Tax Consequence of the Proposed Transfer of a Real Property

February 10, 1988 BIR RULING NO. 032-88 34 (c) (2) (c) 402-87 032-88 Gentlemen : This refers to your letters dated January 6, 7 and 12, 1988 requesting a ruling on the tax consequence of the proposed transfer by your clients, Messrs. Romeo Villonco and Teofilo Villonco and Mesdames Nelly V. Katigbak, Nida V. Alzate and Ofelia V. Viola of a real property owned by them in common to Life Theater, Inc. It is represented that the transferors, Messrs. Romeo Villonco and Teofilo Villonco and Mesdames Nelly V. Katigbak, Nida V. Alzate and Ofelia V. Viola are the sole stockholders of the transferee-corporation, Life Theater, Inc.; that the transferors owned 18,874.2 shares of stock each of the transferee-corporation with unpaid balances in the sum of P1,033,300.00 each or a total of P5,175,500.00; that the transferors are the co-owners of a parcel of land situated in Pasay City covered by TCT No. 125323 of the Registry of Deeds for Rizal on which stands a commercial building; that the said property has been appraised by the Asian Appraisal Co., Inc., a real estate appraiser in the sum of P1,730,000.00 for the lot and P2,877,000.00 for the building of which each of the transferors has an equity of P575,400.00; that the transferors have agreed to make a partial payment on the unpaid balances of their subscriptions by means of an assignment in favor of the transferee of their individual interests in the aforementioned property; that the transferors will individually assign in favor of the transferee, its successors and assigns, their respective equalities in the above described property to the extent of P575,400.00 each leaving a balance of P459,900.00 for each of them, or a total of P2,299,500.00; and that after the exchange and as a result of the exchange, the five transferors who owned 20% each of the capital stock of the transferee corporation will only have an unpaid balance on their subscription of P459,900.00 each. cdta 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 No. 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 51% of the total voting power of all classes of stocks entitled to vote. Control is determined by the amount of stock received i.e., subscribed and paid-up, 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. Accordingly, no gain or loss shall be recognized both to the transferors and the transferee corporation on the transfer by Messrs. Romeo Villonco and Teofilo Villonco and Mesdames Nelly V. Katigbak, Nida V. Alzate and Ofelia V. Viola of their real property as partial payment on the unpaid balances of their subscription to the capital stock of Life Theater, Inc., considering that after the exchange and as a result of said exchange, the transferors who owned 20% each of the capital stock of the transferee corporation will only have an unpaid balance of P459,900.00 each. In short, the transferors will gain control of the corporations. 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, 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 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)(c) of the Tax Code, as amended, they should comply with the requirements hereunder mentioned: cdti (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 with its income tax return for the taxable year in which the exchange was consummated the following: 1. Complete description of the property received from the transferors; 2. A statement of the original acquisition cost or other basis of the property in the hands of the transferors and the adjusted cost basis thereof at the time of the transfer and; a. The total issued and outstanding capital stock prior to and immediately after the exchange, with a complete description of each class of stocks; b. The classes of stock 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 the information listed above in order to facilitate the determination of gain or loss from a subsequent disposition of stock/properties received in the exchange. Moreover, pursuant to Section 196 of the Tax Code, as amended, a conveyance or deed whereby land is assigned or transferred to the purchaser is subject to documentary stamp tax based on the consideration or value received or contracted to be paid for such realty. A stock in a corporation is a valuable consideration for transfer of real property (Section 177 Documentary Stamp Tax Regulations). Accordingly, if a parcel of land is exchanged with stocks in a corporation as in this case, the latter is the consideration, the value of which shall be the basis of the documentary stamp tax on the aforesaid deed. (BIR Ruling No. 245-00-000-00-109-82 dated April 5, 1982) The certificates of stocks to be issued by the Life Theater, Inc. are, in all probability, original issues, which are subject to the documentary stamp tax imposed by Section 175 of the Tax Code, as amended. Furthermore, under Section 248(d) in relation to Section 173 of the Tax Code as amended by PD 1994, in case of failure to affix the proper documentary stamps 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 240 of the same Code. After payment of the corresponding documentary stamp tax including its corresponding penalty, the aforesaid real properties may now be registered by the Registry of Deeds concerned in the name of Life Theater, Inc. cdtech Very truly yours, (SGD.) BIENVENIDO A. TAN, JR. Commissioner