bir ruling [da-(c-005) 023-08] (condonation of debt)

Copyright 2013 CD Technologies Asia, Inc. and Accesslaw, Inc. Philippine Taxation Encyclopedia First Release 2013 1

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 OfficeUnit 106 G/F Le Metropole CondominiumTordesillas 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 notsubject to income tax; and

2. That the execution of a compromise agreement to effect the terms andconditions of the condonation is not subject to the documentary stamptax (DST). DaEATc

It is represented that LCI is a corporation duly organized and existing underand by virtue of Philippine laws; that it is a corporation established primarily tomanufacture, 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 taxableyear ended June 30, 2007, LCI has reflected a capital deficit position to the extent ofP3,519,811,094.00; that the said capital deficiency is comprised of liabilities of thecompany, which, in the opinion of its auditors, "indicate the existence of a materialuncertainty which may cast substantial doubt about the Company's ability to continueas a going concern; and that a part of the said liabilities pertains to a loan taken from a


third party creditor with a principal value amounting to P296,441,053.23 (consistingof principal and capitalized interest).

It is further represented that in view of the fact that the liabilities haveremained unpaid, LCI has offered a compromise settlement with the said third partycreditor; that out of the total liability, LCI offered to pay P180,000,000.00 andrequested the cancellation and condonation of the remaining portion of the principalvalue of the loans amounting to P116,441,053.23 plus accrued interests; that after theproposed condonation, LCI will still be in a capital deficit position as reflected in theattached Pro Forma Financial Statements.

In reply, please be informed that in BIR Ruling No. DA-419-04 dated August4, 2004, the BIR held as follows:

"Thus, the condonation of the CPI's debt to SJ shall not be subject toincome tax considering that CPI is in a capital deficiency position and willremain insolvent before and after the said condonation considering that theamount to be condoned would only be P84,198,555.20. Moreover, thecondonation is likewise not subject to gift tax since there is no donative intenton the part of SJ but solely for business consideration."

The above ruling was issued by the BIR on the basis of the discussions statedin BIR Ruling No. 076-89 dated April 17, 1989 which states as follows: aDcTHE

"Cancellation and forgiveness of indebtedness may amount to apayment of income, to a gift, or to a capital transaction, dependent upon thecircumstances. If for example, an individual performs services for a creditorwho, in consideration thereof cancels the debt, income to that amount isrealized by the debtor as compensation for his services. If, however, a creditormerely desires to benefit a debtor and without any consideration thereforcancels the debt, the amount of the debt is a gift from the creditor to the debtorand need not be included in the latter's gross income. If a corporation to whicha stockholder is indebted forgives the debt, the transaction has the effect of thepayment of a dividend. (Sec. 50 Revenue Regulations No. 2) The waiver ofinterest by the banks on non-trade and trade related indebtedness of GMPI isnot subject to income tax considering that the deduction of said interest asexpense in prior years did not offset nor reduce the taxable income of GMPIsince it was in a financial loss position even without the deduction. (SeeBarnhart-Marrow Consolidated v. Commissioner of Internal Revenue, 47BTA 590) Moreover, when a creditor cancels a debt as part of a businesstransaction, the debtor is enriched or its net assets has been increased and,therefore, he realized taxable income (Philippine Fiber Processing Co. v. CIR,


CTA Case No. 1407 Dec. 29, 1966). However, a transaction whereby nothingof exchangeable value comes to or is received by a taxpayer does not give riseto or create taxable income. (See Dallas Transfer and Terminal WarehouseCo. v. Commissioner of Internal Revenue, 5 Cir. 70 F 2d 95, 13AFTR 930)Accordingly, the condonation of GMPI's indebtedness by GM-US is notsubject to income tax since before and after the condonation GMPI remainsinsolvent, i.e., in a capital efficiency position. The condonation is likewise notsubject to gift tax since there is no donative interest on the part of GM-US butsolely for business consideration since Isuzu will only acquire the GMPIshares from GM-US if GMPI has a "clean" balance sheet with no outstandingliabilities except those to Isuzu."

It is clear from the foregoing that the condonation of LCI's indebtedness is notsubject to income tax if nothing of exchangeable value comes to or is received byLCI. This is based on the basic and generally accepted principle of taxation thattaxable income is created from the inflow of wealth. Therefore, if after thecondonation 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 saidcondonation is also not subject to donor's tax in the hands of LCI, for lack of donativeintent on the part of its creditor.

Accordingly, the condonation in favor of LCI by one of its creditors of the loanamount of P116,441,053.23 plus accrued interest and penalties out of the total loanobligation 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 theterms of the above mentioned condonation is not subject to the documentary stamp taximposed under Section 179 of the Tax Code.

In BIR Ruling No. DA-378-2008 dated June 24, 2008 issued to Prime OrionPhilippines 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. Onevery original issue debt instruments, there shall be collected adocumentary stamp tax of One Peso (P1.00) on each twohundred pesos (P200), or a fraction thereof, of the issue priceof any such debt instruments: Provided, that for such debtinstruments with terms of less than one (1) year, the

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documentary stamp tax to be collected shall be of aproportional amount in accordance with the ratio of its terms innumber of days to three hundred sixty five (365) days:Provided, further, That only one documentary stamp tax shallbe imposed on either loan agreement, or promissory notesissued to secure such loan."

In the case of POPI, the compromise agreement is notin the nature of a loan agreement, but is executed precisely toeffect the payment of terms embodied in a loan agreement.Since POPI did not execute any document that may beconsidered as a loan agreement to which the tax under Section179 of the Tax Code, as amended, is imposed, and since acompromise agreement is not one among those instrumentsfalling under any of the documents enumerated under the TaxCode that are subject to a specific DST, then the saidcompromise agreement which provides for the new terms andconditions of payment of an original loan, shall not be subjectto documentary stamp tax (BIR Ruling No. 146-95 datedSeptember 19, 1995 and BIR Ruling No. DA-381-08-24-98dated August 24, 1998).

Accordingly, the execution of a compromise agreementto document and effect the terms of a previously agreed uponcondonation of a loan by POPI from one of its creditors, is notsubject to the documentary stamp tax."

In view of the foregoing, the execution of a compromise agreement todocument and effect the terms of a previously agreed upon condonation of a loanbetween LCI and one of its creditors, is not subject to the documentary stamp taximposed 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 aredifferent, then this ruling shall be considered null and void. ADCEaH

Very truly yours,

Commissioner of Internal Revenue


By:

(SGD.) JAMES H. ROLDANAssistant Commissioner

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bir ruling [da-(c-005) 023-08] (condonation of debt)

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