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
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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 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,
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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 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
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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 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
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By:

(SGD.) JAMES H. ROLDAN

Assistant Commissioner
Legal Service

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