Checking financial capacity in transfers of properties

Most, if not all, individuals and corporate entities alike, have had some experience buying, selling, exchanging, transferring, inheriting or donating real and/or personal property/ies. We are well aware that such transfers of properties are subject to applicable income/capital gains taxes (based either on the selling price or fair market value of the properties transferred or gain realized on the transfer) as well as documentary stamp tax (DST) in the case of transfers of real properties and shares of stock not traded in the stock exchange. In the case of transfers of real or personal properties that are held for sale or lease or are used in the business, the same are also subject to value-added tax (VAT). In addition to these national taxes, the sale or exchange of real properties is subject to applicable transfer taxes payable to the concerned local government unit.

Once the taxes have been paid, there is a need to secure from the relevant Bureau of Internal Revenue (BIR) -- Revenue District Office (RDO) the required Certificates Authorizing Registration (CAR) and/or Tax Clearance (TCL). In the case of transfers of real properties, the CAR and/or TCL must be presented to the concerned Register of Deeds in order for the latter to issue a new transfer certificate of title in the name of the buyer/transferee. Similarly, with respect to transfers of shares of stock (not traded in the stock exchange), the CAR must be presented to the corporate secretary of the investee corporation so that the latter can record the transfer in the stock and transfer book of the corporation as well as issue the stock certificate in the name of the buyer/transferee. 

The CAR and/or TCL is processed by the One Time Transaction (ONETT) unit of the concerned BIR-RDO and their primary objective is to ensure that the correct taxes have been paid on the transaction. In the course of processing the CAR and/or TCL, the main documents required by the ONETT (as per BIR Revenue Memorandum Order 15-2003) include the contract or deed evidencing the transfer and consideration therefor; documents to support the acquisition cost as well as the fair market value (FMV) of the properties transferred; proof of payment of applicable taxes; and the authority of the respective parties to effect the transfer.

Recently, the BIR issued Revenue Memorandum Order (RMO) Nos. 24-2016 and 25- 2016 dated June 7 and 12, 2016, respectively, prescribing guidelines to investigate the financial capacity of the parties to acquire the properties subject of certain transfers. 

The transactions covered by the above RMOs are, but not limited to, those subject to: (1) final capital gains Tax (CGT) on sale of real properties considered as capital assets; (2) CGT on sale, transfer or assignment of stocks not traded in the stock exchange; (3) expanded withholding tax (EWT) on the sale of real properties considered as ordinary assets; (4) donor’s tax; (5) estate tax; (6) other taxes including documentary stamp tax related to the sale/transfer of properties, and (7) those covered by tax-free exchange/transfer under Section 40 of the Tax Code (i.e., where a transferor exchanges property for shares or shares for shares of a transferee corporation wherein the transferor gains control or further control of the transferee corporation), involving taxes in excess of Php 1 Million and transactions exempt from CGT/EWT.

In addition to the supporting documents required when applying for CARs and/or TCLs under RMO 15- 2003, the parties (buyer/transferor and seller/transferee) may be subjected to an audit/investigation to determine their capacity to hold and/or acquire properties. 

In all cases, the ONETT team shall verify in the BIR Integrated Tax System (ITS) that the parties regularly file tax returns and report income sufficient to establish financial capacity. 

For individuals not required to file an income tax return to establish his financial capacity, he shall submit an affidavit stating why he is not required to file an income tax return, total annual income and sources of income. In addition, presentation of documents, such as, but not limited to Income Tax Return, Certificate of Creditable Tax Withheld at Source, Certificate of Final Tax Withheld at Source, or loan documents as the source of the consideration for the acquisition of the subject property may be used to establish financial capacity.

If the buyer/transferee is proven to have no financial capacity to acquire the subject property, the transaction shall be deemed a donation, not a sale. Donor’s tax shall be imposed instead of CGT, and a duly executed deed of donation shall be required.

RMO 25-2016 amended the above provision of RMO 24-2016 and added the following:

“If the seller/transferor/assignor is a corporation or is a stranger to the buyer/transferee/assignee, and it is proven that the said buyer/transferee/assignor does not have any financial capacity to purchase the subject property, it shall be presumed that the buyer/transferee/assignee has earned income that he did not declare and taxes due thereon where not paid. In addition to the tax due on the sale/transfer/assignment, deficiency income tax shall be assessed on the buyer/transferee/assignee on the amount of consideration for the transfer which cannot be supported by his financial capacity, on the taxable year when the sale/transfer/assignment of the subject property occurred.”

The original wording of RMO 24-2016 refers to the financial capacity of the buyer/transferee. If it is proven that the buyer/transferee has no financial capacity to acquire the property, the transaction is taxed as a donation and not a sale. But, the amendment introduced by RMO 25-2016 specifically refers to a situation where the seller/transferor/assignor is a corporation or a stranger and the financial capacity of the buyer/transferee/assignor is similarly not proven. Some questions arise. If the seller is a corporation or a stranger but the buyer has no financial capacity, will the transaction be considered a donation (and taxed accordingly) or will it be taxed as a sale? Does the provision on treating the transfer as a donation due to inability to prove buyer’s financial capacity apply to transactions between individuals and related parties but not to corporate entities and unrelated parties? 

The amendment mentions that in addition to the tax due on transaction, the buyer may be liable for deficiency income tax on the portion of the consideration that was not supported by his financial capacity. But, if the transaction will already be taxed as a donation due to the inability to prove the buyer’s financial capacity, should the buyer still be exposed to deficiency income tax? Is it reasonable that the same transaction will give rise to two types of tax, one that is in the nature of a penalty and the other in the form of a deficiency tax? 

The RMO 24-2016 expressly provides that the lack of financial capacity of the seller/transferor/assignor shall not stop the processing and issuance of the CAR/TCL for the subject property. However, the RDO may recommend the issuance of a Letter of Authority to conduct an audit or investigation.

In case of applications for ruling/certification on the consequences of tax-free exchanges under Section 40 of the Tax Code, the documents required under existing rules shall be submitted to the Law Division of the BIR National office. If it is determined that the transferor/assignor does not have the financial capacity to acquire the properties subject of the tax-free exchange, the case shall be forward to the National Investigation Division (NID) for initiation of an audit/investigation. The processing of the BIR certification/ruling and issuance of CARs and TCLs on the transfer of property in exchange for shares of stock shall likewise proceed notwithstanding the audit or investigation.

A perusal of the above RMOs seems to indicate that ostensibly, the purpose is not only to ensure that correct taxes are paid but more importantly, that these transfers of properties, particularly those between related parties, involve actual exchange of consideration and are not simulated. Requiring proof of financial capacity of the seller/transferor/ assignor (to acquire the property) as well as the buyer/transferee/assignee (to purchase the property) will also have a deterrent effect on money-laundering activities and hiding ill-gotten wealth. The BIR can be lauded for its efforts in this regard but it is hoped that these RMOs will not unduly delay the processing and issuance of CARs/TCLs for bona fide transactions which are done in the ordinary course of business and for legitimate purposes such as corporate restructuring. 

The RMOs grant a great degree of discretion on the part of the ONETT examiners with respect to acceptable proof of financial capacity. It is hoped that the BIR examiners will be reasonable in evaluating the financial capacity of the parties, particularly with respect to corporate entities, domestic or foreign because in their case, alternative sources of information (such as published news/articles on significant corporate deals; annual report; disclosures of publicly listed entities, etc.) that will demonstrate their financial capacity are readily available.

Tata Panlilio-Ong is a director of the Tax Advisory and Compliance division of Punongbayan & Araullo. P&A is a leading audit, tax, advisory and outsourcing services firm and is the Philippine member of Grant Thornton International Ltd.

As Published in Business World, dated 21 June 2016