Tax Consequence of the Contemplated Transfer of Shares in Exchange for Shares and in Payments of Subscription

November 28, 1988 BIR RULING NO. 561-88 34-c-2-c 330-88 561-88 Gentlemen : This refers to your letter dated September 9, 1988 requesting a ruling on the tax consequence of the contemplated transfer by CADECO Agro-Development Phils., Inc. (CADECO) and the Lorenzo Family of 9,000,000 shares of Surfield Development Corporation (Surfield) to Macondray Holdings Corporation (Macondray) in exchange for 4,500,000 shares of Macondray and in payments of subscription payable in the aggregate sum of P7.5 million. cdti It is represented that Macondray, a Philippine company has a pending application with the Securities and Exchange Commission for the increase of its authorized capital stock from P50 million to P125 million; that upon such approval, Macondray will have 58,500,000 shares subscribed and outstanding (with a par value of P1.00 per share) broken down as follows: Luis F. Lorenzo 2,415,000 Luis P. Lorenzo, Jr. 19,165,000 Alicia P. Lorenzo 1,165,000 Regina L. Davila 1,165,000 Marco A.P. Lorenzo 1,165,000 Lourdes B.P. Lorenzo 1,165,000 Jose Paulo P. Lorenzo 1,165,000 Martin I.P. Lorenzo 1,165,000 Tomas A.P. Lorenzo 1,165,000 Luisa P. Lorenzo 1,165,000 Cadeco Agro-Development Phils., Inc. 17,599,997 Jesus M. Manalastas 3,000,001 Victoria Z. Egan 2,300,001 Edmundo T. Lim 4,700,001 58,500,000 that CADECO and the ten (10) individuals comprising the Lorenzo Family, who are all stockholders of record in Macondray own the following fully paid shares of stock in Surfield, a Philippine company: Luis F. Lorenzo 750,000 Luis P. Lorenzo, Jr. 750,000 Alicia P. Lorenzo 750,000 Regina L. Davila 750,000 Marco A.P. Lorenzo 750,000 Lourdes B.P. Lorenzo 750,000 Jose Paulo P. Lorenzo 750,000 Martin I.P. Lorenzo 750,000 Tomas A.P. Lorenzo 750,000 Luisa P. Lorenzo 750,000 Cadeco Agro-Development Phils., Inc. 1,500,000 9,000,000 that each of the Surfield shares has a par value of P1.00 per share; that the Lorenzo family and Cadeco will transfer all of their 9,000,000 Surfield shares (with an aggregate par value and acquisition cost of P9.0 million) in favor of Macondray in exchange for 4,500,000 fully paid shares of Macondray (with an aggregate par value of P4.5 million) and in payment of subscriptions payable to Macondray in the sum of P7.5 million; that each of the 10 Lorenzo family members will transfer 340,000 Surfield shares in exchange for 450,000 Macondray shares; that a total of 3,400,000 Surfield shares with an aggregate par value of P3,400,000 will be exchanged for 4,500,000 Macondray shares with an aggregate par value of P4,500,000; that each of the 10 Lorenzo family members will transfer 410,000 Surfield shares in payment of their outstanding subscription payable to Macondray to the extent of P5,625,000; that the Lorenzo family has an outstanding subscription payable to Macondray in the sum of P7,500,000 arising from a Deed of Assignment of Subscriptions executed on March 28, 1988; that a total of 4,100,000 Surfield shares with an aggregate par value of P4,100,000 will pay for subscription payable in the amount of P5,625,000; that CADECO will transfer all its 1,500,000 Surfield shares with an aggregate par value of P1,500,000 in full payment of its outstanding subscription payable to Macondray in the sum of P1,875,000; that CADECO has an outstanding subscription payable to Macondray in the sum of P1,875,000 arising likewise from the Deed of Assignment of Subscriptions executed on March 28, 1988; that the resulting stockholding in Macondray will be as follows: Additional Share- holdings in Resulting Beginning Exchange for Share- Stockholder Shareholdings Surfield Shares holdings Luis F. Lorenzo 2,415,000 450,000 2,865,000 Luis P. Lorenzo, Jr. 19,165,000 450,000 19,615,000 Alicia P. Lorenzo 1,165,000 450,000 1,615,000 Regina L. Davila 1,165,000 450,000 1,615,000 Marco A.P. Lorenzo 1,165,000 450,000 1,615,000 Lourdes P. Lorenzo 1,165,000 450,000 1,615,000 Jose Paulo P. Lorenzo 1,165,000 450,000 1,615,000 Martin I.P. Lorenzo 1,165,000 450,000 1,615,000 Tomas A.P. Lorenzo 1,165,000 450,000 1,615,000 Luisa P. Lorenzo 1,165,000 450,000 1,615,000 Cadeco Agro-Dev't. Phils., Inc. 17,599,997 17,599,997 Jesus M. Manalastas 3,000,001 3,000,001 Victoria Z. Egan 2,300,001 2,300,001 Edmundo T. Lim 4,700,001 4,700,001 58,500,000 4,500,000 63,000,000 ========== ========== ========== that as a result of the contemplated transfer of the Surfield shares in exchange for Macondray shares and in payment of subscription payable, three (3) stockholders who will transfer Surfield shares, namely: CADECO, Luis F. Lorenzo and Luis P. Lorenzo, Jr. will have 63.6% of the total voting stock in Macondray. 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 P.D. 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 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 statutory requirement that "said person, alone or together with others, not exceeding four persons, gains control of said corporation" shall be understood to mean that any number of persons may exchange property for stock provided that as a result of the transaction, not more than five transferors would control the 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, 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 transferors and the transferee corporation on the transfer by CADECO and the Lorenzo Family of their Surfield shares of stock in exchange for the shares of stock of Macondray and in payment of subscription therein considering that as a result of the said exchange, even just 3 or not more than 5 of the transferors will gain further 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 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 transferors later sell or exchange the shares of stock acquired by them in the exchange, they 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 transferors of the properties exchanged therefor; and that cost basis to the transferee of the properties exchanged for stocks shall be the same as it would be in the hands of the transferors. (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 transferors must file with their 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 their 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 transferors; 2) A statement of the original acquisition cost or other basis of the properties in the hands of the transferors 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 transferors in the exchange; and (c) The fair market value as of the date of exchange of the capital stock issued to the transferors. In addition to the foregoing requirements, permanent records in substantial form must be kept by the taxpayer's 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, the certificate of stocks issued by Macondray Holdings 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. cdta Very truly yours, (SGD.) EUFRACIO D. SANTOS Deputy Commissioner