"Accumulated and Current Equity in the Investee's Net Earnings"

June 5, 1989 BIR RULING NO. 117-89 28 000-00 117-89 Gentlemen : This refers to your letter dated April 3, 1989 stating that your client, Emar Corporation, a Philippine corporation sold its shares of stock in Philippine Investment Management Corporation (PHINMA), likewise a domestic corporation, the shares of which are not listed nor traded in the stock exchange of the Philippines; that Emar sold 2,500 shares of stock at 200 per share; that the total consideration of the sale is P500,000; that the cost or basis of Emar in the 2,500 PHINMA shares is P122,250 which if computed on a per share basis is P48.90; that out of said transaction Emar realized capital gains in the total amount of P337,750.00; that PHINMA paid capital gains tax of P65,500 and documentary stamp tax of P625; that the payment made by PHINMA of the capital gains tax is based on total selling price less cost; that the audited Financial Statement of PHINMA for the year ending October 1988 which is the fiscal year nearest to the date of sale shows a share in revaluation increment in property in the amount of P114,004,128.00 as well as retained earnings of P159,705,239.00; that the reflection on PHINMA's financial statement of the said share in revaluation increment in property, plant and equipment of the investees and share of PHINMA in the retained earnings of the investees is mandated by equity accounting under Financial Accounting Standard No. 11 wherein it is provided that an investor shall report in its Financial Statement the revaluation increment in the property of the company where it has an investment as well as its share in the retained earnings of the investee even prior to the receipt thereof as dividends; that the said revaluation increment is more of a financial window dressing because the revaluation does not result from taxable gains arising from disposition nor acquisition of new properties nor from improvement or repairs of the property, plant and equipment being revalued; that it's just a mode of upgrading the current fair market value of the property based on current appraisal; that PHINMA's retained earnings of P159,705,239.00 reflected in its financial statements was determined by the application of the equity method of accounting as provided for in Financial Accounting Standard No. 11; that it is not the actual retained earnings of PHINMA because included therein are the prior years accumulated equity in the investee's net earnings in the amount of P37,066,713.00 and the current year equity in the net earnings of the investees in the amount of P80,496,131.00 or a total amount of equity in the investees net earnings of P117,562,844.00; that to arrive at the actual retained earnings of the company the investee net earnings of P117,562,844.00 must be deducted from the retained earnings in the amount of P159,705,239.00; that the difference in the amount of P50,733,932.00 represents the actual retained earnings of PHINMA; and that such subtraction has to be made because there has been no declaration of dividends made by the investees of the amount of P117,562,844.00 which was imputed to PHINMA as its share in the equity of the said investees. cdtech In connection therewith, you now request a ruling as to whether or not the "accumulated and current equity in the investees net earnings" i.e., the imputation but without dividend declaration of the earnings of the subsidiary or sister corporation to the parent or stockholder corporation in the amount of P117,562,844.00 and the "share in revaluation increment" i.e., increase in value of property because of reappraisal thereof at current value without sale or exchange in the amount of P114,004,128.00 should be treated as part of gross income and therefore should be included in the computation of the book value of the PHINMA shares for purposes of the capital gains tax on the sale of said shares. In reply thereto, I have the honor to inform you that appreciation in value of property is not even an accrual of income to a taxpayer prior to the realization of such appreciation through sale or conversion of the property (Sec. 38, Revenue Regulations No. 2). Such being the case, the "accumulated and current equity in the investee's net earnings" i.e., the imputation but without dividend declaration of the earnings of the subsidiary or sister corporation to the parent or stockholder corporation in the amount of P117,562,844.00 and the "share in revaluation increment" i.e., increase in value of property because of reappraisal thereof at current value without sale or exchange in the amount of P114,004,128.00 are not considered as income and should not therefore be included in the determination of the book value of the PHINMA shares for purposes of the capital gains tax on the sale of said shares. Very truly yours, (SGD.) JOSE U. ONG Commissioner