Arm’s Length Transaction and Bona Fide Business Arrangement Not Subject to Donor's Tax

August 16, 2002 BIR RULING NO. 033-02 196, 106 (A) (1) (a) & (B) 34 (D) (1) 000-00 Laya Mananghaya & Co. 22/F Philamlife Tower 8767 Paseo de Roxas Makati City 1226 Metro Manila Attention: Remigio A. Noval Partner, Tax & Corporate Services and Myrna Q. Banzon Manager, Tax & Corporate Services Gentlemen : This refers to your letter dated August 29, 2001 and to your supplemental letter dated February 27, 2002 requesting on behalf of your client, York Refrigeration Philippines, Inc . (York for brevity), for a confirmatory ruling to the effect that: "1. the sale of building, improvements and inventories and other assets which comprise of spare parts inventory, office fixtures and workshop equipment between York and GNQ is subject to documentary stamp tax (DST) of P15 for every P1,000 of the consideration or fair market value, whichever is higher; 2. the sale of building and improvement, being not primarily held for sale to customers or held for lease in the ordinary course of trade or business, shall not be subject to the 10% VAT; while the sale of inventories and other assets shall be subject to the 10% VAT; 3. the sale of building and improvements for consideration less than the total book value or fair market value shall not be subject to the donor's tax since the transaction is for a bona fide business purpose and there is no presence of any donative intent; and 4. the loss (excess of book value over the consideration) to be incurred in the sale of building and improvements, which was undertaken for bona fide business purpose, is deductible for income tax purposes." It is represented that York (formerly Sabroe Philippines, Inc.) is a domestic corporation engaged in the business of wholesale, manufacturing, assembling, installing and/or marketing of industrial equipment and commodities processing equipment, and provides consultation, commodities, processing and other allied and related ventures; York is owned by York Group of Companies (the Group), a non-resident corporation based in Denmark; that as a result of a global restructuring of the Group, York will cease its operations in the Philippines; that consequently, York needs to dispose its properties, particularly its building, improvements and Other Assets; that "Other Assets" consist of spare parts, big roller, forklift, various hand tools, and office furniture and fixtures; that the building and improvements built and physically attached to the land owned by Emram Holdings Corporation (Emram) but leased by York are considered as Real Assets; that in the Contract of Lease covering the land, it is stipulated that the term of the lease will be for a period of fifteen (15) years expiring on June 30, 2012; that the authority of York to construct its own building and improvements on the land is allowed in the Contract of Lease, to wit: "5) INTRODUCTION OF IMPROVEMENTS The LESSEE shall be authorized to undertake at its own expense the construction and introduction of improvements unto the Leased Premises which are necessary to render the Leased Premises suitable for the purpose for which the LESSEE has leased the same. The LESSEE shall secure the necessary permits and licenses for these improvements, copy of which permits and licenses shall be furnished by the LESSEE. That in erecting any building or buildings or any permanent improvements inside the premises, which is hereby allowed by the LESSOR, LESSEE hereby binds himself that he shall effect the same in accordance with the building code and the subdivision and zoning regulations of both the national and local governments enforced at the time and with the proper approval of the proper government authorities concerned at LESSEE's own expense. LESSEE shall also be allowed to erect at its own expense wall or walls around the leased premises as he may deem fit and necessary for the protection of his building. LESSEE shall be responsible in constructing a drainage and sewerage system at the leased premises." that upon introduction of the Real Assets, York is considered a builder in good faith and the owner of the property, as recognized by the LESSOR; that, however, the unexpected closure of York affected its contract of lease with Emram; that the Contract of Lease is silent as to the rights of the parties upon pre-termination of such contract; that to avoid any long standing litigation, Emram decided to look for a new lessee; that thereafter, Emram offered to lease the property to GNQ, a competitor of York; that GNQ indicated interest in leasing the land and acquiring the building because of the special design of the property suited for its business purpose; that York having been required by its mother company to effect the immediate closure of its Philippine operations, risks losing the total book value of the building and improvements upon pre-termination of the lease or becoming liable to the Lessor for the consideration of the unfinished term of the lease; that accordingly York decided to sell its properties; that the Contract of Sale dated December 21, 2000, York sold to GNQ the subject building, improvements and other assets for a consideration of P4,000,000.00; that the market value as reflected in the tax declaration is P13,869,160.00; That, however, the Deed of Sale provides that GNQ will continue the lease of the land where the subject building is located; That also, the Deed of Sale is coupled with the condition that GNQ will respect all the stipulations between Emram and York, to wit: "The BUYER ( GNQ ) is aware that the Real Asset is subject to a right of reversion in favor of Emram Holdings Corporation (the "Lessor"), the owner of the land ("Leased Premises") where the real Asset is situated, pursuant to a Contract of Lease dated July 1, 1997 (the "Contract of Lease") where the ownership of the Real Asset will be transferred to the Lessor upon expiration of the term or termination of the Contract of the Lease, or in case the Contract of Lease is renewed, upon expiration of such renewed term (each such event being the "Turn-Over Date") without obligation on the part of the Lessor to pay the value thereof. The BUYER undertakes, represents and warrants that it shall abide by the terms of the Contract of Lease and it will separately secure or has separately secured from the Lessor a contract of lease over the Leased Premises under the same terms and conditions as the Contract of Cease". And that in support of your request, you submitted copies of the original Lease Contract between Emram Holding Corporation and Sabroe Philippines, Inc. (now York Refrigeration Philippines, Inc.) dated July 1, 1997 pertaining to the Leased Premises, and Deed of Sale between the latter and GNQ Industrial and Contracting Corporation dated December 21, 2000 covering the sale of the Real Assets and Other Assets. We reply as follows: With the exception of the third issue, all the queries made are factual in nature. The Tax Code and previous rulings are clear with regards to the treatment of the subject matter raised herein. Therefore, this Office shall only address the issue on donation. As a rule, under Section 100 of the Tax Code of 1997, transfers for less than an adequate and full consideration in money or money's worth of property, is deemed a gift, to wit: Sec. 100. Transfer for Less Than Adequate and Full Consideration . Where property, other than real property referred to in Section 24 (D) is transferred for less than an adequate and full consideration in money or money's worth, then the amount by which the fair market value of the property exceeded the value of the consideration shall, for the purpose of the tax imposed by this Chapter, be deemed a gift, and shall be included in computing the amount of the gifts made during the calendar year. However, this rule is not absolute. In the case of Commissioner of Internal Revenue vs . B . F . Goodrich Phils . , Inc . [now Sime Darby International Tire Co . , Inc . ] and the Court of Appeals , G.R. No. 104171, February 24, 1999, The Supreme Court ruled that: ". . . It is possible that real property may be sold for less than adequate consideration for a bona fide business purpose; in such event, the sale remains as "arm's length" transaction. In the present case, the private respondent was compelled to sell the property even at a price less than its market value, because it would have lost all ownership rights over it upon the expiration of the parity amendment. In other words, private respondent was attempting to minimize its losses. At the same time, it was able to lease the property for 25 years, renewable for another 25. This can be regarded as another consideration on the price." Judging from the facts, there is no showing of donative intent on the part of York. Though Section 100 does not require donative intent since its purpose is to close any avenue for tax avoidance by encompassing all transactions where there is a disparity in consideration, it is however, indicative or a strong proof that a gratuity is intended, That is why, ordinarily transfer for insufficient consideration is deemed a gift. However, jurisprudence recognizes those instances where there is no gratuity intended these are dealings done in the "ordinary course of business". Although it is true that these dealings per se is not sufficient to rule out existence of donative intent, it is equally true that donative intent is not synonymous with a disparity in consideration (PAUL, Federal Estate and Gift Taxation). Therefore, considering that York's transaction with GNQ is an arm's length transaction and a bona fide business arrangement, the same negates the "fiction" which treats the effect as a donation. Accordingly, it is not subject to donor's tax ordinarily imposed on gift or donation under Section 98 in relation to Section 100 of the Tax Code of 1997. 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