Tax Treatment of the Difference Between the Value of the Shares of Stock and the Acquisition Cost of the Property

August 31, 1988 BIR RULING NO. 421-88 34 (c) (2) (c) 372-81 421-88 Gentlemen : This refers to your letter dated August 3, 1988 stating that Equitable Banking Corporation (EBC) a banking institution duly organized and existing under Philippine laws and China Nonferrous Metals Industry's Foreign Engineering and Construction Corporation (NFC), a corporation duly organized and existing under the laws of the Republic of China entered into a Joint Venture Agreement on June 3, 1988 to form a corporation to be organized under the laws of the Philippines for the primary purpose of engaging in real estate development; that the new corporation to be formed shall be known as Equimark-NFC Development Corporation (Equimark) which shall have an authorized capital stock of P75,000,000.00 divided into 750,000 shares with a par value of P100.00 per share; that EBC will subscribe to 447,000 shares valued at P44,700,000.00 and NFC to 300,000 shares valued at P30,000,000.00 of the total authorized capital stock or a 60%/40% ratio; that the joint venture intends to develop EBC's real estate property located at Malugay St., Makati, Metro Manila; that on July 26, 1988 a Deed of Assignment in Payment of Subscription was executed by EBC in favor of George Go, Treasurer-in-Trust for Equimark where EBC assigns, transfers and conveys to Equimark its aforesaid real estate property located at Malugay St., Makati, Metro Manila; and covered by TCT No. 40167 in payment of its subscription of 447,000 shares valued at P44,700,000.00; that the said property was acquired by EBC for only P4,398,200.46 and carried in its books at the value of P3,555,565.00; and that after the exchange and as a result of the exchange EBC will gain control of Equimark by owning 60% of the total voting power of all classes of stocks entitled to vote. aisadc In connection therewith, you now request a ruling as to the tax treatment of the amount of P41,441,435.00 which is the difference between the value of the shares of stock to be received by EBC from Equimark and the acquisition cost of the property. In reply, 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 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, with 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 stock received i.e, subscribed and paid-up, 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 EBC of its property in exchange for shares of stock of the transferee-corporation, considering that after the exchange of property and as a result of said exchange, the transferor 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 gain or loss from such transaction, for in determining the gain or loss from a subsequent transaction of the property or the stocks involved in the exchange, the original or historical cost of the property or the stocks is considered. Thus, if the transferor later sell or exchange 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 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] 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 property transferred, or of its interest in such property, 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 the property received from the transferor; 2. A statement of the original acquisition cost or other basis of the property in the hands of the transferor and the adjusted cost basis thereof at the time of the transfer and; a. The total issued and outstanding capital stock 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 above in order to facilitate the determination of gain or loss from a subsequent disposition of stocks/property 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 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 aforesaid deed. (BIR Ruling No. 245-00-000-00-102-82 dated April 6, 1982) The certificates of stocks issued by Equimark are, in all probability, original issues, which 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 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 of such unpaid amount which shall be in lieu of the interest prescribed in Section 249 of the same Code. Finally, the abovementioned transaction shall not be subject to the gift tax as there is no intention to donate on the part of any of the parties. After payment of the corresponding documentary stamp tax, the aforesaid real property may now be registered by the Register of Deeds concerned in the name of Equimark-NFC Development Corporation (Equimark). cdtech Very truly yours, (SGD.) BIENVENIDO A. TAN, JR. Commissioner