Adoption of the Pronouncements of Financial Reporting Standards Council (FRSC)

December 23, 2005 BIR RULING NO. 024-05 RR 16-05 Baniqued & Baniqued Suite 803, 8/F Jollibee Centre San Miguel Avenue Pasig City Attention: Atty. Carlos G. Baniqued Atty. Laura Victoria A.S. Yuson-Layug Atty. Kathleen L. Saga Gentlemen : This refers to your letter dated November 25, 2005 stating that your client, Pilipinas Shell Petroleum Corporation (PSPC) is a domestic corporation engaged in the business of processing, treating and refining petroleum for the purpose of producing marketable products and by-products and subsequently selling the same; that among the petroleum products that PSPC markets and sells is LPG; that on the other hand, Shell Gas LPG Philippines, Inc. (SGLPI), a wholly-owned subsidiary of PSPC, is also a domestic corporation engaged in the business of trading, distributing and marketing LPG; that pursuant thereto, it is also authorized to operate and maintain storage terminals, machineries, equipment, dock, harbor and transport facilities used in the business; that in order to streamline operations and achieve optimum efficiency and economy in the management of the operations of PSPC's LPG business, PSPC has deemed it necessary to assign its LPG business, including its fixed assets and inventory, to SGLPI in exchange for shares of stock of the latter pursuant to a tax-free exchange under Section 40(C)(2) of the NIRC; that moreover, the spin-off of PSPC's LPG business is an integral part of a reorganization of the LPG business of Shell companies worldwide; that the assets to be transferred pursuant to the reorganization mentioned above include trade and non-trade receivables, prepaid expenses, deferred tax assets, as well as buildings (consisting of the administrative office, filling plants, and warehouses in filling plants), storage tanks, filling machines, bulk receiving equipment, LPG cylinders on loan to customers, safety facilities (such as fire fighting apparel and sprinkle system, fire pump gas detector, cooling equipment and, water supply), computers, furniture and fixtures, leasehold improvements, security facilities, electricity service, personnel facilities and marine platform (the latter collectively referred to as the "Fixed Assets"); that the abovementioned Fixed Assets are used in the ordinary course of PSPC's LPG business, particularly, in receiving and dispatching products, ensuring safety of filling plants, and attending to administrative and selling tasks; that all the above-mentioned Fixed Assets are depreciated in the books of PSPC over their useful economic lives; that the above-mentioned assets are not intended for sale or for lease in the ordinary course of PSPC's LPG business; that pursuant to the spin-off of the LPG business, PSPC also intends to transfer, along with the Fixed Assets, its existing inventory as of December 31, 2005 (the Inventory) to SGLPI in exchange for shares of stock of the latter; that the Inventory is sold on a regular basis by PSPC to third parties in the ordinary course of conduct of its LPG business; that after the assignment by PSPC of the LPG business to SGLPI, PSPC intends to assign in turn the SGLPI shares to its affiliate, Shell Gas (LPG) Holdings BV (SGHBV), a non-resident foreign corporation organized under the laws of file Netherlands, as an integral part of the reorganization of the LPG business of Shell companies worldwide; that pursuant to such plan of reorganization of Shell's LPG business worldwide, it is envisioned that SGHBV will hold and own the shares of stock of all Shell entities worldwide that are engaged in the LPG business; that the Shell group is currently reviewing a potential global sale of its LPG business; and that any and all subsequent or further plans of reorganization or divestment of Shell's LPG business, whether by way of merger or consolidation, asset or share purchase, and the like, are expected to involve or take place in, and at the level of, SGHBV. In connection therewith, you now request confirmation of your opinion that the assignment by PSPC of the Fixed Assets and Inventory of its LPG business to SGLPI in exchange for shares of stock of the latter pursuant to a tax-free exchange transaction under Section 40(C)(2) of the NIRC, and pursuant to a reorganization of Shell's LPG business worldwide, is not subject to value-added tax (VAT). In reply thereto, please be informed that Section 105 of the Tax Code of 1997, as amended by Republic Act (R.A.) No. 9337, as implemented by Section 4.105-1 of Revenue Regulations No. 16-2005, provides that "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 value-added tax (VAT) imposed in Sections 106 to 108 of the said Code. "The phrase "in the course of trade or business" means the regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto, by any person regardless of whether or not the person engaged therein is a non-stock, non-profit private organization (irrespective of the disposition of its net income and whether or not it sells exclusively to members or their guests), or government entity. cTESIa "xxx xxx xxx" On the other hand, Section 106 (B), supra, as amended by R.A. No. 9337, as implemented by Revenue Regulations No. 16-2005, provides as follows: "(B) Transactions Deemed Sale The following transactions shall be deemed sale: (1) Transfer, use or consumption not in the course of business of goods or properties originally intended for sale or for use in the course of business; (2) Distribution or transfer to: (a) Shareholders or investors as share in the profits of the VAT-registered persons; or (b) Creditors in payment of debt; (c) Consignment of goods if actual sale is not made within sixty (60) days following the date such goods were consigned; and (d) Retirement from or cessation of business, with respect to inventories of taxable goods existing as of such retirement or cessation. It is clear from the above-cited provisions that insofar as goods or properties are concerned, VAT is imposed on the sale, barter or exchange thereof in the course of trade or business, including transactions incidental thereto, as long as there is an actual change of ownership over such goods or properties. In the instant case, the transfer by PSPC of the Fixed Assets of its LPG business to its wholly-owned subsidiary, SGLPI, in exchange for the latter's shares of stock under Section 40(C)(2) of the Tax Code of 1997 and in accordance with the reorganization of the LPG business of PSPC, does not constitute a sale or exchange that is subject to VAT but either a mere change in the form of ownership. This is fortified in the case of Delpher Trades Corporation vs. Intermediate Appellate Court, 157 SCRA 349 (1988) , where the Supreme Court held that the transfer of properties to a corporation in exchange for shares of stock of the corporation pursuant to Section 35(c)(2) of the NIRC, as amended, where the transferors gain control of the said corporation does not constitute a sale of properties. The transaction merely involves a change in the nature of the ownership of properties from unincorporated to incorporated. Ownership over the properties remains the same. DSacAE However, R.A. No. 9337, as implemented by Revenue Regulations No. 16-2005, subjects to VAT the exchange for shares of stock of real properties held for sale or for lease even if the exchange results in corporate control, particularly in Section 4.106-8(b) of Revenue Regulations No. 16-2005 which provides that "Sec. 4.106-8. Change 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 the goods or properties used in business or those comprising the stock-in-trade of the corporation, having a change in corporate control, will not be considered sold, bartered or exchanged despite the change in ownership interest in the said corporation. Illustration: Abel Corporation is a merchandising concern and has an inventory of goods for sale amounting to Php1 million. Nel Corporation, a real estate developer, exchanged its real properties for the shares of stock of Abel Corporation resulting to the acquisition of corporate control. The inventory of goods owned by Abel Corporation (Php1 million worth) is not subject to output tax despite the change in corporate control because the same corporation still owns them. This is in recognition of the separate and distinct personality of the corporation from its stockholders. However, the exchange of real estate properties held for sale or for lease, for shares of stock, whether resulting to corporate control or not, is subject to VAT. This is an actual exchange of properties which makes the transaction taxable. It is to be noted that the underlying assumption of tax-free exchange provisions generally is that the new property received is substantially a continuation of the old investment still unliquidated. In other words, the said transaction does not constitute a sale or exchange of property in the course of trade or business. Hence, the conveyance of assets, property and equipment used in business but not for sale in the ordinary course of trade or business is not subject to VAT. CTaSEI The phrase "in the course of trade or business" connotes regularity of activity. Thus, in the case of Magsaysay Lines, Inc. vs. Commissioner of Internal Revenue , CTA Case No. 4353, April 27, 1992, the Court of Tax Appeals held that the sale by the National Development Company of five (5) vessels leased in the course of business is not subject to VAT since the sale is not in the course of trade or business. The said Court reasoned that the phrase "in the course of trade or business" does not contemplate an activity that can no longer be repeated or carried on with regularity. On the other hand, the word "incidental" contemplates an activity that necessarily follows the carrying out of the primary function. Since the sale of vessels is not necessary in the carrying out of NDC's primary function of leasing personal properties, it should not be subject to VAT. In the instant case, the transfer by PSPC of the Fixed Assets of its LPG business to SGLPI in exchange for the latter's shares of stock pursuant to a tax-free exchange transaction under Section 40(C)(2) of the Tax Code of 1997 is by reason of a reorganization, a transaction which is not done with regularity and would no longer be repeated. The assignment of the Fixed Assets is not undertaken in the course of PSPC's regular conduct of trade or business or in pursuit of a commercial or an economic activity, nor is it incidental thereto. The Fixed Assets are not held by PSPC for sale or for lease in the ordinary course of trade or business. Furthermore, the Fixed Assets do not constitute PSPC's stock-in-trade or inventory. Consequently, the assignment of the Fixed Assets is not subject to VAT. However, the assignment by PSPC of the Inventory of its LPG business to SGLPI, although the same does not occur in the regular conduct by PSPC of its trade or business and is likewise a transaction which is not done with regularity and would no longer be repeated is nevertheless subject to VAT pursuant to the above-cited Revenue Regulations No. 16-2005. WHEREFORE, in view of the foregoing , this Office hereby confirms your opinion as follows (1) The assignment by PSPC of the Fixed Assets of its LPG business to SGLPI in exchange for the latter's shares of stock under Section 40(C)(2) of the Tax Code of 1997 and pursuant to a reorganization of Shell's LPG business worldwide is not subject to VAT; and (2) The transfer by PSPC of its Inventory which constitutes stock-in-trade and is deemed an ordinary asset is subject to VAT. 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, then this ruling shall be considered null and void. DaHcAS Very truly yours, (SGD.) JOSE MARIO C. BUAG Commissioner of Internal Revenue