Tax Consequence of the Transfer of a Real Property with Improvements in Exchange for Shares of Stock

December 20, 1988 BIR RULING NO. 594-88 34-c-2-c 76-87 594-88 Gentlemen : This refers to your letter dated December 5, 1988 requesting in effect a ruling as to the tax consequence of the transfer by Dr. Abundio P. Palencia of his real property together with the improvements thereon to the Central Hospital Corporation (CHC) in exchange for shares of stock of the latter. cdti It is represented that CHC is a domestic corporation organized on February 2, 1987 with an authorized capital stock of P2,000,000.00 divided into 2,000 shares with a par value of P1,000.00 each; that the incorporators of said corporation with their respective subscription and payment thereof are as follows: No. of Amount Amount Name Shares Subscribed Paid Dr. Abundio P. Palencia 130 P130,000.00 P32,500.00 Mrs. Emilia G. Palencia 130 130,000.00 32,500.00 Mr. Joaquin G. Palencia 40 40,000.00 10,000.00 Mr. Raul G. Palencia 40 40,000.00 10,000.00 Mr. Philip G. Palencia 40 40,000.00 10,000.00 Mr. Paul G. Palencia 40 40,000.00 10,000.00 Miss Josephine G. Palencia 40 40,000.00 10,000.00 Mr. Abundio G. Palencia, Jr. 40 40,000.00 10,000.00 TOTAL 500 P500,000.00 P125,000.00 ==== ========== ========== that on December 1, 1988, Dr. Abundio P. Palencia assigned and transferred his real property together with the hospital building, hospital facilities and equipment and other appurtenances and improvements thereon situated at Lag-on, Daet, Camarines Norte covered by Transfer Certificate of Title No. T-4455 to CHC in exchange for 760 shares of its unissued authorized capital stock; that as further consideration of said assignment and conveyance CHC shall assume the obligation of Dr. Abundio P. Palencia to pay the outstanding balance of P298,002.80 as of October 5, 1988 on a loan of P1,000,000.00 obtained by him from the Development Bank of the Philippines, Daet Branch wherein the said real property and the Our Lady of Lourdes Hospital, with all its facilities and equipment, and all other fixtures and appurtenances had been mortgaged by him to said bank to secure the aforesaid loan; that the said assignment and conveyance is subject to the approval of the Development Bank of the Philippines, Daet Branch, as mortgagee; and that after the exchange and as a result of the exchange Dr. Abundio P. Palencia gained control of CHC. 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 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 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 transferor and transferee corporation on the transfer by Dr. Abundio P. Palencia of his real property together with all the improvements existing thereon in payment for the shares of stocks of Central Hospital Corporation, considering that after the exchange of properties and as a result of said exchange, he will gain control of said 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 stocks acquired by him in the exchange, he 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 stocks shall be the same as the original acquisition cost or adjusted cost basis to the transferor of the properties exchange 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)()(a) and (b), Tax Code, as amended by Presidential Decree No. 1773] If pursuant to the exchange transaction, and as a part of the consideration, the transferee corporation assumes the liability of the transferor or acquires from the transferor property subject to a liability such assumed or acquired liability shall not be treated as money and or other property, and shall not prevent the exchange from being tax free. (See Sec. 34(c)(4)(a) of the Tax Code as amended by P.D. No. 1773) if the amount of the liabilities assumed, plus the amount of the liabilities to which the property is subject, exceed the total of the adjusted basis of the property transferred pursuant to such exchange, then such excess shall be considered as a gain from the sale or exchange of a capital asset or of property which is not a capital asset as the case may be (Sec. 34(c)(4)(b) of the Tax Code as amended by P.D. No. 1773). The cost basis or value of the stocks received by the transferor of property subject to a liability, where the liability transferred and assumed by transferee corporation does not exceed the transferor's basis or the original and/or acquisition cost of the property transferred, shall be the difference between the liability or liabilities assumed by the transferee corporation and the acquisition or original cost of the property transferred. On the other hand, where the total liabilities to be assumed by the transferee corporation exceed the original or acquisition cost of the property transferred, the excess shall be recognized as gain to the transferor and the value or cost basis of the stocks to the transferor shall be the difference between the original cost of the property transferred subject to a liability (plus the gain recognized to the transferor) and the liability or liabilities assumed by the transferee corporation. (Sec. 34(c)(5), supra ) 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 his 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 his 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 prior to and immediately after the exchange, with a complete description of each class of stock; b. The classes of stock 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/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 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. 245-00-000-00-109-82 dated April 6, 1982). Furthermore, the certificates of stocks to be issued by Central Hospital 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. Under Section 248(c) 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, 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, after approval of the said Assignment and Conveyance by the Development Bank of the Philippines and 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 Central Hospital Corporation. cdta Very truly yours, (SGD.) BIENVENIDO A. TAN, JR. Commissioner