Gentlemen :
This refers to your letter dated December 22, 2008 requesting for confirmation
of your opinion that the condonation in favor of Metro Pacific Corporation ("MPC")
by its creditor of the loan amount of P63,723,182.16 out of the total loan obligation in
the amount of P109,468,682.16 is not subject to income tax and donor's tax; and that
the execution of a settlement agreement to document and effect the terms of such
condonation is not subject to documentary stamp tax.
Background
MPC has been suffering from capital deficiency arising from financial
difficulties, and that one of the primary reasons of MPC's business downturn is the
continuing incurrence of interest and penalties on the substantial amount of
outstanding liabilities in MPC's books. A portion of said liabilities pertains to a loan
taken from a third-party creditor with a maturity value amounting to P109,468,682.16
The accrued interests from the said loan were incurred by MPC way back
2002. During those taxable years, MPC was in a loss position, thus, it was not able to
claim tax deduction benefits from said interests and penalties.
In view of the fact that the liabilities have remained unpaid, MPC has offered
settlement with the said third party creditor, and out of the total liability, MPC offered
to pay PHP45,745,500.00 and requested the cancellation and condonation of the
remaining portion of the principal value of the loans plus accrued interests amounting
to PHP63,723,182.16. As and by way of documenting and effecting the approved
condonation, the parties have executed a settlement agreement which specified the
terms of payment.
MPC has reflected a capital deficit position and continually sustained losses as
shown by its Audited Financial Statements, as follows:
2007 2006
Net income (losses) (244,372,000) 2,106,593,000
Capital deficiency (425,629,000) (181,257,000)
After the proposed condonation, MPC will still be in a capital deficit position
as reflected in the unaudited Balance Sheet as of September 30, 2008 as follows:
Based on the foregoing, you now request for confirmation on the following
that:
On Income Tax
In several BIR rulings, 1(1) this Office has ruled that before the condonation or
forgiveness of indebtedness will give rise to a 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 a taxable income. Gain or profit is essential to the existence of taxable
income. ECaHSI
In setting forth the above pre-condition for imposing income tax on the
condonation of indebtedness, adopted the principle laid down by the US Supreme
Court in Dallas Transfer & Terminal Warehouse v. Commissioner of Internal
Revenue, 70 F. 2d 95, which held that there must be an increase in assets for there to
be income realized from the reduction or extinguishment of liability. In this case,
Dallas was renting an office building from its lessor. Due to the lease, Dallas incurred
a debt of US$107,880.77 rendering it insolvent. In order to enable Dallas to remain in
business and to have a chance to pay the reduced future rental agreed upon, and also
to keep its building from being vacant and unprofitable, the lessor accepted as partial
payment Dallas' Alamo street property with the appraised value of US$17,507.20 and
cancelled the balance of that debt, charging it off as worthless. The US Supreme
Court in ruling that Dallas did not realize taxable income explained that:
The above ruling was issued on the basis of the discussions stated in BIR
Ruling No. 076-89 dated April 17, 1989 which stated as follows:
"It is clear from the foregoing that the condonation of POPI advances
by Growluck is not subject to income tax if nothing of exchangeable value
comes to or is received by POPI. This is based on the basic and generally
accepted principle of taxation that taxable income is created from the inflow of
wealth.
It is clear from the foregoing that the condonation of MPC's indebtedness is not
subject to income tax if nothing of exchangeable value comes to or is received by
MPC. 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, MPC will remain insolvent or in a capital deficit position,
then the cancellation of the indebtedness is not subject to income tax.
Accordingly, the condonation by the creditor of MPC of its debt in the amount
of P133,723,182 is not subject to income tax considering that after the condonation,
the company will remain to be in a capital deficit position.
On Donor's Tax
In BIR Ruling No. DA-419-04 dated August 4, 2004, it was held that:
". . . 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."
Applying the foregoing, the condonation of the liability of MPC is not subject
to donor's tax if after the condonation, the same remains to be in capital deficit
position. Accordingly, it can be said that the condonation by the creditor of MPC of
its debt in the amount of P133,723,182 is not subject to donor's tax since there is no
donative intent on the part of the creditor but is solely for business consideration.
Section 179 of the Tax Code of 1997, as amended by Republic Act (RA) No.
9243 provides:
3(3) DCISAE
In the case of MPC, the settlement 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 MPC 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 settlement agreement is not one among those instruments falling
under any of the documents enumerated under the Tax Code that are subject to a
specific documentary stamp tax, then the said settlement agreement which provides
for the new terms and conditions of payment of an original loan, shall not be subject
to said tax. 4(4) Accordingly, the execution of a settlement agreement to document and
effect the terms of said condonation of MPC's loan by its creditor, is not subject to
documentary stamp tax.
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 is not complied with, then this ruling
shall be considered null and void.
Copyright 1994-2012 CD Technologies Asia, Inc. Taxation 2011 6
Very truly yours,
By:
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1. BIR Ruling No. DA-376-08 dated June 20, 2008; BIR Ruling No. 076-89 dated April
17, 1989.
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2. BIR Ruling Nos. DA-(C-005)-023-08 dated July 10, 2008; BIR Ruling No.
DA-342-08 dated June 4, 2008; BIR Ruling No. DA-643-07 dated December 13,
2007; BIR Ruling No. DA-593-06 dated October 5, 2006; BIR Ruling No.
DA-419-04 dated August 4, 2004.
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3. As implemented by Revenue Regulations (RR) No. 13-04.
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4. BIR Ruling Nos. DA-(C-005)-023-08 dated July 10, 2008; and DA-378-2008 dated
June 24, 2008 citing BIR Ruling No. 146-95 dated September 19, 1995 and BIR
Ruling No. DA-381-08-24-98 dated August 24, 1998.