Tax Liability of AMC and DMC Stockholders

February 22, 1990 BIR RULING NO. 020-90 34 (c) (2) (c) 160-89 020-90 Gentlemen : This refers to your letter dated November 23, 1989 stating as follows: "1. Apex Motor Corp. (AMC) and Diamond Motor Corp. (DMC) are domestic corporations duly organized and existing under the laws of the Philippines. Both are engaged in the business of automotive sales and/or allied services; "2. The persons owning and controlling both AMC and DMC are virtually the same, except that in addition, AMC as a corporate entity owns 30% of DMC. The stockholders of AMC and DMC and their respective shareholdings and percentages of equity in AMC and DMC are shown as follows: List of Stockholders APEX Motor Corporation Name of Stockholders No. of Shares % (1) Concepcion Blaylock 161,058 32.21% (2) Nieves Whisenhunt 106,566 21.31% (3) Bisco Mgmt. & Invest. Corp. 51,882 10.38% (4) Felizardo Apostol 30,000 6.00% (5) Propeso Llanera 30,000 6.00% (6) Gonzalez Mgmt. Corporation 26,665 5.33% (7) Rodoza Machinery Corp. 24,999 4.99% (8) Flordeliza Gonzalez 7,335 1.47% (9) Francisco A.L. Gonzalez 3,159 0.63% (10) Bonifacio Sison 7,335 1.47% (11) Vitaliano Domingo 1 0.01% (12) Lis Investment Corporation 25,000 5.00% (13) Josefa Gonzalez 6,000 1.20% (14) Cristina Ma. Gonzalez 4,000 0.80% (15) Fernando Jose Gonzalez 4,000 0.80% (16) Francisco Xavier Gonzalez 4,000 0.80% (17) Federico Jose Gonzalez 4,000 0.80% (18) Florante Antonio Gonzalez 4,000 0.80% 500,000 100.00% ======= ======= LIST OF STOCKHOLDERS DIAMOND MOTOR CORPORATION Name of Stockholders No. of Shares % (1) Apex Motor Corporation 308,444 30.84% (2) Concepcion Blaylock 1 0.0001% (3) Nieves Whisenhunt 106,392 10.64% (4) Bisco Mgmt. & Invest Corp. 82,397 8.23% (5) Felizardo Apostol 3,334 0.33% (6) Propeso Llanera 1 0.00% (7) Gonzalez Mgmt. Corporation 39,335 3.93% (8) Rodoza Machinery Corp. 71,965 7.19% (9) Flordeliza Gonzalez 8,617 0.86% (10) Francisco A.L. Gonzalez 25,507 2.55% (11) Bonifacio Sison 1 0.001% (12) Vitaliano Domingo 1,905 0.19% (13) CF Blaylock Mgmt. Corp. 265,965 26.59% (14) Mulawin Investment Corp. 33,334 3.33% (15) Zenaida Blaylock 34,471 3.44% (16) Eduardo Ramos 13,334 1.33% (17) Hector Syquia 5,000 0.50% 1,000,000 100.00% ======== ======= "3. From net profits of the current year and/or accumulated retained earnings, AMC will declare property dividends to its stockholders in the form of shares representing AMC's 30% interest in DMC. This will wipe out AMC's stockholdings in DMC but will increase pro rata the equities of AMC's individual stockholders in DMC; "4. As a group, all the stockholders of AMC and DMC will transfer all their shares of stock in AMC and DMC to a new corporation (H Co.) solely in exchange for shares of stock of H Co. However, out of the 18 transferors in AMC and out of the 16 transferors in DMC, not more than five stockholders of AMC and DMC will acquire at least 51% control of H Co. The result of the transaction is that the stockholders of AMC and DMC will own 100% of H Co. which in turn will own 100% of AMC and DMC. "5. The underlying assets of AMC and DMC will be reappraised and the net asset value arrived at will serve as basis for determining the fair market value of the AMC and DMC shares to be exchanged for H Co. stock. Consequently, the stockholders of AMC and DMC will receive, in exchange, as many H Co. shares as will be sufficient to cover the fair market value of the shares they will be giving up; "6. After the strictly stock-for-stock exchanges shall have been effected, H Co. will embark on a major business expansion program which will call for a broadening of its ownership base. This will hopefully ensure faster growth and achieve the added social dimension of opening up the corporation to the investing public. To attain this objective, H Co. will increase its authorized capital stock then register and list its shares with the SEC and the stock exchanges, respectively. Thereafter, a portion of its capital stock will be offered to the public thru such public listing. But this will not adversely affect the control already held by the five transferors belonging to the original group which exchanged their shares for at least a 515 stake in H Co. They will control H Co." In connection therewith, you now request confirmation of your opinion as follows: cdta "1. No gain or loss shall be recognized for all AMC and DMC stockholders on the transfer of their shares of stock in AMC and DMC respectively solely in exchange for shares of H Co. pursuant to Section 34(c)(2) of the Tax Code. "2. The basis of H Co. stock in the hands of AMC and DMC stockholders shall be the same as their basis in AMC and DMC stocks exchanged pursuant to the above plan of reorganization; "3. The basis of AMC and DMC stock in the hands of H Co. shall be the same as it would be in the hands of AMC and DMC stockholders; "4. The transfer of their shares of stocks by AMC and DMC stockholders in exchange for H Co. stock will not be considered as a transfer of property for an insufficient consideration subject to gift tax since there is no intention to donate on the part of any of the parties and the transaction is effected purely for business reasons; "5. The distribution as property dividends by AMC of its 30% holdings in DMC will not be subject to income tax in view of the repeal of the 10% final tax on dividends received by a domestic corporation from another domestic corporation effective January 1, 1986. Based on the audited financial statement of AMC for the year ended December 31, 1988, AMC has sufficient retained earnings to cover its cost basis in DMC stocks to be declared as dividends to H Co.; "6. The subsequent sale or exchange by H Co. stockholders of their listed H Co. shares effected through the facilities of the stock exchanges shall be subject to the final tax of 1/4 of 1% of the gross selling price of the shares." In reply, I have the honor to inform you that pursuant to Section 34, paragraph (c)(2)(c) of the Tax Code, as amended by Republic Act No. 4522 and Presidential Decree 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 which means that any number of persons may exchange property for stock provided that, as a result of the transaction, not more than five (5) transferors would control the corporation. The term "control" shall mean ownership of stocks in a corporation possessing at least 51% of the total voting power of all classes of stocks entitled to vote. Accordingly, no gain or loss shall be recognized to each of the eighteen (18) transferors (AMC stockholders) as well as the sixteen (16) other transferors (DMC stockholder) and the transferee corporation, H Co. considering that after the exchange and as a result of the said exchange, not more than five (5) of the transferors will gain control of the transferee corporation. Control is determined by the amount of stock received, i.e. subscribed, whether for property or for services by the transferor or transferors. 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. It should be emphasized, however, that Section 34(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, your opinion that 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 is hereby confirmed. (Section 34(c)(5)(a) and (b), Tax Code as amended by Presidential Decree No. 1773) 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 34(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 properties transferred, or of their interest in such properties, together with a statement of 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 properties received from the transferors; 2) A statement of the original acquisition cost or other basis of the properties in the hands of the transferors 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 immediately after the exchange, with a complete description of each class of stock; b. The classes of stocks and number of shares issued to the transferors in the exchange; and c. The fair market value as of the date of exchange of the capital stock issued to the transferors. In addition to the foregoing requirements, permanent records in substantial form must be kept by the taxpayers participating in the exchange showing then information listed above in order to facilitate the determination of gain or loss from a subsequent disposition of stocks/properties received in exchange. Moreover, your opinion to the effect, viz: (1) That the transfer by AMC and DMC stockholders of their shares of stock in exchange for H Co. stock will not be considered as a transfer of property for an insufficient consideration subject to gift tax since there is no intention to donate on the part of any of the parties and the transaction is effected purely for business reasons; (2) That the distribution as property dividends by AMC of its 30% holdings in DMC to AMC's own stockholders (individual and corporate) will not be subject to income tax. Under Section 21(c) (2) of the Tax Code, as amended, dividends received by individuals from a domestic corporation shall be taxed at the rate of 0% effective January 1, 1989; that under Section 24(e) (4) of the same Code, as amended by Executive Order No. 37, dividends received by a domestic corporation from another domestic corporation shall not be subject to tax effective August 1, 1986; and (3) That the subsequent sale or exchange by H Co. stockholders of their listed H Co. shares effected through the facilities of the stock exchanges shall be subject to a final tax of 1/4 of 1% based on the gross selling price of the shares under either Section 21(d) (2) or Section 24(e)(2)(B) of the Tax Code, are hereby confirmed. Furthermore, the certificates of stocks to be issued by H Co. are, in all probability, original issues, which are subject to the documentary stamp tax imposed by Section 173 of the Tax Code, as amended. Finally, under Section 248(d) in relation to Section 173 of the Tax Code as amended by Executive Order No. 273, in case of failure to affix the proper documentary stamp to a document or instrument, there shall, for every violation be imposed, in addition to the amount of documentary stamp tax required to be paid an amount equivalent to twenty-five percent of such unpaid amount which shall be in lieu of the interest prescribed in Section 249 of the same Code. This ruling is being issued on the basis of the foregoing facts as presented. However, if upon investigation it will be disclosed that the facts are different, then this ruling shall be considered without force and effect. Very truly yours, (SGD.) JOSE U. ONG Commissioner