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 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
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 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, 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
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 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 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
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 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

By:

(SGD.) JAMES H. ROLDAN

Assistant Commissioner
Legal Service

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