Alternative gateway for capital infusion
By using this kind of tax-free transaction, a sleeping asset can be utilized as collateral for the corporation to infuse additional capital increasing its fighting chance for survival in this pandemic.
Published in Daily Tribune on September 13, 2020
by: Juan Romulo R. Taleon
Maintaining liquidity is synonymous to survivability. To the layman, it’s akin to a revolving credit and debit cycle where expenses for suppliers and labor are paid from money consumers pay and so on. The importance of liquidity for any corporation is such that its disruption would create a domino effect that can result in instability in a corporation or topple it altogether.
COVID-19 disrupted the most important thing in any economy — the smooth circulation of cash. The result has been catastrophic. The recent Philippine Statistics Authority report suggests that the Philippine economy is down to a record low of -16.5 percent this 2nd quarter, plunging the economy into recession.
Corporations affected by this disruption must adapt to survive. In order to adapt, they must maintain liquidity. To do this, some if not all would resort to decreasing capital expenditures, offering stocks, bonds, or using their assets as collateral and, if worse comes to worst, shutting down just to save whatever cash they have to simply wait for COVID-19 to pass.
Public corporations may just offer their stock to the public to generate needed cash. The situation is different for closed corporations, more particularly some family corporations. It would be hard for them to infuse cash considering their corporate limitation. There is, however, a way to infuse much needed cash into these closed corporations. Section 40(C)(2) of the National Internal Revenue Code (NIRC) allows them to capitalize on tax free transactions.
More specifically, this section of the NIRC provides that “(N)o gain or loss shall be recognized if property is transferred to a corporation by a person in exchange for stock or unit of participation in such corporation of which as a result of such exchange said person, alone or together with others, not exceeding four persons, gains control of said corporation: Provided, that stocks issued for services shall not be considered as issued in return to property.”
As held in CIR v Dominium Realty & Construction Corporation (CTA EB 1713), the requisites for the non-recognition of gain or loss are: a) the transferee is a corporation; b) the transferee exchanges its shares of stock for the property/ies of the transferor; c) the transfer is made by a person, acting alone or together with others, not exceeding four persons; and, d) as a result of the exchange the transferor, alone or together with others, not exceeding four, gains control of the transferee.
The Supreme Court also clarified in CIR v Lucio Co et al. (G.R. 241424) that the element of control is satisfied even if one of the transferors is already owning at least 51 percent of the shares of the transferee corporation, as long as after the exchange, the transferors, not more than five, collectively increase their equity in the transferee corporation by 51 percent or more.
By using this kind of tax-free transaction, a sleeping asset can be utilized as collateral for the corporation to infuse additional capital increasing its fighting chance for survival in this pandemic. Section 40(C)(2) provides a simple and tax-free method for utilizing a person’s sleeping assets not just to strengthen his/her position but to sustain the viability of the family corporation as well.
