The Bureau of Internal Revenue (BIR) has just released Revenue Regulations (RR) No. 6-2013 dated April 11, 2013 which amends BIR RR No. 6-2008, or the Consolidated Regulations Prescribing the Rules on the Taxation of Sale, Barter, Exchange or Other Disposition of Shares of Stock Held as Capital Assets.
Why is this RR important? It is important because it has a significant impact on tax planning initiatives involving real estate kept in corporations. In other words, it plugs a tax loophole.
Tax advantages of booking real estate in a corporation
You may have heard of people putting real estate in the name of corporations instead of their own names, and wondered how exactly that helps them.
Fair warning, this will be a long discussion, but I will attempt to explain this in layman’s terms. Please take note that this will be an overly simplified version for information purposes only. Consult your lawyer for legal advice about your particular circumstances.
Before RR 6-2013
Previously, the fair market value of a share of stock not traded in the stock exchange was based on the corporation’s book value per share.
In accounting for real estate, the asset is recorded at acquisition cost. Meaning, if you bought a piece of land fifty years ago at P5,000.00 and put it in a corporation, the book value of that land will still be P5,000.00 today (unless an appraisal increase was recorded). If instead of land it was a house and lot, technically, the book value will be lower because of depreciation on the house.
What are the taxes if you want to sell the land?
Since the land is booked in the corporation (and it is possible that the corporation has no other asset other than the land), you have a choice of either a) having the corporation selling the land or b) selling the shares of the corporation which holds the land.
Under a), if the land is an ordinary asset of the corporation, the corporation will be subject to 12% VAT, plus income tax which shall be based on the difference between the highest among the selling price, BIR zonal value, and tax declaration value, and the cost (which we expect to be high since the historical cost is so low).
If the land is a capital asset, the corporation will be subject to capital gains tax on the sale of land, which shall be 6% of the highest among the selling price, BIR zonal value, and tax declaration value, without taking the cost into consideration as a deduction.
[Note: You may want to revisit my previous post on the difference between an ordinary and a capital asset.]
Under b), instead of having the corporation sell the land, you will sell the shares of the stock of the corporation which holds the real estate (and the shares are not traded in the stock exchange).
The owner of the shares will then be subject to capital gains tax on the sale of shares not listed in the stock exchange, which is 5% on the first P100,000.00 gain and 10% on the gain in excess of P100,000.00.
Since the tax is on the gain (meaning selling price less acquisition cost), the tax will be less compared to capital gains tax on the sale of real estate which is based on presumed gain.
If a person has an intent of evading the payment taxes, the selling price may be understated to be just a little over the book value of the shares, so the gain will be lower and consequently, the taxes will be lower as well.
Plugging the tax loophole
Under RR 6-2013, the fair market value of shares not sold on the stock exchange is now determined using the Adjusted Net Asset Method. Under this method, all assets and liabilities are adjusted to fair market values. The value of the share shall be the adjusted asset value minus the liability.
RR 6-2013 specifically stated that the appraised value of real property at the time of sale shall be the higher of –
- The fair market value as determined by the Commissioner, or
- The fair market value as shown in the schedule of valued fixed by the Provincial and City Assessors, or
- The fair market value as determined by Independent Appraiser.
Note that based on RR 6-2008, the net capital gain is computed as selling price less acquisition cost. Selling price was further defined as (among others) – in the case of cash sale, the selling price shall be the total consideration per deed of sale. It was defined further that, “In case the fair market value of the shares of stock sold, bartered, or exchanged is greater than the amount of money and/or fair market value of the property received, the excess of the fair market value of the shares of stock sold, bartered or exchanged over the amount of money and the fair market value of the property, if any, received as consideration shall be deemed a gift subject to the donor’s tax under Sec. 100 of the Tax Code, as amended.”