Let's Talk Tax

Clarifications and guidance on tax-free exchanges of properties

Mark Anthony Ponte
By:
Mark Anthony Ponte
Contents

Over the years, our government agencies have been continuously implementing innovations to reduce steps in government processes to upgrade their services and lessen the timeline with regard to government transactions. These developments take place over time. Constant improvements also build trust and confidence on the part of the taxpayers to transact with government agencies. Steady improvements need to be applied at all levels of public administration to be comprehensively effective, and with our tax agency in particular, which is responsible for the collection of the taxes.

The Bureau of Internal Revenue (BIR) just recently issued Revenue Memorandum Circular (RMC) No. 19-2022 which provides clarification and guidance to Revenue District Officers (RDOs), other internal revenue officers, and others concerned on the issuance of Certificate Authorizing Registration (CAR) without a prior confirmation or tax ruling on tax-free exchanges of properties while at the same time ensuring that the proper taxes due to the BIR on their subsequent sale or disposition are protected and collected thru the establishment and proper monitoring of their correct substituted basis.

It can be recalled that under Revenue Regulation (RR) No. 5-2021, it states that “No gain or loss shall be recognized on a corporation or on its stock or securities if such corporation is a party to a reorganization and if it exchanges property in pursuance of a plan of reorganization solely for stock or securities in another corporation that is a party to the reorganization as defined under Section 2 hereof.

No gain or loss shall also be recognized if property is transferred to a corporation by a person, alone or together with others, not exceeding four (4) persons, in exchange for stock or unit of participation in such a corporation of which as a result of such exchange, the transferor or transferors, collectively, gains or maintains control of said corporation, provided, that stocks issued for services shall not be considered as issued in return for property. Sale or exchanges of property used for business for shares of stocks covered under this subsection shall not be subject to value-added tax (VAT).

In all of the foregoing instances of exchange of property, prior BIR confirmation or tax ruling shall not be required for purposes of availing of the tax exemption. The concerned parties can implement the transaction covered by, but not limited to, the issuance of the CAR by the RDO where the property is located, in case of real properties, or by the RDO where the business is registered, in case of shares of stocks, subject to post-transaction audit by the Bureau.

Under Section 40(C) (2) of the 1997 Tax Code, as amended by the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act, the following transactions are covered by the tax-free exchanges of properties, which are (i) reorganization and (ii) transfer to a controlled corporation.  In reorganization, these include the usual corporate transactions involving merger or consolidation and other transactions involving sale or exchange of voting shares of a corporation resulting in the acquisition of control of the buying corporation as well as recapitalization. On the other hand, transfer to a controlled corporation pertains to the transfer of property to a corporation by a person, alone or together with others, not exceeding four (4) persons, in exchange for stock or unit of participation in such a corporation of which as a result of such change, the transferor or transferors, collectively, gains or maintains control of said corporation.

The substituted basis of the properties transferred shall be the original basis of the property, stock, or securities to be transferred less money received, if any, and the fair market value of the other property received, if any, plus the amount treated as dividend of the shareholder, if any, and the amount of any gain that was recognized on the exchange, if any, for stock or securities.  However, for property in the hands of the transferee, the substituted basis shall be the original basis in the hands of the transferor plus the amount of the gain recognized to the transferor on the transfer.

Illustrations and further explanations on the determination of the substituted basis of the properties transferred and stocks received in the exchange are found in existing revenue issuances as follows: RR No. 18-2001, RMR No. 1-2001, RMR No. 1-2002, RMR No. 2-2002, RMO No. 32-2001, and RMO No. 17-2016.

The substituted basis shall be the basis for determining gain or loss on a subsequent sale or disposition of properties subject of the tax-free exchange transactions under Section 40(C)(2) of the 1997 Tax Code, as amended, by the CREATE Act. In the recent BIR issuance, it explicitly laid out the requirements set forth under RR No. 18-2001 for the proper monitoring of the substituted basis. The transfer of properties in exchange for shares of stocks made pursuant to Section 40(C)(2) shall be exempt from capital gains tax, creditable withholding tax, income tax, donor’s tax, value-added tax, and documentary stamp tax on conveyances of real properties and shares of stocks except original issuance of shares in exchange of real properties transferred.

For purposes of the issuance of the CAR for the transferred properties pursuant to the tax-free exchange, the parties to the transaction shall submit the documentary requirements listed in Annex “B” of RMC No. 19-2022 to the RDO having jurisdiction over the place where the property is located, in case of a real property, or in case of shares of stock, the RDO where the issuing corporation is registered.

In case the transaction involves transfer of multiple real properties and/or shares of stock situated in various locations covered by different RDOs, the CAR shall be processed with the RDO having jurisdiction over the place where the transferee corporation is registered. The CAR should specify, among others, that the transaction is a tax-free exchange under Section 40(C)(2) of the Tax Code of 1997, as amended by CREATE, the date of transaction, and the substituted basis of the properties subject therefor.

Taxpayers are not prohibited from seeking legal opinion or ruling to resolve legal issues and taxability affecting the transactions made pursuant to Section 40(C)(2) of the Tax Code. The Law and Legislative Division of the BIR National Office shall evaluate whether the request involves question/s of law that would merit the issuance of a ruling. Otherwise, it shall endorse the request to the concerned RDO for appropriate action.

With the recent BIR issuance, corporate taxpayers will no longer suffer the ordeal of complying with previous intricate procedures issued by the tax authority just for them to avail of tax-free exchange transactions. The recent guidelines are appropriate to the current situation and will definitely benefit a lot of corporate taxpayers in their transactions involving exchange of properties.

Let's Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.

 

As published in BusinessWorld, dated 15 February 2022

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