Redemption of shares of stock

Let’s Talk Tax
Tata Panlilio-Ong

Posted on February 25, 2014

IN the past few years, not only has the Bureau of Internal Revenue (BIR) issued rulings that effectively revoke long-standing precedents, it has also issued several revenue memorandum circulars (RMCs) circularizing to the revenue district offices certain internal memos that modify previous rulings issued to specific taxpayers.

Needless to say, this has caused a great degree of uncertainty among taxpayers -- individuals as well as corporations -- leading them to re-examine the tax impact of these developments on their transactions and businesses.

In RMC No. 3-2014, dated Jan. 6, the BIR circularized the text of a memo to a certain regional director modifying a 2008 ruling on the tax implications of redemption of shares paid by way of conveyance of parcels of land.

Under the Corporation Code of the Philippines, a corporation has the power to re-acquire or redeem its own shares for certain legitimate purposes. This reacquisition of shares of stock that a corporation previously issued is what is commonly referred to as a share buy-back. On the other hand, when a corporation purchases or takes up redeemable shares, this is known as redemption of shares.

A corporation is allowed to issue redeemable shares when expressly provided in its articles of incorporation, that is to say, shares that can be redeemed by the issuing corporation upon expiration of a certain period or upon the option of either the stockholder or the corporation.

The most notable difference between an ordinary share buy-back and redemption of shares is that a share buy-back can be undertaken only when the corporation has sufficient unrestricted retained earnings to cover the cost of the buy-back, while redemption can be done regardless of the existence of unrestricted retained earnings (URE).

Under the Securities and Exchange Commission (SEC) Rules Governing Redeemable and Treasury Shares, "[N]o corporation shall redeem, repurchase or reacquire its own shares, of whatever class, unless it has an adequate amount of unrestricted retained earnings to support the cost of the said shares, except when the shares are reacquired in the redemption of redeemable shares or pursuant to the conversion right of convertible shares, in accordance with the provision expressly provided for in its articles of incorporation."

Some of the reasons a corporation may undertake a share buy-back include: a) eliminating fractional shares arising out of stock dividends; b) collecting unpaid subscription in a delinquency sale or purchasing delinquent shares in said sale; and c) paying dissenting or withdrawing stockholders. In addition to having adequate URE, a share buy-back must not impair the corporation’s capital as well as prejudice creditors.

Redemption of shares is an exit mechanism for investor-stockholders to unload their shares after an agreed period and/or at a certain redemption price that allows them to realize agreed returns on investment. Even though redemption can be done without sufficient URE, the corporation must not be rendered insolvent as a result thereof. Redeemable shares may be redeemed, regardless of the existence of URE, provided that the corporation has, after such redemption, sufficient assets to cover its liabilities, inclusive of capital stock.

A share buy-back or redemption is also resorted to when the other stockholders are not willing to purchase the shares of the withdrawing shareholder or when such purchase by the other stockholders would change agreed share ownership structures or violate foreign ownership restrictions.

When the issuing corporation subsequently re-acquires shares which have been previously issued and fully paid for by purchase or redemption, the same become treasury shares. Treasury shares do not revert to unissued shares and are not entitled to voting rights nor dividends. But, treasury shares are regarded as property of the corporation which may be re-issued as property dividend or disposed of at a reasonable price to be fixed by the board of directors -- provided, however, that in the case of redeemable shares that are reacquired, the same are considered retired and no longer issuable, unless otherwise provided in the articles of incorporation.

There is also a notable difference in the taxation of an ordinary share buy-back vis-à-vis redemption of shares. Under BIR Revenue Regulations No. (RR) 6-2008, where a corporation voluntarily buys back its own shares in which it becomes treasury shares, the stock transaction tax of 1/2 of 1% of the gross selling price shall apply if the shares are listed and executed through the trading system of the Local Stock Exchange.

If the shares are not listed and traded, any gain realized by the holder of the re-acquired shares is subject to the 5% (on the first P100,000 gain) and 10% (on the gain after the 1st P100,000) capital gains tax."

On the other hand, when preferred shares are redeemed at a time when the issuing corporation is still in its "going-concern" and is not contemplating dissolving or liquidating, capital gain or loss upon redemption shall be recognized based on the difference between the amount/value received at the time of redemption and the cost of the preferred shares. The capital gain or loss on the part of the holder of the redeemed shares shall be subject to the 30% regular corporate income tax (RCIT) for corporations or to the 5% to 32% regular income tax for individuals.

On the part of the corporation re-acquiring or redeeming the shares, the transaction is not subject to income tax considering that it does not realize any gain or loss as the share buy-back or redemption is not a sale or exchange but rather, akin to a partial liquidation of the corporation.

In the 2008 BIR Ruling, the redemption price was paid by transferring parcels of land. In the said ruling, the BIR held that the difference between the value of the land received in redemption (i.e., higher of the zonal value and the value fixed by the City Assessor’s Office in the real property tax (RPT) declaration) and the cost basis of the redeemed shares was subject to RCIT on the part of the holder of said shares.

The transfer of the real estate properties by the redeeming corporation was not made in the course of trade or business and thus, not subject to value-added tax (VAT). Likewise, the transfer of the parcels of land was not subject to documentary stamp tax (DST) as the conveyance was a distribution in liquidation of real estate without valuable consideration.

RMC No. 3-2014 upheld the income tax implications of the transfer of land in payment of the redemption price but modified the 2008 BIR Ruling in that the transfer was subject to VAT and DST.

In the RMC, the BIR explained that since the redeeming corporation is a real estate developer, all real properties acquired by it -- whether developed or undeveloped as of the time of the acquisition -- as well as all real properties it holds primarily for sale or lease to customers in the ordinary course of trade or business, and all real properties used in its trade or business are considered ordinary assets.

Even though the transfer of the real properties by the redeeming corporation in redemption of the shares held by the stockholder is not occurring in the regular course of business and is a transaction not done with regularity, the transfer is subject to VAT, the same being considered a "deemed sale" transaction, i.e., transfer, use or consumption not in the course of business, of goods or properties originally intended for sale or for use in the course of business.

The VAT was based on the gross selling price defined as the higher of the consideration received (i.e., redemption price for the redeemed shares) and the fair market value (FMV) of the real property transferred (i.e., FMV in the RPT declaration issued by the Assessor’s Office or zonal value, whichever is higher).

The transfer was likewise deemed a sale or conveyance of real property subject to DST.

Given the current predilections of the BIR, taxpayers must be vigilant in keeping abreast of the latest issuances of the tax authorities before they undertake certain transactions.

The author is a director with Punongbayan & Araullo’s tax advisory and compliance division. P&A is a member firm within Grant Thornton International Ltd.