—Timothy Joseph N. Lumauig, Partner
—Aidyl Pearl U. Perez, Associate

On 17 August 2020, the Bureau of Internal Revenue (the “BIR”) issued Revenue Regulations (“RR”) No. 20-2020,[1] which revised the rules for determining the fair market value (“FMV”) for the sale, barter, exchange or other disposition of shares of stock not traded through the stock exchange.

A key highlight of the new RR is the removal of the requirement to appraise real properties owned by the corporation at the time of sale in connection with the Adjusted Net Asset (“ANA”) Method previously imposed under RR No. 06-2013. Rather, FMV of shares in a corporation are generally based on book value per latest audited financial statements (“AFS”), which is typically lower than the resulting FMV under the ANA Method for corporations that own real property. Consequently, transfers of shares in these types of corporations may result in lower capital gains taxes (“CGT”).

Thus, with the developments to FMV determination of shares of stock under RR No. 20-2020, taxpayers can explore potential tax-saving structures for transactions directly or indirectly involving underlying real properties, which we look into in this newsletter.

Significance of FMV on Sale of Shares and CGT

The sale of shares in a domestic corporation not listed and traded in the stock exchange is subject to CGT, which is currently at 15% of the net capital gain realized on the transfer.[2] Net capital gain is the difference between the gross selling price or FMV of the shares (whichever is higher) and their corresponding acquisition cost. Where FMV of shares transferred is higher than their stipulated selling price, the difference between these values may be deemed a gift subject to donor’s tax, unless proven to be sold at arm’s length, free from any donative intent and in the ordinary course of business.[3]

The FMV effectively provides a general minimum, on which net capital gain and corresponding CGT will be based. Thus, the BIR’s rules on determining FMV impacts CGT liability on a sale of shares.

FMV under Previous Rules: the Adjusted Net Asset Method & Appraisal Reports

Under RR No. 06-2008, FMV was already based on book value of the shares as shown in the AFS nearest to the sale date.[4] In 2013, however, RR No. 06-2013 changed the tax landscape when it prescribed the use of the ANA Method to determine the FMV of the shares of stock for CGT purposes. Particularly for corporations with real properties, RR No. 06-2013 required an independent appraisal of the current FMV of real properties owned, to adjust the value of the assets of the corporation under the ANA Method.[5]

In practice, the ANA Method commonly resulted in higher FMV of shares as compared to their book values, which in turn resulted in higher CGT liabilities on corresponding share transfers. The issuance of RR No. 06-2013 caused parties to revisit the tax implications on transactions involving sale of shares. Naturally, this affected transfers of shares ultimately aimed at transferring underlying real properties already held by the corporate vehicles, but also had an impact on other share transfers, including internal corporate restructuring exercises with intercompany transfers.

Presumably to the delight of taxpayers after 7 years from the issuance of RR No. 06-2013, the requirement for an independent appraisal for FMV determination has been abandoned under RR No. 20-2020.

Determination of FMV under RR No. 20-2020[6]

RR No. 20-2020 expressly provides that in determining the FMV of shares in a corporation, the book value of the 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. In other words, the book value as stated in the corporation’s latest AFS will suffice, doing away with a requirement for an independent appraisal of real properties.

RR No. 20-2020 further establishes the definition of the FMV of shares of stock to be sold, as follows:

• For common shares, the prima facie FMV shall be the book value based on the latest available audited financial statements, which shall not be earlier than the immediately preceding taxable year to the sale.

• For preferred shares of stock, the liquidation value shall be considered as the FMV. The liquidation value is determined as follows:

 Liquidation Value 

= (Redemption of Preferred Shares on the Balance Sheet nearest to transaction date) + 
(Premium and Cumulative Preferred Dividends in arrears)

• In cases where there are both common and preferred shares, the book value per common share is computed as follows:

(Total Equity of the Corporation) – (Liquidation Value of Preferred Shares)
___________________________________________________________________________________
 Number of Outstanding Common Shares as of Balance Sheet Date nearest to Transaction Date 

Practical Applications Today

Prior to the issuance of RR No. 06-2013, it was common to see real properties parked in holding companies or special purpose vehicles. With lower FMV per book values, CGT on sale of shares was generally seen as more manageable to taxpayers than taxes on a straight sale of real property before the imposition of the ANA Method. Thus, corporations were used as tax-saving mechanisms, through which the underlying real properties can be further transacted. For instance, the underlying property held by a corporate vehicle may ultimately be sold (if the entity is wholly-sold), jointly developed (if shares are partly sold to a partner), or even distributed as part of an estate plan (through a distribution of shares).

The issuance of RR No. 20-2020 allows taxpayers to explore such potential tax-saving transaction structures once again. Especially considering the unprecedented circumstances faced today, the new RR may prove to be beneficial for property owners seeking to liquidate assets or businesses looking to spinoff a portion of their enterprise that use real properties. Similarly, larger companies or conglomerates looking to internally reorganize their operations, and/or bring in potential investors via share acquisitions, may likewise benefit from these new rules for FMV-determination, making RR No. 20-2020 a welcome, if not much-needed, development from the BIR.

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[1] Amending Certain Provisions of Revenue Regulations No. 06-2008 entitled Consolidated Regulations Prescribing the Rules on the Taxation of Sale, Barter, Exchange or Other Disposition of Shares of Stock held as Capital Assets [Revenue Regulations No. 20-2020], 17 August 2020.

[2] See Tax Reform for Acceleration and Inclusion [TRAIN Law], Republic Act No. 10963, 19 December 2017, Sections 5 and 7.

[3] See Clarifying Section 100 of National Internal Revenue Code (NIRC) of 1997, as Amended by Republic Act (RA) No. 10963, or the “Tax Reform for Acceleration and Inclusion (TRAIN Law)” in Relation to Sale of Shares of Stock Not Traded or Listed [Revenue Memorandum Circular No. 030-19] 28 February  2019.

[4] Rules on the Taxation of Sale, Barter, Exchange or Other Disposition of Shares of Stock Held as Capital Assets [Revenue Regulations No. 06-08], 22 April 2008, Section 7(c.2.2.).

[5] Amending Certain Provision of Revenue Regulations No. 06-2008 Entitled Consolidated Regulations Prescribing the Rules on the Taxation of Sale, Barter, Exchange or Other Disposition of Shares of Stock Held as Capital Assets [Revenue Regulations No. 06-13, 11 April 2013, Section 2.

[6] Revenue Regulation No. 20-2020, Section 2.