Tax Consequence of a Corporate Transfer of Property

December 21, 1989 BIR RULING NO. 265-89 34 (c) (2) (e) 83-89 265-89 S i r : This refers to your letter dated September 7, 1989 stating that the RPMC was incorporated on May 26, 1989 with an authorized capital stock of P2,000,000.00 divided into 200,000 shares with a par value per share of P10.00; that upon incorporation, 500,000 shares were subscribed and the amount of P1,250,000.00 was paid on the subscriptions; that at present the stockholders and their respective subscriptions and payments on subscription are as follows: No. of Shares Amount Stockholder Subscribed Paid U.F. 498,750 P1,246,875.00 M.S.J. 200 500.00 R.S.L. 200 500.00 S.L.M. 200 500.00 C.A.L. 200 500.00 M.L.A.S. 200 500.00 A.L.Z. 200 500.00 F.A.S. 50 125.00 500,000 P1,250,000.00 ======= ============ that UF controls the corporation to the extent of 99.75%;that UF will transfer to RPMC in exchange for RPMC shares of stock the following properties which are not anymore being used in its educational activities together with their respective book values and fair market values: cdtech Land Cost P 4,805,310.86 Market value per Tax Declaration 23,382,910.65 Improvements Cost P 2,630,046.60 Book value (Depreciated Value) 1,200,970.71 Market value per Tax Declaration 10,551,250.15 Shares of Stock Cost P 5,732,927.01 Fair market value/Book value 43,028,608.20 that the shares of stock consist, of listed shares in the stock exchanges and unlisted shares; that the market values of listed shares were taken from the closing price of the stock exchanges on the last day they were traded on May 15, 1989, while the book values of unlisted shares were taken from the latest audited balance sheets of the corporations in which UF has shares of stock. Based on the foregoing representations, you now request a ruling on the following queries: "1. Is the exchange subject to income tax? "2. At what values should the following properties of UF be exchanged for the shares of stock of RPMC? "A. Land "B. Improvements "C. Shares of stock "1. Listed in the stock exchange "2. Not listed in the stock exchange "3. Assuming the improvements are to be exchanged at their market value, may the transferee depreciate such improvements at the amount they were transferred? "4. Will there be any other tax or taxes that may be levied on the exchange on the part of the transferor and of the transferee? casia "5. What other conditions will your Office impose on the transferor and the transferee should the exchange materialize?" In reply, I have the honor to inform you 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 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, although to the extent that the stock received is for services, the transferor is liable for income tax, (par. 2503.01 p. 31,012, Vol. 3A CCH (1986), cited in BIR Ruling No. 150-89 dated July 13, 1989). 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 transferor corporation and the transferee corporation on the proposed transfer of UF of its properties in exchange for shares of stock of the transferee corporation, RPMC, considering that after the exchange of properties and as a result of said proposed exchange, UF will gain further control of RPMC, the transferee corporation. 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 transaction of the properties 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 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 to the transferor of the property exchanged therefor; and that the cost basis to the transferee of the properties 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] In other words, the property acquired by a transferee corporation "in connection with a reorganization" ordinarily takes a "carryover" basis equal to the transferor's basis, increased by any gain recognized to the transferor on such transfer, (par. 14.33, pp. 14-108, Bittker & Eustice' Federal Income Taxation of Corporations and Shareholders. 4th ed.) Accordingly, the properties of the transferor consisting of land, improvements and shares of stock, may be transferred and exchanged for stocks of the transferee corporation either at their fair market value or book value as the case may be, provided that for purposes of determining gain or loss from a subsequent transaction of the said properties or of the stocks involved in the exchange, the original or historical cost of the properties or of the stocks (whether or not listed in the stock exchange) is considered as basis. For income tax purposes, an asset's depreciable basis, depreciation period, and salvage value must generally be known in order to compute the deductible depreciation allowance. Basis for depreciation is ordinarily the same as for determining gain on sale of the asset. The basis of depreciable property for purposes of depreciation is its adjusted basis for determining gain upon its subsequent sale or other disposition. (par. 5545, p. 244, 34 Am. Jur. 2d (1976) Accordingly, the original acquisition cost or adjusted cost basis of the improvements in the hands of the transferor (not "at the amount they were transferred" ) is the basis of the depreciation allowance to be claimed by the transferee-corporation, RPMC as well as for purposes of computing gain or loss in a subsequent disposition of properties or stocks received as a consequence of the exchange. In other words, the capital sum (investment) recoverable by RPMC through depreciation allowance is an amount equal to the historical cost or adjusted cost basis of the improvements to UF, acquired from UF in exchange for stocks issued to UF . Moreover, the transfer of the aforementioned properties is not subject to the donor's gift tax as there is no intention to donate in this case. Finally, 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 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 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. 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 including improvements thereon 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. 245-00-000-00-109-82 dated April 6, 1982) 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 stamp 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 (25%) of such unpaid amount which shall be in lieu of the interest prescribed in Section 249 of the same Code. Finally, the Certificates of stocks to be issued by RPMC are, in all probability, original issues, which are subject to the documentary stamp tax imposed by Section 175 of the Tax Code, as amended. Should the aforementioned proposed transaction materialize and after payment of the corresponding documentary stamp tax, the aforesaid real properties may be registered by the Register of Deeds concerned in the name of the transferee corporation, RPMC. aisadc Very truly yours, (SGD.) JOSE U. ONG Commissioner