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Jaffy Y.  Azarraga

Taxwise Or Otherwise

Prior to the enactment of the TRAIN Law, Section 100 of the Tax Code generally imposed a donor’s tax on transfers for less than an adequate and full consideration in money or money’s worth, whereby the amount by which the fair market value of the property exceeded the value of the consideration was deemed a gift, and included in computing the amount of gifts made during the calendar year.

Viewed on its own, the provision itself is not controversial, since transfers for less than the adequate and full consideration are, for all intents and purposes, actually donations insofar as the amounts foregone or given away is concerned. However, the complication arises when one tries to define what is considered as “adequate and full consideration,” or in other words, “fair market value.”

As the phrase suggests, “fair market value” is dictated by the market. In its simplest sense, fair market value is the price a property would sell for in the open market. It is the sum result of the confluence of factors that are present in a free or uncontrolled market characterized as follows: prospective buyers and sellers are reasonably knowledgeable about the asset, behaving in their own best interests, free of undue pressure to trade, and given a reasonable time period for completing the transaction, among others. Given these conditions, an asset’s fair market value should represent an accurate valuation or assessment of its worth.

However, in attempting to define the “fair market value,” the tax authority has come up with a mechanism, whereby real properties would be assessed and valued by the Commissioner or his duly authorized representatives on a periodic basis pursuant to the tax code. This resulted in a schedule of zonal values in which properties located within a certain location are prescribed such fair market value or “zonal value” as determined by the Commissioner, which will then be compared with the fair market value as shown in the schedule of values of the Provincial and City Assessors, and whichever is higher shall be the value of the property for tax purposes. With respect to shares of stock not traded through the stock exchange, the Bureau of Internal Revenue (BIR) based the fair market value on the adjusted net asset value, with real properties adjusted to their value as determined under the tax code

While generally the zonal value/value of the property as determined under the tax code may adequately represent the fair market value of properties in an area, there are numerous cases of disparities with the actual fair market value due to certain contributory factors, such as location, condition of the property, situation of the parties, terms and conditions of the contract, timing, etc. In other words, the dynamic environment of the business and the market determines the fair market value of the property, and not merely the value as estimated from time to time by the Commissioner or his agents.

Consequently, in cases where the “value of the property” prescribed by the BIR actually exceeds the actual fair market value of the property, the outright application of such value under Section 100 resulted in the imposition of donor’s tax notwithstanding the absence of any donation, or transfer below full and adequate consideration. In such cases, donor’s tax will be imposed even though there is no donation at all and the parties are transacting on an arm’s-length basis in the usual or ordinary course of business. In other words, the donor’s tax imposed without any underlying donation to begin with was illogical, illegal, and ultimately, void. However, the costs and/or delays of contesting such outcome were burdensome on the taxpayers, who eventually treated the tax as cost of the transactions to the detriment of their businesses.

Due to the prevalence of such cases, Congress deemed it proper to introduce, under the TRAIN Law, an amendment to Section 100 of the Tax Code, which reads:

“Provided, however, that a sale, exchange, or other transfer of property made in the ordinary course of business (a transaction which is 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.”

The amendment merely clarified what should have been read as part and parcel of the law itself, but which was somehow lost or ignored upon implementation by the tax authority.

Notwithstanding the amendment, the BIR recently issued Revenue Memorandum Circular No. 30-2009 in which the BIR seeks to reimpose its position that the proviso should be strictly construed and applied, as follows:

“Since an arm’s-length transaction is a question of fact, it therefore behooves upon the party, seeking to apply the exception to prove that indeed the sale involves no irregularity between unrelated and independent parties. This would require presentation and reception of reasonable evidence sufficient enough to convince that the sale of the shares of stock for less than its FMV is without intent to evade tax and defraud the government (of the tax due therein).”

While the regulation, without doubt, eases the implementation of the provision on the part of the BIR or its agents, it shifts the burden of proof entirely on the taxpayer. By requiring reception of evidence, the BIR is now vested with unbridled authority to determine whether such burden has been properly dispensed with. As the outcome is dependent solely on the BIR’s discretion, the situation has not improved at all since taxpayers will again be faced with the prospect of paying the donor’s tax notwithstanding the absence of intent to donate.

With all due respect to the tax authorities, intent to evade and defraud the government of taxes is not a reasonable presumption that must be overcome by the parties to any transaction. Stated differently, parties do not enter into transactions to defraud the government of revenues and taxes. Rather, parties have legitimate business or commercial reasons for doing so, i.e., to realize gain, profit or advantage from productive activity. To require the parties, upon consummation of the transaction, to show proof that it is not meant to defraud the government of taxes, is to impose a presumption that they have an intent to evade taxes in the first place, and must overcome the burden by proving otherwise. This situation is abhorrent and violative of the Constitution, which provides for the legal presumption of innocence unless proven guilty. As a general principle of law, “proof lies on him who asserts, not on him who denies.”

Further, by adding another burden to tax compliance, compliant taxpayers are essentially punished, while tax evaders are left unscathed. Even as currently worded, the RMC is still subject to potential abuse by unscrupulous taxpayers. For instance, a taxpayer may still claim donor’s tax exemption provided the amount of the difference is P250,000 or less for a given year. Also, a taxpayer may simply declare a selling price lower than the actual fair market value or zonal value, as the case may be, and pay the donor’s tax on the difference, since the donor’s tax rate was reduced to 6%; in contrast, capital gains tax was increased to 15%.

While it has been customary on the part of the tax authority to introduce more onerous measures to address compliance issues and to meet mounting pressures to increase tax collections, this may not be the best and most productive way to meet these objectives, as borne by experience in more developed countries. There, the focus is not to add burdens, but to ease compliance and the cost of doing business. Also, by treating businesses as partners of the government in nation-building rather than presumptive tax evaders, industries prosper, and consequently, government’s tax collection efforts succeed as well.

To my mind, now is the time for our tax regulators to discard conventional views and consider more progressive ways to implement our tax laws that encourage compliance and reduce costs on businesses. By doing so, the government may be able to restore health to the “Sick Man of Asia” and finally transform itself into an industrialized country in Southeast Asia, a transformation which is long overdue.

The views or opinions expressed 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.


Jaffy Y. Azarraga is a Director at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of PricewaterhouseCoopers global network.