Ambiguity with NOLCO

Ambiguity with NOLCO by: Lesley Noreen G. Lato

In a merger, can the Net Operating Loss (NOLCO) be transferred to and claimed as deduction by the surviving corporation? The answer used to be a "yes" subject to the conditions in the regulations. But because of a recent ruling issued by the Bureau of Internal Revenue (BIR), this has become an ambiguous situation.

The BIR has consistently ruled that the Net Operating Loss Carryover (NOLCO) balance of absorbed corporations are among the rights, privileges, properties and/or interests that will be transferred to and vested in the surviving corporation upon the approval of the merger by the Securities and Exchange Commission (SEC).
 
Under the regulations, although the surviving corporation shall acquire the NOLCO balances of the absorbed corporations, it will only be able to utilize said NOLCO balances if there has been no substantial change in the ownership of the business or enterprise. Hence, the absorbed corporation will gain control of at least 75% or more in nominal value of the outstanding issued shares or paid up capital of the surviving corporation, as provided under Section 34 (D) (3) of the Tax Code, as amended, and implemented by Revenue Regulations No. (RR) 14-2001, to wit:

"(3) Net Operating Loss Carryover. -- The net operating loss of the business or enterprise for any taxable year immediately preceding the current taxable year, which had not been previously offset as deduction from gross income for the next three (3) consecutive taxable years immediately following the year of such loss: Provided, however, That any net loss incurred in a taxable year during which the taxpayer was exempt from income tax shall not be allowed as a deduction under this Subsection: Provided, further, That a net operating loss carry-over shall be allowed only if there has been no substantial change in the ownership of the business or enterprise in that --

Not less than seventy-five percent (75%) in nominal value of outstanding issued shares, if the business is in the name of a corporation, is held by or on behalf of the same persons; or

Not less than seventy-five percent (75%) of the paid up capital of the corporation, if the business is in the name of a corporation, is held by or on behalf of the same persons."

In determining whether there is a substantial change in the ownership of the business, the ownership of shares held by a corporation should be traced to its ultimate beneficial owners since Section 34 (D) (3) of the Tax Code, as amended, explicitly provides that there is no substantial change in the ownership of the business if not less than 75% of the nominal value or paid-up capital of the corporation (if the business is in the name of a corporation) is "held by or on behalf of the same persons".

The phrase "held by or on behalf of the same persons" in the above-quoted Section 34 (D) (3) of the Tax Code encompasses not only ownership that is directly held by or is in the name of a person, but also ownership that is indirectly held on behalf of or for that person. Consequently, the implication from the use of the phrase "on behalf of the same persons" is that the law requires ownership to be traced through corporate tiers to the ultimate beneficial owners.

On March 28, 2012, the BIR issued Ruling No. 214-2012 which made a new interpretation of the transferability of NOLCO in relation to tax free mergers. In the said ruling, in order to promote efficiency and reduce both administrative and operating costs, the respective board of directors of two mining companies which are owned by the same shareholders, proposed the merger of the two companies in accordance with the Corporation Code of the Philippines. The BIR, while maintaining its position on the exemption of value-added tax (VAT) and documentary stamp tax (DST), emphasized that NOLCO is not one of the assets of the absorbed corporation that can be transferred and absorbed by the surviving corporation, as this privilege or deducti on can be availed of only by the absorbed corporation.

The legal basis of the position taken by the BIR in the said ruling was not explained in detail. It merely mentioned that NOLCO is not one of the assets that can be transferred and that NOLCO is a privilege/deduction reserved for the absorbed corporation.

The BIR may be correct in that NOLCO is not by itself one of the listed assets in the balance sheet. The NOLCO, however, may be claimed as deduction from gross income for three succeeding years. Accordingly, the benefit from NOLCO may be recognized as a deferred tax asset (DTA) for financial reporting purposes because it possesses the characteristics of an asset, to wit, it may be utilized for some future economic benefit.

There were also questions on whether the denial was premised on the requirement for the shareholders of the absorbed corporation to gain control of the surviving corporation.

Given the ambiguous circumstance, entities that are planning on some restructuring that involve transfers of NOLCO have become apprehensive. To avoid confusion, the BIR should issue clarificatory rules and regulations further describing situations where NOLCO may or may not be transferred to the surviving corporation.