Tax Consequence of the Transfer of Property to a Corporation by a Person in Exchange for Stock

May 18, 1987 BIR RULING NO. 131-87 35 (c) (2) (c) 069-87 131-87 M a d a m : This refers to your letter dated March 30, 1987 requesting tax clearance for the spouses Jesus Magsaysay and Miguela Magsaysay in connection with the exchange of real property owned by them and the shares of stock issued by Jessmag, Inc. It appears that the spouses Jesus Magsaysay and Miguela Magsaysay have unpaid subscription Jessmag, Inc. in the amount of P2,253,395.74, that to pay for such subscription, they executed a Deed of Assignment dated January 16, 1984 transferring ownership/Title of certain real properties to Jessmag, Inc., viz: Description/TCT Fair Market No. of Property Location Value 1. Condominium Unit Manila P500,000.00 (Unit F, Legazpi Towers) CCT No. 3821 2. TCT No. 103745 Mandaluyong P800,000.00 Lot 16, Blk. 53 3. TCT No. 1724 Pasay City P453,395.74 Lot No. 4663 & TCT No. 3751 Lot No. 4664 4. TCT No. 111248 Kaingin, Q.C. P500,000.00 Lot No. 4533-B & TCT No. 111249 Lot No. 4553-C TOTAL P2,253,395.74 ========== that after the transfer, the spouses Jesus P. Magsaysay and Miguela Magsaysay gained control of the corporation by owning 53.25% of the authorized capital stock, and that the spouses availed of the compromise settlement for unpaid documentary stamp tax on said transaction by paying P5,407.80, or 30% of their documentary stamp tax liability thereon pursuant to Executive Order No. 44. In reply thereto, please be informed that pursuant to Section 35, 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 others not exceeding four person, 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. Control is determined by the amount of stocks received i.e., subscribed and paid up, whether for property or services by the transferor or transferors. 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. aisadc Accordingly, no gain or loss shall be recognized both to the transferors and the transferee corporation on the transfer by the spouses Jesus F. Magsaysay and Miguela Magsaysay of their real properties as payment for the unpaid subscription to Jessmag, Inc., considering that after the exchange of properties and as a result of the said exchange, the transferors will gain control of the said corporation. 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 received in the exchange, the original or the 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)(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 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 for all facts pertinent to the exchange, including: 1. A description of the properties transferred, or of their 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 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 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 transferors; 2. A statement of the original acquisition cost or other basis of the properties in the hands of the transferors and the adjusted cost basis thereof at the time of transfers; and 3. Information with respect to the capital stock of that corporation including: a. the total issued and outstanding capital stocks 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; and c. the fair market value as of the date of exchange of the capital stock issued to the transferors. 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. Very truly yours, (SGD.) EUFRACIO D. SANTOS Deputy Commissioner