Implementation of the Informal Entry System for Low Dutiable Express Shipments

October 29, 2008 BIR RULING [DA-(S40M-013) 369-08] 40 (C) (2) & (6) (b); S-40-004-2003 Bernaldo Mirador & Directo Law Offices Unit 1807 Cityland Condominium 10 Tower 1 6815 Ayala Avenue cor. H.V. dela Costa St. Makati City Attention: Atty. Rosario S. Bernaldo Managing Partner Gentlemen : This refers to your letter dated February 20, 2006 requesting, on behalf of your client, Puregold Price Club, Inc. (Puregold) for a confirmation of your opinion that the transfer of assets and liabilities of Suremart Incorporated (Suremart) to Puregold pursuant to a plan of merger qualifies as a tax-free merger under Section 40 (C) (2) and (6) (b) of the National Internal Revenue Code of 1997. The facts, as represented, are as follows: 1. On August 5, 2006, Puregold and Suremart, both domestic corporations, executed a Plan of Merger and Articles of Merger whereby they agreed that it is to their best interest to merge into one corporation that will redound to their advantage and welfare. 2. Puregold has an authorized capital stock consisting of five hundred thousand (500,000) common shares with a par value of P100.00 per share. As of March 15, 2005, Puregold's audited balance sheet shows total assets of P1,272,266,369 and total liabilities of P1,194,206,538. 3. Suremart has an authorized capital stock consisting of one hundred thousand (100,000) common shares with a par value of P100.00 per share. As of March 15, 2005, Suremart's audited balance sheet shows total assets of P204,107,560 and total liabilities of P226,274,680. DHSCEc 4. As of the effective date of merger, March 15, 2005, Puregold shall be the surviving corporation and the separate corporate existence of Puregold and Suremart shall cease. Puregold shall thereupon and thereafter possess all the rights, properties, offices and franchises of Suremart and all property, real or personal; and all receivables due on whatever account, including subscriptions to shares and other choses in action, and all and every other interest of, or belonging to, or due to Suremart , shall be taken by and deemed transferred to and as provided in Section 80 (4) of the Corporation Code, without further act or deed. 5. Pursuant to the Plan of Merger and to the determination of the Board of Directors, there shall be no issuance of shares of stocks since Suremart has capital deficiency amounting to P28,417,120 as of March 31, 2005. 6. The fair market value, acquisition cost (excluding cash) of the assets and liabilities to be transferred by Suremart, the value of the shares of stock to be received by Suremart from Puregold, in consideration of such transfer and the excess of liability over costs of assets (excluding cash) are as follows: cIHDaE Assets Acquisition Cost Fair Market Value Cash and Cash Equivalents P15,149,695 Accounts Receivables P8,239,225 8,239,225 Inventories 76,740,494 76,740,494 Other Current Assets 24,401,983 24,401,983 Property and Equipments 58,126,163 58,126,163 Other non-Current Assets 21,450,000 21,450,000 P188,957,865 P204,107,560 ========== ========== Liabilities Accounts Payable-Accrued Expenses P118,617,631 P118,617,631 Loans Payable 9,600,000 9,600,000 Advances from Stockholders 94,860,505 94,860,505 Other Current Liabilities 3,196,544 3,196,544 P226,274,680 P226,274,680 ========== ========== P37,316,815 (Excess of liability over costs of assets excluding cash) Net Assets Transferred P22,167,120 (Value of Shares Received) ========== In reply thereto, please be informed as follows: 1. Pursuant to Section 40 (C) (2) (a) and (6) (c) of the Tax Code of 1997, no gain or loss shall be recognized if property is transferred to a corporation by a person, in exchange for stock in such a corporation of which as a result of such exchange, said person, alone or together with others, not exceeding four persons, gain 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 stocks received i.e. , total subscribed by the transferors. In determining the 51% stock ownership, only those persons who transferred property for stocks in the same transaction may be counted up to a maximum of five. Accordingly, no gain or loss shall be recognized both on the transferor and the transferee corporation on the transfer by Suremart of its assets and liabilities in exchange for the shares of stock of Puregold, considering that as a consequence of the exchange, Puregold gained control of the transferee corporation by owning 100% of its total voting stocks. However, if pursuant to the exchange transaction and as part of the consideration, the transferee corporation assumes the liability of the transferors or acquires from the transferors 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 [Sec. 40 (C) (4) (a) of the Tax Code of 1997] . 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. 40 (C) (4) (b) of the Tax Code of 1997] Applying the foregoing in the instant case, and since the liabilities to be transferred to Puregold exceed the original basis of the properties transferred, a taxable gain, therefore, shall be recognized in the aggregate amount of THIRTY SEVEN MILLION THREE HUNDRED SIXTEEN THOUSAND PESOS EIGHT HUNDRED FIFTEEN PESOS (P37,316,815). 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. xxx xxx xxx." However, Section 4.100-5 (b) (1) and (3) of Revenue Regulations No. 7-95 (now RR 16-2005) specifically excepts mergers from being subject to output tax. Hence, "SEC. 4.100-5. Changes in or cessation of status as a 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 occurrences 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 stockholder, 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. 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 (now RR 16-2005), otherwise known as the "Consolidated Value-Added-Tax Regulations", the said transfer being considered a transaction "not subject to output tax" under the said Section. DSHcTC 3. Section 199 (m) of the 1997 Tax Code, as amended by Republic Act No. 9243, provides as follows: "SEC. 199. Documents and Papers not Subject to Stamp Tax . The provisions of Section 173 to the contrary notwithstanding, the following instruments, documents and papers shall be exempt from the documentary stamp tax: xxx xxx xxx (m) Transfer of property pursuant to Section 40(c)(2) of the National Internal Revenue Code of 1997, as amended." Thus, no documentary stamp taxes should be due on the transfer by Suremart of its assets and liabilities to Puregold. TEcCHD It should be emphasized, however, that Section 40 (C) (2) and (6) (c) of the Tax Code of 1997 merely defers recognition of the gain or loss from such transaction, for in determining the gain or loss from a subsequent transaction of the property or of the stocks involved in the exchange, the original or historical cost of the property or stocks is considered. Thus, if the transferors later sell or exchange the shares of stock they acquired in the exchange, they shall be subject to income tax on the gains they derived from such sale or exchange, taking into consideration that the cost basis of the shares shall be the same as the original acquisition cost or adjusted cost basis to the transferors of the property exchanged therefor; and that the cost basis to the transferee of the property exchanged for stocks shall be the same as it would be in the hands of the transferors. [Sec. 40 (C) (5) (a) and (b) of the Tax Code of 1997] . Moreover, 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 40 (C) (2) and (6) (c) of the Tax Code of 1997, they should comply with the requirements hereunder mentioned: A. The transferor must file with its income tax return for the taxable year in which the exchange transaction was consummated, a complete statement of all facts pertinent to the exchange, including: 1. A description of the property it transferred, or of its interest in such property, with a statement of the original acquisition cost/adjusted cost basis or other basis thereof at the time of the transfer; 2. The kinds of stocks received and preferences, 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. SEcTHA 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 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 ESTCDA c. The fair market value as of the date of the exchange of the capital stock issued to the transferor. In addition to the foregoing requirements, the parties shall enclose with their respective income tax returns for the taxable year in which the tax-free exchange 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 persons shall include as a note to their respective audited financial statements for the taxable year in which the exchange occurred a statement to the effect that they hold such assets/shares acquired in a tax-free exchange and the year in which such exchange occurred, and in the taxable years until the subject properties are subsequently transferred to another transferee. The fair market value as stated above shall be subject to verification by the RDO concerned. 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 are 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