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PM Reyes: exchange of properties involved therein shall be subject or not to

the capital gains tax. The criterion laid down by the law is that the
A, B, C were majority stockholders of ABC Theatrical Co. They were
merger must be undertaken for a bona fide business purpose and
also the majority stockholders of XYZ Theatrical Co which was
not solely for the purpose of escaping the burden of taxation. It is
engaged in the same business. ABC and XYZ agreed to merge. Under
clear, in fact that the purpose of the old merger was to continue the
the agreement, all business, assets and goodwill of ABC will be
business of the Old corporation, whose corporate life was about to
transferred to XYZ in exchange of XYZ stocks for each stock held in
expire, through the New Corporation to which all the assets and
ABC. Is the exchange subject to capital gains tax?
obligations of the former had been transferred. The exemption from
No. As held in CIR v. RUFINO (Feb. 27, 1987), it is well established the tax of the gain derived from exchanges of stock solely for stock
that where stocks for stocks were exchanged, and distributed to the of another corporation was intended to encourage corporations in
stockholders of the corporations, parties to the merger or pooling, combining or expanding their resources conducive to the
consolidation, pursuant to a plan of reorganization, such exchange economic development of the country. The merger in question
is exempt from capital gains tax. The basic consideration, of course, involved a pooling of resources aimed at the continuation and
is the purpose of the merger, as this would determine whether the expansion of business and so came under the letter and
intendment of the NIRC exempting from the capital gains tax 1959. Unfortunately during this time the new corporation was
exchange of property. not able to issue the shares to the respondents because they
had to increase their authorized capital stock from 200,000
to 2,000,000 which was only approved on August 20, 1959.
Hence the BIR gave deficiency assessment to the respondents
saying that there was no valid merger between the two
corporations and hence respondents is liable for capital gains
CIR vs. Vicente A. Rufino tax. But the CTA ruled in favor of the respondents saying
that there was indeed a valid merger and they are not liable
Private respondents were majority stockholders of two SC affirmed CTA. It ruled that the merger was valid and was
corporations. The first corporation’s charter was about to made for a bona fide business purpose. It said that the
expire hence the respondents entered into a Deed of reason of the merger was to continue the operations of the
Assignment with the second corporation (the new one) where business of the old corporation, whose corporate life was
the assets, goodwill and liabilities of the first corporation about to expire, through the New Corporation. Since the
would be transferred to the latter in exchange for shares of merger was valid, they are not liable for CGT.
stock. The Deed of Assignment was signed on January 9,
which the new corp was able to issue the corresponding
Mr. & Mrs. Vicente A. Rufino............... 17,083 shares
The private respondents in this case are majority Mr. & Mrs. Rafael R. Rufino ................. 16,881 shares
stockholders of two corporations: Mr. & Mrs. Ernesto D. Rufino .............. 18,347 shares
1st the defunct EASTERN THEATRICAL CO., INC. (OLD Mr. & Mrs. Manuel S. Galvez ............... 16,882 shares
CORP) a corporation organized in 1934 and was
terminated on January 25, 1959. It was organized to The series of transactions of both corporations were
engage in the business of operating theaters more examined by the BIR and was declared not undertaken for a
particularly the Lyric and Capitol Theaters in Manila. The bona fide business purpose. That it was only done to avoid
president of the corporation during the year in question liability for the capital gains tax in exchange of the old for the new
was Ernesto D. Rufino. shares of stock. Hence the BIR imposed deficiency assessments
against the private respondents in the amount of P187,681.16
2nd is the new EASTERN THEATRICAL CO., INC. (NEW (including interest and surcharge). The private respondents
CORP) which was organized on December 8, 1958. It has request for reconsideration but was denied. Hence they
an authorized capital stock of P200,000 with par of elevated the matter to the CTA.
P10.00. The corporation is engaged in the same kind of
business as the Old Corporation. The Gen. Manager of
The CTA ruled in favor of the private respondents. It ruled
the corporation at the time was Vicente A. Rufino.
that the exchange of stocks were in pursuant of a valid
In a special meeting of the stockholders of the Old reorganization plan and that no taxable gain was derived by
Corporation, a resolution was passed authorizing the Old the petitioners from the exchange of their old stocks
Corp to merge with the New Corp by transferring its business, pursuant to Section 35 (c) (2) in relation to (c)(5) of the
assets, goodwill and liabilities to the latter, in exchange for NIRC.
shares of stocks (new stock equivalent to the number of
stocks held by respondent in d corp) of the new corporation. The BIR argues that:
Pursuant to the resolution, Ernesto Rufino and Vicente Rufino The Deed of Assignment was concluded by the private
signed the Deed of Assignment on January 9, 1959. respondents merely to evade the burden of taxation, the
petitioner points to the fact that the New Corporation did
In order for the new corporation to satisfy the number of not actually issue stocks in exchange for the properties of the
shares they must issue to the respondents, they increased Old Corporation at the time of the supposed merger on
their authorized capital stock from 200,000 pesos to January 9, 1959. The exchange, he says, was only on paper.
2,000,000 pesos, though this was only registered to the SEC The increase in capitalization of the New Corporation was
on March 5, 1959 and was approved on August 20, 1959. After registered with the Securities and Exchange Commission only
on March 5, 1959, or 37 days after the Old Corporation deemed part and parcel of, and indispensable to the validity
expired on January 25, 1959. Prior to such registration, it and enforceability of, the Deed of Assignment.
was not possible for the New Corporation to effect the
exchange provided for in the said agreement because it was In this case, it is clear that the purpose of the merger was to
capitalized only at P200,000.00 as against the capitalization continue the business of the Old Corporation, whose
of the Old Corporation at P2,000,000.00. Consequently, as corporate life was about to expire, through the New
there was no merger, the automatic dissolution of the Old Corporation. The court took note of the fact that the old
Corporation on its expiry date resulted in its liquidation, for corporation code which was in effect at that time, prohibits
which the respondents are now liable in taxes on their the amendment of charter to extend the life of a
capital gains. corporation. Thus, the only available remedy of expiring
corporations are to merge with other corporations, like in the
ISSUE: present case. To date, the private respondents have not
W/N THERE IS A VALID MERGER BETWEEN THE derived any benefit from the merger of the Old Corporation
CORPORATIONS? and the New Corporation, since the sto

There was a VALID MERGER and hence they are not liable for Notes:
any CGT
Sec. 35. Determination of gain or loss from the sale or
Although the actual transfer of the properties subject to the other disposition of property. — The gain derived or loss
Deed of Assignment was not made on the date of the merger.
sustained from the sale or other disposition of property, real,
In the nature of things, this was not possible. Obviously, it
personal or mixed, shall be determined in accordance with
was necessary for the Old Corporation to surrender its net
the following schedule:
assets first to the New Corporation before the latter could
issue its own stock to the shareholders of the Old Corporation
xxx xxx xxx
because the New Corporation had to increase its
capitalization for this purpose. This required the adoption of
the resolution to this effect at the special stockholders (c) Exchange of property-
meeting of the New Corporation on January 12, 1959, the
registration of such issuance with the SEC on March 5, 1959, (1) General Rule. — Except as herein provided upon the
and its approval by that body on August 20, 1959. All these sale or exchange of property, the entire amount of the gain
took place after the date of the merger but they were or loss, as the case may be, shall be recognized.
(2) Exceptions. — No gain or loss shall be recognized if in
pursuance of a plan of merger or consolidation (a) a
corporation which is a party to a merger or consolidation,
exchanges property solely for stock in a corporation which is
a party to the merger or consolidation, (b) a shareholder
exchanges stock in a corporation which is a party to the
merger or consolidation solely for the stock of another
corporation, also a party to the merger or consolidation, or
(c) a security holder of a corporation which is a party to the
merger or consolidation exchanges his securities in such
corporation solely for stock or securities in another
corporation, a party to the merger or consolidation.

xxx xxx xxx

(5) Definitions.-(a) x x x (b) The term "merger" or

"consolidation," when used in this section, shall be
understood to mean: (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; Provided, That for a transaction to be
regarded as a merger or consolidation within the purview of
this section, it must be undertaken for a bona fide business
purpose and not solely for the purpose of escaping the
burden of taxation; Provided further, That in determining
whether a bona fide business purpose exists, each and every
step of the transaction shall be considered and the whole
transaction or series of transactions shall be treated as a
single unit: ...