Payment of Capital Gains Tax on the Difference on Property Dividends Declaration and Exchange of Shares

November 20, 1991 BIR RULING NO. 252-91 25 000-00 252-91 Gentlemen : This refers to your letter dated July 15, and August 13, 1991 stating that your client, Phimco Industries, Inc. (Phimco), a corporation organized and existing under Philippine laws is engaged in the business of manufacturing safety matches; that its total outstanding capital stock is 754,197 shares, 96.26% of which or 726,009 shares (Phimco shares) is owned by and duly registered under the name of Swedish Match A.B. (SMAB), a foreign corporation organized and existing under the laws of Sweden; that beginning 1989, SMAB has embarked in a worldwide reorganization divesting itself of packaging, that to implement this global reorganization, SMAB declared last September 15, 1990 as property dividend all of its Phimco shares (726,009 shares) in favor of Swedish Match N.V. (SMNV), a corporation organized and existing under the laws of the Netherlands; that SMAB is a wholly owned corporation of SMNV and that the 726,009 Phimco shares declared as property dividend has a book value of P657.25 per share or a total of P477,169,415.20; that on January 10, 1991 SMNV transferred the entire 726,009 Phimco shares to Casa Fuego Limited, a Cayman Island Corporation in exchange for its 1,000 shares with an aggregate par value of US $17,000,000.00 or equivalent to P476,000,000.00 at the rate of P28.00 per US $1.00; that after the transaction, all Casa Fuego shares are owned by SMNV; and that the Phimco shares had an increased book value of P681.71 per share as of December 31, 1990. cdtech In connection therewith, you now request a ruling on the following: "(A) On the property dividend declaration by SMAB to SMNV of the Phimco shares: "1. That the declaration by SMAB of the Phimco shares as property dividend in favor of SMNV is not taxable in this jurisdiction pursuant to the provisions of the tax treaty between the Philippines and Sweden, as well as that of the National Internal Revenue Code, specifically Sec. 36 (a) (2) (B), considering that less than 50% of SMAB's gross income were derived from Philippine source for the last 3 years preceding the dividend declaration . . . . "(B) On the exchange of Phimco shares for Casa Fuego shares: "1. Did SMNV realize a taxable gain from the exchange of Phimco shares with Casa Fuego shares, considering that the acquisition value of the Phimco shares by SMNV as a result of the property dividend was at its book value as of 30 September 1990 while at the time of the exchange on January 10, 1991, the book value of Phimco shares had changed to P494,927,595.30? xxx xxx xxx "2. That on the part of Casa Fuego Limited, the recipient of Phimco shares transferred by SMNV, no tax is imposable or can be imposed by your Honorable Office for the following reasons: "a) no tax is imposable on the transferee or vendee of any property sold or exchanged; "b) assuming that Casa Fuego Ltd. will or may derive a gain in the exchange of its shares with Phimco shares, the gain, if any, was a result of the transfer, exchange or sale of its own shares (Casa Fuego shares) to SMNV, and being a non-resident foreign corporation, the same is outside the taxing authority or jurisdiction of this Honorable Office; and "c) since at the particular instance that the exchange of shares were made the only asset of Casa Fuego being the Phimco shares and that the only shares issued by Casa Fuego were the only shares exchange, then the gain, if any, by Casa Fuego is the premium on the stocks over the par value it generated in the exchange and which is clearly taxable only in the country of domicile." cdta Moreover, your client is requesting for a waiver or condonation or whatever surcharge, interest and other charges that may be imposed on the taxes due, i.e., capital gains tax and documentary stamp tax on the exchange of the Phimco shares with the Casa Fuego shares last January 10, 1991 because SMNV was not able to pay the taxes due on the exchange due to a preliminary injunction issued by the Regional Trial Court of Pasig, Branch 153 last January 14, 1991 in Civil Case No. 60297 entitled "ALS Management and Development Corporation, et al., plaintiffs, versus Swedish Match, A.B., et al defendants, which expressly enjoined the sale, transfer and conveyance of the 726,009 Phimco shares by SMAB to any party other than the plaintiffs in said case considering that as per Stock and Transfer Book of Phimco, SMAB still appears as the stockholder and registered owner of the Phimco shares because the shares have not as yet been transferred to SMNV and later to Casa Fuego Ltd. However, last April 17, 1991 when the injunction was dissolved because of a court order dismissing the case although motion for reconsideration has been filed by the plaintiffs, SMNV has manifested its willingness to pay all the taxes due to the government at the same time it is requesting the waiver of interest, surcharge and other civil penalties. Investigation of this case disclosed that based on the financial statements of SMAB and Phimco for the three years preceding the declaration the property dividend by SMAB to SMNV, only an average of 1.6% of gross income of SMAB consists of gross income from Phimco. Details of the computation of the percentage of Phimco's gross revenues, while for 1988 this percentage was 1.7%. Moreover, the book value of the Phimco shares as of September 30, 1990 is P644.82 and not P657.25 as represented by the taxpayer. Thus, the value of the 726,009 Phimco shares is P468,145,123.38 and not P477,169,415.20 as of September 30, 1990. Furthermore, the book value of Phimco shares as of December 31, 1990 is P681.71 or P494,927,595.30 for the 726,009 Phimco shares. In reply thereto, I have the honor to inform you as follows: (1) Pursuant to Section 36 (a) (2) (B) of the Tax Code, as amended, dividends received from a foreign corporation shall be treated as income from sources within the Philippines unless less than fifty per centum of the gross income of such foreign corporation for the three year period ending with the close of its taxable year preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence was derived from sources within the Philippines. Based on the financial statements of SMAB and Phimco for the three years preceding the declaration of the property dividend by SMAB to SMNV, only an average of 1.6% of gross income of SMAB consists of gross income from Phimco. Details of the computation of the percentage of Phimco's gross income to SMAB's gross income for the three year period show that for 1987 and 1989 Phimco's gross income was only 1.6% of SMAB's gross revenues, while for 1988 this percentage was 1.7%. Accordingly, the property dividend which was declared by SMAB in favor of SMNV cannot be considered as income derived from sources within the Philippines subject to Philippine tax; (2) SMNV is subject to capital gains tax on the difference between the book value of the Phimco shares of P468,145,123.38 at the time it was declared as property dividend in its favor by SMAB on September 30, 1990 and the book value of the Phimco shares of 927,595.30 at the time it was exchanged by it with the Casa Fuego shares on January 10, 1991 pursuant to Section 25 (b) (5) (C) (i) of the Tax Code, as amended; (3) That although Casa Fuego, Ltd. as the transferee of the Phimco shares realized gain from the exchange of its 1,000 shares of stock with an aggregate value equivalent to P476,000,000.00 with Phimco shares of stock with a book value of P494,927,595.30, nevertheless said gain is subject to tax in Cayman Island; considering that Casa Fuego Ltd. is a non-resident foreign corporation not deriving income from sources within the Philippines; and (4) Considering that the failure of SMNV to pay the Philippine income tax on the difference between the book value of the Phimco shares of P468,145,123.38 at the time it was declared as property dividend in its favor by SMAB on September 30, 1990 and the book value of the Phimco shares of P494,927,595.30 at the time it was exchanged by it with the Casa Fuego shares on January 10, 1991 as well as the documentary stamp tax on the certificate of stock of the Phimco shares was due to justifiable reasons, this Office hereby waives the imposition of the interest and surcharges on the taxes due. Moreover, in case of subsequent disposition of the Phimco shares by Casa Fuego, Ltd., the cost basis of the Phimco shares shall be P494,927,595.30 which is the fair market value of the shares per investigation at the time SMNV transferred them to Casa Fuego, Ltd. aisadc In view thereof, it is requested that you urge your client, Phimco, to pay to this Office, through the Chief, Legislative, Ruling & Research Division, BIR National Office Building, East Avenue, Quezon City, the amount of P5,346,494.38 as capital gains tax under Section 25 (b) (5) (C) (i) of the Tax Code, as amended, on the difference between the book value of the Phimco shares of P468,145,123.38 at the time it was declared as property dividend by SMAB in favor of SMNV on September 30, 1990 and the book value of the Phimco shares of P494,927,595.30 at the time it was exchanged by SMNV with Casa Fuego shares on January 10, 1991 and the amount of P363,004.50 as documentary stamp tax on the certificate of stock of the Phimco shares pursuant to Section 176 of the Tax Code, as amended, with fifteen (15) days from receipt hereof. Very truly yours, (SGD.) JOSE U. ONG Commissioner