No Gain or Loss Shall be Recognized Both to the Transferor and the Transferee Corporation on the Transfer of Assets and Liabilities in Exchange for Shares of Stock

June 17, 1991 BIR RULING NO. 106-91 32 (c) (2) (c) 171-81 106-91 Gentlemen : This refers to your letter dated April 16, 1991 stating that on November 29, 1990, the Board of Investments approved Phimco Industries, Inc. (PHIMCO) application for the spin-off of its Lighter Division into a separate entity; that the purpose of the spin-off is to separate the operation of said division from the rest of the company; that on February 14, 1991, the Securities and Exchange Commission approved the incorporation of Swedish Match Philippines, Inc. (SMPI) as the separate entity; that SMPI has an authorized capital stock of P300 million, divided into 300 million shares of stock with par value of P1.00 each; that the following or the incorporators of SMPI: cdt No. of Amount NAME shares Subscribed/paid Leonardo Siguion Reyna 1 share P1.00 Lars Lindqvist 1 share P1.00 Sixto Clemente, Jr. 1 share P1.00 Augusto San Pedro 1 share P1.00 Don Pitulia 1 share P1.00 that on the basis of the above-mentioned BOI approval, PHIMCO, on December 26, 1990, executed a Deed of Transfer whereby it transferred to SMPI substantially all the operating assets of the Lighter Division based on their outstanding balances as of September 30, 1990 amounting to P253,833.00; that the assets transferred to SMPI consisted mainly of property and equipment inventories and account receivables; that the property and equipment totalling P92,771,453 includes a revaluation increment of P21,793,389.00 based on the appraisal report issued by an independent appraiser; that in exchange for the above assets, SMPI issued to PHIMCO its shares of stock amounting to P171,068,300.00 equivalent to 1,710,683 shares; that the amount of P82,026,533 (representing the difference between total value of assets transferred of P253,094,833) pertain to accounts payable were incurred directly in connection with the operations of the Lighter Division; and that after the above-described exchange of assets for share of stock, PHIMCO, gained 100% control of SMPI. Based on the foregoing representations, you now request a ruling to the effect that the above-mentioned revaluation increment on property of P21,793,389 is a non-taxable income, and that the entire spin-off of your Lighter Division, a tax-free transaction. In reply, please be informed that pursuant to Section 34 paragraph (c) (2) (c) of the Tax Code, as amended by Republic Act No. 4522 and Presidential Decree 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 other, not exceeding four persons, gains control of said corporation. The term "control" shall mean ownership of stocks vested with at least fifty-one (51%) percent of the total voting power of all classes of stocks entitled to vote. In determining the 51% stock ownership, only those persons who transferred property for 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 PHIMCO of its assets and liabilities in exchange for the shares of stock of SMPI, considering that as a result of the said exchange, PHIMCO will gain control of the transferee corporation, SMPI. No gift tax is payable under the abovementioned transaction as PHIMCO will receive in exchange for its assets transferred by it shares of stock of equivalent value. 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 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 the cost basis to the transferee of the properties exchanged for stock shall be the same as it would be in the hands of the transferor. If pursuant to the exchange transaction, and as part of the consideration, the transferee corporation assumes the liability of the transferor or acquires from the transferor property subject to a liability, such assumption or acquisition shall not be treated as money and/or other property, and shall not prevent the exchange from being tax free. (See Sec. 34 (c) (4) (a) of the Tax Code as amended by P.D. No. 1773) If the amount of the liabilities assumed, plus the amount of the liabilities to which the property is subject, exceed the total of the adjusted cost basis of the property transferred pursuant to such exchange, then such excess shall be considered as gain from the sale or exchange of a capital asset or of property which is not capital asset as the case may be. (Sec. 34 (c) (4) (b) of the Tax Code as amended by P.D. No. 1773) The cost basis or value of the stocks received by the transferor of property subject to a liability, where the liability transferred and assumed by the transferee corporation does not exceed the transferor's basis or the original and/or acquisition cost of the property transferred, shall be the difference between the liability or liabilities assumed by the transferee corporation and the acquisition or original cost of the property transferred. On the other hand, where the total liabilities to be assumed by the transferee corporation exceed the original or acquisition cost of the property transferred, the excess shall be recognized as gain to the transferor and the value or cost basis of the stocks to the transferor shall be the difference between the original cost of the property subject to a liability (plus the gain recognized to the transferor) and the liability or liabilities assumed by the transferee corporation. (Sec. 34 (c) (5), supra ). Moreover, for financial reporting purposes, it is a generally accepted accounting practice to reflect in the financial statements the increase in value of fixed assets as a result of appraisal. This is in conformity with the Statement of Financial Accounting Standard No. 12 issued by the Board of Accountancy which establishes the standards of financial accounting and reporting when an entity elects to revalue its plan, property and equipment through appraisal. The appraisal increase or excess increment on the property over the stated cost is credited to an account called appraisal surplus to show that such is the result of an estimated increase in the value of the property (SEC Opinion, May 14, 1970). Thus, the transferor in reflecting such appraisal on said properties appropriately showed its Stockholder's Equity as appraisal surplus in the amount of P21,793,389.00. However, for tax purposes, the computation of the book value of the transferor's shares shall not include the effects of the appraisal because such appreciation in value is not even an accrual of income prior to the realization of such appreciation through sale or conversion of the property. (Sec. 38, Revenue Regulations No. 2) In this connection, you are further advised that in order that the parties to the exchange can avail of the non-recognition of gain 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 corporation 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 its interest in such properties, 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 preferences, 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 after the exchange with a complete description of each class of stock; b. The classes of stocks and numbers of shares issued to the transferor in the exchange; and c. The fair market value as of the date of the 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 above in order to facilitate the determination of gain or loss from a subsequent disposition of stocks/properties received in the exchange (BIR Ruling No. 171-81). The parties shall also cause to be annotated on the Transfer Certificate of Titles and at the back of the Certificate of Stocks, the date of the Deed of Transfer (exchange) was executed, the original historical cost of acquisition of the properties or shares of stock involved, and the fact that no gain or loss was recognized as a result of such exchange (spin-off). Moreover, pursuant to Section 196 of the Tax Code, as amended a conveyance of deed whereby land is assigned or transferred to the purchaser is subject to documentary stamp tax based on the consideration or value received or contracted to be paid for such realty. A stock in a corporation is a valuable consideration for transfer of real property. (Section 177, Documentary Stamp Tax Regulations) Accordingly, if a parcel of land, is exchanged with stocks in a corporation, as in this case, the latter is the consideration, the value of which shall be the basis of the documentary stamp tax on the Deed of Transfer executed to effect the aforesaid transfer (BIR Ruling No. 109-82 dated April 6, 1982). The value shall be the fair market value which shall not be less than the par value of the stocks. 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 (25%) of such unpaid amount which shall be in lieu of the interest prescribed in Section 249 of the same Code. cdtech Finally, the certificates of stocks to be issued by SMPI to PHIMCO are, in all probability original issues which are subject to the documentary stamp tax imposed by Section 175 of the Tax Code, as amended. After payment of the corresponding documentary stamp tax, the assets transferred by the transferor pursuant to the said exchange consisting of real properties may be registered by the Register of Deeds concerned in the name of the transferee corporation, SMPI. 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. Very truly yours, (SGD.) JOSE U. ONG Commissioner