Tax Consequence of the Proposed Reorganization of the Philippine Branch of a Corporation Into a Wholly-owned Subsidiary

October 18, 1991 BIR RULING NO. 210-91 34-C 2-C 102-89 210-91 Gentlemen : This refers to your letter dated June 7, 1990 requesting a ruling on the tax consequence of the proposed reorganization of the Philippine Branch of your client, Ault & Wiborg Company (Far East) into a wholly-owned subsidiary to be named BASF Coatings and Inks Philippines, Inc. (BCIP) cdta It is represented that your client, Ault & Wiborg Company (Far East) (Ault and Wiborg) established a duly authorized and licensed Philippine Branch; that its specific line of business involves manufacturing and marketing of all types of printing ink and industrial finishes, including automotive, metal, decorating, plywood, wood and leather finishes, paper, board and foil coatings, lacquers and everprint varnishes, textile colors and finishes, adhesives and sealants, synthetic resins and varnishes, pigment dispersions, marking and stencil inks and marking pigments, as well as marketing of graphic arts machinery and equipment, parts, accessories therefor and graphic arts supplies; that due to the worldwide corporate reorganization of Ault & Wiborg whose parent company was acquired by BASF Corporation in U.S.A., the Philippine branch has likewise to reorganize itself into a wholly-owned subsidiary which process will involve the transfer of the operations, markets, assets and liabilities of the Philippine Branch of Ault & Wiborg to the subsidiary, BCIP; that the assets to be transferred to BCIP will consist mainly of plant and equipment, inventories, the assigned capital of the Philippine Branch, and unremitted branch profits; that in turn, BCIP will issue to Ault & Wiborg 200,000 common shares and 550,000 preferred shares both with a par value of P100.00 per share, or a total of P20,000,000.00 common stock and P55,000,000.00 preferred stock which, combined, represent 100% of the authorized, subscribed and paid-up capital of BCIP; and that after the subsidiary, BCIP shall have been duly organized and registered by the Securities and Exchange Commission, it shall take over the business of the Philippine Branch of Ault & Wiborg, which branch will then cease to do business in the Philippines and its license, accordingly withdrawn. In reply thereto, I have the honor to inform you that pursuant to Section 34, paragraph (c) (2) (c) of the Tax Code as amended by Republic Act No. 4522 and P.D. 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 corporation of which as a result of such exchange said person, alone or together with others, not exceeding four persons, gains control of said corporation. The statutory requirement that "said person, alone or together with others, not exceeding four persons, gains control of said corporation" shall be understood to mean that any number of persons may exchange property for stocks provided that as a result of the transaction, not more than five transferors would control the corporation. The term "control" shall mean ownership of stocks in a corporation possessing at least fifty-one percent (51%) of the total voting power of all classes of stocks entitled to vote. Control is determined by the amount of stock received, i.e., subscribed, whether for property or for 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. Accordingly, no gain or loss shall be recognized both to the transferor and the transferee corporation on the transfer by Ault & Wiborg of the operations, markets, assets and liabilities of its branch in exchange for the shares of stock of the subsidiary considering that as a result of the said exchange, Ault & Wiborg will gain control of the subsidiary. It should be emphasized, however, that Section 34 (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 transactions of the properties or of the stocks involved in the exchange, the original or historical cost of the properties or the stock 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 of the transferor of the properties exchanged therefor; and that the cost basis to the transferee of the properties exchange for stocks shall be the same as it would be in the hands of the transferor. [Section 34 (c) (5) (a) and (b), Tax Code as amended by Presidential Decree No. 1773]. cdtech 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 34 (c) (2) (c) of the Tax Code, as amended, they should comply with the requirements hereunder mentioned. a) The transferor must file with its income tax return for the taxable year in which the exchange was consummated a complete statement of all facts pertinent to the exchange, including; 1) A description of the properties transferred, or of its 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 the transfer; 2) The kind of stock received and preference 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 the 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 transferor; 2) A statement of the original acquisition cost or other basis of the properties in the hands of the transferor and the adjusted cost basis thereof at the time of the transfer; and, 3) Information with respect to the capital stock of the corporation, including: (a) The total issued and outstanding capital stock immediately prior to and immediately after the exchange, with a complete description of each class of stocks; (b) The classes of stocks and number of shares issued to the transferor in the exchange; and (c) The fair market value as of the date of exchange of the capital stock issued to the transferor. 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 in order to facilitate the determination of gain or loss from a subsequent disposition of stocks/properties received in the exchange. The parties shall also cause to be annotated on the Transfer Certificate of Titles, if any, and at the back of the certificate of stocks, the date the deed of exchange was executed, the original or historical cost of acquisition of the properties or shares of stock involved, and the fact that no gain or loss was recognized as a result of such exchange. Since among the assets to be transferred consist of the plant and equipment which are considered real properties, the transfer thereof is subject to the documentary stamp tax imposed under Section 196 of the Tax Code. The tax shall be based on the value of the stocks as the consideration corresponding to the said real properties. (BIR Ruling No. 109-82) Said value shall be the fair market value which shall not be less than the par value of the stock. Moreover, if the certificates of stocks issued by the subsidiary are original issues, the same are subject to the documentary stamp tax imposed by Section 175 of the Tax Code, as amended. Furthermore, under Section 248 (d) in relation to Section 173 of the Tax Code as amended by Executive Order No. 273, in case of failure to affix the proper documentary stamps to a document or instrument, there shall, for every violation be imposed, in addition to the amount of documentary stamp tax required to be paid an amount equivalent to twenty-five percent of such unpaid amount which shall be in lieu of the interest prescribed in Section 249 of the same Code. Finally, the exchange of real properties with shares of stock is not subject to VAT because neither real property nor securities, e.g., shares of stock come within the purview of VAT-taxable goods as defined in Section 2 (p) of Revenue Regulations No. 5-87.However, with respect to goods on hand whether capital goods, stock-in-trade, supplies or materials as of the date of the reorganization, the transaction is one of the "deemed sale" of personal property as contemplated in Section 4 (E) (i) of the same Regulations implementing Section 100 (b) of the Tax Code, as amended by Executive Order No. 273; hence, subject to the 10% VAT. cdta This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation it will be disclosed that the facts are different, and/or any of the requirements imposed in this letter are not complied with, then this ruling shall be considered null and void. Very truly yours, (SGD.) JOSE U. ONG Commissioner