July 10, 2008
BIR RULING [DA-(C-005) 023-08] Sec. 27 (A); 98 & 179; DA-419-04; DA-378-2008 Aranas Consunji & Barleta Law Office Unit 106 G/F Le Metropole Condominium Tordesillas Corner Dela Costa Streets, Salcedo Village, Makati City Attention: Atty. Jesus Clint O. Aranas Gentlemen : This refers to your letter dated 7 July 2008, requesting on behalf of your client, Lepanto Ceramics Inc. (LCI), confirmation of your opinion as follows: 1.
That the condonation in favor of LCI by one of its creditors is not subject to income tax; and
2.
That the execution of a compromise agreement to effect the terms and conditions of the condonation is not subject to the documentary stamp tax (DST). DaEATc
It is represented that LCI is a corporation duly organized and existing under and by virtue of Philippine laws; that it is a corporation established primarily to manufacture, buy and sell on wholesale or retail basis tiles, marbles, mosaics, fireplaces, bronzes and other articles, products and incidentals pertaining to the same; that its business address at Km. 54, Bo. Makiling, Calamba Laguna; that for taxable year ended June 30, 2007, LCI has reflected a capital deficit position to the extent of P3,519,811,094.00; that the said capital deficiency is comprised of liabilities of the company, which, in the opinion of its auditors, "indicate the existence of a material uncertainty which may cast substantial doubt about the Company's ability to continue as a going concern; and that a part of the said liabilities pertains to a loan taken from a Copyright 2013
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third party creditor with a principal value amounting to P296,441,053.23 (consisting of principal and capitalized interest). It is further represented that in view of the fact that the liabilities have remained unpaid, LCI has offered a compromise settlement with the said third party creditor; that out of the total liability, LCI offered to pay P180,000,000.00 and requested the cancellation and condonation of the remaining portion of the principal value of the loans amounting to P116,441,053.23 plus accrued interests; that after the proposed condonation, LCI will still be in a capital deficit position as reflected in the attached Pro Forma Financial Statements. In reply, please be informed that in BIR Ruling No. DA-419-04 dated August 4, 2004, the BIR held as follows: "Thus, the condonation of the CPI's debt to SJ shall not be subject to income tax considering that CPI is in a capital deficiency position and will remain insolvent before and after the said condonation considering that the amount to be condoned would only be P84,198,555.20. Moreover, the condonation is likewise not subject to gift tax since there is no donative intent on the part of SJ but solely for business consideration."
The above ruling was issued by the BIR on the basis of the discussions stated in BIR Ruling No. 076-89 dated April 17, 1989 which states as follows: aDcTHE
"Cancellation and forgiveness of indebtedness may amount to a payment of income, to a gift, or to a capital transaction, dependent upon the circumstances. If for example, an individual performs services for a creditor who, in consideration thereof cancels the debt, income to that amount is realized by the debtor as compensation for his services. If, however, a creditor merely desires to benefit a debtor and without any consideration therefor cancels the debt, the amount of the debt is a gift from the creditor to the debtor and need not be included in the latter's gross income. If a corporation to which a stockholder is indebted forgives the debt, the transaction has the effect of the payment of a dividend. (Sec. 50 Revenue Regulations No. 2) The waiver of interest by the banks on non-trade and trade related indebtedness of GMPI is not subject to income tax considering that the deduction of said interest as expense in prior years did not offset nor reduce the taxable income of GMPI since it was in a financial loss position even without the deduction. (See Barnhart-Marrow Consolidated v. Commissioner of Internal Revenue, 47 BTA 590) Moreover, when a creditor cancels a debt as part of a business transaction, the debtor is enriched or its net assets has been increased and, therefore, he realized taxable income (Philippine Fiber Processing Co. v. CIR, Copyright 2013
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CTA Case No. 1407 Dec. 29, 1966). However, a transaction whereby nothing of exchangeable value comes to or is received by a taxpayer does not give rise to or create taxable income. (See Dallas Transfer and Terminal Warehouse Co. v. Commissioner of Internal Revenue, 5 Cir. 70 F 2d 95, 13AFTR 930) Accordingly, the condonation of GMPI's indebtedness by GM-US is not subject to income tax since before and after the condonation GMPI remains insolvent, i.e., in a capital efficiency position. The condonation is likewise not subject to gift tax since there is no donative interest on the part of GM-US but solely for business consideration since Isuzu will only acquire the GMPI shares from GM-US if GMPI has a "clean" balance sheet with no outstanding liabilities except those to Isuzu."
It is clear from the foregoing that the condonation of LCI's indebtedness is not subject to income tax if nothing of exchangeable value comes to or is received by LCI. This is based on the basic and generally accepted principle of taxation that taxable income is created from the inflow of wealth. Therefore, if after the condonation of the liability, LCI will remain insolvent or in a capital deficit position, then the cancellation of the indebtedness is not subject to any tax. The said condonation is also not subject to donor's tax in the hands of LCI, for lack of donative intent on the part of its creditor. Accordingly, the condonation in favor of LCI by one of its creditors of the loan amount of P116,441,053.23 plus accrued interest and penalties out of the total loan obligation in the amount of P296,441,053.23 is not subject to income tax. In addition thereto, the execution of a compromise agreement to implement the terms of the above mentioned condonation is not subject to the documentary stamp tax imposed under Section 179 of the Tax Code. In BIR Ruling No. DA-378-2008 dated June 24, 2008 issued to Prime Orion Philippines Inc., the BIR ruled as follows: TDSICH
In reply, please be informed that Section 179 of the Tax Code of 1997, as amended by Republic Act (R.A.) No. 9243, provides: "Sec. 179. Stamp Tax on all Debt Instruments. — On every original issue debt instruments, there shall be collected a documentary stamp tax of One Peso (P1.00) on each two hundred pesos (P200), or a fraction thereof, of the issue price of any such debt instruments: Provided, that for such debt instruments with terms of less than one (1) year, the Copyright 2013
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documentary stamp tax to be collected shall be of a proportional amount in accordance with the ratio of its terms in number of days to three hundred sixty five (365) days: Provided, further, That only one documentary stamp tax shall be imposed on either loan agreement, or promissory notes issued to secure such loan." In the case of POPI, the compromise agreement is not in the nature of a loan agreement, but is executed precisely to effect the payment of terms embodied in a loan agreement. Since POPI did not execute any document that may be considered as a loan agreement to which the tax under Section 179 of the Tax Code, as amended, is imposed, and since a compromise agreement is not one among those instruments falling under any of the documents enumerated under the Tax Code that are subject to a specific DST, then the said compromise agreement which provides for the new terms and conditions of payment of an original loan, shall not be subject to documentary stamp tax (BIR Ruling No. 146-95 dated September 19, 1995 and BIR Ruling No. DA-381-08-24-98 dated August 24, 1998). Accordingly, the execution of a compromise agreement to document and effect the terms of a previously agreed upon condonation of a loan by POPI from one of its creditors, is not subject to the documentary stamp tax."
In view of the foregoing, the execution of a compromise agreement to document and effect the terms of a previously agreed upon condonation of a loan between LCI and one of its creditors, is not subject to the documentary stamp tax imposed under Section 179 of the Tax Code, 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 as represented are different, then this ruling shall be considered null and void. ADCEaH
Very truly yours, Commissioner of Internal Revenue Copyright 2013
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By:
(SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service
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