Taxwise Or Otherwise
By Jaffy Y. Azarraga
The definition of fair market value or FMV for purposes of computing the capital gains tax on the transfer of shares has undergone numerous revisions over the years. What constitutes fair market value has long been a push-and-pull between taxpayers and the tax authority, as this affects the computation of the gain, and hence, the tax due on the transaction.
As early as 1940, Revenue Regulations (RR) No. 2-40 defined market value as “the fair value of the property in money as between one who wishes to purchase and one who wishes to sell.” It is the price at which a seller is willing to sell at a fair price, and a buyer is willing to buy at a fair price, both having reasonable knowledge of the facts and the willingness to trade.
Subsequently, RR No. 2-82 provided that the book value of unlisted shares of stock should be considered as their prima facie FMV; in case the shares are valued at lower than their book values, the deviation from the book value should be justified with supporting evidence. Years later, RR No. 6-2008 fixed the FMV at the book value of the unlisted shares of stock as shown in the financial statements duly certified by an independent certified public accountant nearest to the date of sale.
Departing radically from the previous issuances, however, RR No. 6-2013 required that in determining the FMV of the shares, the adjusted net asset (ANA) method must be used where all the underlying assets and liabilities of the company are adjusted to their FMVs. For this purpose, the appraised value (FMV) of any real property owned by the company at the time of sale shall be the FMV either as determined by the Commissioner, as shown in the schedule of values fixed by the Provincial and City Assessors, or as determined by an Independent Appraiser, whichever is higher.
The application of such a method invariably resulted in the upward adjustment of the FMV, particularly for companies owning substantial real properties, since the latest appraised values of the properties are considered in determining the value of the shares. Further, such adjusted FMV could lead to donor’s tax exposure in case the shares are actually worth less since disposal at less than the FMV under the ANA method is deemed a donation.
To address the donor’s tax issue, Congress included a provision under the TRAIN Law that any transfer of property in the ordinary course of business (i.e., bona fide, at arm’s length, and free from any donative intent) will be considered as done for an adequate and full consideration in money or its worth.
Notwithstanding the law, however, the BIR subsequently issued Revenue Memorandum Circular (RMC) No. 30-2019, which effectively imposed on the taxpayer the burden to prove that indeed the sale involves no irregularity between unrelated and independent parties. It required the presentation of sufficient, reasonable evidence that the sale of shares of stock at less than FMV is without intent to evade tax and defraud the government. Saddled with the burden of proof that donor’s tax should not be assessed or imposed even in case of inflated or overstated FMV of the shares under the ANA method, the directive weighed down the taxpayer unfavorably.
Perhaps due to appeals from taxpayers, the BIR issued RR No. 20-2020, which takes effect today (15 days from the publication on Aug. 19). Under the regulation, the latest audited financial statements (AFS) are deemed sufficient in determining the FMV of the shares subject of the sale, barter, exchange, or other disposition.
The FMV of common shares of stock not listed and traded in the stock exchange shall be the book value based on the latest available AFS before the date of sale, but not earlier than the immediately preceding taxable year. For preferred shares, the FMV shall be the liquidation value, which is equal to the redemption price of the preferred shares as of balance sheet date nearest to the transaction date, including any premium and cumulative preferred dividends in arrears. The book value of common shares or the liquidation value of the preferred shares need not be adjusted to include any appraisal surplus from any property of the corporation not reflected or included in the latest AFS.
The RR is a welcome reversion to the policies under RR 6-2008, which was not only reasonable but also efficient. Taxpayers can now expect no upward adjustment in the fair value of the underlying assets, little or no overstatement of the FMV, and no requirement for appraisal of properties before the sale. Still, there were cases where shares were previously sold at overstated prices under the ANA method despite the actual market price being lower, in order to avoid donor’s tax exposure. The same shares could now be sold at the actual market price due to lower prescribed valuation under the AFS, in which case the seller sustains a loss, and with the purchaser having a lower cost basis. Thereafter, any increase in the market value will be taxed as capital gain again in the hands of the last purchaser. Thus, while the reversion in policy yields higher tax collections, it was only at the expense of compliant taxpayers.
Also, the determination of the redemption price of preferred shares under the regulations could be questioned. It is unclear exactly what the regulation means when it mentions the redemption price as of balance sheet date. Notably, the Revised Corporation Code provides that the Board of Directors, where authorized in the articles of incorporation, may fix the terms and conditions of preferred shares of stock. Thus, by basing the redemption price on the balance sheet, the regulations appear to constrain the right granted to a company’s Board of Directors under the law to fix the terms and conditions of preferred shares of stock, including the redemption price thereof.
The foregoing situations only highlight the need to study and review amendments thoroughly and with the keen eyes of fairness and objectivity. Revisions have impact and should not be made hastily nor to favor short-term advantages or tax collections at the expense of long-term trust and confidence on the part of taxpayers, who bear the burden of paying taxes. Nonetheless, done properly, the return to more feasible, and well-accepted policies certainly comes a long way towards regaining the trust and confidence of taxpayers, and in return, the government might reasonably expect enhanced tax compliance and higher revenue collections which it may earmark for nation-building and national emergencies such as the current pandemic.
The views or opinions presented in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The article is for general information purposes only and should not be used as a substitute for consultation with professional advisors.
Jaffy Y. Azarraga is a Director at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of PricewaterhouseCoopers global network.
