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Let's Talk Tax

Is there taxable liquidation in an upstream merger?

At a time when all hope seems lost, witnessing people coming together to help each other in the battle against COVID-19 may be what’s needed to have one’s faith in humanity restored. Frontliners, from health care workers and emergency response teams to grocery workers and food delivery riders, are being lauded as heroes, and rightfully so. Whether it is our lives or dinners that are on the line, these frontliners work hand in hand and with the rest of the world, despite the risk to their personal safety every time. The Bayanihan spirit we have been seeing these past few weeks is a show of solidarity that is definitely one for the ages.

As tempting as it is to dig deeper into how frontliners have integrated themselves into our daily lives, this article will tackle a different kind of union: one that existed long before this pandemic challenged business leaders to think on their feet. To the business-savvy, these unions are known as mergers or consolidations.

In the Philippines, companies resort to mergers and consolidations because of the demands of their business strategy. Corporations combine into a single unit to pool their resources for greater efficiency. In fact, mergers and consolidations are an option that businesses might consider after the enhanced community quarantine (ECQ) ends.

Our laws actually recognize and provide incentives for such transactions. For instance, our current tax laws exempt corporations that enter into a tax-free merger from income tax and other forms of taxes. Under this scheme, a corporation that absorbs another corporation through a merger and exchanges its shares for the property of the latter is exempt from income tax, value-added tax (VAT), and other forms of tax.

However, in Bureau of Internal Revenue (BIR) Ruling No. 508-2012, the BIR held that an upstream merger where no shares were issued to the absorbed corporation in exchange for its assets is a taxable donation and does not qualify as a tax-free exchange under Section 40 (C) (2) of the Tax Code, as amended. In the same manner, the intended merger has the effect of dissolving and liquidating the subsidiary without paying the corresponding taxes.

Upon the review of the Secretary of Finance in Department of Finance (DoF) Opinion No. 012-2018, the DoF emphasized that tax exemptions are to be construed in strictissimi juris (strictly) against the taxpayer and liberally in favor of the taxing authority. Without complying with the requirement to issue shares in exchange for the property of the absorbed corporation, the upstream merger failed to qualify as a tax-free exchange. The DoF clarified, however, that the upstream merger is not a donation made by a subsidiary to its parent company, as there is no intent to donate on the part of the subsidiary. Finally, the DoF held that, since the upstream merger is not a tax-free merger, proper taxes on dissolution and liquidation must be imposed.

But what is a merger, and what does the process involve? The Supreme Court (SC) has defined a merger as “a union between two or more corporations, whereby one or more existing corporation is absorbed by another.” The parties to a merger, or constituent corporations, are dissolved, leaving only the surviving corporation. For this transaction to be tax-exempt, jurisprudence requires the following conditions: (1) there must be a legal merger or consolidation, or transfer of all or substantially all of the properties of a corporation for the stock of another corporation; and (2) such business restructuring or reorganization must be for a bona fide business purpose.

In an upstream merger, the parties are the parent company (the surviving corporation) and its wholly-owned subsidiary (the absorbed corporation). Since the surviving corporation is the sole stockholder of the subsidiary, the merger does not result in the issuance of shares, as issuing shares to the stockholders of the absorbed corporation would result in the issuance of treasury shares.

As a result of the merger, all of the absorbed subsidiary’s assets and liabilities are transferred to the surviving corporation by operation of law. The DoF has stated that, since the upstream merger failed to qualify as tax-free, the dissolution of the absorbed corporation brought about by the merger amounts to taxable dissolution and liquidation. Hence, it is subject to pertinent taxes under the Tax Code. However, in a long line of cases decided not only by the Court of Tax Appeals, but also by the SC, the consistent doctrinal pronouncement is that there is no winding up of the affairs or liquidation of the assets of the dissolving corporation in a merger, because the surviving corporation automatically acquires all its rights, privileges, and powers, as well as its liabilities, by operation of law.

In a merger, the surviving corporation can achieve a continuous life of the juridical personalities and business enterprises of the dissolving corporation. As ruled by the SC in several cases, there is no legal break in such juridical personalities and business enterprises, as they end up combined in the surviving or consolidated corporation. Since there is no legal break in the juridical personality of the absorbed corporation, then there is no liquidation to speak of. While there is a dissolution of the absorbed corporation by operation of law, there is no winding up of its affairs or liquidation of its assets, since the surviving corporation would continue the combined business. Liquidation contemplates the death of a corporation, one that amounts to the winding up of the affairs of a corporation. Such is not present in a merger.

The future of our people and our economy has been greatly affected as the COVID-19 pandemic continues to claim lives and opportunities. We have been reading news about mass layoffs by several corporations around the world due to community lockdowns and the onset of a global recession. Many businesses have been paralyzed, with several companies implementing a no-work-no-pay scheme to counter the effects of the pandemic.

At this point, the private sector has been thinking of ways to ease the serious consequences of the ECQ. In order to continue business operations, an option would be to enter into mergers. With the efficiencies and scale achieved through mergers, businesses may be able to prevent serious losses and laying off workers. The government should consider supporting this kind of union, especially among corporations bearing the brunt of the economic impact resulting from the global pandemic. For this to work, however, the government must review its existing policies, particularly those concerning upstream mergers, in order to provide a stable future.

Let’s Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.


Dabuimar Burgos is a tax associate of Tax Advisory & Compliance division of P&A Grant Thornton, the Philippine member firm of Grant Thornton International Ltd.


As published in BusinessWorld, dated 21 April 2020