For various reasons, corporate reorganizations are undertaken to align group structures with new business models, prepare for the entry of investors, or prime for divestitures, among others. Typically, these may involve exchanges of property for shares which may qualify as a tax-free exchange (TFE) transaction, subject to certain conditions.
In case of transfers of real property located in the Philippines and Philippine shares of stock, a Certificate Authorizing Registration (CAR) is required before the change in legal ownership can be recorded by the Register of Deeds and the Corporate Secretary, respectively. In case a tax exemption is invoked, the Bureau of Internal Revenue (BIR), in the past, required a confirmatory ruling issued by the BIR’s Law and Legal Division (LLD) to support the CAR application. From experience, the application process is tedious and protracted, which unnecessarily holds up the CAR issuance, and consequently, the transfer of legal title. Although technically not mandatory, taxpayers must comply because, without the ruling from the LLD, a CAR will not be issued by the Revenue District Offices (RDOs).
With the enactment of the CREATE Law, the need for a prior confirmatory ruling to avail of a tax exemption was revoked. TFEs, after all, are free from certain taxes, regardless of the BIR’s confirmation. To further add teeth to this policy directive, the BIR issued Revenue Memorandum Circular (RMC) 19-2022, a much-awaited guideline, clarifying the rules on the issuance of a CAR without a prior BIR confirmatory ruling for TFEs.
ROLE OF THE RDOs: EVALUATION AND POST-AUDIT
Following the enactment of CREATE, the review and evaluation of TFE transactions were effectively transferred to the RDOs. While taxpayers are not precluded from obtaining confirmation from the LLD, the RMC limited the ruling option to applications involving questions of law.
The RMC provided a list of documentary requirements to support the CAR application, notably incorporating some of the documents previously required by the LLD, including BIR Form No. 1927 or the Application and Joint Certification for transfers to a controlled corporation under Section 40(C)(2) of the Tax Code. The details of the TFE must be reported in this form. However, to avoid confusion, an updated version must be issued to revise items that still refer to an application for a confirmatory ruling, which should not be the case.
Moreover, the CAR applications must be filed with the RDO having jurisdiction over the following places: where the property is located (in case of real property), where the issuing corporation is registered (in case of shares of stock), or where the transferee corporation is registered (in case of multiple properties).
Following existing revenue issuances on tax audit and assessment, the RDOs are also tasked under the RMC to conduct a post-audit of TFE transactions to determine their taxability. If the transaction is found to be not qualified as a TFE, the CAR previously issued is not invalidated; instead, the transaction will be subject to the applicable taxes, plus interest, penalty, and surcharge.
SUBSTITUTED BASIS: GOOD HOUSEKEEPING OR EXCESSIVE MONITORING?
A TFE transaction is exempt from applicable value-added tax and documentary stamp taxes. While a TFE is not subject to capital gains (CGT) or income tax, it merely defers the taxation of the gain/loss until captured in a subsequent taxable transaction. Thus, for monitoring purposes, the RMC reiterated and clarified that the existing revenue issuances on the establishment and monitoring of the substituted basis of the properties transferred and stocks received continue to apply. Reporting obligations under the RMC include:
• Tax filing. A complete statement of all facts pertinent to the non-recognition of gain or loss in connection with the reorganization must be filed as part of or incorporated in the income tax return in the taxable year within which the reorganization occurred.
• Yearly audited financial statements (AFS) disclosure. During the holding period, the parties need to disclose as a note to their respective AFS that they hold assets/shares acquired in a TFE and the year in which such exchange occurred.
• Annotations on the titles and stock certificates. The parties shall cause to annotate, at the back of the Transfer Certificate of Title, Condominium Certificate of Title, and Certificates of Stock, the date the deed of exchange was executed, the original or historical acquisition cost of the properties or shares of stock transferred, and the fact that no gain or loss was recognized as a result of such exchange. Certified true copies of these documents should be submitted to the RDO which issued the CAR, within 90 days from the date of the receipt of the CAR by any of the parties to the exchange. Otherwise, the RDO shall refer the docket of the case to the LLD for appropriate action.
• Mandatory accounting. The shareholders of the absorbed/transferor corporation and the surviving/ transferee corporation shall record in their respective books the mandatory accounting entries.
REASONABLE STREAMLINING OF THE CAR PROCESS
The RMC’s no-confirmatory ruling guidelines echo the directive of CREATE. On the positive side, devolving the evaluation function from the LLD to the RDOs generates efficiency. However, the post-audit of an already approved TFE transaction, duly supported by a CAR, issued by the same (or another RDO), and the additional reporting requirements, seem superfluous. Since the CAR has been issued, the RDO presumably reviewed the application already; hence, a re-evaluation of the same application is redundant. Noteworthy too, is that foreign parties to a TFE, being beyond the RDO’s jurisdiction, are not covered by existing audit issuances and therefore could not be subject to post-audit. Other than the annotation of the stock certificates which is justified, foreign parties cannot be compelled to comply with the tax reporting and accounting requirements. These lopsided circumstances put Philippine-based parties to a TFE at a disadvantage.
Thus, while tax exemptions are strictly construed against taxpayers, prescribing unnecessary administrative requirements defeats the dispensation of the confirmatory ruling. The annotation of the relevant ownership documents should be sufficient for purposes of establishing and monitoring the substituted cost and capturing the deferred gain in the next transaction. Establishing layers of monitoring only encumbers tax-free reorganizations.
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.
Eileen Flor Abalos is a tax director at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network.