Tax Consequence of An Exchange Transaction

February 5, 1980 BIR RULING NO. 016-80 Selecta Feeds, Inc. 32 Selecta Drive, A. Bonifacio Balintawak, Quezon City Attention: Mr . Mauro C . Arce, Sr . President and General Manager Gentlemen : This refers to your letter dated June 26, 1978 requesting a ruling as to the tax consequence of the transaction described as follows: F A C T S "A single proprietorship under the name of Mauro C. Arce, Sr.,married to Priscilla S. Arce has a total assets of P612,500.00 which will be transferred by the couple to Selecta Feeds, Inc. in exchange for 6,125 shares of stock of the latter; that Selecta Feeds, Inc. was incorporated on October 15, 1975 with an authorized capital stock of Two Hundred Thousand Pesos (P200,000.00) divided into Two Thousand shares with a par value of P100.00 each; and that the said capital stock has been increased to P2,000,000.00 divided into 20,000 shares with a par value of P100.00 each. The following are the incorporators of Selecta Feeds, Inc. their subscribed and paid up capital stock: Name Amount Subscribed Amount Paid Mauro C. Arce, Sr. P210,500.00 P52,625.00 Priscilla S. Arce 118,000.00 29,500.00 Faustino S. Arce 29,100.00 7,275.00 Mauro S. Arce, Jr. 21,200.00 5,300.00 Eloisa Arce Romero 10,800.00 2,700.00 Rodolfo S. Arce 10,400.00 2,600.00 P400,000.00 P100,000.00 ======== ======== that after the aforementioned exchange the transferor will gain control of the corporation by owning 95% of the capital stock of the latter. Q U E S T I O N S "1. What are the tax consequences of the aforementioned exchange? Is the transaction subject to capital gains tax? 2. Is the aforementioned transaction subject to the stock transaction tax?" 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 R.A. No. 4522, no gain or loss shall be recognized if a person exchanges his property for stock in 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. Accordingly, no gain or loss shall be recognized on the transfer of the assets of the single proprietorship in exchange for the shares of stock of the aforementioned corporation, it appearing that after the exchange Mr. Mauro C. Arce, Sr. and his wife will gain control of the corporation by owning 95% of the total voting power of all classes of stocks entitled to vote. cdt 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 the 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 stocks shall be the same as it would be in the hands of the transferors. (Section 35(c)(4) of the Tax Code) The transferee corporation is not subject to the stock transaction tax imposed by Republic Act No. 6141, as amended, the stocks involved in the transaction being original issues. The abovementioned transactions shall not be subject to the gift tax as the transferor will receive in exchange for the assets transferred by it, shares of stock of equivalent value. In this connection, you are further advised that in order that the parties to the exchange ca avail of the non-recognition of gain provided for in Section 35(c)(2) of the Tax Code, as amended, they should comply with the requirements hereunder mentioned. (a) The Transferors must file with their 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 their 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 its income tax return for the taxable year in which the exchange was consummated the following: (1) A complete description of the property received from the transferors; (2) A statement of the original acquisition cost or other basis thereof in the hands of the transferors and the adjusted cost basis at the time of the transfer; (3) Information with respect to the capital stock of the corporation, including: (a) The total issued and outstanding capital stock immediately prior to and immediately after the exchange, with a complete description of each class of stock; (b) The classes of stock and number of shares issued to the transferors in the exchange; (c) The fair market value of the capital stock as of the date of exchange which was issued to the transferors. In addition to the foregoing requirements, permanent records in substantial form must 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 received in the exchange. Very truly yours, RUBEN B. ANCHETA Acting Commissioner