For foreign and domestic investors, selling shares in Philippine companies have always been fraught with difficulty and uncertainty. In the past, the most complex issue has been the determination of the fair market value of the shares to be sold. The rules created various complications and requirements that sellers and buyers had to be aware of before even considering the transaction. Hence, any move to simplify the process is certainly a welcome development. One of these new developments is Revenue Regulations 20-2020 (RR 20-20) published on Aug. 19. The revenue regulations make the determination of fair market value relatively easier for shareholders selling shares.
BRIEF REFRESHER ON CAPITAL GAINS TAX OF UNLISTED SHARES
Several provisions in the Tax Code provide for capital gains tax (CGT) on the sale, barter, exchange, or other disposition of shares of stock not listed and exchanged in the stock exchange, or “unlisted shares.” The percentage of the tax rate varies by the kind of taxpayer. For individual taxpayers, both resident and non-resident, and domestic corporations, the CGT is at 15%. For foreign corporations, for gains not over P100,000, the rate is 5% while any amount in excess of P100,000 shall be at the rate of 10%.
The tax is imposed on the net capital gain derived from the sale. Gains or losses from the sale are determined by deducting the seller’s cost basis for the shares sold or disposed plus expenses of sale/disposition, if any, from the amount of consideration contracted to be paid.
Under current rules, the selling price cannot be lower than the fair market value of the shares sold. Otherwise, the difference may be subject to donor’s tax under certain circumstances. Hence, prior to agreeing on the selling price, the seller and buyer must establish the fair market value of the shares.
SUMMARY OF THE RULES UNDER RR 20-20
Prior to RR 20-2020, the BIR required the use of the “Adjusted Net Asset Method” in determining the fair market value of the unlisted shares pursuant to Revenue Regulations 06-2013. This means that all assets and liabilities are adjusted to fair market value. The net of adjusted assets minus the liability values is the indicated value of the equity.
If the company whose shares are being sold owns real property, these must be appraised and the higher value among the (a) zonal value, (b) assessed value, (c) fair market value as determined by an independent appraiser, shall be used to arrive at the adjusted net asset value of the company.
In RR 20-2020, the BIR removed the use of the adjusted net asset value. The prima facie fair market values of unlisted shares shall now be the book value based on the latest available financial statements duly certified by an independent public accountant prior to the date of sale, but not earlier than the immediately preceding taxable year.
For preferred shares of stock, the book value shall be based on the liquidation value. Liquidation value is equal to the redemption price of the preferred shares as of the balance sheet date nearest to the transaction date including any premium and cumulative preferred dividends in arrears.
In cases where the unlisted shares sold are both common and preferred shares, liquidation value of the preferred shares shall first be deducted from the total equity of the corporation. The remaining equity shall be divided by the total number of outstanding common shares to arrive at the book value per common share.
INTERIM AUDITED FINANCIAL STATEMENTS
The rule in RR 20-2020 requires the “latest available financial statement duly certified by an independent public accountant prior to the date of sale.” The phrase “prior to the date of the sale” is very important as it precludes the BIR from using audited financial statements after the date of sale.
In the case of CIR v. Sara Lee Kiwi Holdings, LLC, CTA Case No. 8741 (Feb. 13, 2017), the CTA (and later on affirmed by the Supreme Court) upheld the use of audited financial statements for fiscal year ending June 30, 2011 in determining the fair market value of shares sold on April 4, 2011. The same is true in DoF Opinion 008-19 (June 10, 2019) in which the DoF upheld the use of audited financial statements ended Dec. 31, 2015, for a sale that happened on Nov. 26, 2015.
With the latest rule that latest audited financial statement prior to the date of sale must be used, taxpayers can rely on a fixed amount at the time of sale instead of having to adjust or amend CGT returns later on when the audited financial statements become available.
However, the rules do not clarify if the taxpayer may use interim financial statements as long as they are audited by an independent public accountant to determine the fair market value of unlisted shares.
Prior to 2008, taxpayers may use a value other than the book value from the latest audited financial statements. In the old Revenue Regulations 02-82, a taxpayer may adopt a fair market value lower than book value provided a justification for the deviation from the book value is properly supported. Assuming that substantial business reverses or losses are suffered in the interim, may taxpayers present an interim audited financial statement instead of the year-end audited financial statements? Considering that the book value per latest audited financial statements is only prima facie fair market value, the taxpayers should be allowed to support a value lower than that derived from the year-end audited financial statements. Hopefully, the BIR can clarify this issue in subsequent regulations.
DONOR’S TAX INSTEAD OF CAPITAL GAINS TAX?
The amendment of the Tax Code by the TRAIN Law changed the donor’s tax rate to 6% which is a far cry from the 15% or 5-10% CGT tax rate. Under RR 06-08, in the event that the fair market value of the unlisted shares is greater than the amount of money received, then the excess shall be deemed as a gift subject to donor’s tax.
Thus, a question arises on whether it would be better for the taxpayer to sell at a “loss” and pay the 6% donor’s tax rather than the CGT. In some cases, particularly if the cost basis for the shares is minimal, the tax payable under donor’s tax may be substantially lower than the CGT. This is a matter that should be looked into by BIR as it paves the way for unscrupulous taxpayers to disregard the fair market value of unlisted shares for them to pay the lower donor’s tax rate.
Further, Section 100 of the Tax Code imposing donor’s tax on sales with inadequate consideration has been amended by the TRAIN Law. Under the amended provision and implemented by Revenue Memorandum Circular No. 30-2019, a bona fide sale made in the ordinary course of business, at arm’s length, and free from any donative intent, is no longer subject to donor’s tax even if the selling price is lower than the established fair market value.
Given the changes in the rules removing the adjusted net asset value for determining fair market value of unlisted shares, taxpayers can now look forward to easier and simplified steps in processing their sales of unlisted shares. Although there are still some unresolved issues, at least the burden has been lightened and taxpayers can look forward to more transactions in the 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.
John Patrick L. Paumig is an associate from the Tax Advisory & Compliance division of P&A Grant Thornton, the Philippine member firm of Grant Thornton International Ltd.