No Gain or Loss shall be Recognized by Members of Phil. Stock Exchange on the Issuance of Its Shares of Stocks to Its Members Upon Its Conversion from a Non-stock to a Stock Corporation Under Its Demutualization Plan

July 27, 2001 BIR RULING NO. 032-01 Philippine Stock Exchange, Inc. Philippine Stock Exchange Centre Exchange Road, Ortigas Center Pasig City Attention: Ramon T. Garcia President Gentlemen : This refers to your letter dated July 18, 2001 requesting for confirmation of your opinion that no gain or loss shall be recognized by the members of the Philippine Stock Exchange, Inc. on the issuance of its shares of stocks to its members upon its conversion from a non-stock to a stock corporation under its demutualization plan as mandated by Section 33.2 of the Securities Regulation Code. The facts, as represented, are as follows: The Philippine Stock Exchange, Inc. (PSE) is a non-stock corporation which operates the only stock exchange in the Philippines. It has one hundred eighty-four (184) members who own membership rights therein. Under Section 33.2 of the Securities Regulation Code (SRC), PSE is required to be reorganized as a stock corporation pursuant to A plan of demutualization approved by the Securities and Exchange Commission (SEC) within one (1) year from the effectivity of the SRC on August 8, 2001, to wit: "33.2 Registration of an Exchange shall be granted upon compliance with the following provisions: (a) That the applicant is organized as a stock corporation: Provided, That any registered Exchange existing prior to the effectivity of this Code shall within one (1) year reorganize as a stock corporation pursuant to a demutualization plan approved by the Commission; . . .." In accordance with the above-quoted provision of the SRC, the SEC, in a letter dated May 3, 2001, approved the conversion of PSE from a non-stock corporation to a stock corporation through the amendment of its Articles of Incorporation. The Balance Sheet of PSE prior to its conversion, dated October 31, 2000, shows that its 184 members have a total Members' Contribution of P286,627,000.00. Upon amendment of its Articles of Incorporation as approved by the SEC, PSE will issue 9,200,000 shares with a par value of P1.00 per share out of the Members' Contribution of P286,627,000.00. Thus, each member/broker will subscribe to a total of 50,000 shares of stock with a par value of P1.00 per share. The balance of the Member's Contribution in the amount of P277,427,000.00 will be treated as Additional Paid-In Surplus in the books of the demutualized PSE. PSE will not issue shares of stock for the value of its donated assets. The donated assets consisting of two (2) pieces of real property located in Makati City and Pasig City, where its trading floors are located, are subject to restrictions on their transferability until the year 2004 based on the deeds of donation. Upon the expiration of the restriction, PSE may transfer the donated real properties to a new corporation in exchange for shares of stock of the latter and distribute the same to the members/brokers on a tax-free basis pursuant to Section 40(C)(2) of the NIRC of 1997. Your position, that no gain or loss shall be recognized by the members of the PSE on the issuance by the latter of its shares of stocks to its members on account of its conversion from a non-stock to stock corporation in accordance with its demutualization plan, is anchored on the following grounds: aSTAHD a. The shares of stocks to be issued by PSE to its members will only be to the extent of said members' contributions to the PSE. Since the subscription by the members to the shares of stocks of the PSE will be taken out of their existing contributions, no income will accrue to them upon receipt of the said shares; b. PSE will not issue shares of stocks to its members for the value of the donated surplus in view of the restriction on the deeds of donation; hence, the members will not realize or receive the value thereof upon demutualization; c. Similarly, the book value of the 9,200,000 shares of stocks of the PSE to be issued to its members upon demutualization will exclude the donated surplus pertaining to the donated assets; d. When PSE converts from a non-stock to a stock corporation, it is merely reorganizing itself to comply with the mandate of the SRC. Such reorganization results only in a change in corporate form and should not give rise to any taxable income to PSE or to its members; e. What the members have before and after the conversion of the PSE is the same, only the form or evidence of investment has changed, i.e ., from certificates of membership to shares of stocks. Hence, it cannot be said that its members have "cashed in" on any theoretical gain. f. The cost basis of the newly issued shares of stocks of the PSE in the hands of its members will not be stepped-up and shall remain the same as their cost basis in the membership rights in the PSE prior to its demutualization; g. The book value of the shares of stocks issued to the members upon demutualization shall exclude the value of the donated surplus pertaining to the donated assets; In reply, please be informed that this Office finds your opinion meritorious. No gain or loss shall be recognized by either the members or the PSE on the issuance of shares of stocks to the members of PSE upon its conversion from a non-stock to a stock corporation under its plan for demutualization. In the case of Commissioner of Internal Revenue vs. A. Soriano Corporation, otherwise known as ANSCOR and the Court of Tax Appeals, C.A. G.R. SP. No. 26017, January 15, 1993, the Court of Appeals ruled: "The conversion of the 11,400 common shares of the Estate of Don Andres Soriano and 138,864 common shares of Doa Carmen Vda. De Soriano into 11,140 and 138,860 preferred shares, respectively, with the same par value may not be considered as essentially equivalent to a distribution of taxable dividend within the contemplation of Section 83(b). The conversion was merely a reclassification of petitioner's capital structure in order to give greater shares of stocks to the active Managers (Jose M. Soriano and Andres Soriano, Jr.) of the corporation to reduce the risk of being overturned by the vote of Doa Carmen Vda. de Soriano (their mother) who owns majority of the stocks in ANSCOR without actual gain being realized from the transaction by the stockholders concerned from the exchange or conversion." Comparative analysis of the Balance Sheet of PSE as of October 31, 2000 (Annex "C", Letter/Request for ruling) and its pro-forma balance sheet after its demutualization (Annex "D", Letter/Request for Ruling) shows that in the conversion of PSE from a non-stock to a stock corporation under its plan for demutualization was merely a reclassification of the capital structure of the PSE. The members of the PSE surrendered their proprietary interests in exchange for shares of stocks of the demutualized PSE. Though only a part of the Members' Contribution were utilized to convert the PSE from a non-stock to a stock corporation, the Members' Equity and the Stockholders' Equity before and after its conversion remained the same. Only the form of investment was changed, i.e ., from membership rights to shares of stocks without actual gain being realized from the transaction by the members concerned. It is a principle of taxation that income, in the broad sense, means all wealth which flows into the taxpayer other than mere return of capital (Section 36, Revenue Regulations No. 2, "The Income Tax Regulations"). The issuance of shares of stocks to the members of PSE is not a flow of wealth from PSE to the members as it is a mere reclassification of their membership rights in view of the compulsory conversion of the PSE from a non-stock to a stock corporation as mandated by the SRC. There is, therefore, no income to speak of that will result in the imposition of income tax. Likewise, the Additional Paid-In Surplus in the amount of P277,427,000.00, which is the balance of the Members' Contribution after deducting therefrom the value of their subscription, is not subject to income tax since the same represents a mere reclassification of a part of the Members' Contribution to Additional Paid-In Surplus. At any rate, it is a capital investment which is not within the purview of the term "taxable income" as defined in Section 31 in relation to Section 32, both of the Tax Code of 1997 (see BIR Ruling No. 127-89, dated June 13, 1989). TASCEc However, the issuance by PSE of shares of stock to its members is subject to the documentary stamp tax under Section 175 of the NIRC of 1997 which imposes documentary stamp tax on every original issue of shares of stocks by any association, company or corporation whether on organization, reorganization or for any lawful purpose. This ruling is being issued on the basis of the foregoing facts as represented. If, upon investigation, it is ascertained 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