Whether Gain or Loss Shall be Recognized on the Issuance of Shares in Exchange for Cessation of Membership Rights

December 8, 1998 BIR RULING NO. 172-98 40 (C) (2) (b) & (C) (6) (b) (ii)-000-00-172-98 SGV & Co. 6760 Ayala Avenue 1226 Makati City Attention: Mr . Joel L . Tan-Torres Tax Division Gentlemen : This refers to your letter dated September 4, 1998 requesting on behalf of your client, SUN LIFE ASSURANCE COMPANY OF CANADA (SLAC) , for a ruling that no gain or loss shall be recognized on the issuance of shares by a newly incorporated holding company to the eligible policyholders of SLAC in exchange for the cessation of their membership rights and interests in SLAC as a mutual company. It is represented that SLAC is a mutual life insurance company organized and existing under the laws of Canada; that it was originally incorporated with share capital by Special Act of Parliament of Canada in 1865 but was converted into a mutual company in 1962; that its Special Act was replaced in 1992 by letters patent issued under the Canadian Insurance Companies Act (ICA); that SLAC carries on insurance business in Canada and internationally through branches, mainly in the United States, the United Kingdom, the Philippines and Hongkong; that SLAC has been doing business in the Philippines through its branch office since 1895; that SLAC has life insurance, investment management, mutual fund management, banking, trust and other subsidiaries established in various jurisdictions around the world; that its insurance products include policies which entitle policyholders to participate in the profits of the company (participating policies) and policies which do not so entitle the holders; that being a mutual life insurance company, SLAC has no issued and outstanding shares; that policyholders, through the purchase of participating policies, aside from the usual contractual rights to payment under the life insurance policy, acquire other proprietary rights and interests in SLAC, akin to that of a shareholder of a stock corporation; that these rights include the right to vote at meetings and to elect directors, the right to receive dividends or bonuses when declared by the Board of Directors and the theoretical right to participate in the remaining surplus of SLAC upon its liquidation; and that although the ICA does not explicitly use the term "member" in relation to mutual insurance companies, these rights can generally be described as "membership rights". It is further represented that on January 27, 1998, the Board of Directors of SLAC announced that it had requested management to develop a plan for a worldwide reorganization whereby SLAC would convert from a mutual insurance company into an insurance with common share capital through a process known as "demutualization"; that "demutualization" is a transactions by which a mutual company converts into a corporation with share capital the main purpose of which is to simplify the capital structure of the mutual insurance company, to enhance the company's ability to raise equity capital and to permit its eligible policyholders to convert their membership rights into a marketable equity security; that accordingly, the eligible policyholders who possess membership rights will surrender these rights in the mutual company in exchange for shares of the company or a company that holds all of the shares of the insurance company; that typically, the shares received by the eligible policyholders are listed on one or more exchanges to facilitate their sale; that SLAC's demutualization will take place in accordance with regulations to be promulgated under Section 237 of the ICA wherein the SLAC's counsel expects that "eligible policyholders" will be defined as participating and voting policyholders whose policies were in force on a certain specified date; that as part of the process, a holding company organized under the laws of Canada (CanHoldCo) will be established in order to accomplish several business objectives for SLAC; that at a general level, the creation of holding company will result in the optimal corporate structure for the Sun Life group of companies which will afford the greatest on-going flexibility for future financing which can be done through CanHoldCo or SLAC; that it also permits the non-life insurance business to be carried on in subsidiaries of CanHoldCo that are not subject to insurance company regulation; and that SLAC's demutualization will be effected in the following manner: "(a) CanHoldCo will issue shares to all SLAC's eligible policyholders worldwide, including those in the Philippines, in exchange for the surrender of their membership rights and interests in SLAC as a mutual company; "(b) SLAC will issue its shares to CanHoldCo; and "(c) the shares of CanHoldCo will then be listed on several exchanges worldwide. In reply, please be informed that pursuant to Section 40(C)(2)(b) of the Tax Code of 1997 which provides that "SEC. 40. Determination of Amount and Recognition of Gain or Loss . "xxx xxx xxx "(C) Exchange of Property . "xxx xxx xxx "(2) Exception . No gain or loss shall be recognized if in pursuance of plan of merger or consolidation "(a) . . . "(b) A shareholder exchanges stock in a corporation, which is party to the merger or consolidation, solely for the stock of another corporation also a party to the merger or consolidation." LexLib The foregoing provision shall apply in the instant case considering that in the course of demutualization, the policyholders will have to surrender their membership interests in the Company as a mutual company, in exchange for the publicly-traded shares issued in Canada by the new Sun Life Assurance Company or CanHoldCo. For this purpose, the eligible policyholders of SLAC may be considered as shareholders contemplated under the foregoing provision, it being defined in Section 22(M) of the same Tax Code of 1997 that "(M) The term 'shareholders' shall include holders of a share/s of stock, warrant/s and/or option/s to purchase shares of stock of a corporation, as well as a holder of a unit of participation in a partnership (except general professional partnership), in a joint-stock company, a joint account, a taxable joint venture or a member of an association, recreation or amusement club (such as golf, polo or similar clubs), and a holder of a mutual fund certificate , a member in an association, joint stock company, or insurance company ." (Emphasis supplied.) Furthermore, the steps to be taken to effect demutualization of SLAC constitute a " de facto merger or consolidation" under clause (ii) of Sec. 40(C)(6)(b) of the Tax Code of 1997, thus "(b) The term ' merger' or ' consolidation' when used in this Section, shall be understood to mean: (i) . . ., or (ii) the acquisition by one corporation of all or substantially all the properties of another corporation solely for stock; Provided, That for a transaction to be regarded as merger or consolidation within the purview of this Section, it must be undertaken for a bona fide business purpose and not solely for the purpose of escaping the burden of taxation: Provided , further , That in determining whether a bona fide business purpose exists, each and every step of the transactions shall be considered and the whole transaction or series of transactions shall be treated as a single unit: Provided , finally , That in determining whether the property transferred constitutes a substantial portion of the property of the transferor, the term 'property' shall be taken to include cash assets of the transferor." In the light of the foregoing and considering that the demutualization is clearly for a bona fide business purpose, the same falls within the purview of Sec. 40(C)(2) of the Tax Code of 1997. Such being the case, the receipt of CanHoldCo shares by eligible SLAC policyholders shall not be subject to tax. The basis of the CanHoldCo shares so received shall be the same as their basis of the policyholders membership rights in the Company which they surrendered. Likewise, the basis of the shares of SLAC issued to CanHoldCo shall be same as the basis of the shares issued by CanHoldCo to the eligible policyholders of SLAC in exchange for the surrender of their membership rights in SLAC as a mutual company. llcd It should be emphasized, however, that Section 40(C)(2) of the Tax Code of 1997, merely defers recognition of the gain or loss from such transaction, for in determining the gain or loss from a subsequent transaction of the shares of stock involved in the exchange, the original or historical cost of the stocks is considered. Thus, if the Filipino shareholders later sell or exchange the shares of stock acquired by them in the exchange, they shall be subject to income tax on gains derived from such sale or exchange, taking into consideration that the cost basis of the shares shall be the same as the original cost or adjusted cost basis to the transferor. dctai This ruling is being issued on the basis of the foregoing facts as represented and without prejudice to whatever requirements, if any, which may be imposed or presently imposed by the Securities and Exchange Commission or other competent authorities in this jurisdiction with respect to the surrender of the Filipino policyholders' membership rights in exchange for shares of stock contemplated in the transaction. It is likewise understood that if upon investigation it shall be disclosed that the facts are different than that as represented, then this ruling shall be considered null and void. Very truly yours, (SGD.) BEETHOVEN L. RUALO Commissioner of Internal Revenue