Tax Consequences of the Transfer of Assets to a Partnership in Exchange for Partnership Interest in such Partnership

May 20, 1994 BIR RULING NO. 105-A-94 34 (c) (2) & (6) (c), 20 (b) 000-00 105A-94 Bautista Picazo Buyco Tan & Fider 8th Floor, Singapore Airlines Bldg. 139 H. V. de la Costa St., Salcedo Village Makati, Metro Manila Attention: Atty . Silverio Benny J . Tan Gentlemen : This refers to your letter dated May 9, 1994 stating that Atlas Consolidated Mining & Development Corporation (ATLAS) is a mining company which operates coal fired thermal power plants in Sangi and diesel electric power plants in Carmen, Toledo City, Cebu; that the power plants consist of industrial buildings, machineries and equipment and all properties, real or personal, located within the premises of the power plants which are actually, directly and primarily used or necessary to meet the needs of the power plants, including but not limited to steam generators, boilers, fuel pumps, water pumps, turbine generators, conveyors, compressors, diesel engine generators, generator control panels, fuel storage tanks, etc. but excluding the leased land on which part of the power plants is located; that the acquisition cost/historical cost of Atlas for the power plants is P1.454 Billion; that the appraised value of the power plants as determined by Cuervo Appraisers, Inc. as of September 1993 is P1.689 Billion; that Atlas shall transfer all its power plants assets to Toledo Power Co., a general partnership which was organized under Philippine laws for the purpose of acquiring, owning, rehabilitating, maintaining and operating these power plants; that Toledo Power Co. was organized with an initial capital of P100,000.00; that it will increase its capital to P1.689 Billion to absorb the capital contribution from Atlas; that Toledo Power Co. shall grant fully paid partnership interest to Atlas amounting to P1.689 Billion in exchange for the power plants assets and shall be the managing partner; that as a result of the exchange of the power plants assets for partnership interest, Atlas will control Toledo Power Co.; that the capitalization and equity in Toledo Power Co. will appear as follows: cdta Before the transfer of power plants assets : Before the transfer of power plants assets: Partners Amount Contributed David Perry P22,500 Benjamin Abela 67,500 P100,000 ====== After the transfer of power plants assets: Amount Contributed Atlas P1,659,000,000 David Perry 32,500 Benjamin Abela 67,500 P1,689,100,000 ========= In connection therewith, you now request confirmation of your opinion, as follows: (1) That the provision of Section 34(c)(2) of the Tax Code, as amended, on non-recognition of gains or loss applies to the transfer of assets to a partnership in exchange for partnership interest in such partnership of which as a result of such exchange, the transferor, alone or together with others, not exceeding four persons, gains control of said partnership; (2) That the transfer of real and personal properties forming part of the power plants pursuant to the tax free exchange are not subject to the creditable withholding tax on sale or transfer of real property and the value-added tax; and (3) That the non-recognition of gain or loss on the aforesaid transfer of assets for partnership interest will still apply even if the power plant assets are transferred to the partnership at their historical cost of P1.454 Billion, instead of at appraised value of P1.689 Billion. In reply thereto, please be informed as follows: (1) Pursuant to Section 34(c)(2) and (6)(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 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. Although Section 34, paragraphs (c)(2) and (6)(c) of the Tax Code, as amended refers to the transfer of property to a corporation, nevertheless, not only a corporation but a partnership can be a transferee of property under said provision since the term "corporation" as defined in Section 20(b) of the Tax Code, as amended, includes inter alia partnerships, no matter how created or organized. Moreover, no gain or loss shall be recognized to a partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership (See Helvering vs. Walbridge, 70 F. 2d 683 (2d cir. 1934). Accordingly, your opinion that the provision of Section 34(c)(2) of the Tax Code, as amended on the non-recognition of gains or loss applies to the aforementioned transfer and exchange of properties, is hereby confirmed. Thus, no gain or loss shall be recognized both to the transferor and the transferee partnership on the transfer by Atlas of all its power plants assets in exchange for partnership interest considering that as a consequence thereof. Atlas will gain control of Toledo Power Co. by owning more than 51% of its partnership interest. It is understood, however, that Section 34(c)(2) and (6)(c) of the Tax Code merely defers recognition of the gain or loss from such transaction, for in determining the gain or loss from a subsequent transaction of the properties or of the partnership interest involved in the exchange, the original or historical cost of the properties or of the partnership interest is considered. Thus, if the transferor later sells or exchange the partnership interest acquired by it in the exchange transaction, 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 partnership interest shall be same as the original acquisition cost or adjusted cost basis to the transferor of the properties exchanged therefor; and that the cost basis to the transferee partnership of the properties exchanged for partnership interest shall be the same as it would be in the hands of the transferor. (Section 34(c)(5)(a) & (b), Tax Code, as amended by P.D. No. 1773). (2) That your opinion to the effect that the transfer of real and personal properties forming part of the power plants pursuant to the tax-free exchange is not subject to the 51% creditable withholding tax on sales, exchanges or transfers of real property under Revenue Regulations No. 1-90 and to VAT is hereby confirmed; and (3) That your opinion that the non-recognition of gain or loss on the aforesaid transfer of assets in exchange for partnership interest will still apply even if the power plants assets are transferred to the partnership at their historical cost of P1.454 Billion, instead of at their appraised value of P1.689 Billion is, likewise, hereby confirmed. 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) and (6)(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 transaction was consummated, a complete statement of all facts pertinent to the exchange, including a description of the properties transferred, or of its interest in such properties, with a statement of the original acquisition cost/adjusted cost basis or other basis thereof at the time of the transfer. b. On the other hand, the transferee partnership 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 properties received from the transferors; and 2. A statement of the original acquisition cost or other basis of the property in the hands of the transferor and the adjusted cost basis thereof at the time of the transfer. 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 the properties received in the exchange. The parties shall also cause to be annotated on the Transfer Certificate of Title, the date the Deed of Exchange/Assignment was executed, the original or historical cost of acquisition of the properties in the fact that no gain or loss was recognized as a result of such exchange. The Deed of Conveyance of the real properties to the partnership is subject to documentary stamp tax based on the value of the partnership interest pursuant to Section 196 of the Tax Code, as amended. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, and/or any of the requirements imposed in this letter are not complied with, then this ruling shall be considered null and void. aisadc Very truly yours, VICTOR A. DEOFERIO, JR. Acting Commissioner