BIR Ruling No. 051-83

March 28, 1983 BIR RULING NO. 051-83 Gentlemen : This refers to your letter dated September 24, 1981 requesting confirmation to the effect that the capital gains which your client, City Trust Banking Corporation (City Trust), will derive from the sale of its real properties are exempt from tax pursuant to Presidential Decree No. 1738. It is represented that City Trust is a domestic corporation engaged in banking operations; that it has remaining unissued capital stock; that it proposes to increase capitalization through the following means: City Trust will sell on arm's length basis some of its real properties to a third party, realizing a gain in the process; that within six (6) months from the date of sale of the real properties, City Trust will capitalize by way of stock dividend declaration an amount equivalent to the entire proceeds of the sale; that the gain realized on the sale and the balance of the previous retained earnings before the sale will be sufficient to cover the total value of the shares to be issued, as original issues, by way of stock dividends; that it will debit "retained earnings" for an amount equivalent to the cash proceeds of the sale and credit "capital stock" for the same amount; and that it will subsequently issue new shares of stocks corresponding to the stock dividends declared. In reply, please be informed that pursuant to Section 3(b) of Revenue Regulations No. 11-80, implementing Presidential Decree No. 1738, gains arising from the disposition of property, real or personal, that corresponds to that portion of the proceeds of the sale that is invested within six (6) months from the date the gains were realized, in new issues of capital stock of banks and nonbank financial intermediaries existing as of the date of approval of the said Decree, shall be exempt from income tax, if the disposition of asset upon which the gain was realized occurred within the period from September 17, 1980 up to September 16, 1985. Likewise, the gains from sale of shares of stock to the extent invested in new issues of share of stock in banks and non-bank financial intermediaries shall be exempt from the capital gains tax on stock transaction pursuant to Section 5 of Revenue Regulations No. 14-80 implementing Presidential Decree No. 1739. A stock dividend, converts surplus assets into capital. The declaration of stock dividend involves the creation and issue of new shares of stock; it puts surplus assets into permanent capital account, which in effect, increases capitalization for corporate uses and not for distribution to stockholders. "The declaration of a stock dividend involves the creation and issue of new shares of stock. The basis of the issue, insofar as payment into the corporation is not required of the recipient, is surplus assets which thus become converted into strict capital with all which that implies. From the process there results an increase of both the number of outstanding shares and the amount of the corporate assets which have had that peculiar dedication to the corporate uses which entitles them to the name of capital, strictly speaking Green v. Bissell, 79 Conn. 547, 65 Atl. 1056, 8 L.R.A. (N.S.) 1011, 118 Am St. Rep. 156, 9 Ann. Cas. 287". (11 Fletcher, Cyclopedia of Corporation p. 904.) The purpose of the above tax exemption is to increase the capitalization of banks so as to insure that funds are available for investment and credit requirements. (Wherein Clause, P.D. No. 1738) This purpose will be attained in the above transaction to be entered into by City Trust. In view thereof, and since the proceeds of the sale of the real properties of City Trust will be invested in new shares corresponding to the amount of stock dividends declared, the gains realized therefrom shall be exempt from income tax. However, the stock dividends that changes the proportionate interest of any of the stockholders of City Trust after declaration/distribution is taxable as ordinary income to him in the year paid or accrued; otherwise, the stockholder, may realize income only upon subsequent sale thereof. cdtech Very truly yours, (SGD.) RUBEN B. ANCHETA Acting Commissioner Bureau of Internal Revenue