Tax Consequence of the Transfer of Properties in Exchange Solely for Shares of Stock of the Newly-Organized Corporation

October 14, 1988 BIR RULING NO. 508-88 34 (c) (2) (c) 171-81 508-88 Gentlemen : This refers to your letter dated August 16, 1988 requesting a ruling on the tax consequence of the transfer of one of the properties of the Greenfield Development Corporation to a wholly-owned corporation that it will organize in exchange solely for shares of stock of the newly-organized corporation. cdt It is represented that Greenfield Development Corporation is a corporation organized and existing under the laws of the Philippines; that it is engaged in the real estate business and owns several properties that are subject of development; that one of the properties that it intends to develop is a lot in Alabang, Muntinlupa, Metro Manila with an area of more or less 343,000 square meters; that the company intends to develop this property into a residential community and will enter into a development contract with another corporation which shall prepare all the necessary plans and provide all the improvements in the property of the company; that the objective of Greenfield Development Corporation in transferring the property into another corporation is to separate the operation of the company as a profit center without comingling any of its income and expenses to the existing activities of Greenfield Development Corporation; that by this method, the company will be able to determine and report accurately all income and expenses that it will derive from its operation; that the set-up is also intended as a safeguard against any business risk that may exist in the new phase of activity that the company for the first time will be engaged in; that by transferring the property, Greenfield Development Corporation will receive in exchange shares of stocks of the new corporation; that not more than four (4) persons will gain control of the corporation since Greenfield Development Corporation will own almost 100% of the shares except the qualifying shares of the directors. 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 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 persons, gains control of said corporation. The term "control" shall mean ownership of stocks in a corporation possessing at least fifty-one percent (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. cdtech Accordingly, no gain or loss shall be recognized both to the transferor and the transferee corporation, on the transfer by Greenfield Development Corporation of its property in exchange for shares of stock of the new corporation it will organized (sic) considering that as a result of said exchange, Greenfield Development Corporation 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 of the stocks involved in the exchange, the original or historical cost of the property 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 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 proposed 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 (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 stocks; b) The classes of stock and number 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 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, the certificates of stocks issued by the new corporation are, in all probability, original issues, which are subject to the documentary stamp tax imposed by Section 188 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. Very truly yours, (SGD.) EUFRACIO D. SANTOS Deputy Commissioner