Tax Consequences of the Transfer of Assets of a Domestic Corporation to a New Corporation in Exchange for the Latter's Shares of Stock

October 31, 1991 BIR RULING NO. 222-91 34 (c) (2) (c) 221-90 222-91 Gentlemen : This refers to your letter dated August 12, 1991 stating that San Miguel Corporation (SMC) a domestic corporation majority-owned by Filipinos, is a manufacturing concern which operates several independent divisions; that it proposes to transfer substantially all the assets of one of its operating divisions, Magnolia Division, to FJV, a new corporation solely in exchange for shares of stock of the latter; that FJV is proposed to be capitalized at P3,000,000,000.00 divided into P2,400,000,000.00 of common voting shares (A shares) and P600,000,000.00 of preferred shares (B shares non-voting); that the exchange envisions: (a) Fixed assets [machinery and equipment, transportation equipment, land and building, among other] will be exchanged for common shares with a total par value of P750,000,000.00 and (b) Remaining fixed assets and non-fixed assets [inventories, accounts, receivables, prepayment, among others] net of liabilities assumed by FJV will be exchange for preferred shares; that the liabilities of SMC to be assumed by FJV shall not exceed the cost basis of SMC in the assets transferred; that considering the administrative difficulties such as obtaining consent from many creditors and suppliers, certain liabilities may initially be paid by SMC and FJV will subsequently reimburse the same amount to SMC; that SMC is vigorously pursuing expansion plan for its Magnolia Divisions; that the main objective of the spin-off, therefore is to admit new investors into FJV which would not be possible if Magnolia Division would continue to remain an integral part of SMC; that the prospective investors are interested only in Magnolia Division of SMC; that the incorporation of Magnolia Division would achieve greater efficiency and allow wider access to financing including infusion of additional equity from new investors and technology; that after the above exchange, SMC will sell at a premium 40% of its outstanding common shares in FJV; that all the employees of Magnolia Division will be absorbed by FJV who will consider the original date of hire by SMC for purposes of determining their tenure; and that the accrued retirement benefits of Magnolia Division employees as determined by independent actually will be transferred to a successor retirement trust fund to be set up by FJV as a BIR qualified private benefit plan. cdti In connection therewith, you now request confirmation of your following opinions: "1 No gain or loss shall be recognized by SMC on the transfer of its assets to FJV pursuant to Sec. 34 (c) (2) of the Tax Code, considering that as a result of the transfer of the assets, SMC will gain control of FJV through the ownership of at least 51% of the voting stock of FJV; "2 The transfer by SMC of its assets in exchange for FJV shares will not be considered as a transfer of property for insufficient consideration subject to gift tax since there is no intention to donate and the transaction is effected solely for business reasons; "3 The assets may be transferred by SMC to FJV either at cost or market value without affecting the tax-free character of the transfer; "4 Documentary stamp tax is due on the transfer of real properties by SMC which shall be based on the par value of the shares of FJV to be received in the exchange; "5 The certificate of stocks to be issued by FJV are subject to documentary stamp tax, being original issues, pursuant to Section 178 of the Tax Code; "6 The sale by SMC of 40% of its common shares in FJV will result in a capital gain taxable at the rate of 10% 20% under Section 24 (e) (2) (A) of the Tax Code. In determining the gain, the cost basis of the shares of stock shall be the same as the original acquisition cost or adjusted cost basis to SMC of the fixed assets exchanged therefor; and "7 The accrued retirement benefits of the employees of Magnolia Division may be carried over or transferred without income tax consequences to the SMC and the employees of the Magnolia Division to the retirement trust fund to be set up by FJV as a BIR-qualified private benefit plan." In reply thereto, please be informed that pursuant to Section 34 (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 other, not exceeding four persons, 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 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, your opinion that no gain or loss shall be recognized both to the transferor corporation and the transferee corporation on the proposed transfer by SMC of substantially all the assets of one of its operating divisions, Magnolia Division in exchange for shares of stock of the transferee corporation FJV, considering that as a result of said proposed exchange, SMC will gain control of FJV, the transferee corporation, is hereby confirmed. It should be noted, 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 transaction of the fixed and non-fixed assets 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 will later sell or exchange the shares of stock acquired by it in the exchange, the same 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 property exchanged therefor; and that the cost basis to the transferee of the property exchanged 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 connection therewith, 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-corporation 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 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 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 stock; 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 the 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 above 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 Certificates of Titles 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. Moreover, pursuant to Section 196 of the Tax Code, as amended, a conveyance or deed whereby land is assigned or transferred to the purchaser is subject to documentary stamp tax based on the consideration or value received or contracted to be paid for such realty. A stock in a corporation is a valuable consideration for transfer of real property. (Section 177, Documentary Stamp Tax Regulations). Accordingly, if parcels of land are exchanged with stocks in a corporation, as contemplated in this case, the latter is the consideration, the value of which shall be the basis of the documentary stamp tax on the deed to be executed to effect the aforesaid proposed transfer. (BIR Ruling No. 109-82 dated April 6, 1982). The value shall be the fair market value which shall not be less than the par value of the stocks. cdta Furthermore, your opinion to the effect, viz: (1) That the transfer by SMC of its assets in exchange for FJV shares will not be considered as a transfer of property for insufficient consideration subject to gift tax since there is no intention to donate on the part of any of the parties and the transaction is effected purely for business reasons; (2) That the assets may be transferred by SMC to FJV 1 either at cost or market value without affecting the tax-free character of the transfer; (3) That the certificates of stocks to be issued by FJV, which are in all probability, original issues, are subject to the documentary stamp tax imposed by Section 175 of the Tax Code, as amended; and (4) That the sale by SMC of 40% of its common shares in FJV will result in a capital gain taxable at the rate of 10% 20% under Section 24 (e) (2) (A) of the Tax Code. In determining the gain, the cost basis of the shares of stock shall be the same as the original acquisition cost or adjusted cost basis to SMC of the fixed and non-fixed assets exchanged therefor are hereby confirmed. Item No. 7 relative to the tax consequence of the transfer of accrued retirement benefits of the Magnolia Division employees to the proposed FJV Retirement Plan shall be adjudicated upon submission to this Office of the copies of the written program constituting the Retirement Plan of FJV employees; Amended Retirement Plan of SMC/Magnolia Division updated actuarial Valuation Report of both Plans duly certified to by an independent Consulting Actuary who must be a Fellow of the Actuarial Society of the Philippines; BIR Form No. 17.60 duly accomplished (for FJV); and Trust Agreement executed by and between FJV & Trustee/Trustees of the FJV Retirement Trust Fund. 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 exchange, the transaction is one of "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 10% VAT. 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. cd Very truly yours, (SGD.) JOSE U. ONG Commissioner