Tax Consequence of the Proposed Reorganization of a Branch Office

May 15, 1989 BIR RULING NO. 102-89 34-c-2-c 561-88 102-89 Gentlemen : This refers to your letter dated March 14, 1989 requesting a ruling on the tax consequence of the proposed reorganization of the branch office of your client, National Semiconductor (HK) Distribution Limited (National Semiconductor) into a wholly-owned subsidiary. It is represented that National Semiconductor is a HongKong corporation with a Philippine branch engaged in the export production of integrated circuits at the Export Processing Zone in Cebu; that pursuant to a corporate reorganization, the branch office will be reorganized into a wholly-owned subsidiary; that the subsidiary will take over the business, properties, assets and liabilities of the branch; that the subsidiary will initially have an authorized capital stock of P10,000 divided into 100 common shares with a par value of P100.00 each all of which will be subscribed and fully paid up; that subject to SEC approval the paid up capital stock will be increased to approximately P280M; that all of the shares constituting the paid up capital stock of the subsidiary will be issued to National Semiconductor in exchange for the assets, business and liabilities of the branch which will be acquired by the subsidiary as a going concern; that the subsidiary will continue the business of the branch; and that the branch will cease to do business in the Philippines after it has transferred its assets and liabilities to the subsidiary. In reply thereto, 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 P.D. Nos. 1705 and 1773, no gain or loss shall be recognized if the property is transferred to a corporation, by a person in exchange for stock in such 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 statutory requirement that "said person, alone or together with others, not exceeding four persons, gains control of said corporation" shall be understood to mean that any number of persons may exchange property for stocks provided that as a result of the transaction, not more than five transferors would control the corporation. The term "control" shall mean ownership of stocks in a corporation possessing at least fifty-one percent (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, whether for property or for services, by the transferor or transferors. In determining the 51% stock ownership only those persons who transferred property for the 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 transferor and the transferee corporation on the transfer by National Semiconductor of the assets, business and liabilities of its branch in exchange for the shares of stock of the subsidiary considering that as a result of the said exchange, National Semiconductor will gain control of the subsidiary. 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 transferor later sells or exchanges the shares of stock acquired by it in the exchange, it 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 transferor of the properties exchanged therefor; and that cost basis to the transferee of the properties exchanged for stocks shall be the same as it would be in the hands of the transferor. [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. a) The transferor must file with its 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 properties transferred, or of its interest in such properties, 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 all properties received from the transferor; 2) A statement of the original acquisition cost or other basis of the properties in the hands of the transferor and the adjusted cost basis thereof at the time of the transfer; and 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 stocks and number of shares issued to the transferor in the exchange; and (c) The fair market value as of the date of exchange of the capital stock issued to the transferor. 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 in order to facilitate the determination of gain or loss from a subsequent disposition of stocks/properties received in the exchange. Moreover, the certificates of stocks issued by the subsidiary 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 Executive Order No. 273, 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 249 of the same Code. Finally, the exchange of real properties with shares of stock is not subject to VAT because neither real property nor securities, e.g., shares of stock, come within the purview of VAT-taxable goods as defined in Section 2(p) of Revenue Regulations No. 5-87.However, with respect to goods on hand whether capital goods, stock-in-trade, supplies or materials as of the date of the reorganization, the transaction is one of the "deemed sale" of personal property as contemplated in Section 4(E)(i) of the same Regulations implementing Section 100(b) of the Tax Code, as amended by Executive Order No. 273; hence, subject to 10% VAT. cdtech Very truly yours, (SGD.) JOSE U. ONG Commissioner