BIR Ruling No. 004-07

February 19, 2007 BIR RULING NO. 004-07 27 (D) (2) 28 (B) (5) (b); 000-00 SGV & Co . 6760 Ayala Avenue Makati City, Philippines Attention: Atty. Cirilo P. Noel Deputy Managing Partner and Head, Tax Services Atty. Antonette C. Tionko Principal, Tax Services Gentlemen : This refers to your letter dated January 4, 2007 stating that your client, San Miguel Corporation (SMC) is seeking confirmation on the tax implications of the various transfers of shares in connection with the sale of shares in Coca-Cola Bottlers Philippines, Inc. (CCBPI) by SMC to Coca-Cola Holdings Overseas Ltd. (KO). It is represented that Coca-Cola Bottlers Philippines, Inc. (CCBPI) is a domestic corporation organized and existing under the laws of the Philippines. Its shareholders include: San Miguel Corporation (SMC), a domestic corporation organized and existing under the laws of the Philippines; San Miguel Beverages Ltd. (SMBL), a foreign corporation organized and existing under the laws of Malaysia; San Miguel Holdings, Ltd. (SMH), a foreign corporation incorporated in the British Virgin Islands (BVI); Coca-Cola Holdings Overseas Ltd. (KO), a foreign corporation organized and existing under the laws of the United States of America. As of July 1, 2006, the details of CCBPI's stock ownership are as follows: Common Shares Shareholders Par No. of Common Amount Paid/ Percentage of Shares Acquisition Cost Ownership SMC P1,000 39,830 Php1,350,000,000.00 3% SMBL P1,000 726,291 Php15,677,090,696.00 62% KO P1,000 412,527 35% TOTAL 1,178,648 100% Preferred Shares Shareholders Par No. of Preferred Amount Paid/ No. of Preferred Shares-A Acquisition Cost Shares-B SMC P50,000 53,465 (A) Php3,955,295,716.75 SMH P50,000 119,477 (A) Php9,175,270,651.00 KO P50,000 42,541 (B) KO P1,913 50,582 (B) TOTAL 172,942 (A) 93,123 (B) It is further represented that SMBL, SMH, SMC and KO shall be performing the following: Step 1 In order to consolidate its shareholdings in CCBPI in the Philippines, SMBL will sell to SMC its 726,291 CCBPI Common Shares at a price of Php11,559,355,461 ( which is a price not lower than its book value ). SMH shall likewise sell its CCBPI shares, consisting of 119,477 Preferred Shares (A) to SMC at a price of Php 9,175,270,651, ( which is likewise a price not lower than book value ). In this way, only one transferor, i.e., SMC, will have to deal with KO under Step 3 below. tax2007cdasia Step 2 CCBPI will declare dividends on the preferred shares held by SMC and KO. CCBPI is in need of additional capital to finance its operations, hence, SMC and KO will then contribute the declared dividends as additional paid-in capital (APIC) in CCBPI to provide funds to support operations. Step 3 SMC shall thereafter sell all of its CCBPI shares comprising of 776,121 common shares and 172,942 preferred shares to KO. DcAaSI Based on the foregoing, you are now requesting confirmation of the following: Step 1 1. a) The assignment by SMBL of its 726,291 CCBPI Common Shares to SMC at a price of Php11,559,355,461, which is higher than its book value or fair market value, will not result in a gain to SMBL. b) Likewise, the assignment by SMH of its CCBPI shares, consisting of 119,477 Preferred Shares (A) to SMC at a price equal to its acquisition cost of Php 9,175,270,651, which is likewise above its book value or fair market value, will not result in gain or loss to SMH. Step 2 2. Dividends on preferred shares held by SMC from CCBPI shall not be subject to tax pursuant to Section 27 (D) (4) of the Tax Code. On the other hand, dividends on preferred shares held by KO from CCBPI shall be subject to 15% final withholding tax on such dividends pursuant to Section 28 (B) (5) (b) of the 1997 Tax Code. 3. The contribution by SMC and KO of the declared dividends on preferred shares as additional paid-in capital (APIC) in CCBPI to provide funds to support operations shall form part of the cost of investment and, not subject to income tax, donor's tax and documentary stamp tax (DST). Step 3 4. The sale by SMC of its CCBPI shares comprising of 766,121 common shares and 172,942 preferred shares to KO shall be subject to capital gains tax and documentary stamp tax. In reply please be informed as follows: 1. a) This Office confirms that the assignment by SMBL of its 726,291 CCBPI Common Shares to SMC at a price of Php11,559,355,461 which is higher than its book value or fair market value, will not result in a gain to SMBL. b) Likewise, this Office confirms that the assignment by SMH of its CCBPI shares, consisting of 119,477 Preferred Shares (A) to SMC at a price equal to its acquisition cost of Php 9,175,270,651, which is likewise above its book value or fair market value, will not result in a gain or loss to SMH . Under Sections 27 (D) (2); 28 (A) (7) (c); and 28 (B) (5) (c) of the Tax Code, there is a capital gains tax (CGT) imposed on net capital gains derived by a seller of shares of stock of a domestic corporation not sold and traded in the local stock exchange, at the rate of 5% on the first P100,000 of gain and 10% on the excess gain. The net capital gain is the difference between the gross selling price or fair market value (FMV) of the shares, whichever is higher, and the acquisition cost of the shares. Gross selling price, for this purpose, is defined as "the total amount of money or its equivalent which the purchaser pays the vendor to receive or get the goods." On the other hand, the FMV of shares is the book value nearest the valuation date ( BIR Ruling No. 146-98 dated October 14, 1998 ). The BIR has held that "Section 5 of Revenue Regulations No. 2-2003 provides that in the case of shares of stocks, the fair market value shall depend on whether the shares are listed or unlisted in the stock exchanges. Unlisted common shares are valued based on their book value while unlisted preferred shares are valued at par value. In determining the book value of common shares, appraisal surplus shall not be considered as well as the value assigned to preferred shares, if there are any" ( BIR Ruling No. DA-091-05 ). In this case, SMBL will transfer its 726,291 CCBPI Common Shares to SMC at a price of Php11,559,355,461. SMH, on the other hand, will transfer its Class A preferred shares in CCBPI to SMC of a price equivalent to its acquisition cost of Php 9,175,270,651. Considering that the shares to be transferred are unlisted common and preferred shares, the FMV of the said shares shall be valued based on their book value (for common shares) and their par value (for preferred shares) , respectively. Pursuant to the foregoing, therefore, there will be no gain or loss on the transfer by SMBL and SMH of their CCBPI common and preferred shares, respectively, to SMC for reasons stated below. SMBL will transfer its 726,291 CCBPI Common Shares to SMC at a price of Php11,559,355,461. Based on the latest Unaudited Financial Statements of CCBPI for 2005, the book value of the CCBPI common shares held by SMBL amounted to Php3,681,176,881.86 [ 726,291 common shares x Php5,068.46 book value per share ], which is lower than its acquisition cost of Php15,677,090,696.00. Consequently, said transfer will not result in a gain to SMBL. Likewise, there will be no gain or loss on the transfer by SMH of its Class A preferred shares in CCBPI to SMC at a price equivalent to its acquisition cost of Php9,175,270,651, which is higher than its par value (fair market value) of Php5,973,850,000.00 [ 119,477 Preferred Shares x par value of Php50,000 per share ]. Both assignments of shares shall be subject to Documentary Stamp Tax (DST) pursuant to Section 175 of the Code. Step 2 2. This Office confirms that cash dividends on preferred shares held by SMC from CCBPI shall not be subject to tax pursuant to Section 27 (D) (4) of the Tax Code. On the other hand, cash dividends on preferred shares held by KO from CCBPI shall be subject to 15% final withholding tax on such dividends pursuant to Section 28 (B) (5) (b) of the 1997 Tax Code . a. The cash dividends to be issued by CCBPI on the preferred shares of stock held by SMC shall not be subject to tax under Section 27 (D) (4) of the Tax Code, to wit: "SEC. 27. Rates of Income Tax on Domestic Corporations . xxx xxx xxx (D) Rates of Tax on Certain Passive Incomes. xxx xxx xxx (4) Intercorporate Dividends. Dividends received by a domestic corporation from another domestic corporation shall not be subject to tax ." (emphasis supplied) Considering that both SMC and CCBPI are domestic corporations, the distribution by CCBPI of cash dividends on the preferred shares of stock to SMC should not be subject to tax under the aforequoted section of the Tax Code. aTICAc b. With respect to the cash dividends on the preferred shares of stock held by KO, on the other hand, the same should be subject to the fifteen percent (15%) final withholding tax under Section 28 (B) (5) (b) of the Tax Code, as amended by R.A. No. 9337, viz: (b) Intercorporate Dividends. A final withholding tax at the rate of fifteen percent (15%) is hereby imposed on the amount of cash and/or property dividends received from a domestic corporation, which shall be collected and paid as provided in Section 57 (A) of this Code, subject to the condition that the country in which the nonresident foreign corporation is domiciled, shall allow a credit against the tax due from the nonresident foreign corporation taxes deemed to have been paid in the Philippines equivalent to twenty percent (20%), which represents the difference between the regular income tax of thirty-five percent (35%) and the fifteen percent (15%) tax on dividends as provided in this subparagraph: Provided, That effective January 1, 2009, the credit against the tax due shall be equivalent to fifteen percent (15%), which represents the difference between the regular income tax of thirty percent (30%) and the fifteen percent (15%) tax on dividends; The tax on inter-corporate dividends is reduced by 20% from 35% to 15% subject to the conditions mentioned above. The tax deemed paid is adjusted to correspond to the decreasing corporate income tax rate. The law specifies that such tax credit for "taxes deemed paid in the Philippines", must, as a minimum, reach an amount equivalent to 20 percentage points which represents the difference between the regular 35% dividend tax rate and the preferred 15% rate. ( Commissioner of Internal Revenue vs. Procter & Gamble Philippine Manufacturing Corporation, G.R. 66838, December 2, 1991 ) In other words, in the instant case, the reduced fifteen percent (15%) dividend tax rate is applicable if the USA shall allow tax credit in favor of KO for "taxes deemed paid in the Philippines" against its US taxes. The Supreme Court in Commissioner of Internal Revenue vs. Procter and Gamble Philippine Manufacturing Corp. (P & G) and Court of Tax Appeals (G.R. 66838, December 2, 1991 ) had occasion rule that dividends paid to a US resident shall be subject to fifteen percent (15%) dividend tax rate, as follows: It is important to note that Section 34(b) (1), NIRC, now Section 25(b)(5)(B) of the Tax Code, does not require that the US must give a "deemed paid" tax credit for the dividend tax (20 percentage points) waived by the Philippines in making applicable the preferred dividend tax rate of fifteen percent (15%). In other words, our NIRC does not require that the US tax law deem the parent-corporation to have paid the twenty (20) percentage points of dividends tax waived by the Philippines, The NIRC only requires that the US "shall allow" P&G-USA a "deemed paid" tax credit in an amount equivalent to the twenty (20) percentage points waived by the Philippines. In BIR Ruling No. 175-00, the BIR reiterated the findings of the Supreme Court in the case of Procter and Gamble Philippines Manufacturing Corp. vs. Comm. of Internal Revenue (G.R. No. 66838), saying that it "has confirmed that Section 901 of the United States Internal Revenue Code meets the 20% deemed tax credit requirement provided under then Section 25 (b) (5) (B) of the 1993 Tax Code [now Section 28 (B) (5) (b)]." In this connection, therefore, dividends distribution by CCBPI on the preferred shares of stock held by KO shall be subject to the fifteen percent (15%) final withholding tax under Section 28 (B) (5) (b) of the Tax Code. 3. This Office confirms that contribution by SMC and KO of the declared dividends on preferred shares as additional paid-in capital (APIC) in CCBPI to provide funds to support operations shall form part of the cost of investment and, not subject to income tax, donor's tax and documentary stamp tax (DST) . SMC and KO shall contribute the aforementioned dividends on their preferred shares of stock as additional paid-in capital (APIC) in CCBPI without the issuance of shares of stock. The contribution shall form part of the cost of investment and, shall not be subject to income tax, donor's tax and documentary stamp tax. In BIR Ruling No. DA-221-02, US Filter, a major stockholder of Vivendi-Phils., sought to infuse APIC into the latter in the nature of additional funds to be used as capital of the corporation for which no corresponding shares of stock will be issued. The BIR held as follows: 1. Query Nos. 1 & 2. Section 56 of Revenue Regulations No. 2 provides that where a corporation requires additional funds for conducting its business and obtains said funds through voluntary payments by its shareholders, the amounts so received being credited to its surplus account or to a special capital account, will not be considered income, although there is no increase in the outstanding shares of stock of the corporation. The payments in such circumstances are in the nature of voluntary assessments upon, and represent an additional price paid for, in shares of stock held by the individual shareholders, and will be treated as an addition to and as part of the operating capital of the company. Corollarily, in BIR Ruling No. 586-88 dated December 19, 1988, this Office had the occasion to rule that the additional contribution in the form of donated surplus without the necessity of issuing additional shares of stock is deemed capital investment which is not included within the purview of the term "taxable income'' and is not subject to income tax. In another occasion, this Office ruled that additional capital contribution without necessarily issuing additional shares of stock, which merely increase the basis of the stockholders' stock but not their proportionate equity in the corporation, is a transaction not subject to income or gift taxes. (BIR Ruling Nos. 270-87 dated September 8, 1987; 127-89 dated June 13, 1989) Accordingly, the infusion of APIC by US Filter into Vivendi-Phils. is in the nature of additional funds which will be used as, and forms part of, the latter's working capital for which no corresponding shares of stock will be issued. As such, the APIC does not constitute an income on the part of Vivendi-Phils. 3. Considering that the infusion of the APIC will not result in the issuance of shares of stock by Vivendi-Phils., the same shall not be subject to documentary stamp tax imposed under Section 175 of the Tax Code of 1997." In line with the foregoing, the contribution by SMC and KO of the dividends on their preferred shares of stock as additional paid-in capital (APIC) in CCBPI to provide funds to support operations without the issuance of shares of stock shall not be subject to income tax, donor's tax and documentary stamp tax. Step 3 4. This Office confirms that the sale by SMC of its CCBPI shares comprising of 766,121 common shares and 172,942 preferred shares to KO shall be subject to capital gains tax and documentary stamp tax . cCTIaS Section 27 (D) (2) of the Tax Code of 1997 reads Sec. 27. (D) Rates of Tax on Certain Passive Incomes. (2) Capital Gains from the Sale of Shares of Stock Not Traded in the Stock Exchange . A final tax at the rates prescribed below shall be imposed on net capital gains realized during the taxable year from the sale, exchange or other disposition of shares of stock in a domestic corporation except shares sold or disposed of through the stock exchange: Not over P100,000 5% Amount in excess of P100,000 10% The term "net capital gain" means the excess of the gains from the sales or exchanges of capital assets over the losses from such sales or exchanges. On the other hand, "net capital loss" means the excess of the losses from sales or exchanges of capital assets over the gains from such sales or exchanges. (Sec. 39 (A) (2) & (3) of the Tax Code of 1997) Thus, the sale by SMC of its CCBPI shares comprising of 766,121 common shares and 172,942 preferred shares to KO may give rise to gains which shall be subject to the capital gains tax, or to losses during the taxable year. In determining net capital gains, the selling price shall be the fair market value of the common and preferred shares disposed pursuant to Section 6 (a) of Revenue Regulations No. 2-82, which provides: (a) Determination of selling price . The selling price of the shares of stocks shall be the fair market value of the shares of stocks transferred or exchanged and not the fair market value of the property received in exchange. If the total consideration of the sale or disposition consists partly in cash or money and partly in kind, the selling price shall be the fair market value of the shares disposed. (1) the case of shares traded through the stock exchange, "fair market value" shall consist of the actual selling price as shown in the sales confirmation issued by the member of the stock exchange through whom the sale was effected. (2) In the case of shares not traded through the stock exchange, but listed in one or more stock exchanges, the highest closing price on the day when the shares are sold, transferred or exchanged, shall be the "fair market value." When no sale is made in any stock exchange, the highest closing price on the day nearest to the day of sale, transfer or exchange of the shares shall be the fair market value. (3) In the case of sale, transfer or exchange of shares not listed in the stock exchange, the following rules shall be observed: (i) In general, the unlisted shares shall be valued at their book value nearest the valuation date. The book value of these unlisted shares of stock shall be prima facie considered as their fair market value. xxx xxx xxx If such lower fair market valuation is not clearly established and documented, the book value of the unlisted shares of stock shall be adopted. If there have been previous sales/exchanges of the unlisted shares of stock, the price at which these shares exchanged hands should be taken/considered as its fair market value/s. On the other hand, the cost shall be the actual purchase price plus all costs of acquisition such as commission, documentary tax, transfer fees, etc., pursuant to Section 6 (b) (1) of Revenue Regulations No. 2-82 which states: xxx xxx xxx "(1) If the stocks can be identified, then the cost shall be the actual purchase price plus all costs of acquisition such as commission, documentary tax, transfer fees, etc." Accordingly, the net capital gains, if any, shall be subject to 5% for the first P100,000 and 10% for the amount in excess of P100,000. The CGT is required to be paid and a return filed by the seller not later than 30 days from the date of sale. With respect to the documentary stamp tax on the said transaction, Section 175 of the Code, as amended, provides as follows: SEC. 175. Stamp tax on Sales, Agreements to Sell, Memoranda of Sales, Deliveries or Transfer of Shares or Certificates of Stock . On all sales, or agreements to sell, or memoranda of sales, or deliveries, or transfer of shares or certificates of stock in any association, company, or corporation, or transfer of such securities by assignment in blank, or by delivery, or by any paper or agreement, or memorandum or other evidences of transfer or sale whether entitling the holder in any manner to the benefit of such stock, or to secure the future payment of money, or for the future transfer of any stock, there shall be collected a documentary stamp tax of Seventy-five centavos (P0.75) on each Two hundred pesos (P200), or fractional part thereof, of the par value of such stock: Provided, That only one tax shall be collected on each sale or transfer of stock from one person to another, regardless of whether or not a certificate of stock is issued, indorsed, or delivered in pursuance of such sale or transfer: and Provided, further, That in case of stock without par value the amount of the documentary stamp tax herein prescribed shall be equivalent to twenty-five percent (25%) of the documentary stamp tax paid upon the original issue of said stock. Thus, the DST is to be paid and a return filed not later than the fifth day following the close of the month of the sale. ADaSET 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. Very truly yours, (SGD.) JOSE MARIO C. BUAG Commissioner of Internal Revenue