TAX ALERT

December 31, 2005

THE TRANSFER BY A CORPORATION OF ITS FIXED ASSETS TO ANOTHER

CORPORATION IN EXCHANGE FOR SHARES OF STOCK OF THE LATTER
PURSUANT TO A TAX-FREE EXCHANGE TRANSACTION UNDER SECTION
40(C)(2) OF THE 1997 TAX CODE IS NOT SUBJECT TO VAT. HOWEVER, THE
TRANSFER OF INVENTORY IS SUBJECT TO VAT.
Facts: P Corporation is a domestic corporation engaged in the production and sale of
petroleum products, including liquefied petroleum gas (LPG). S Corporation is a wholly-
owned subsidiary of P Corporation engaged in the business of trading, distributing and
marketing LPG. To streamline operations and achieve optimum efficiency and economy in
the management of the operations of P Corporation’s LPG business, and as part of the
reorganization of the LPG business of P companies worldwide, P Corporation deemed it
necessary to assign its LPG business, including its fixed assets and inventory, to S
Corporation in exchange for shares of stock of the latter pursuant to a tax-free exchange
transaction under Section 40(C)(2) of the 1997 Tax Code. Issue: Whether or not the transfer
of fixed assets and inventory by P Corporation to S Corporation in exchange for shares of
stock of the latter pursuant to a tax-free exchange transaction under Section 40(C)(2) of the
1997 Tax Code is subject to VAT. Ruling: The transfer by P Corporation of the fixed assets
of its LPG business to S Corporation in exchange for the latter’s shares of stock under
Section 40(C)(2) of the 1997 Tax Code, and in accordance with the reorganization of the
LPG business of P companies worldwide, does not constitute a sale or exchange subject to
VAT, but rather a mere change in the form of ownership. As held by the Supreme Court in
Delpher Trades Corporation v. Intermediate Appellate Court, 157 SCRA 349 (1988), 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 [now Section 40(C)(2)], 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. 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 held for sale in the ordinary course of trade or business is not subject to VAT.
Consequently, the transfer by P Corporation of the fixed assets of its LPG business to S
Corporation is subject to VAT. However, the transfer of inventory which constitutes stock-
in-trade is subject to VAT in accordance with Section 4.106-8(b) of Revenue Regulations
No. 16-2005. BIR Ruling No. 24-2005 dated December 23, 2005.

8/F Jollibee Centre, San Miguel Avenue, Ortigas Center, Pasig City, 1605 Philippines
Telephone: (632) 633-9418 ‚ Facsimile: (632) 633-1911
E-mail: baniqued@info.com.ph
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COMMISSIONER OF INTERNAL REVENUE ISSUES GUIDELINES AND

PROCEDURES IN HANDLING LETTER NOTICES (“LN”) FOR DEPLOYMENT
IN THE YEARS 2005 ONWARDS.
This covers VAT and income tax liabilities of individual and corporate taxpayers issued LNs
deployed via the Information Delivery Portal for the following period: (1) Bureau of
Customs (“BOC”) LNs covering taxable year 2003; and (2) Consolidated (RELIEF/SLSP
and BOC) LNs for taxable years 2004 onwards. The pertinent guidelines are as follows: (1)
A taxpayer issued an LN may voluntarily pay deficiency income tax and VAT resulting from
the findings of discrepancy in the LN and shall be entitled to the abatement of interests and
penalties provided he pays within 60 days from receipt of the LN. Any payment of tax
liabilities beyond the 60-day period shall be assessed the corresponding interests and
penalties; (2) The deficiency income and VAT shall be computed using the prescribed
formula and corresponding payment shall be made using BIR Form No. 0611-A; (3) The
prescribed formula shall apply only to LNs issued to taxpayers that are not subject of an
investigation pursuant to a Letter of Authority (“LA”); (4) The settlement and payment of
deficiency taxes under an LN does not preclude the BIR from issuing an LA covering a
comprehensive audit of a taxpayer’s tax liability; (5) LNs served on taxpayers for which no
response was received or LNs that remained unserved due to failure to locate the taxpayers
shall be converted to LAs after the lapse of the 60-day period after the LN issuance; (6) If the
taxpayer disputes the discrepancy shown in LN, he will be given 120 days from receipt of the
LN to reconcile his records with those of the BIR; and (7) In case the discrepancy remains
unresolved after the 120-day period, the Revenue Officer assigned shall recommend the
issuance of LA to replace the LN. Revenue Memorandum Order No. 32-2005 dated
November 24, 2005.

COMMISSIONER PRESCRIBES THE USE OF SEPTEMBER 2005 ENHANCED

VAT FORMS.
To wit: (1) BIR Form No. 2550M (Version September 2005 ENCS) – the Monthly Value
Added Tax Declaration; and (2) BIR Form No. 2550Q (Version September 2005 ENCS) –
the Quarterly Value Added Tax Return. Revenue Memorandum Circular No. 68-2005
dated December 1, 2005.

COMMISSIONER PRESCRIBES GUIDELINES AND PROCEDURES FOR THE

REGISTRATION OF PARTNERSHIPS AND CORPORATIONS WITH THE BIR
UPON THEIR REGISTRATION WITH THE SECURITIES AND EXCHANGE
COMMISSION (“SEC”) AND UPON THE ISSUANCE OF THEIR PRE-
GENERATED TINs.
Thus: (1) Issuance of pre-generated TINs shall cover only new partnership/corporate
registrants; (2) Systems Operations Division of the BIR shall assign pre-generated TINs to
the SEC; (3) SEC shall issued pre-generated TINs to registrants and shall submit them to the
BIR with the corresponding registration information for uploading to the Integrated Tax
System (“ITS”) database; (4) The RDO shall receive from the taxpayer the fully
accomplished BIR Form No. 1903 and a certified photocopy of its SEC Certificate of
Registration with SEC Registration No. and pre-generated TIN indicated therein; (5) The
RDO shall validate with the BIR ITS database if the pre-generated TIN is valid and existing;
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(6) The RDO shall process the registration of the new corporation and shall issue the
corresponding Certificate of Registration; (7) The date of registration shall be effective on
the date the pre-generated TIN was issued by the SEC to the taxpayer; (8) Corporations
found to operate without the necessary registration requirements from the BIR shall be
penalized pursuant to Sections 258 and 264 of Republic Act 8424. Revenue Memorandum
Order No. 30-2005 dated October 25, 2005.

A CORPORATION MAY ISSUE NEW CERTIFICATES OF STOCK UNDER THE

CORPORATE-STOCKHOLDER’S NEW NAME TO REPLACE THE OLD
CERTIFICATES OF STOCK UNDER THE STOCKHOLDER’S FORMER NAME
WITHOUT NEED OF PAYMENT OF CAPITAL GAINS TAX AND
DOCUMENTARY STAMP TAX.
Considering that the corresponding change of name of the corporate-stockholder does not
create a new legal entity, but merely is the same corporation under a different name, the
change of name did not result in any barter, sale, exchange, or other disposition of its shares
of stock in the investee company. Accordingly, the registration of the stockholder’s shares
under its new corporate name is not subject to capital gains tax and documentary stamp tax.
BIR Ruling No. DA-451-2005 dated November 8, 2005.

ACCRUED BUT UNPAID INTEREST CONVERTED INTO ADDITIONAL PAID IN

CAPITAL WITHOUT THE ISSUANCE OF ADDITIONAL SHARES IS NOT
SUBJECT TO INCOME TAX AND DONOR’S TAX.
A parent company extended a loan to its subsidiary. Due to continuing business losses,
however, interests that were accrued in the books of the subsidiary were not remitted to the
parent. Subsequently, the accrued but unpaid interests were converted into additional paid in
capital without the issuance of additional shares. The contribution of paid-in surplus in the
form of money or property without the issuance of additional shares by the company’s major
stockholders is not subject to income tax. This is because a capital contribution generally
does not give rise to a taxable event pursuant to Section 56 of the Income Tax Regulations.
Furthermore, the conversion into additional paid-in capital of accrued but unpaid interest will
not give rise to donor’s tax on the part of the parent considering that there is no donative
intent in a debt-to-equity conversion transaction. BIR Ruling No. DA-444-2005 dated
October 27, 2005.

A DEBTOR DOES NOT REALIZE “CANCELLATION-OF-INDEBTEDNESS

INCOME” IF THE CONDONATION OR FORGIVENESS OF INDEBTEDNESS DID
NOT RESULT TO AN INCREASE IN THE ASSETS OF THE DEBTOR.
A parent company extended a loan to its subsidiary. Due to continuing business losses,
however, the parent suspended, waived or condoned interest due from, but not accrued by,
the subsidiary. Notwithstanding the condonation, however, the subsidiary remained
insolvent in that its liabilities still exceeded its assets. Before the condonation or forgiveness
of indebtedness will give rise to taxable income, there must be an increase in the assets of the
debtor thereby enriching the latter. A transaction whereby nothing of exchangeable value
comes to or is received by a taxpayer does not give rise to or create taxable income. Gain or
profit is essential to the existence of taxable income. The condonation of indebtedness must
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result in the debtor acquiring something of exchangeable value in addition to what he has
before. While there was a reduction or extinguishment of liabilities, there was no
corresponding increase in assets. The debt condonation did not have the effect of making the
subsidiary’s assets greater than they were before. BIR Ruling No. DA-444-2005 dated
October 27, 2005.

MOREOVER, NO WITHHOLDING TAX IS DUE ON THE ACCRUED BUT

UNPAID INTEREST AND ON THE INTEREST DUE BUT WAS NOT ACCRUED IN
THE BOOKS OF THE DEBTOR BECAUSE NO INTEREST WAS IN FACT
REMITTED.
In so holding, BIR Ruling No. DA-444-2005 dated October 27, 2005 cited the case of
Commissioner of Internal Revenue v. Mar Fishing Co., Inc., CA-G.R. No. 29838 dated
January 31, 1994, which held that where technical fees were accrued in the books but no
actual payment was made to the foreign corporation, no withholding tax can be imposed
thereon since there was no income realized by the foreign corporation subject to Philippine
income tax.

BIR DISTINGUISHES BETWEEN SERVICES FEES AND ROYALTIES.

To distinguish between compensation for service and royalty payments, the taxpayer must
inquire on whether the payee has proprietary interest in the property that gave rise to the
income. If the payee has none, the payment constitutes compensation for personal services.
If the payee has proprietary interest, the payment constitutes royalty. BIR Ruling No. DA-
ITAD 139-05 dated November 15, 2005, citing Philippine Refining Company v. CIR, CTA
Case No. 2872 dated January 15, 1986.

A NON-RESIDENT FOREIGN CORPORATION IS TAXABLE ONLY ON INCOME

DERIVED FROM SOURCES WITHIN THE PHILIPPINES.
Since the design and support services of the non-resident foreign corporation are to be
performed entirely in Korea, the Philippines-Korea tax treaty does not apply. The transaction
does not result in a case of double taxation of business profits for which a tax treaty relief
may be sought. The fees to be remitted by the Philippine corporation are considered income
derived from sources outside the Philippines. These are not subject to Philippine income tax
and, consequently, to withholding tax. BIR Ruling No. DA-ITAD 130-05 dated November
14, 2005; BIR Ruling No. DA-ITAD 129-05 dated November 11, 2005.

SERVICES RENDERED BY A NON-RESIDENT FOREIGN CORPORATION FOR

A PERIOD OR PERIODS NOT EXCEEDING AN AGGREGATE OF 183 DAYS
SHALL NOT CONSTITUTE CARRYING ON OF BUSINESS THROUGH A
PERMANENT ESTABLISHMENT.
The income derived by a Singaporean corporation is not subject to Philippine tax pursuant to
Article 7(1) in relation to Article 5 of the Philippines-Singapore tax treaty. BIR Ruling No.
DA-ITAD 137-05 dated November 15, 2005.
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GROSS REVENUES FROM PHILIPPINE SOURCES DERIVED BY THE BRANCH

OF A FOREIGN AIRLINE ARE SUBJECT TO 1½% INCOME TAX PURSUANT TO
ARTICLE 8 OF THE PHILIPPINES-SINGAPORE TAX TREATY.
The term “profits” as used in Article 8 of the Tax Treaty, although for treaty purposes may
include profits other than those from the carriage of passengers and cargoes, shall mean only
profits as described in Section 28(A)(3)(a) of the Tax Code. Any profits outside the scope of
Gross Philippine Billings shall not be subject to the preferential rate of 1½% but to the rate of
32%, the tax rate imposed on the taxable income of a resident foreign corporation under
Section 28(A)(1) of the Tax Code. BIR Ruling No. DA-ITAD 142-05 dated November 23,
2005.

ROYALTY PAYMENTS ARE SUBJECT TO VAT.

Section 108(A)(1) and (5) of the 1997 Tax Code states that “the use of certain ‘know-how’
formulations and technical information” and “the supply of services by a nonresident person
or his employee in connection with the use of property or rights belonging to the non-resident
person” both fall within the definition of sale or exchange of services subject to ten percent
(10%) VAT pursuant to Section 108 of the Code. The domestic corporation, being the
resident withholding agent and payor in control of the payment, shall be responsible for
withholding the 10% VAT on such royalty fee before remitting any payment to the non-
resident foreign corporation. In remitting the VAT withheld, the domestic corporation shall
use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other
Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and proof of payment shall
serve as documentary substantiation for the domestic corporation’s claim of input tax upon
filing its own VAT return, if it is a VAT-registered taxpayer. In case that it is a non-VAT
registered taxpayer, the passed on VAT withheld shall form part of the cost of the service
purchased which may be treated as an “expense” or as an “asset”, whichever is applicable. In
addition, the domestic corporation is required to issue the Certificate of Final Tax Withheld
at Source (BIR Form No. 2306) in quadruplicate, the first three copies of which are to be
given to the non-resident foreign corporation upon its request, and the fourth copy to be
retained by the domestic corporation as its file copy. BIR Ruling No. DA-ITAD 135-05
dated November 15, 2005. See also BIR Ruling Nos. DA-ITAD 137-05 and DA-ITAD 134-
05, both dated November 15, 2005.

WITHHOLDING AGENT NOT SUBJECT TO 25% SURCHARGE FOR LATE

PAYMENT OF FINAL WITHHOLDING TAX ON INTEREST ON FOREIGN
LOANS, BUT ONLY LIABLE TO PAY DEFICIENCY BASIC TAX AND 20%
INTEREST BECAUSE IT WAS ABLE TO FILE ON TIME ITS MONTHLY
REMITTANCE RETURN OF FINAL INCOME TAXES WITHHELD (BIR FORM
NO. 1601-F) FOR ITS OTHER MONTHLY INCOME PAYMENTS SUBJECT TO
FINAL WITHHOLDING TAX.
Taxpayer failed to report in its monthly remittance return of final income taxes withheld
(BIR Form No. 1601-F) duly filed with the BIR the withholding taxes on interest on a
foreign loan. Taxpayer, however, duly filed on time BIR Form No. 1601-F for its other
income payments subject to final withholding tax. Taxpayer failed to report the final
withholding taxes on its interest on foreign loan because the interest due was never remitted.
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Inasmuch as the taxpayer duly filed on time BIR Form No. 1601-F covering its other income
payments subject to final withholding tax, the 25% surcharge shall not be imposed on its
voluntary filing of an amended BIR Form No. 1601-F including the deficiency withholding
tax on interest on foreign loan. Taxpayer, however, is still liable to pay the 20% interest on
the deficiency withholding tax. BIR Ruling No. DA-446-2005 dated October 27, 2005.

A PEZA REGISTERED ENTERPRISE ENJOYING THE 5% PREFERENTIAL TAX

RATE IN LIEU OF ALL TAXES IS EXEMPT FROM VAT. BIR Ruling No. DA-ITAD
131-05 dated November 14, 2005; BIR Ruling No. DA-ITAD 131-05 dated November 14,
2005.

SINCE PEZA-REGISTERED EXPORT ENTERPRISES MAY NEITHER BE

PASSED ON NOR CLAIM INPUT VAT, PAYMENTS MADE BY PEZA-
REGISTERED EXPORT ENTERPRISES TO NON-RESIDENT FOREIGN
CORPORATIONS ARE EXEMPT FROM VAT. BIR Ruling No. DA-ITAD 130-05
dated November 14, 2005; BIR Ruling No. DA-ITAD 129-05 dated November 11, 2005.

NOTE:

The information provided herein is general and may not be applicable in all situations. It
should not be acted upon without specific legal advice based on particular situations. If you
have any questions, please feel free to contact any of the following at telephone number
(632) 633-9418, facsimile number (632) 633-1911, or at the indicated e-mail address:

Atty. Carlos G. Baniqued cgbaniqued@baniquedlaw.com

Atty. Laura Victoria A.S. Yuson-Layug lvyusonlayug@baniquedlaw.com
Atty. Terence Conrad H. Bello thbello@baniquedlaw.com
Atty. Ma. Carlota Christina G. Laiño-Santiago cglaino@baniquedlaw.com
Atty. Suzette A. Celicious sacelicious@baniquedlaw.com
Atty. Madeline L. Zialcita-Villapando mlzvillapando@baniquedlaw.com
Atty. Kathleen L. Saga klsaga@baniquedlaw.com