Net Operating Losses Are Preserved Even After Purchase of Shares from Existing Stockholders

March 27, 2002 BIR RULING NO. 011-02 NOLCO S34 (D) (3) RR No. 14-2001 000-00 SGV & Co. 6760 Ayala Avenue 1226 Makati City Attention: Atty. Emmanuel C. Alcantara Tax Division Gentlemen : This refers to your letter dated December 1, 2000 requesting for confirmation of your opinion that the net operating losses of Grand Cement Manufacturing Corporation ("Grand") is preserved even after the purchase from the existing stockholders of eighty-eight percent (88%) of its outstanding and issued shares by Taiheiyo Cement Corporation ("Taiheiyo") and may still be carried over and claimed as a deduction from its gross income, pursuant to Section 34(D)(3) of the Tax Code of 1997, as implemented by Revenue Regulations No. 14-2001. It is represented that Grand is a domestic corporation duly organized and existing under the laws of the Philippines and is engaged in the production and trading of cement products of all kinds, with principal office address at San Fernando, Cebu City; that it is a BOI-registered enterprise with a non-pioneer status, enjoying certain tax benefits, including an income tax holiday for four (4) years from January 1, 1993; that its income tax holiday, including the one (1) year extension granted by the BOI on February 14, 1997, ended on January 1, 1998; that Taiheiyo is a non-resident foreign corporation duly organized and existing under the laws of Japan; that Taiheiyo invested in Grand's existing cement business in the Philippines on October 25, 2000 by acquiring approximately eighty-eight percent (88%) of the outstanding and issued capital stock of the latter; that Grand adopts a calendar year accounting period; that for the taxable years ending December 31, 1998 and December 31, 1999, Grand incurred NOLCO; and that in support of your request, you submitted the following documents: 1) Articles of Incorporation of Grand Cement Manufacturing Corporation; 2) SEC Certificate of Registration of Grand Cement Manufacturing Corporation; 3) Certification by the corporate secretary of Grand Cement Manufacturing Corporation of its authorized capitalization, the par value of the shares of stock and the list of stockholders of record of Grand Cement Manufacturing Corporation; and 4) Audited financial statements of Grand Cement Manufacturing Corporation for the years 1999 and 1998. In reply, please be informed that Section 34 (D) (3) of the Tax Code provides: "Sec. 34 Deductions from gross income. . . . (D) Losses. (3) Net operating loss carry-over . The net operating loss of the business or any enterprise for any taxable year immediately preceding the taxable year, which had not been previously offset as deduction from gross income, shall be carried over as a deduction from gross income for the next three (3) consecutive taxable years immediately following the year of such loss; Provided, however, That any net loss incurred in a taxable year during which the taxpayer was exempt from income tax shall not be allowed as a deduction under this subsection; provided, further, that a net operating loss carry-over shall be allowed only if there has been no substantial change in the ownership of the business in that (i) Not less than seventy-five percent (75%) in nominal value of outstanding issued shares, if the business is in the name of a corporation, is held by or on behalf of the same persons; or (ii) Not less than seventy-five percent (75%) of the paid-up capital of the corporation, if the business is in the name of a corporation, is held by or on behalf of the same persons. For purposes of this subsection, the term "net operating loss" shall mean the excess of allowable deduction over gross income of the business in a taxable year; . . ." The above provision is clarified by Revenue Regulations No. 14-2001, pertinent portions of which provide: "SEC. 2. General Principles and Policies . 2.1 For purposes of these Regulations, the allowance for deduction of NOLCO shall be limited only to net operating losses accumulated beginning January 1, 1998. 2.2 In general, NOLCO shall be allowed as a deduction from the gross income of the same taxpayer who sustained and accumulated the net operating losses regardless of the change in its ownership. This rule shall also apply in the case of a merger where the taxpayer is the surviving entity. xxx xxx xxx 2.4 NOLCO shall also be allowed if there has been no substantial change in the ownership of the business or enterprise in that not less than 75% in nominal value of outstanding issued shares or not less than 75% of the paid up capital of the corporation, if the business is in the name of a corporation, is held by or on behalf of the same persons. The 75% equity, ownership or interest rule prescribed in these Regulations shall only apply to a transfer or assignment of the taxpayer's net operating losses as a result of or arising from the said taxpayer's merger or consolidation or business combination with another person . . . SEC. 3. Definition of Terms. For purposes of these Regulations, the words and phrases herein provided shall mean as follows: xxx xxx xxx 3.8 Substantial Change in the Ownership of the Business or Enterprise. The term "Substantial Change in the Ownership of the Business or Enterprise" shall refer to a change in 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. xxx xxx xxx SEC. 5. Determination of Substantial Change in Ownership of the Business . xxx xxx xxx 5.2 When Change Occurs . A change in the ownership of the business occurs when the person who sustained net operating losses enters into a merger, or consolidation or combination with another person, thereby resulting to the transfer or conveyance of the said net operating losses, to another person, in the course of the said merger or consolidation or combination. xxx xxx xxx." [Emphasis supplied] In this case, the NOLCO, which Grand seeks to preserve, have not been previously offset as a deduction from gross income, and they were incurred in the taxable years during which it was no longer exempt from income tax, particularly the taxable years 1998 and 1999. The transfer of shares by the previous stockholders of Grand were through straight purchase and sale and not through merger, consolidation or business combination. As such, the transfer of shares did not cause a substantial change in ownership as a result of or arising from merger, consolidation or combination with another person as defined in subsection 3.8 of Revenue Regulations No. 14-2001. Accordingly, we hereby confirm your opinion that the NOLCO of Grand is preserved even after the purchase from the existing stockholders of eighty-eight percent (88%) of its outstanding and issued shares by Taiheiyo, and may still be carried over and claimed as a deduction from its gross income for the next three (3) consecutive taxable years immediately following the year of such loss. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation it shall be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) REN G. BAEZ Commissioner of Internal Revenue