Subsequent Disposition of Shares of Stock Previously Acquired in a Tax-free Exchange is Subject to Capital Gains Tax Not to Corporate Income Tax

September 11, 1991 BIR RULING NO. 186-91 24 (e) (2) (A) 000-00 186-91 Gentlemen : This refers to your letters dated July 24 and August 15, 1991 requesting that an order be issued by this Office directing the Regional Director of Revenue Region No. 4-A to issue a tax clearance or certificate authorizing registration of Swedish Match Phils. Inc. (SMPI) Stock Certificates from Phimco Industries, Inc. (PHIMCO) to Swedish Match, N.V. (SMNV) in the stock and transfer book of SMPI pursuant to BIR Ruling No. 106-91 dated June 17, 1991; and a ruling confirming your client's (PHIMCO) position that in the transfer of the said SMPI shares from PHIMCO to SMNV, the gain derived therefrom is subject to the capital gains tax of 10% under Section 24 (e) (2) of the Tax Code, and not to the ordinary corporate income tax of 35%. cdta Records show that this Office in BIR Ruling No. 106-91 opined that no gain or loss shall be recognized in the transfer of all operating stock of the Lighter Division of PHIMCO to SMPI in exchange for the latter corporation's shares as a consequence of which PHIMCO gain 100% control of SMPI; that the total book value of the operating assets of the lighter division transferred by PHIMCO to SMPI was P253,094,833.00 which amount was inclusive of liabilities totalling P82,026,533.00 incurred directly from the operations of said division and a revaluation increment of P21,793,389.00 on the value of the property and equipment of P92,771,453.00; that in consideration of the said transfer of assets and liabilities, PHIMCO received a total of 1,710,683 SMPI shares valued at P171,068,300.00 which amount represents the value of the assets less the liabilities or accounts payable of P82,026,533.00; that on June 20, 1991, PHIMCO assigned the 1,710,683 SMPI shares which are not listed nor traded in the local stock exchange and which is the entire outstanding shares of SMPI in favor of SMNV for a total consideration of P171,752,573.20; that based on the foregoing facts and figures, PHIMCO files on July 1, 1991 the capital gains tax returns on said stock transaction reflecting the following entries: Selling Price P171,752,573.20 Cost (net of revaluation increment) 149,274,911.00 Net Gain P22,477,662.20 ============= for which it paid the amount of P4,485,532.44 as capital gains tax; that despite the said payment including that of the corresponding documentary stamp tax due on the said transaction (stock), Revenue District Officer, Atty. Renato L. Manalili, of Revenue District No. 26 of Revenue Region No. 4-A refused to issue the corresponding tax clearance certificate and totally ignored the aforecited BIR Ruling issued in favor of your client, insisting that the tax due on the said transfer or disposal of the SMPI shares is the corporate income tax of 35% imposed under Section 24(a) of the Tax Code and not the capital gains tax of 20% prescribed under Section 24 (e) (2) (A) of the same Code and proposing to assess your client the amount of P6,968,248.71 based on his said opinion; but that, you are of the opinion that the applicable tax under the circumstance is the capital gains tax prescribed under Section 24 (e) (2) (A) of the Tax Code, because it specifically covers stock transactions involving shares which are not listed and traded through a local stock exchange. Moreover, in connection with the spin-off of your client's light division into a distinct and separate entity under the corporate name Swedish Match Phils., Inc. (SMPI), subject matter of the aforementioned BIR Ruling whereby your client transferred all of the operating assets of its lighter division in favor of SMPI, your client likewise paid the aggregate amount of P1,834,597.29 as value-added tax on the inventories that were transferred to SMPI. In a nutshell, the sole issue now to be resolved is whether the gain derived from the subsequent transfer/assignment in favor of SMNV by PHIMCO of its 1,710,683 SMPI shares previously acquired by the corporate-assignor in a tax-free exchange and which are not listed nor traded in the local stock exchange, should be taxed under Section 24 (a) or under Section 24 (e) (2) (A) of the Tax Code. Stated differently, what is the income tax rate applicable on the gains realized/derived from the subsequent sale or transfer of the shares of stock previously acquired by the seller or transferor in a tax-free exchange and which are not now listed nor traded through a local stock exchange? In reply, please be informed that this Office has consistently ruled as in BIR Ruling No. 106-91 that Section 34 (c) (2) (c) of the Tax Code merely defers recognition of gain or loss from said exchange transaction for in determining the gain or loss from a 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 stocks shall be the same as it would be in the hands of the transferor. (Sec. 34 (c) (5) (a) and (b), NIRC as amended by P.D. 1773) It is to be noted that tax-free exchanges under Section 34 (c) (2) of the Tax Code merely defer recognition of gain or loss from such transactions, not the tax due . In other words, as of the time of the exchange which is tax-free, there is actually no gain or loss to tax or deduct, as the case may be. The gain or loss, if ever, is recognized only upon subsequent transaction which may be a sale or exchange or disposition of the properties or of the stocks involved in the exchange. Consequently, the law providing for the taxability or prescribing the applicable tax rate at the time of actual sale or exchange or disposition of the properties or shares shall govern and not such law which is effective at the time of the tax-free exchange . It is axiomatic that the law in force as of the time of the taxable event shall govern. Thus, the applicable law, Section 24 (e) (2) (A) of the Tax Code provides that capital gains realized from the sale, exchange or disposition of shares of stocks in any domestic corporation shall be taxed as follows: "(A) Net capital gains as defined in Section 33 (a) (2) of the same Code realized during each taxable year from sale or exchange or other disposition of shares of stock not traded through a local stock exchange: Not over P100,000 10% Over P100,000 20% xxx xxx xxx Moreover, Section 24 (a) imposing the corporate income tax of 35% provides that unless otherwise provided the 35% tax prescribed therein shall be imposed upon the taxable income received during each taxable year from sources within and without the Philippines by every corporation organized in, or existing under the laws of the Philippines. Hence, the aforementioned subsequent disposition of SMPI shares of your client in favor of SMNV is subject to Section (24) (e) (2) (A) of the Tax Code which specifically imposes a capital gains tax on such stock transaction and not to the corporate income tax of 35% under Section 24 (a) which could only be imposed if there is no tax rate otherwise specifically applicable to a particular transaction. In view of the foregoing considerations, your opinion to the effect that the subsequent disposition in favor of SMNV by your client PHIMCO of its SMPI shares of stock previously acquired in a tax-free exchange under Section 34 (c) (2) (c) of the Tax Code, is subject to the capital gains tax imposed under Section 24 (e) (2) (A) of the Tax Code and not to corporate income tax imposed under Section 24 (a) of the same Code is hereby confirmed considering that such SMPI shares of your client are not listed nor traded through the local stock exchange. Accordingly, a copy of our letter of even date is enclosed herewith directing the Regional Director, Revenue Region No. 4-A to issue a tax clearance or a certificate authorizing the registration of Swedish Match Phils., Inc. (SMPI) Stock Certificates from PHIMCO to Swedish Match N.V. in the Stock and Transfer Book of SMPI, pursuant to BIR Ruling No. 106-91 dated June 17, 1991. cdtech Very truly yours, (SGD.) EUFRACIO D. SANTOS Deputy Commissioner (Officer-in-Charge)