BIR Ruling [UN-021-94]

January 18, 1994 BIR RULING [UN-021-94] Jara, Baarde & Associates Suite 201, Yusho Building 941 EDSA, Philam Life Homes Quezon City Attention: Mr . Felicisimo G . Quiogue, Jr . Gentlemen : This refers to your letter dated March 15, 1993 stating that your client, Jacinto Iron & Steel Sheets Corporation, a domestic corporation (referred to as Investor),invested in Camara Steel Industries Inc.,another domestic corporation (referred to as Investee) the amount of P1.4 Million for which your client received 93% of the capital stock of the latter; that the stocks of both corporations are not listed in any stock exchange; that in 1991, in order to improve the debt-to-equity ratio of Investor corporation, it used the equity method of accounting as authorized by Financial Accounting Standards No. 11, so it can present the current reappraised value of its investment in Investee corporation; that your client reported in its Financial Statement the revaluation increment in the physical assets of Investee corporation amounting to P35 Million, as well as its imputed share of P37.6 Million in the undistributed retained earnings of Investee; that up to the present there has been no dividend declaration by Investee corporation; that your client has in its books actual retained earnings amounting to P8,285,018.00 (P45,885,018.00 less the imputed share of P37.6 Million in the undistributed retained earnings of Investee corporation) as of December 31, 1991; that the Board of Directors and stockholders of Investor corporation contemplates declaring as property dividend all the shares of stocks in Investee corporation. In connection therewith, you now request confirmation of your opinion as follows: cdi 1. The revaluation increment on the assets of Investee corporation as well as the share of Investor corporation in the undistributed retained earnings of said Investee are not considered as actual income or accrued income pursuant to Section 38 of Revenue Regulations No. 2; 2. That upon property dividend declaration by Investor corporation, the value to be recognized on said shares of stocks to be distributed shall be at the original or acquisition cost of P1.4 Million and not the revaluation value; and 3. That the stockholders receiving the shares as property dividend shall be taxed 0%; that the documentary stamp tax on the instrument evidencing distribution of the shares of stocks as property dividend shall be based on par value of the shares of stocks under Section 176 of the Tax Code prescribing the rate of fifty centavos for every two hundred pesos or a fraction thereof. In reply thereof, please be informed as follows: 1. This Office hereby confirms your opinion that the "revaluation increment" in the property and assets of Investee corporation and the "imputed share in the undistributed retained earnings of Investee corporation" are not to be considered as taxable income pursuant to Section 38 of Revenue Regulations No. 2 (Income Tax Regulations), quoted below: "SEC. 38. Bases of computation . Approved standard methods of accounting will be ordinarily regarded as clearly reflecting income. A method of accounting will not, however, be regarded as clearly reflecting income unless all items of gross income and all deductions are treated with reasonable consistency. All items of gross income shall be included in the gross income for the taxable year in which they are received by the taxpayer and deductions taken accordingly, unless in order clearly to reflect income such amounts are to be properly accounted for as of a different period. For instance, in any case, in which it is necessary to use an inventory, no accounting in regard to purchases and sales will correctly reflect income except an accrual method. A taxpayer is deemed to have received items of gross income which have been credited to or set apart for him without restriction. On the other hand, appreciation in value of property is not even an accrual of income taxpayer prior to the realization of such appreciation through sale or conversion of the property." 2. Under Section 38 of Revenue Regulations No. 2, the revaluation increment in the assets of Investee corporation is not considered as income even if accrued in the books of Investor corporation. Likewise, the same rule applies to the imputed share in the undistributed retained earnings of Investee corporation for the reason that there was no crediting or setting apart in favor of Investor corporation of any part of the retained earnings of Investee corporation. It is only upon crediting or setting apart without restriction in favor of Investor by the Investee, of part or all of its retained earnings can it be said that Investor has had a constructive income. Consequently, no income is realized by Investor when it accrued its imputed share in the undistributed retained earnings of Investee, and therefore Investor corporation can only declare as property dividend its investment in Investee corporation using as basis for such dividend the acquisition cost or original cost of P1.4 Million. It also appears that there is more than sufficient retained earnings to cover the property dividends to its stockholders. 3. Under Section 21 (c) (2) of the Tax Code, as amended dividends received by an individual from a domestic corporation shall be subject to tax at the rate of 15% in 1986; 10% effective January 1, 1987; 5% effective January 1, 1988 and 0% effective January 1, 1989. Such being the case, dividends received from a domestic corporation are no longer includible as taxable. Documentary stamp tax on the deed evidencing transfer or conveyance of shares of stock as property dividend shall be imposed and collected at the rate of fifty centavos on each two hundred pesos of fractional part thereof, of the par value of the shares of stock. (BIR Ruling Nos. 117-89 dated June 5, 1989 and 108-93 dated March 16, 1993) Very truly yours, JAIME M. MAZA Assistant Commissioner (Legal Service)