriles. In fact, the above treatment is mandated by the Securities and Exchange Commission (SEC for brevity) in SEC-SRC Rule No. 68, as amended, or the RULES AND REGULATIONS COVERING FORM AND CONTENT OF FINANCIAL STATEMENTS dated February 14, 2002, whereby it is stated that: "(21) Treasury Stock (A) Treasury stock should be recorded at cost irrespective of whether these are acquired below or above par value. The total cost of treasury stock should be shown in the balance sheet as a deduction from the total stockholders' equity. If possible, the cost of each acquisition should be accounted for separately. HDATCc Upon resale (reissuance) of the treasury shares, the treasury stock account is credited for the cost. "Gains" on such sales shall be credited to additional paid-in capital-treasury stock transactions for the class of stock. "Losses" shall be charged against additional paid-in capital but only to the extent of previous net "gains" from sales or retirements of the same class of stock; otherwise, "losses", should be charged to retained earnings. " Gains or losses on sales of treasury shares should not be credited or charged to income ." (Emphasis supplied.) Moreover, in a SEC opinion dated April 14, 1988 addressed to Atty. Augusto Sunico, the SEC confirmed the long-standing accounting principle that gains on sales of treasury shares should be credited to additional paid-in capital since these are not ordinary profits which would form part of retained earnings. Clearly, the purpose of the reissuance of the treasury shares to Juan Ponce Enrile is for him to regain control of JIC. No income is earned by JIC in the transaction since the excess amount it received over the cost of the treasury shares is intended as additional working capital of JIC given its financial requirements. Such excess amount, while apparently a "gain" to JIC, is no different from the excess amount it received from the additional subscription of Juan Ponce Enrile to the unissued shares which is booked as additional paid-in capital and not income. There is no logical reason for treating the two transactions and excess amounts differently, i.e., if the excess amount received on the original issuance of unissued stock is not a capital gain to the company, then the excess amount received on the reissuance of treasury stock should likewise not be a taxable gain to the company. It is of course correct to say that treasury stock is considered an asset of the company which the latter may subsequently dispose of. But it is treated as an asset only because (i) it cannot be considered a "liability" to the shareholders and (ii) the company may reissue or sell the same without the legal restrictions applicable to the issuance of unissued stock, i.e. , the company may sell or reissue the treasury stock even, below par value. The fact remains that treasury stock becomes outstanding shares when reissued, equal in all respects to every other issued share. Hence, the reissuance of treasury stock for any price, like the issuance of unissued shares, should be considered a capital stock or equity transaction, and not an asset transaction, and therefore should not be a taxable transaction. In view thereof, this Office hereby confirms your opinion that the reissuance of treasury shares by JIC to Juan Ponce Enrile is not subject to capital gains or income tax. 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 void. Very truly yours, (SGD.) JOSE MARIO C. BUAG Commissioner of Internal Revenue