What is it that evokes a childlike delight in us when we receive a gift? Personally, I think it is the absence of any expectation of getting something in return, other than the recipient’s gratitude.
On the flip side, can there be instances of “unintended gifts” or gifts given away without expecting or intending to do so? Yes, there are “unintended gifts” under our tax rules.
This idea of “unintended gifts” is connected to the sale of property (other than real property) in the ordinary course of business. In a regular sale transaction, an exchange of resources will take place and, in an independent or arm’s length deal, the exchange will generally result in a gain on the part of the seller. In most cases, the usual process of selling and buying and its corresponding taxes will be undisturbed.
But what if the tax authorities inform you that apart from selling, you actually carried out a donation?
This situation may happen when the selling price of your property is lower than its fair market value. This will lead to the presumption that the intention of the parties is actually to execute a donation to the extent that fair market value exceeds the selling price.
How is fair market value determined?
In the case of real properties such as land and building used in business, one needs to know the zonal values determined by the Commissioner of Internal Revenue (CIR) and the assessed value from the Provincial/City Assessors. The higher between the two values shall be the value of the property to be used in computing any internal revenue tax as prescribed by Section 6(E) of the Tax Code.
For shares of stock not traded on the stock exchange, the fair market value shall be the adjusted value of all the underlying assets and liabilities of the company. If there are real properties, such shall be valued from the highest among the 1) zonal value determined by the CIR, 2) the assessed value fixed by the City/Municipal Assessors, or 3) the value established by a third party or independent appraiser.
For properties other than real property and shares of stock, our tax authorities have yet to provide specific guidelines on how to account for their fair market values. Conservatively, it would be better to align the price of your property based on the prevailing price of the same/sufficiently similar property in the market.
If property is sold at less than fair market value, the arrangement will be subject to income tax on any gain (which is the difference between the selling price and the cost of acquiring the property) and in addition, a donor’s tax for the supposed gift based on the excess of the fair market value over the selling price as prescribed by Section 100 of the Philippine Tax Code.
Inspired by Article 725 of the Civil Code, for a number of years, the high court emphasized that a transaction cannot be regarded as a donation without its essential elements. One of these elements is the need for the transferor/seller to have an intention to donate during the course of the transaction. The tax authorities have adopted the same principle in several early rulings by exempting from donor’s tax taxpayers who sold their properties below their fair market value without donative intent.
However, in 2014, the Supreme Court ruled that the absence of donative intent does not exempt a taxpayer from donor’s tax. Applying the then Section 100 of the Tax Code (prior to the amendment under the Tax Reform for Acceleration and Inclusion Act “TRAIN”), the amount by which the fair market value of the property exceeded the selling price shall be deemed a gift, even if there is really no intent to give gratuitously. This decision was later on adopted by the Court of Tax Appeals in a 2016 decision when it ruled that the difference in price between the book value and the amount to be paid for the buy-back of shares raised the legal presumption that the transaction was a donation, regardless of the absence of an intention to donate.
With the amendments introduced by the TRAIN effective Jan. 1, 2018, however, the donor’s tax risk has been mitigated with the inclusion of a provision in Section 100 of the Tax Code stating categorically that “a sale, exchange, or other transfer of property made in the ordinary course of business (a transaction which is a bona fide, at arm’s length and free from any donative intent), will be considered as made for an adequate and full consideration in money or money’s worth”. This is a welcome relief for taxpayers intending to transfer property without any donative intent.
Moreover, under the old rules of the 1997 Tax Code, there was a burdensome tax rate of 30% for donations to strangers and 2% to 15% for gifts to relatives. Starting 2018, the comprehensive tax reform program has also amended the donor’s tax rate to a fixed rate of 6% of the total gifts, regardless of whether this was made to a relative or a stranger. This 6% tax will only apply to gifts in excess of P250,000. The first P250,000 of your total gift for a given year will be donor’s-tax free.
A donation is a gratuitous act on the part of the giver. There‘s no reason to make the transfer more onerous than it ought to be.
The views or opinions in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.
Pervis D. Velasco is a senior consultant at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network.