Tax Consequences of Transfer of Real Estate Properties in Exchange for Shares of Stock

November 8, 1991 BIR RULING NO. 237-91 34 (c) (2) (c) 100-91 237-91 S i r : This refers to your letter dated October 3, 1991 stating that on July 31, 1991, the Securities & Exchange Commission approved the incorporation of the CBY Enterprises, Inc. with the primary purpose, to wit: "To purchase, acquire, lease, or in any manner hold, own, use, sell or turn into account or dispose of, land and real estate of any kind and description, to lease, use, equip, improve, operate, or in any manner turn to account or dispose of buildings of any kind such as but not limited to industrial, commercial real estate properties or residential/office condominiums, stores, warehouses, factories, plants, etc. with all its appurtenances and appliances, to the fullest extent permitted by law." cdt that it has an authorized capital of P1,000,000.00 divided into 10,000 shares with a par value of P100.00 each; that the total amount of capital actually subscribed is P250,000.00 and the total sum paid on the subscription is P100,000.00; that the incorporators/subscriber of the corporation subscribed for the sum opposite their respective names: Name No. of Shares Sum Subscribed Percentage 1. ROSA Y. ESPARAZ 2,400 P240,000.00 90.% 2. YU KIM CHUY 25 2,500.00 2.5% 3. LIM SIN CHIAO YU 25 2,500.00 2.5% 4. BETTY YU YEH 25 2,500.00 2.5% 5. NELSON L. CHUA 25 2,500.00 2.5% TOTAL 2,500 P250,000.00 100% ====== =========== ====== that the Board of Directors of the corporation recently approved a resolution to authorize the corporation to actively engage in the purpose for which the corporation was primarily organized by initially looking for residential properties worthwhile developing, rehabilitating and/or improving with the end in view of reselling such properties at a profit; that considering the limited working capital generated from the payment on the subscriptions to the authorized capital, it was decided to raise the needed working capital through borrowings from commercial banks; that it was pointed out that to borrow funds from the banks, the corporation would need to put up acceptable collaterals; that in order to provide the corporation with the needed collaterals, two (2) of the minority stockholders-spouses Yu Kim Chuy and Lim Sin Chiao Yu have offered and their offer was accepted by the corporation to assign their real estate properties covered by Transfer Certificate of Title Nos. 5110 and *485306) 12836 both of the Registry of Deeds for Metro Manila (District II) and Transfer Certificate of Title No. T-14392 of the Registry of Deeds for Tagaytay City, in exchange for additional 3,900 shares of stock of the corporation based on the market value stated in the existing tax declarations, spouses Yu Kim Chuy and Lim Sin Chiao Yu, executed a Deed of Exchange, in favor of the corporation; that as a result of the transfer of the aforementioned properties in exchange for 3,900 additional shares to be issued out of the authorized capital of the corporation, the spouses became the owners/holders of a total of 3,950 shares (including their original subscription of 50 shares) representing approximately 61.70% of the total subscribed and outstanding shares, thus gaining control of the corporation, as shown below: Name No. of Shares Sum Subscribed Percentage 1. ROSA Y. ESPARAZ 2,400 P240,000.00 37.50% 2. YU KIM CHUY 1,975 197,500.00 30.85% 3. LIM SIN CHIAO YU 1,975 197,500.00 30.85% 4. BETTY YU YEH 25 2,500.00 .40% 5. NELSON L. CHUA 25 2,500.00 .40% TOTAL 6,400 P640,000.00 100% ====== =========== ====== In connection therewith, you are requesting a ruling to the effect that the abovementioned transfer of real estate properties by spouses Yu Kim Chuy and Lim Sin Chiao Yu in exchange for shares of stock of the CBY Enterprises, Inc. is a tax-free exchange under Section 34 (c) (2) (c) of the Tax Code, as amended. Moreover, the titles to the properties transferred may be registered in the name of the corporation without the transferors paying the capital gains tax prescribed in Revenue Regulations No. 1-90. 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 a 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 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., total 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 stocks in the same transaction may be counted up to a maximum of five. cdtech Accordingly, no gain or loss shall be recognized both to the transferors and transferee corporation on the transfer by spouses Yu Kim Chuy and Lim Sin Chiao Yu of their real properties in exchange for shares of stock of CBY Enterprises, Inc. considering that after the exchange of properties and as a result of the exchange, the transferors will gain control of the transferee corporation. It should be emphasized, however, that Section 34 (c) (2) (c) of the Tax Code merely defers recognition of the gain or loss from such 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 stocks is considered. Thus, if the transferors later sell or exchange the shares of stocks 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 acquisition cost or adjusted cost basis to the transferors of properties exchange therefor; and that the cost basis of the transferee of the properties exchanged for stocks shall be the same as it would be in the hands of the transferors. [Section 34 (c) (5) (a) and (b) of the Tax Code, as amended by Presidential Decree No. 1773]. 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 transferors must file with their 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 their interest in such properties, 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 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 the properties received from the transferors; 2. A statement of the original acquisition cost or other basis of the properties in the hands of the transferors 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 transferors in the exchange; and c. the fair market value as of the date of the exchange of the capital stock issued to the transferors. 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 Certificate 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. 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 of 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 a parcel of land, is exchanged with stocks in a corporation as in this case, the latter is the consideration, the value of which shall be the basis of the documentary stamp tax on the deed of assignment executed to effect the aforesaid transfer (BIR Ruling No. 245-00-000-00-109-82 dated April 06, 1982). The value shall be the fair market value which shall not be less than the par value of the stocks. aisadc Moreover, 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 the documentary stamp tax required to be paid, an amount equivalent to twenty-five percent (25%) of such unpaid amount which shall be in lieu of the interest prescribed in Section 249 of the same Code. Furthermore, the certificate of stocks to be issued by CBY Enterprises, Inc. are, in all probability original issues, which are subject to the documentary stamp tax imposed by Section 175 of the Tax Code, as amended. After payment of the corresponding documentary stamp tax, the real properties may be registered by the Register of Deeds concerned in the name of the transferee corporation, CBY Enterprises, Inc. Finally, since the aforementioned exchange is not subject to the creditable withholding tax on sales, exchanges or transfers of real property under Revenue Regulations No. 1-90, titles to the aforesaid properties may be registered in the name of CBY Enterprises, Inc. without the payment of the creditable withholding tax. This ruling is being issued 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