The COVID-19 pandemic may have unwittingly triggered acquisition activity as private equity investors demonstrate an increased appetite for Philippine companies. Despite the expected economic slowdown, investors continue to look for opportunities, with many entities needing sufficient capital to sustain their businesses.
Whether it be due to corporate restructuring or a simple divestment, the sale or transfer of shares of stock in a domestic corporation remains a routine commercial transaction.
Under the Tax Code, the sale, barter, exchange or transfer of shares in a domestic corporation, not traded on the stock exchange, is subject to capital gains tax and documentary stamp tax. Donor’s tax may also be imposed if the consideration for the transfer of the shares is below fair market value, though amendments to the Tax Code by the TRAIN Law emphasizes that the sale, transfer, or exchange of property made in the ordinary course of business will be considered as made for an adequate and full consideration.
As such, the Department of Finance (DoF), on the recommendation of the Bureau of Internal Revenue (BIR), recently issued Revenue Regulations (RR) No. 20-2020 effective Sept. 3, which simplified the process of determining the fair market value (FMV) of shares of stock for sale, exchange, or transfer.
RR No. 20-2020
Under RR No. 20-2020, the FMV of common shares is prima facie equivalent to the book value based on the latest audited financial statement (AFS) prior to the sale, but not earlier than the immediately preceding taxable year. For preferred shares, the FMV is set at the liquidation value equivalent to the redemption price as of the balance sheet nearest the transaction date, including any cumulative and preferred dividends in arrears.
If the investee corporation has both common and preferred shares, the book value of the common shares will be derived by deducting the liquidation value of the preferred shares from the equity and dividing the result by the number of the issued and outstanding common shares. Thus, RR No. 20-2020 underscores the difference in the valuation for common and preferred shares, given the nature and rights of each class of shares.
This clarity on the valuation of preferred shares is a welcome development since, for the longest time, previous rules did not provide details in determining the FMV of preferred shares.
NET BOOK VALUE ADJUSTMENT
Prior to the effectivity of RR No. 20-2020, FMV was determined following the provisions of RR No. 6-2013. The 2013 regulations prescribed that to determine the FMV of shares of stock, the book value of the shares, based on the investee corporation’s (corporation selling shares) latest AFS, must be adjusted to take into account the actual FMV of the real properties owned, if any, by the investee corporation.
This net book value (NBV) adjustment requires, among others, the actual valuation of the real property by an accredited appraiser and the tax declaration of the real property as issued by the City or Provincial Assessor. The highest FMV of the real property (among the appraisal report, the tax declaration, or the BIR’s zonal value) will be used to adjust the book value of the shares for FMV purposes. Consequently, the independent appraisal report and the tax declaration must be submitted to the BIR during the processing of the Certificate Authorizing Registration (CAR) covering the transfer of the shares of stock. Without the CAR, the transfer of the shares from the buyer to the seller cannot be recorded in the investee corporation’s books.
Such requirements have complicated the processes of transferring shares, depriving the government of revenue from the taxes on such transactions. The preparation of an appraisal report may take some time, depending on the properties of the investee corporations to be assessed, and entails additional costs since the appraisal report must be prepared by an independent appraiser.
Since RR No. 20-2020 removed the net adjusted value requirement under RR No. 6-2013, all that is needed is the latest AFS in order to determine the FMV of the shares.
STREAMLINING TAX PROCEDURES FOR COMPLIANCE
RR No. 20-2020 also appears to be consistent with the government’s objectives to streamline tax procedures. It can be recalled that RR No. 12-2018 (or the consolidated regulations to Donor’s and Estate Taxes incorporating the TRAIN Law amendments), expressly exempted the valuation of shares of stock of a decedent for Estate Tax purposes from the provisions of RR No. 6-2013 in requiring the valuation report. Both RRs give credence to the government’s intent to streamline procedures.
We can expect the simplified requirements under RR No. 20-2020 to lead to an increase in tax compliance. Without the need for a costly and complicated appraisal report, more parties may be encouraged to transfer shares. Establishing the FMV will also be easier and will minimize disputes among parties since the latest AFS should be able to provide the FMV that will serve as the base consideration.
RR No. 20-2020 can also be expected to expedite the process of securing the CAR since the independent appraisal report and the tax declaration are no longer necessary, taxpayers will need to submit fewer documents to process and secure the CAR.
Implicit in RR No. 20-2020 is the need for the investee corporation to maintain its AFS, which must also be submitted to the BIR and the Securities and Exchange Commission. Since the RR now requires that book value be based on the latest AFS not earlier than the immediately preceding taxable year, it is now imperative for corporations to always have the AFS of the immediately preceding taxable year prepared.
POTENTIAL IMPACT ON OTHER REGULATIONS
However, RR No. 20-2020 may also have an impact on other regulations that refer to RR No. 6-2013. For instance, Revenue Memorandum Order (RMO) No. 17-2016 requires that shares to be transferred from an absorbed corporation to the surviving corporation in a merger should also be valued following the guidelines under RR No. 6-2013. Now that RR No. 6-2013 has been superseded by RR No. 20-2020, it remains to be seen how the BIR will interpret the requirement in RMO No. 17-2016 on the adjustment of the FMV of shares to be transferred in a merger, as well as whether it will also adopt RR No. 20-2020 for such valuation purposes.
RR No. 20-2020 is a welcome respite for taxpayers. With greater facility of transactions comes a potential increase in compliance. In turn, improved compliance can lead to an increase in the Government’s tax revenues, which could go a long way to support Government efforts in these challenging times.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views reflected in this article are the views of the authors and do not necessarily reflect the views of SGV, the global EY organization or its member firms.
Partner Jonald Vergara and Senior Manager Betheena Dizon are from the Tax Service Line of SGV & Co.