BIR Ruling No. 194-15

June 10, 2015 BIR RULING NO. 194-15 Sections 100 & 99 (B) of NIRC; RMC 025-11; RR 6-2008; BIR Ruling No. 557-12; BIR Ruling No. 154-12; BIR Ruling No. 015-12 Angara Abello Concepcion Regala & Cruz Law Offices 22/F ACCRALAW Tower, Second Avenue corner 30th Street Crescent Park, West Bonifacio Global City 0399 Taguig, Metro Manila Attention : Attys. Iolanda B. Abella Karen H. Gaviola-Climaco and Patricia O. Ko Gentlemen : This refers to your letter dated October 25, 2013 requesting on behalf of your client, Lexmark International Technology, S.A. ("Lexmark") for confirmation that the sale of Lexmark of its shareholdings in Lexmark International Philippines, Inc., now Funai Electric Cebu, Inc. (the "Target"), to Funai Electric Co., Ltd. ("Funai") is not subject to donor's tax under Section 100 of the National Internal Revenue Code ("Tax Code") since the said sale is an arm's length business transaction made for legitimate business purposes, and absent any donative intent on the part of Lexmark. Background Lexmark is a joint stock company duly organized and existing under the laws of Switzerland and the registered and beneficial owner of one hundred percent (100%) of the total outstanding capital stock of the Target consisting of Three Million Six Hundred and Forty Four Thousand, One Hundred and Forty Four (3,644,144) shares (including five (5) shares in the hands of Lexmark's nominee directors), with par value of Php100 per share (the "Subject Shares"). The Target is a domestic corporation engaged in the manufacturing of inkjet printer, duly organized under Philippine laws and registered with the Philippine Economic Zone Authority. Lexmark subscribed to the Subject Shares by paying up the amount of Two Billion, Seven Hundred Sixty Five Million Six Hundred Fifty Five Thousand Nine Hundred and Ten Pesos (P2,765,655,910.00). This paid-up capital has been consistently reflected in the audited financial statements of the Target as share capital of P364,414,400.00 and the balance of the paid-up capital amounting to P2,401,241,510 as share premium forming part of the Target's equity. Accordingly, Lexmark's paid-up cost per share is at Seven Hundred Fifty Eight Pesos and Ninety Three Centavos (P758.93). Unfortunately, the advent of digital devices such as smartphones and tablet computers allowing paperless storage and retrieval of data resulted in the decline in the use of computer printers. This had a negative impact on all computer printer manufacturers, such as the Target, which experienced a decline in revenue and profit margins. Lexmark itself experienced a 61% decline in its earnings for the third quarter of 2012. This decline caused Lexmark to undergo a global restructuring, which led to its decision to exit from the inkjet business and the termination of the operations of the Target. CAIHTE On August 30, 2012, Lexmark, following the formal announcement of restructuring made by Lexmark International, Inc., as a listed company in the New York Stock Exchange on August 28, 2012, announced its intention to close the operations of the Target by the year 2015. This announcement was made through a press conference held by Lexmark's executives. During the said press conference, Lexmark revealed that it was withdrawing from the inkjet printer business due to the popularity of digital devices that have lowered the market demand for personal printers, and resulted in low return of investment and profitability. The closure of operations of the Target was expected to result in the loss of employment of its 1,100 employees as well as the loss of revenues to both the National and Local Government, particularly the City of Lapu-Lapu where the Target held its manufacturing operations. Sometime early 2013, however, Lexmark received an offer from a Japanese Company, Funai, interested in acquiring Lexmark's inkjet printer facilities and operations. Having weighted the consequences of a sale of its shareholdings in the Target as against an outright closure of the latter, and taking into consideration not only the economic benefits of such sale but also the welfare of its employees, Lexmark decided to sell rather than to close down the Target. Pursuant to the Deed of Assignment of Shares executed by Lexmark and Funai, the parties agreed on a purchase price for the Subject Shares amounting to US Dollars: Sixty Million (USD60,000,000.00) or at a selling price equivalent to P2,468,400,000.00, or P677.36 per share (the "Purchase Price"). The sale resulted in a loss on the part of Lexmark of 297,255,910.00. It is also worth mentioning that while the paid-up value per share of the Subject Shares is P758.93, the Subject Shares had an adjusted fair market value at the time of the sale to Funai of P739.15 per share, an amount less than the paid-up value of the said shares. In other words, even where the selling price per share was made equivalent to the adjusted fair market valuation, Lexmark still remain at a loss position. It is beyond cavil that the Purchase Price is the "best price" or the "fair market value" ( i.e. , the price at which the seller is willing to sell, and the buyer is willing to purchase) of the Subject Shares as determined by both Lexmark and Funai. The sale of the Subject Shares at a loss was not made to avoid the payment of taxes but was made necessary due to the following circumstances: (a) the Target was one of Lexmark subsidiaries with the lowest return of investment; (b) Lexmark had already intended to close the Target's operations, and divest itself of its inkjet printer facilities, and had in fact already proceeded on the assumption that the Target's closure of operations would be completed by the year 2015. Hence, Lexmark had every expectation of losing the full amount of its investment in the Target and no expectation of being able to provide a stable return of investment ration that would entice third persons to enter a profitable sale transaction with Lexmark; and (c) the market demand for the manufacturer of inkjet printers has passed its maturity, and is shrinking with the proliferation of laserjet printers and other alternatives such as digital devices, which had a negative impact on the long term profitability of operating an inkjet printer manufacturing facility. In sum, the sale of the Subject Shares is an ordinary commercial arms-length transaction motivated by legitimate business reasons. The Purchase Price was arrived at after negotiations in good faith by two unrelated parties, each looking after its own interests. It goes without saying that there was no intention to donate on the part of Lexmark when it sold the Subject Shares to Funai. In reply, please be informed that Section 99 (B) of the Tax Code, as amended, imposes a 30% donor's tax on gifts made to a stranger including a corporation. The tax is payable on gratuitous transfers and on transfers with insufficient consideration. Relative thereto, Section 100 of the Tax Code provides that: "SEC. 100. Transfer for Less Than Adequate and Full Consideration. Where property, other than real property referred to in Section 24 (D), is transferred for less than an adequate and full consideration in money or money's worth, then the amount by which the fair market value of the property exceeded the value of the consideration shall, for the purpose of the tax imposed by this Chapter, be deemed a gift, and shall be included in computing the amount of gifts made during the calendar year." DETACa Based on the above, where property is transferred for less than an adequate and full consideration in money or money's worth, the amount by which the fair market value of the property exceeded the value of the consideration shall be considered a gift subject to the donor's tax. Prescinding from the above-mentioned provisions, it is undisputed that there is no mention of any exempt transaction. The provisions are clear and free from any doubt or ambiguity. Hence, there is no room for interpretation. There is only room for application. (Cebu Portland Cement Co. vs. Municipality of Naga, Cebu, et al., G.R. Nos. 24116-17, August 22, 1968). The Supreme Court Decision in the case of Commissioner of Internal Revenue vs. B.F. Goodrich Phils., Inc. [now Sime Darby International Tire Co., Inc.] and the Court of Appeals, G.R. No. 104171, February 24, 1999 which was used as reference in various BIR Rulings invoked is not applicable in this case because the issue resolved in that case was about prescription. It is noteworthy to state a significant portion of the said Decision, to wit: "Ineludibly, the BIR failed to show that private respondent's 1974 return was filed fraudulently with intent to evade the payment of the correct amount of tax. Moreover, even though a donor's tax, which is defined as 'a tax on the privilege of transmitting one's property or property rights to another or others without adequate and full valuable consideration', is different from capital gains tax, a tax on the gain from the sale of the taxpayer's property forming part of capital assets, the tax return filed by private respondent to report its income for the year 1974 was sufficient compliance with the legal requirement to file a return. In other words, the fact that the sale transaction may have partly resulted in a donation does not change the fact that private respondent already reported its income for 1974 by filing an income tax return." Section 100 of the Tax Code is implemented by Revenue Regulations (RR) 6-2008, as amended by RR 6-2013, insofar as the property involved are shares of stocks. Section 7 (c) (c.1) (c.1.4) of the Regulations provides as follows: "(c) Determination of Amount and Recognition of Gain or Loss. (c.1) In the case of cash sale, the selling price shall be the consideration per deed of sale. xxx xxx xxx (c.1.4) In case the fair market value of the shares of stock sold, bartered, or exchanged is greater than the amount of money and/or fair market value of the property received, the excess of the fair market value of the shares of stock sold, bartered or exchanged over the amount of money and the fair market value of the property, if any, received as consideration shall be deemed a gift subject to the donor's tax under Section 100 of the Tax Code, as amended." (Underscoring supplied) Further, Section 7 (c.2) (c.2.1) (c.2.2) of the same Regulations, as amended, provides that: aDSIHc "(c.2) Definition of 'fair market value' of the Shares of Stock. For purposes of this Section, 'fair market value' of the share of stock sold shall be: xxx xxx xxx (c.2.1) In the case of listed shares which were sold, transferred, or exchanged outside of the trading system and/or facilities of the Local Stock Exchange, the closing price on the day when the shares are sold, transferred, or exchanged. When no sale is made in the Local Stock Exchange on the day when the listed shares are sold, transferred, or exchanged, the closing price on the day nearest to the date of sale, transfer or exchange of the shares shall be the fair market value. (c.2.2) In the case of shares of stock not listed and traded in the local stock exchanges, the value of the shares of stock at the time of sale shall be the fair market value. In determining the value of the shares, the Adjusted Net Asset Method shall be used whereby all assets and liabilities are adjusted to fair market values. The net of adjusted asset minus the liability values is the indicated value of the equity. For purposes of this section, the appraised value of real property at the time of sale shall be the higher of (1) The fair market value as determined by the Commissioner, or (2) The fair market value as shown in the schedule of valued fixed by the Provincial and City Assessors, or (3) The fair market value as determined by Independent Appraiser." Based on the above provisions, in case the consideration of the sale of shares of stock listed or not listed and traded through the local stock exchange is lower than the fair market value (FMV)/book value of the shares, the difference between the book value and the selling price of the shares is considered a gift subject to donor's tax under Section 100 of the Tax Code. Corollary to this is Revenue Memorandum Circular (RMC) No. 025-11, dated March 2, 2011, in which, this Office revoked BIR Ruling No. [DA-(DT-065) 715-09] dated November 27, 2009 for lack of factual and legal basis and clarified that Section 100 of the Tax Code does not admit any exception. The RMC, thus, provides: "It is noteworthy to state that the above provisions (Section 100 of the Tax Code) do not mention of any exempt transactions. The above provision is clear and free from any doubt and/or ambiguity. Hence, there is no room for interpretation. There is only room for application. (Cebu Portland Cement Co. vs. Municipality of Naga, Cebu, et al., G.R. Nos. 24116-17, August 22, 1968) In City of Iloilo, et al. vs. Smart Communications, Inc., G.R. No. 167260, February 27, 2009 , the Supreme Court held that: The basic principle in the construction of laws granting tax exemptions has been very stable. As early as 1916, in the case of Government of the Philippine Islands v. Monte de Piedad, this Court has declared that he who claims an exemption from his share of the common burden of taxation must justify his claim by showing that the Legislature intended to exempt him by words too plain to be beyond doubt or mistake. This doctrine was repeated in the 1926 case of Asiatic Petroleum v. Llanes , as well as in the case of Borja v. Commissioner of Internal Revenue (CIR) decided in 1961. Citing American jurisprudence, the Court stated in E. Rodriguez, Inc. v. CIR : ETHIDa The right of taxation is inherent in the State. It is a prerogative essential to the perpetuity of the government; and he who claims an exemption from the common burden, must justify his claim by the clearest grant of organic or statute law . . . When exemption is claimed, it must be shown indubitably to exist. At the outset, every presumption is against it. A well-founded doubt is fatal to the claim; it is only when the terms of the concession are too explicit to admit fairly of any other construction that the proposition can be supported. In the recent case of Digital Telecommunications, Inc. v. City Government of Batangas, et al. , we adhered to the same principle when we said: A tax exemption cannot arise from vague inference. . . Tax exemptions must be clear and unequivocal. A taxpayer claiming a tax exemption must point to a specific provision of law conferring on the taxpayer, in clear and plain terms, exemption from a common burden. Any doubt whether a tax exemption exists is resolved against the taxpayer." In view of the foregoing, this Office is of the opinion, as it hereby rules, that the excess of the fair market value of the shares of stock sold over its selling price is a taxable donation subject to the 30% donor's tax under Section 99 (B) of the Tax Code, in relation to Section 100 of the same Code. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue