Requirements for Tax-free Merger

November 24, 2005 BIR RULING NO. S-40-023-05 MERGER S-40 Air Liquide Gateway Business Park-SEZ Javalera, General Trias, Cavite Attention: Mr. John Lok President Gentlemen : This refers to your letters dated July 8, 2005 and October 26, 2005 requesting a ruling that the merger between Air Liquide Pipeline Utilities Service, Inc. ("ALPLUS") and Air Liquide-NCTO Industrial Gas, Inc. ("AL-NCTO") qualifies as a tax-free merger under Section 40(c)(2) and 6(b) of the 1997 Tax Code, as amended. The facts, as represented, are as follows: ALPLUS and AL-NCTO are both engaged in the manufacturing and selling of specialty gases for industrial and commercial uses. Both corporations are 100% owned by Air Liquide Phils. Inc. The respective Board of Directors of both companies and their stockholders deemed it necessary to merge the two corporations into one, with ALPLUS as the surviving corporation, to streamline the business operations and achieve greater efficiency in the use of the resources of ALPLUS and AL-NCTO. CaTcSA In the implementation of the merger, all outstanding shares of capital stock of AL-NCTO amounting to 403,200 shall be surrendered and cancelled in exchange for 225,252 shares of stock of ALPLUS out of the latter's unissued authorized capital stock (or at the exchange rate of 1.79 AL-NCTO shares for every ALPLUS share). In reply thereto, please be informed as follows: 1. The above reorganization of AL-NCTO and ALPLUS, the latter as the surviving corporation, is a merger within the contemplation of Section 40(C)(6)(b) of the Tax Code of 1997, as amended, for the reason that ALPLUS will acquire/assume all the assets, franchise, licenses, powers, rights, interests, titles, equities, privileges, immunities and liabilities of AL-NCTO, for the purpose of allowing the said companies to avail of and benefit from the various operational advantages that will be realized from the consolidation of their respective businesses, such as, but not limited to, integration of the administrative facilities of the two corporations that will result in economies of scale and efficiency of operations and the more productive use of their properties. Hence, the merger is being undertaken for a bonafide business purpose, and not for the purpose of escaping the burden of taxation. cITaCS The merger of ALPLUS and AL-NCTO qualifies for non-recognition of gain or loss for income tax purposes in accordance with Section 40 (C) (2) of the 1997 Tax Code, as amended. Thus, no gain or loss shall be recognized by AL-NCTO, as transferor, on the transfer of all its assets and liabilities to ALPLUS pursuant to the Plan of Merger. Likewise, no gain or loss shall be recognized by ALPLUS, as the transferee, on its receipt of the assets and liabilities of AL-NCTO pursuant to and as a consequence of the merger. The basis of the assets to be received by ALPLUS shall be the same as it would be in the hands of AL-NCTO; the cost basis to the transferee of the property transferred, pursuant to the merger, shall be the same as it would be in the hands of the AL-NCTO [Sec. 40 (C) (5) (a) and (b) of the Tax Code of 1997]. Accordingly, the substituted basis of the assets transferred by AL-NCTO to ALPLUS pursuant to the merger are as follows: PROPERTY SUBSTITUTED BASIS Current Assets Cash 2,096,480 Receivables 2,481,734 Inventories 1,012,221 Total Current Assets P25,590,436 ======== Non-Current Assets Property and Equipment 20,009,576 Other non-current assets 9,101,671 Total Non-current Assets P29,111,247 Total Assets P54,701,683 ======== The basis of the ALPLUS shares received by Air Liquide Phils. Inc., the sole stockholder of AL-NCTO, shall be the same basis as the AL-NCTO shares it had prior to the merger [ BIR Ruling No. DA-075-03, BIR Ruling No. DA-037-02, BIR Ruling No. DA 039-02, BIR Ruling No. DA 184-02 ]. EDSHcT It is understood, however, that upon subsequent sale or exchange of the assets or shares of stock acquired by the parties, the gain derived from such sale or exchange shall be subject to income tax taking into consideration the cost basis of the transferred properties and the cost basis of the shares received. 2. Section 105 of the Tax Code of 1997 identifies the persons liable for the Value-Added Tax. Thus: "SEC. 105. Persons Liable. Any person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, renders services, and any person who imports goods shall be subject to the value-added tax (VAT) imposed in Sections 106 to 108 of this Code. . . . ." However, Section 4.100-5(b)(1) and (3) of Revenue Regulations No. 7-95, otherwise known as the "Consolidated Value-Added Tax Regulations," specifically excepts mergers from being subject to output tax. Hence: "Section 4.100-5. Changes in or cessation of status as VAT-registered person. xxx xxx xxx (b) Not subject to output tax. The VAT shall not apply to goods or properties existing as of the occurrence of the following: (1) Change of control of a corporation by the acquisition of the controlling interest of such corporation by another stockholder or group of stockholders, Example: Transfer of property to a corporation in exchange for its shares of stock under Section 34(c)(2) and (6)(c) of the Code 1. . . . (3) Merger or consolidation of corporations. The unused input tax of the dissolved corporation as of the date of the merger or consolidation shall be absorbed by the surviving or new corporation." Thus, the above-mentioned transaction shall not be subject to value-added tax under Section 4.100-5(b)(1) of Revenue Regulations No. 7-95, the said transfer being considered a transaction "not subject to output tax" under the said Section. 3. Well-settled in our jurisprudence is the fact that the essential elements of a valid donation are: (1) the reduction of the patrimony of the donor, (2) the increase in the patrimony of the donee; and (3) the intent to do an act of liberality ( animus donandi ). Clearly, there is no intention on the part of AL-NCTO to donate its assets to ALPLUS since the transaction is being undertaken for purely business purposes. Thus, the aforesaid merger will not be subject to gift tax since there is no intention to donate, and the transaction is a bona fide merger effected solely for business reasons. 4. No documentary stamp tax (DST) shall be due on the transfer by AL-NCTO of its properties to ALPLUS pursuant to the merger transaction. Section 199 of the Tax Code, as amended by R.A. No. 9243, expressly provides that transfer of property pursuant to Section 40(C)(2) of the Tax Code is exempt from the DST. However, the original issuance of shares of stock by ALPLUS to Air Liquide Phils. Inc. is subject to the DST at the rate of P1.00 per P200.00, or fractional part thereof, of the par value of such shares of stock. SHIcDT Moreover, in order that the above-described reorganization can be considered as merger under Section 40(C)(2) of the Tax Code of 1997, the parties to the merger should comply with the following requirements: A. The plan of reorganization should be adopted by each of the corporations, parties thereto, the adoption being shown by the acts of its duly constituted responsible officers and appearing upon the official records of the corporation. Each corporation, which is a party to the reorganization, shall file, as part of its return for the taxable year within which the reorganization occurred, a complete statement of all facts pertinent to the non-recognition of gain or loss in connection with the reorganization, including: (1) A copy of the plan of reorganization, together with a statement, executed under the penalties of perjury, showing in full the purposes thereof and in detail all transactions incident to, or pursuant to the plan; (2) A complete statement of the cost or other basis of all properties, including all stocks or securities, transferred incident to the plan; (3) A statement of the amount of stock or securities and other property or money received from the exchange including a statement of all distribution or other disposition made thereof. The amount of each kind of stock or securities and other property received shall be stated on the basis of the fair market value thereof at the date of the exchange; and (4) A statement of the amount and nature of any liabilities assumed upon the exchange, and the amount and nature of any liabilities to which any of the property acquired in the exchange is subject. HICATc B. Every taxpayer, other than a corporation, who is a party to the reorganization, who received stock or securities and other property or money upon a tax-free exchange in connection with a corporate reorganization shall incorporate in his income tax return for the taxable year in which the exchange takes place, a statement of all facts pertinent to the non-recognition of gain or loss upon such exchange including: (1) A statement of the cost or other basis of the stock or securities transferred in the exchange; and (2) A statement in full of the amount of the stock or securities and other property or money received from the exchange, including any liability assumed upon the exchange, and any liability to which property received is subject. The amount of each kind of stock or securities and other property (other liabilities assumed upon the exchange) received shall be set forth upon the basis of the fair market value thereof at the date of exchange. C. Permanent records in substantial form shall be kept by every taxpayer who participates in a tax-free exchange in connection with a corporate reorganization showing the cost or other basis of the transferred property or money received (including any liability assumed on the exchange, or any liability to which any of the properties received were subject), in order to facilitate the determination of gain or loss from a subsequent disposition of such stock and other property received from the exchange. In addition to the foregoing requirements, the parties shall enclose with their respective income tax returns for the taxable year in which the merger occurred a copy of the request for ruling filed with, and the corresponding ruling issued by, the Bureau of Internal Revenue, both duly stamp-received by the appropriate office of the Bureau of Internal Revenue. Such parties shall include as a note to their respective audited financial statements for the taxable year in which the merger occurred a statement to the effect that they hold such assets/shares acquired in a merger and the year in which such merger occurred, and in the taxable years, until the subject properties are subsequently transferred to another transferee. TaDIHc Finally, the parties are required to submit proof of annotation of the substituted or cost basis of the shares of stock involved in the transfer to the Law Division, Bureau of Internal Revenue, within ninety (90) days from receipt of this ruling. Violation of the above requirements is subject to the penalties provided in Sections 269 and 275 of the Tax Code of 1997, as amended. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, and/or any of the requirements imposed in this letter is not complied with, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. Section 40(C)(2) of the 1997 Tax Code, as amended.