BIR Ruling [UN-210-94]

July 13, 1994 BIR RULING [UN-210-94] Sycip Gorres Velayo & Co. P.O. Box 589, Manila Attention: Atty . T . A . Tejada Tax Division Gentlemen : This refers to your letter dated October 8, 1990 requesting a ruling as to the tax consequence of the corporate restructuring of your clients, Rorer Philippines, Inc. (RPI) and Rhone Poulenc Natterman Pharma, Inc. (RPNP) which will ultimately result in the merger of said companies with RPI as the surviving corporation. It is represented that RPI is a domestic corporation primarily engaged in importing, manufacturing processing, compounding, repacking, preparing for the market, buying, selling at wholesale, distributing, transporting, and promoting general merchandise, goods and wares of all kinds and description such as, but no limited to, pharmaceutical preparations, drugs, medicines, chemicals, compounds, druggist, sundries and supplies, perfumeries, toilet articles, scientific apparatus and physicians and hospitals' supplies; that it has an authorized capital stock of 35,000 no par value shares of stock of which 19,736 shares are subscribed and fully paid; that it is 100% owned by Rorer International Overseas, Inc., a US corporation; that RPNP is likewise a domestic corporation primarily engaged in the business of importing, buying, repacking, manufacturing, selling at wholesale, distributing, transporting and promoting pharmaceutical preparations, drugs and medicines of all kinds and descriptions; that it has an authorized capital stock of 300,000 shares, of which 220,216 shares are issued and outstanding; that out of its issued and outstanding shares, 41% is owned by Rhone Poulenc Philippines, Inc. (RPPI) while the remaining 59% is owned by Natterman, a company domiciled in West Germany (Natterman-Germany); that prior to the merger between RPI and RPNP, RPI will buy from RPPI the latter's 41% shareholding in RPNP for P25.8 million); that RPNP will then be owned by RPI to the extent of 41% and by Natterman-Germany to the extent of 59% of its outstanding capital stock; that likewise on August 14, 1990 prior to the de Facto merger, RPNP which has, among its assets, two (2) condominium units (Suite Nos. 601 and 602 located at Gammon House, 110 Rada St., Legaspi Village, Makati, Metro Manila), agreed to sell to RPI said two (2) condominium units for P9,200,000.00; that under the terms of the final Deed of Sale, executed on September 27, 1990, RPI will pay the said purchase price of P9,200,000.00 on October 30, 1990; that RPI and RPNP will then enter into and implement a "de facto" merger agreement between them; that in deciding and agreeing to merge, RPI and RPNP are motivated by the following business reasons; (1) there is a necessity for their operations to be harmonized along unified operations policies in order to achieve efficiency and effectiveness and to optimize the use of the resources of both constituent corporations; (2) the reorganization will enable the constituent corporations to simplify operations and achieve efficiency and economy by eliminating duplication of efforts and facilities; (3) the reorganization will strengthen RPI's long term competitiveness in the domestic and worldwide economies and enable RPI to achieve and maintain a stronger financial position; (4) the reorganization will result in business advantages among which are (a) reduction of overall operation and production costs; (b) simplified management and greater efficiency; and (c) increased profitability through the pooling of resources; that under the terms of a Deed of Assignment with Assumption of Liabilities, which will implement the de facto merger of RPNP into RPI, the latter as the surviving corporation (whose name will be changed to Rhone Poulenc Rorer Philippines, Inc. upon the effectivity of the merger) shall acquire all the existing assets and business and assume all liabilities of RPNP as of September 27, 1990 in exchange for the issuance by RPI of its 15,264 no par value shares to RPNP at an issue value of P21,824,903.00 which shares shall be fully paid and non-assessable. The assets and business of RPNP to be acquired by RPI by virtue of the merger shall include, without limitation, all of RPNP's inventories, goodwill and its right to the use of its name, its rights and interest in, to and under all patents, patents application, trademarks, trademarks registration and applications therefor, all trade rights, whether or not registered, all inventions, discoveries, improvements, processes, formulae, trade secrets, ideas and other know-how, whether patentable or not, and all licenses and other agreements relating in whole or in part to the foregoing, and all assets accruing to RPNP from July 1, 1990 to September 27, 1990 exclusive of the two condominium units covered by CCT Nos. S-1967 and S-1968 located at Gammon House, 110 Rada St., Legaspi Village, Makati, Metro Manila, the sale of which has been noted in RPNP's audited financial statements as of June 30, 1990 and those products specifically described in a list attached to the Deed of Assignment with Assumption of liabilities; that the parties had agreed to consider the following items, in addition to the audited balance sheet of RPNP as of June 30, 1990 in determining the above total issue value of RPI's shares of stock to be issued in exchange of the net assets of RPNP as of September 27, 1990: cdtech "a. the approximate gain arising from the sale of RPNP to RPI of two (2) condominium units on September 27, 1990 at P9,200,000.00; "b. the excess of the prevailing market value over cost as of June 30, 1990 of the investments held by RPNP, as follows: (i) 1 proprietary share, Manila Polo Club Class 'B' (ii) 1 proprietary share, Makati Sports Club Class 'B' (iii) 32,000 shares, Ayala Property Ventures, Inc. Class 'B' "c. the separation benefits payable to RPNP employees upon RPNP's dissolution estimated at about P24,000,000 which has been approved in appropriate resolutions by the Board of Directors and stockholders of RPNP." that pursuant also to the terms, and as an essential part, of the reorganization, RPNP will be dissolved by shortening its corporate life to October 30, 1990; that it will thus distribute its remaining assets consisting of the 15,264 RPI no par value shares, as liquidating dividends, to its two stockholders, namely RPI and Natterman-Germany, in exchange for the surrender or cancellation of their shareholdings in RPNP; that RPI will thus receive from RPNP 41% of its own shares (which it will hold as treasury shares) while Natterman-Germany will receive from RPNP 59% of the 15,264 RPI shares, both as liquidating dividends; that thereafter, Natterman-Germany will transfer as property dividend to its sole stockholder, Verwaltung, a West Germany company that was organized only in 1990, all the RPI shares of stock that it will receive as liquidating dividend from RPNP; and that Verwaltung, in turn will declare and transfer the same RPI shares of stock as property dividend to Rhone Poulenc Rorer, Inc. (RPR) a U.S. corporation. In connection therewith, you now request confirmation of your opinion that "1. RPPI will be subject to the 10% / 20% capital gains tax under Section 24(e)(2)(A) of the Tax Code on the gain that it will realize from the sale to RPI of its 41% shareholdings in RPNP. The taxable capital gain is the excess of its selling price of P25.8 million over its acquisition cost of the shares; "2. Natterman-Germany will be subject to the 10% /20% capital gains tax under Section 25(b) (3) (c) (i) of the Tax Code in relation to Article 13 (3) of the Philippine-Germany Tax Treaty on the gain that it will realize from the sale to Verwaltung of its 59% shareholding in RPNP. "3. The said sale by RPPI of the RPNP shares shall be subject to documentary stamp tax under Section 176 of the Tax Code at P.50 on each P200, or fractional part thereof, of the par value of the shares sold; "4. The gain to be realized by RPNP from the sale of its two (2) condominium units shall be included, for income tax purposes, in the short period (July 1 to October 30, 1990) final income tax return to be filed by RPNP. However, the gross selling price of P9,200,000.00 will no longer be subject to the 5% creditable withholding tax under Revenue Regulations No. 1-90 since at the time the said consideration of P9,200,000.00 is supposed to be paid by RPI to RPNP in October 30, 1990, per the Contract of Sale, RPI (the buyer) has assumed the assets and liabilities of RPNP (the seller) pursuant to the Deed of Assignment with Assumption of Liabilities, so that the personality of the debtor and creditor have merged, thereby extinguishing the obligation to pay the consideration. Hence, there is no more "gross selling price" or payment of consideration on which the 5% creditable tax is to be applied and withheld. The Certificate Authorizing Registration will thus be authorized to be issued because the 5% creditable withholding tax is no longer applicable under the peculiar circumstances of this case. The Deed of Sale through which RPNP will sell, transfer and convey the two (2) condominium units to RPI will however, be subject to documentary stamp tax under Section 196 of the Tax Code; "5. The "merger" of RPI and RPNP, with RPI as the surviving corporation, under which RPNP will transfer all its assets and liabilities to RPI in exchange for the latter's 15,264 no par value shares at an issue value of P21,824,908.00 qualifies for non-recognition of gain or loss for income tax purposes in accordance with Par. (c)(2), in relation to Par. (c)(6)(b), both of Section 34 of the Tax Code, . . . Thus, no gain or loss shall be recognized to RPI and RPNP upon the transfer of the assets and liabilities of RPNP to RPI in exchange for RPI's shares of stock; "6. RPI, the transferee corporation, can depreciate the depreciable assets received by it from RPNP on the basis of the costs of such assets which is the ratable portion of the issue value of the 15,264 RPI no par value shares that is allocable to the depreciable assets received by RPI in the tax-free exchange, exclusive of the two (2) condominium units, (BIR Ruling Nos. 76-87 March 18, 1987; 30-84, January 7, 1984) "7. The abovementioned transaction shall not be subject to gift tax since there is no intention to donate on the part of any of the parties; "8. The transfer of RPNP's goods, including inventories, office furnitures and equipment, etc. pursuant to the merger agreement will not be subject to value-added tax. This is so provided in Section 5(b)(3) of Revenue Regulations No. 5-87, and confirmed in your BIR Ruling No. 106-89 dated May 16, 1989. The unused input VAT of RPNP as of the date of merger shall be absorbed by RPI, the surviving corporation; "9. The issuance by RPI of its 15,264 no par value shares to RPNP in consideration of the latter's conveyance of its assets and liabilities to RPI would be subject to DST pursuant to Section 175 of the Tax Code, based on the actual consideration received by RPI for the issuance of the stock; "10. Upon the dissolution of RPNP in accordance with the terms of the merger agreement, the receipt of RPPI and Natterman-Germany of the RPI shares as liquidating dividend shall not be subject to income tax or capital gains tax as the same is an integral part of the tax-free merger under Section 34(c)(2) of the Tax Code; "11. The DST to be paid upon the distribution by RPNP of the RPI no par value shares shall be as provided in Section 176, namely equivalent to 25% of the DST paid upon the original issue of said stock; "12. Whether or not Verwaltung and RPR, both foreign corporations, will be subject to Philippine income tax on the property dividend that they will receive will depend on whether said property dividend can be considered as Philippine source income as determined under Section 36 (a) (2) (B) of the Tax Code . . .; "13. The conveyances by Natterman-Germany to Verwaltung and by Verwaltung to RPR of the RPI shares as property dividend are not subject to documentary stamp tax since the declarations of the dividend and the conveyance of the shares are all done outside the Philippines. The DST is an excise tax and therefore it may be imposed only if the declaration and transfer or conveyance of the property dividend are performed in the Philippines." In reply thereto, I have the honor to inform you as follows: 1) Since investigation conducted by our International Tax Affairs Division disclosed that the shares of stock are not traded through a local stock exchange, RPPI is subject to the 10%/20% Capital Gains Tax under Sec. 34(e) (2) (A) of the Tax Code on the gain that it will realize from the sale to RPI of its 41% shareholdings in RPNP. The taxable capital gains is the excess of its selling price of P25.8 million over the acquisition-cost of the shares; 2) The gains realized by Natterman-Germany on the sale of its 59% shareholdings in RPNP or 130,209 shares to Verwaltung is likewise subject to capital gains tax in accordance with Section 25(b) (5) (c) (i) of the Tax Code in relation to Article 13(3) of the RP-West Germany Tax Treaty. 3) The sale by RPPI of the RPNP shares to RPI shall be subject to documentary stamp tax under Section 176 of the Tax Code at P.50 on each P200 or fractional part thereof, of the par value of the shares sold; 4) The gain to be realized by RPNP from the sale of its two (2) condominium units shall be included, for income tax purposes, in the short period (July 1 to October 30, 1990) final income tax return to be filed by RPNP. However, pursuant to Revenue Regulations (RR) No. 7-90, in relation to Section 3 of RR No. 6-85, the gross selling price of P9,200,000.00 will not be subject to the 5% creditable withholding tax inasmuch as at the time the said consideration is to be paid on October 30, 1990, per the contract of sale, RPI (the buyer) has assumed the assets and liabilities of RPNP (the seller) pursuant to the Deed of Assignment with Assumption of Liabilities, the personality of the debtor and creditor have merged, thereby extinguishing the obligation to pay the consideration. In other words, since at the time the obligation to deduct and withhold under RR 6-85 arose, the personality of the debtor and creditor have merged, there is no more "gross selling price" or payment of consideration on which the 5% creditable tax is to be applied and withheld. Thus, the Certificate Authorizing Registration may be issued because the 5% creditable withholding tax is not applicable under the particular circumstances of this case. However, the Deed of Sale executed by RPNP conveying its two (2) condominium units to RPI shall be subject to documentary stamp tax under Section 196 of the Tax Code, as amended. 5) That the merger of RPI and RPNP with RPI as the surviving corporation, under which RPNP will transfer all its assets and liabilities to RPI solely in exchange for the latter's 15,264 no par value shares at an issue value of P21,824,908.00 shall not give rise to the recognition of gain or loss for income tax purposes in accordance with Section 34(c)(2) of the Tax Code, as amended. No gain or loss shall be recognized to RPI and RPNP upon the transfer of the assets and liabilities of RPNP to RPI in exchange for RPI's shares of stock, the transaction undertaken being for a bona fide business purpose and not solely for the purpose of escaping the burden of taxation; 6) The assets were acquired by the transferee corporation, RPI in a tax-free exchange/transfer of property due to merger within the contemplation of Section 34 (c) (2) of the Tax Code, as amended. This Office has consistently ruled that the basis of the assets/property transferred in the hands of the transferee shall be the same as it would be in the hands of the transferor increased by the amount of the gain recognized to the transferor on the transfer. (Sec. 34(c)(5)(b), Tax Code) In other words, the property acquired by a transferee corporation "in connection with a reorganization" ordinarily takes a "carry over" basis equal to the transferor's basis, increased by any gain recognized to the transferor on such transfer. (par. 14-33, pp. 14-108, Bittker & Eustice; Federal Income Taxation of Corporations and Shareholders, 4th Ed.) Under Section 29(f)(1) of the Tax Code as amended, a deduction from gross income for depreciation is allowed but limits the recovery to the capital invested in the assets being depreciated. The law does not authorize the depreciation of an asset beyond its acquisition cost. (Basilan Estates, Inc. vs. Commissioner, G.R. No. L-22492, September 5, 1967) Basis for depreciation is ordinarily the same as for determining gain on sale of the asset. The basis of depreciable property, for purposes of depreciation is its adjusted basis for determining gain upon its subsequent sale or other disposition . [par. 5545, p. 244, 34 Am. Jur. 2d (1976)] Accordingly, contrary to our opinion, the capital sum (investment) recoverable by the transferee corporation, RPI through depreciation allowance is an amount equal to the historical cost or adjusted cost basis of the assets (to RPNP) acquired from RPNP in exchange for its (RPI) stocks issued to RPNP. (pls, see BIR Ruling No. 083-89 dated April 25, 1989 revoking cited BIR Ruling No. 030-84 dated January 7, 1984) 7) That the abovementioned transaction shall not be subject to gift tax since there is no intention to donate on the part of any of the parties; 8) That the transfer of RPNP's goods, including inventories, office furnitures and equipment, etc. pursuant to the merger agreement will not be subject to the value-added tax. The unused input VAT of RPNP as of the date of merger shall be absorbed by RPI, the surviving corporation (Section 5(b) (3) Revenue Regulations No. 5-87; BIR Ruling No. 106-89 dated May 16, 1989); 9) That the issuance by RPI of its 15,264 no par value shares to RPNP in consideration of the latter's conveyance of its assets and liabilities to RPI would be subject to DST pursuant to Section 175 of the Tax Code, based on the actual consideration received by RPI for the issuance of the stock; 10) That no gain or loss shall be recognized to RPNP upon the distribution of its RPI shares to RPNP stockholders in complete redemption of their stocks under Section 34(c)(2) of the Tax Code. No gain or loss shall be recognized to RPNP stockholders, namely: RPI and Natterman-Germany upon the exchange of their stocks solely for RPI stocks under Section 34(c)(2) of the Tax Code. Thus, upon the dissolution of RPNP in accordance with the terms of the merger agreement, the receipt by RPI and Natterman-Germany of the RPI shares as liquidating dividend shall not be subject to income tax or capital gains tax in accordance with Section 66(a) in relation to Section 25, both of the Tax Code, as amended. However, upon computation, the transaction resulted in a capital loss such that no tax is due on the issuance of the liquidating dividend; 11) That the DST to be paid upon the distribution by RPNP of the RPI no par value shares shall be as provided under Section 176 equivalent to 25% of the DST paid upon the original issue of said stock; 12) Since investigation conducted by the International Tax Affairs Division disclosed that Verwaltung was organized only in 1990 and has not received any income from Philippine source, the property dividend received by RPR, US from Verwaltung in the form of 129,927 RPNR shares, is not subject to tax in accordance with Section 36(a) (2) (B) of the Tax Code; 13) The above transfer of RPNP shares from Verwaltung to RPR, US through property dividend declaration is subject to documentary stamp tax in accordance with Section 176 of the Tax Code and Section 20 of Regulations No. 26 or the Documentary Stamp Tax Regulations. However, in order that the above-described re-organization can be considered as merger under Section 24(c) (2) of the Tax Code, 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, or party to a 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 property, including all stock 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 distributions or other disposition made thereof. The amount of each kind of stock or securities and other property received shall be stated as the basis of the fair market value thereof at the date of the exchange. 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 real property acquired in the exchange is subject. B. Every taxpayer, other than a corporation 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 complete 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 stock or securities and other property or money received from the exchange, including any liabilities assumed upon the exchange, and any liabilities to which property received is subject. The amount of each kind of stock or securities and other property (other than liabilities assumed upon the exchange) received shall be set forth upon the basis of the fair market value thereof at the date of the 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 liabilities assumed on the exchange, or any liabilities 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 or securities and other property received from the exchange. In addition to the foregoing requirements, permanent records in substantial form must be kept by the corporation participating in the merger showing the information listed above in order to facilitate the determination of gain or loss from a subsequent disposition of the stock received as a consequence of the merger. (BIR Ruling No. 237-89 dated November 21, 1989) Very truly yours, ALICIA P. CLEMENO Acting Assistant Commissioner Legal Service