Legal basis and amended tax code provisions
- Republic Act No. 4522 amends Commonwealth Act No. 466 (otherwise known as the National Internal Revenue Code, as amended).
- Republic Act No. 4522 specifically amends Section 35(c) by revising paragraphs two, three, and five.
Tax treatment: no recognized gain or loss
- Section 35(c)(2) provides that no gain or loss shall be recognized in pursuance of a plan of merger or consolidation when property is exchanged under specified stock-for-stock arrangements.
- Section 35(c)(2)(a) covers where a corporation that is a party to a merger or consolidation exchanges property solely for stock in a corporation that is a party to the merger or consolidation.
- Section 35(c)(2)(b) covers where a shareholder exchanges stock solely for stock of another corporation that is also a party to the merger or consolidation.
- Section 35(c)(2)(c) covers where a security holder exchanges securities solely for stock or securities in another corporation, a party to the merger or consolidation.
- Section 35(c)(2) also provides a control-based exception: no gain or loss shall be recognized if a person exchanges his property for stock in a corporation and, as a result, said person alone or together with others, not exceeding four persons, gains control of the corporation.
- Section 35(c)(2) excludes one situation from the control-based stock issuance rule: stocks issued for services shall not be considered as issued in return for property.
Partial consideration: money or other property
- Section 35(c)(3)(a) provides that if, in connection with an exchange under the exceptions, the recipient receives not only permitted stock or securities but also money and/or other property, then the gain is recognized, but not in excess of the sum of (i) the money received plus (ii) the fair market value of such other property received.
- Section 35(c)(3)(a) provides a dividend overlay for shareholders: if the money and/or other property received has the effect of a distribution of a taxable dividend, the shareholder is taxed as a dividend in an amount not in excess of the shareholder’s ratable share of the undistributed earnings and profits; the remainder, if any, of the recognized gain is treated as a capital gain.
- Section 35(c)(3)(b)(1) provides that where the transferor corporation receives money and/or other property in addition to permitted stock, no gain to the corporation is recognized if the receiving corporation distributed it in pursuance of the plan of merger or consolidation.
- Section 35(c)(3)(b)(2) provides that where the receiving corporation does not distribute the other property and/or money in pursuance of the plan, the corporation recognizes gain, if any, but not in excess of the sum of the money received plus the fair market value of such other property so received, which is not distributed.
- Section 35(c)(3)(c) excludes certain liabilities from being treated as additional consideration: if the taxpayer receives stock or securities that would qualify for nonrecognition if sole consideration is used, but another party assumes a liability of the taxpayer or acquires property subject to a liability, the assumption or acquisition is not treated as money and/or other property, and it does not prevent the exchange from qualifying within the exceptions.
Exceptions and structure of the transaction
- Section 35(c)(2) makes nonrecognition dependent on a plan of merger or consolidation.
- Section 35(c)(2) requires that permitted exchanges be solely for the specified stock or securities in the described circumstances.
- Section 35(c)(3) applies recognition rules when the exchange includes additional consideration in the form of money and/or other property.
Definitions for applying the merger exception
- Section 35(c)(5)(a) defines “securities” to mean bonds and debentures, but not “notes” of whatever class or duration.
- Section 35(c)(5)(b) defines “merger” or “consolidation” to include:
- (1) the ordinary merger or consolidation; or
- (2) the acquisition by one corporation of all or substantially all the properties of another corporation solely for stock.
- Section 35(c)(5)(b) requires a bona fide business purpose and prohibits qualifying transactions done solely for the purpose of escaping the burden of taxation.
- Section 35(c)(5)(b) mandates an anti-fragmentation approach: in determining whether a bona fide business purpose exists, each and every step is considered and the whole transaction or series of transactions is treated as a single unit.
- Section 35(c)(5)(b) requires that, for determining whether transferred property constitutes a substantial portion, “property” includes the cash assets of the transferor.
- Section 35(c)(5)(c) defines “control” as ownership of stocks in a corporation possessing at least fifty-one per cent (51%) of the total voting power of all classes of stocks entitled to vote.
- Section 35(c)(5)(d) authorizes the Commissioner of Internal Revenue to issue rules and regulations to determine the proper amount of transferred assets meeting the “substantially all” standard and to implement the section.
Administrative rulemaking authority
- The Commissioner of Internal Revenue is empowered to issue rules and regulations to determine the proper amount of transferred assets that meet the standard of “substantially all”.
- The Commissioner of Internal Revenue is empowered to issue rules and regulations for the proper implementation of the nonrecognition provisions in Section 35(c).