BIR Ruling No. 549-12

August 31, 2012 BIR RULING NO. 549-12 Section 40 (C) (2) of the 1997 Tax Code; RMR 01-2001 De Leon & Desiderio Law Firm Suite 7C Belvedere Tower San Miguel Avenue, Ortigas Center, Pasig City Attention: Atty. Felix B. Desiderio, Jr. Dear Mr. Kanaan : This refers to your letter dated May 16, 2011 on behalf of your client, 7th AVENUE PROPERTY HOLDINGS AND MANAGEMENT, INC. ("7th Avenue"), requesting confirmation that the transfer of real properties of Spouses Pablo and Josefina Siongco to 7th Avenue qualifies as a tax-free transfer under Section 40 (C) (2) of the Tax Code of 1997, as amended, and is not subject to value-added tax. Documents submitted disclose that 7th Avenue, with Taxpayer Identification No. 007-323-248-000, is a duly registered domestic corporation with an authorized capital stock of Five Hundred Thousand Pesos (P500,000.00) divided into Five Thousand shares (5,000) with a par value of One Hundred Pesos (P100.00) per share; that during incorporation of 7th Avenue, Josefina Siongco subscribed to One Thousand Three Hundred (1,300) 7th Avenue shares of stock in the total amount of One Hundred Thirty Thousand Pesos (P130,000.00) and that of this subscription, Josefina Siongco paid a total of Twenty Thousand Pesos (P20,000.00); that after 7th Avenue's incorporation, spouses Pablo and Josefina Siongco assigned, transferred and conveyed to it their real property composed of a parcel of land with improvements thereon and covered by Transfer Certificate of Title (TCT) No. 44722 with an area of Two Hundred Thirty (230) square meters (sq.m.) located at 7th Avenue, Cubao, Quezon City; that as a result of the transfer by the said spouses of their property in exchange for Pablo Siongco's subscription to Six Hundred Eighty Five (685) 7th Avenue shares and in payment of Josefina's unpaid subscription of 7th Avenue shares; and that the documentary stamp tax for the issuance of One Thousand Three Hundred Seventy (1,370) 7th Avenue shares; and that you now request for confirmation of your opinions that: a) No gain or loss shall be recognized, no income tax or capital gains tax shall be due from the transferor and the transferee (7th Avenue) as a result of the transfer by the transferor of his property in exchange for the shares of stocks of 7th Avenue, considering that as a consequence of the exchange, the transferor gained control of 7th Avenue; b) The original issuance of shares of 7th Avenue to the transferor shall be subject to documentary stamp tax imposed by Section 175 of the Tax Code of 1997, as amended; and c) The transfer of the property for shares will not be subject to value-added tax (VAT). In reply, please be informed that the relevant portion of Section 40 (C) of the Tax Code of 1997, as amended, being invoked as legal basis for the exemption provides that: TSacAE "SEC. 40. Determination of Amount and Recognition of Gain or Loss. (C) Exchange of Property. (1) General Rule. Except as herein provided, upon the gain or exchange of property, the entire amount of the gain or loss, as the case may be, shall be recognized. (2) Exception. No gain or loss shall be recognized if in pursuance of a plan of merger or consolidation xxx xxx xxx (c) . . . No gain or loss shall also be recognized if property is transferred to a corporation by a person in exchange for stock or unit of participation in such a corporation of which as a result of such exchange said person, alone or together with others, not exceeding four (4) persons, gains control of said corporation; . . ." In clarifying the existing guidelines on the tax consequences of a non-recognition transaction consisting of a tax-free exchange of property for shares of stock under Section 40 (C) (2) of the Tax Code of 1997, Revenue Memorandum Ruling (RMR) No. 01-01 1 dated November 29, 2001 states its application to a specific set of facts and circumstances: "I. FACTS xxx xxx xxx 3. The Transferor transfers the property to the Transferee. In exchange, the Transferee issues shares to the Transferor out of the unissued portion of its existing authorized capital stock , or, if such existing authorized capital stock is insufficient, out of shares from an increase in the Transferee's authorized capital stock. The Transferor does not receive any money or property other than the aforementioned shares of the transferee. HcTDSA xxx xxx xxx IV. FURTHER CLARIFICATION OF FACTS AND TAX CONSEQUENCES xxx xxx xxx 2. No. 3 of "I. Facts" mentions the issuance of the Transferee's shares from the "unissued portion of its existing authorized capital stock, or, if such existing authorized capital stock is insufficient, out of shares from an increase in the Transferee's authorized capital stock". This statement of fact excludes the following , which if present, would give rise to a different tax consequence treated elsewhere other than in this Revenue Memorandum Ruling 2.1 . . . 2.2 Settlement of subscription receivables. Therefore, the tax consequences described above shall not apply to the extent that the property is transferred in payment for the unpaid balance of the subscription to shares ." ( Underscoring supplied ) Applying the foregoing provisions to the facts in this case, the assignment by the transferors of the real properties cannot qualify as a non-recognition transaction consisting of a tax-free exchange of property for shares of stock under said provision of the Tax Code considering that as represented, the real properties are transferred by the spouses Siongco for additional payment of Josefina Siongco's unpaid subscription. While the assignment of real properties is also being made in exchange for Pablo Siongco's subscription of 685 7th Avenue shares, still, the transaction cannot legally qualify as a tax-free exchange under Section 40 (C) (2) of the Tax Code since, as a result of such exchange, Pablo Siongco does not gain control of 7th Avenue. EcHIDT In view of the foregoing, this Office is of the opinion and hereby holds as follows: a) The assignment of the real properties by spouses Pablo and Josefina Siongco to 7th Avenue does not qualify as a tax-free exchange under Section 40 (C) (2) of the Tax Code of 1997, as amended, hence, the gain or loss shall be recognized on such transaction under Sections 39 and 40 (A). Capital gains tax as imposed by Section 24 (D) (1) of the same tax code shall be due from the transferors; b) Likewise, on the transfer of real properties, transferors shall be liable for documentary stamp tax under Section 196, Tax Code of 1997 based on the higher of: (i) the consideration contracted to be paid for such real property, and (ii) the fair market value as determined in accordance with Section 6 (E) of the Tax Code of 1997; c) The original issuance of shares of 7th Avenue subscribed by the transferor Pablo Siongco shall also be subject to documentary stamp tax imposed by Section 175 of the Tax Code of 1997, as amended; and d) The transferors are not subject to VAT on the transfer of their residential property as it appears that they are not engaged in a business that is subject to the VAT under Title IV of the Tax Code of 1997. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be ascertained that the facts are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Tax Consequences of Tax-Free Exchange of Property for Shares of Stock of a Controlled Corporation Pursuant to Section 40 (C) (2) of the National Internal Revenue Code of 1997.