No Gain or Loss in Exchanges of Property for Stock Resulting in Control of the Corporation

January 14, 1982 BIR RULING NO. 007-82 035-c-2 171-81 007-82 Messrs. Gozon, Elma, Berenguer and San Juan 6th Floor, Legaspi Towers 200 107 Paseo de Roxas, Legaspi Village Makati, Metro Manila Attention: Atty . Felipe L . Gozon Gentlemen : This refers to your letter dated December 2, 1981 requesting a ruling on behalf of your client, GMD Group Development and Management, Inc. (GMD Group) on the tax consequence of the proposed transfer of their real properties, consisting of land and buildings, to 4-J Farms, Inc. It is represented that 4-J Farms, Inc., was incorporated on August 13, 1981; that of its total authorized capital stock of P8,000,000.00, P2,000,000.00 has been subscribed and GMD Group's subscription amounted to P1,999,993.00 with a payment of P499,993.00; that with this subscription GMD Group owns practically 100% of the outstanding share of 4-J Farms, Inc.; and that the proposed transfer of real properties to 4-J Farms, Inc. shall be as follows: 1. Details of properties to be transferred: KIND OF PROPERTY APPRAISED VALUE 1. Land P2,618,400.00 2. Land Improvements 195,900.00 3. Buildings 8,315,600.00 Total P11,129,900.00 =========== 2. Proposed Transfer: a. Appraised Value of the Properties P11,129,900.00 b. Less: Assumption by 4-J Farms, Inc. of the Loan Obligations of GMD Group with the Development Bank of the Philippines 3,599,747.06 c. Balance in exchange for shares of stock of 4-J Farms, Inc. 7,530,152.94 ========== Say 7,500,000.00 ========== With the proposed exchange as enumerated above, GMD Group will apply the value of the properties as follows: 1. Payment of unpaid subscription in 4-J Farms, Inc. P1,500,000.00 2. Payment of additional subscription in 4-J Farms, Inc. 6,000,000.00 TOTAL P7,500,000.00 =========== that the ownership of 4-J Farms, Inc. will not change and GMD Group will still have the majority of the outstanding shares of 4-J Farms, Inc. cdtech In reply thereto, I have the honor to inform you that pursuant to Section 35 paragraph (c)(2)(c) of the Tax Code, as amended by Republic Act No. 4522 and Presidential Decrees Nos. 1705 and 1773 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 fifty one (51%) percent of the total voting power of all classes of stocks entitled to vote. In determining the 51% stock ownership, only those persons who transferred property for stock in the same transaction may be counted, up to a maximum of five. Accordingly, no gain or loss shall be recognized both to the transferor and the transferee corporation on the transfer by GMD Group of its real properties in payment of its unpaid subscription and in payment of additional subscription in 4-J Farms, Inc. considering that as a result of the said exchange, GMD Group which is already in control of 4-J Farms, Inc. will gain further control of the latter corporation. It should be emphasized, however, that Section 35(c)(2)(c) of the Tax Code merely defers recognition of 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 the stocks is considered. Thus, if the transferors later sell or exchange the shares of stock acquired by them in exchange, they shall be subject to income tax on the gains derived from such sale or exchange, taking into consideration that the cost basis of the shares of stock shall be the same as the original acquisition cost or adjusted cost basis to the transferors of the properties exchanged therefor; and that the cost basis to the transferee of the properties exchanged for stock shall be the same as it would be in the hands of the transferor. (Section 35(c)(5)(a) & (b), NIRC as amended by P.D. 1773). If pursuant to the exchange transaction, and as a part of the consideration, the transferee corporation assumes the liability of the transferor or acquires from the transferor property subject to a liability, such assumed or acquired liability shall not be treated as money and or other property, and shall not prevent the exchange from being tax free. [See Sec. 35(c)(4)(a) of the Tax Code as amended by P.D. No. 1773]. If the amount of the liabilities assumed, plus the amount of the liabilities to which the property is subject, exceed the total of the adjusted basis of the property transferred pursuant to such exchange, then such excess shall be considered as a gain from the sale or exchange of a capital asset or of property which is not a capital asset as the case may be [Sec. 35(c)(4)(b), of NIRC as amended by P.D. No. 1773]. The cost basis or value of the stocks received by the transferor of property subject to a liability, where the liability transferred and assumed by transferee corporation does not exceed the transferor's basis or the original and/or acquisition cost of the property transferred, shall be the difference between the liability or liabilities assumed by the transferee corporation and the acquisition or original cost of the property transferred. On the other hand, where the total liabilities to be assumed by the transferee corporation exceed the original or acquisition cost of the property transferred, the excess shall be recognized as gain to the transferor and the value or cost basis of the stocks to the transferor shall be the difference between the original cost of the property transferred subject to a liability (plus the gain recognized to the transferor) and the liability or liabilities assumed by the transferee corporation. (See Sec. 35(c) 5, supra ) In this connection, you are further advised that in order that the parties to the exchange can avail of the non-recognition of gains provided for in Section 35(c)(2)(c) of the Tax Code, as amended, they should comply with the requirements hereunder mentioned. (a) The transferor must file with its income tax return for the taxable year in which the exchange was consummated a complete statement of all facts pertinent to the exchange, including: (1) A description of the property transferred, or of its interest in such property, together with a statement of the original acquisition cost or other basis thereof and the adjusted cost basis at the time of the transfer; (2) The kind of stock received and preference, 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 corporation must file with its income tax return for the taxable year in which the exchange was consummated the following: (1) A complete description of all property received from the transferor; (2) A statement of the original acquisition cost or other basis of the property in the hands of the transferor 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; a) The total issued and outstanding capital stock immediately prior to and after the exchange, with a complete description of each class of stock; b) The classes of stock and number of shares issued to the transferor in the exchange; and c) The fair market value as of the date of exchange of the capital stock issued to the transferor. In addition to the foregoing requirements, permanent records in substantial form must be kept by the taxpayers participating in the exchange, showing the information listed above in order to facilitate the determination of gain or loss from a subsequent disposition of stocks/properties received in the exchange. Very truly yours, RUBEN B. ANCHETA Acting Commissioner