Tax Consequences of the Proposed Plan of Incorporation of a Company

May 16, 1980 BIR RULING NO. 063-80 Sycip, Gorres, Velayo & Co. 6760 Ayala Avenue Makati, Metro Manila Attention: Mr . B . V . Abela Tax Division Gentlemen : This refers to your letter dated March 5, 1980 requesting a ruling on the tax consequences of the proposed plan of incorporation of a company to be known as the Semirara Coal Corporation (SCC) by you clients, Seafront Petroleum and Mineral Resources, Inc. (Seafront), Sulu Sea Oil Development Corporation (Sulu Sea) and Vulcan Industrial and Mining Corporation (Vulcan) described hereunder as follows: "1. Seafront, Sulu Sea and Vulcan, acting through their individual nominees, will set up a corporation to be known as the Semirara Coal Corporation. Thereafter, these three companies will transfer and assign to the new joint venture corporation the assets listed in Annex "A" hereof with a total value of P55 million, of which P50 million will be equity contribution and P5 million will be advances to the company, and the three companies each will receive in return P100 million par value shares of stock of SCC or a total of P300 million par value shares. "2. Solely in exchange for the net assets transferred, SCC will issue shares of its capital stock to Seafront, Sulu Sea and Vulcan in proportion to the interest of each corporation in the Semirara Coal Consortium Project. Thus, SCC will issue to Seafront 100,000 of its shares of stock, to Sulu Sea 100,00 shares of its capital stock, and to Vulcan 100,000 shares of its capital stock, all with a par value of P1,000 per share or a total issued value of P500 million. "3. It is contemplated that after the initial transfer as above-described, Seafront, Sulu Sea and Vulcan will be transferring such properties as may be needed by SCC to develop, exploit and utilize fully the coal deposits in Semirara Island but solely in exchange for shares of stock of SCC. "4. It is likewise contemplated that Seafront, Sulu Sea and Vulcan will cause the shares of the capital stock of SCC to be listed and traded in stock exchanges in the Philippines or elsewhere to allow public participation in the equity of SCC." In reply thereto, I have the honor to inform you that pursuant to Section 35(c)2(c) of the Tax Code as amended by Republic Act No. 4522, no gain or loss shall be recognized if a person exchanges his property for stock in 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 fifty-one (51%) percent of the total voting power of all classes of stocks entitled to vote. Accordingly, no gain or loss shall be recognized on the first transfer of assets and liabilities of Seafront, Sulu Sea and Vulcan in exchange for shares of stock of SCC, it appearing that after the exchange the transferors will gain control of SCC by owning 100% of the total voting power of all classes of stocks entitled to vote. cdta The subsequent transfer by Seafront, Sulu Sea and Vulcan of their other assets or properties as may be needed by SCC to develop, exploit and utilize fully the coal deposits in Semirara Island, solely in exchange for shares of stock of SCC, a corporation which is already controlled by said transferors, will result in their gaining further control of SCC. Such being the case, no gain or loss shall be recognized on the aforementioned transfer. (see B.I.R. Ruling dated October 11, 1966) It should be emphasized, however, that Section 35(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 35(c)(4) of the Tax Code) If pursuant to the exchange transaction, and as part of the consideration, SCC or the transferee corporation assumes the liability of the transferors or acquires from the transferors property subject to a liability, such assumed liability or liabilities shall not be treated as money and/or other property, and shall not prevent the exchange from being tax-free. (See Sec. 35(c)(3)(c), N.I.R.C.) No gain or loss will be recognized on the obligation assumed by the transferee corporation. The cost basis or value of the stocks received in this case by the transferors of property subject to a liability, where the liability transferred and assumed by SCC does not exceed the transferors' basis or the original and/or acquisition cost of the property transferred, shall be the difference between the liability or liabilities assumed by SCC and the acquisition or original cost of the property transferred. (see B.I.R. Ruling No. 015-80 dated Feb. 5, 1980) No gift tax is payable by Seafront, Sulu Sea and Vulcan and SCC, considering that property in this case is transferred and exchanged by them in a bona fide and at arm's length transaction; and that the said property is transferred to SCC, a 100% controlled corporation. SCC, the transferee corporation is not subject to the stock transaction tax imposed by Republic Act No. 6141, as amended, the stocks involved in the transaction being original issues. cdta 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 35(c)(2)(c) 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 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) A complete description of the property received from the transferors; (2) A statement of the original acquisition cost or other basis thereof in the hands of the transferors and the adjusted cost basis at the time of the transfer; (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 stock and number of shares issued to the transferors in the exchange; (c) The fair market value of the capital stock as of the date of exchange which was issued to the transferors. In addition to the foregoing requirements, permanent records in substantial form must be kept by the taxpayer participating in the exchange showing the information listed above in order to facilitate the determination of gain or loss from a subsequent disposition of stocks received in the exchange. Very truly yours, RUBEN B. ANCHETA Acting Commissioner