REVENUE MEMORANDUM CIRCULAR NO. 19-2022 issued on February 4, 2022 provides clarification and guidance on Section 8 of Revenue Regulations No. 5-2021 on the tax-free exchanges of properties under Section 40(C)(2) of the National Internal Revenue Code of 1997, as amended by Republic Act No. 11534 (CREATE).
Under Section 40(C)(2) of the 1997 Tax Code, as amended by CREATE, reorganization and transfer of property to a controlled corporation are covered by the tax-free exchanges of properties.
Under Section 40(C)(5) of the 1997 Tax Code, as amended, the substituted basis of the properties transferred shall be determined as follows:
a. The substituted basis of the stock or securities received by the transferor on a taxfree exchange shall be:
i. The original basis of the property, stock or securities to be transferred;
ii. Less: (a) money received, if any, and (b) the fair market value of the other property received, if any;
iii. Plus: (a) the amount treated as dividend of the shareholder, if any, and (b) the amount of any gain that was recognized on the exchange, if any.
However, the property received as ‘boot’ shall have as basis its fair market value. The term “boot” refers to the money received and other property received in excess of the stock or securities received by the transferor on a tax-free exchange.
If the transferee of property assumes, as part of the consideration to the transferor, a liability of the transferor or acquires from the latter property subject to a liability, such assumption or acquisition (in the amount of the liability) shall, for purposes of computing the substituted basis, be treated as money received by the transferor on the exchange.
Finally, if the transferor receives several kinds of stock or securities, the Commissioner is authorized to allocate the basis among the several classes of stocks or securities.
b. The substituted basis of the property transferred in the hands of the transferee shall be:
i. the original basis in the hands of the transferor;
ii. Plus: the amount of the gain recognized to the transferor on the transfer.
c. The original basis of the property to be transferred, as mentioned in the Circular, shall be the following, as may be appropriate:
i. The cost of the property, if acquired by purchase on or after March 1, 1913;
ii. The fair market price or value as of the moment of death of the decedent, if acquired by inheritance;
iii. The basis in the hands of the donor or the last preceding owner by whom the property was not acquired by gift, if the property was acquired by donation. If the basis, however, is greater than the fair market value of the property at the time of donation, then, for purposes of determining loss, the basis shall be such fair market value; or,
iv. The amount paid by the transferee for the property, if the property was acquired for less than an adequate consideration in money or money’s worth.
v. The adjusted basis of (i) to (iv) above, if the acquisition cost of the property is increased by the amount of improvements that materially add to the value of the property or appreciably prolong its life less accumulated depreciation.
vi. The substituted basis, if the property was acquired in a previous tax-free exchange under Section 40(C)(2) of the Tax Code of 1997.
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 listed in Item VII of the Circular.
The substituted basis, as determined in Item Ill of the Circular, shall be the basis for determining gain or loss on a subsequent sale or disposition of properties subject of the taxfree exchange transactions under Section 40(C)(2) of the 1997 Tax Code, as amended, by CREATE.
For proper monitoring of the substituted basis, the parties to the tax-free exchange/reorganization should comply with the following requirements as set forth under Revenue Regulations No. 18-2001:
a. Each corporation, which is a party to the reorganization, shall file, as part of its return for the taxable year within which the reorganization occurred, a complete statement of all facts pertinent to the non-recognition of gain or loss in connection with the reorganization.
b. Every taxpayer, other than a corporation, party to the reorganization, who received stock or securities and other property or money upon a tax-free exchange in connection with a corporate reorganization shall incorporate in his Income Tax return for the taxable year in which the exchange takes place a complete statement of all facts pertinent to the non-recognition of gain or loss upon such exchange.
c. The parties thereto shall include as a note to their respective audited financial statements for the taxable year in which the exchange occurred a statement to the effect that they hold such assets/shares acquired in a tax-free exchange and the year in which such exchange occurred, and in the taxable years until the subject properties are subsequently transferred to another transferee.
d. The parties shall cause to annotate, at the back of the Transfer Certificate of Title (TCC), Condominium Certificate of Title (CCT) and Certificates of Stock, the date the deed of exchange was executed, the original or historical cost of acquisition of the properties or shares of stock transferred, and the fact that no gain or loss was recognized as a result of such exchange.
e. A photocopy of the TCT/CCT/Certificate of Stock that bears the annotation of substituted bases of the real properties/shares of stock transferred/ received in connection with the transaction, as duly certified by the Register of Deeds/Corporate Secretary, should be submitted to the Revenue District Office (RDO) which issued the Certificate Authorizing Registration (CAR), within ninety (90) days from the date of the receipt of the CAR, by any of the parties to the exchange transaction. Otherwise, the RDO shall refer the docket of the case to the Legal Division for appropriate action.
f. Moreover, the shareholders of the absorbed/transferor corporation and the surviving/transferee corporation shall record in their respective books the mandatory accounting entries stated in Annexes “A” “A-I” and “A-2” of the Circular, as the case may be, pursuant to Revenue Memorandum Order No. 17-2016.
The transfers of properties in exchange for shares of stocks made pursuant to Section 40(C)(2) of the 1997 Tax Code, as amended, shall be exempt from the following taxes:
a. Capital Gains Tax (CGT);
b. Creditable Withholding Tax (CWT);
c. Income Tax (IT);
d. Donor’s Tax (DT);
e. Value-Added Tax (VAT); and
f. Documentary Stamp Tax (DST) on conveyances of real properties and shares of stocks
However, the original issuance of shares in exchange for the properties transferred shall be subject to the DST under Section 174 of the 1997 Tax Code, as amended.
The following revenue issuances (listed under Item VII of the Circular) shall continue to apply on exchanges of properties made pursuant to Section 40(C)(2) of the 1997 Tax Code, as amended by CREATE, particularly on the establishment and monitoring of substituted basis of the properties transferred and stocks received in case of their subsequent sale or disposition, including their tax treatment:
a. Revenue Regulations No. 18-2001
b. Revenue Memorandum Ruling (RMR) No. 1-2001
c. RMR No. 1-2002
d. RMR No. 2-2002
e. Revenue Memorandum Order (RMO) No. 32-2001
f. RMO No. 17-2016
For purposes of the issuance of the CAR for the transferred properties pursuant to the tax-free reorganization/exchange, the parties to the transaction shall submit the documentary requirements listed in Annex “B” of the Circular 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 stocks 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 involved 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.
Following issuance of the corresponding CAR on the transactions falling under Section 40(C)(2) of the Tax Code, as amended by CREATE, the concerned RDO shall conduct a postaudit of said transactions pursuant to existing revenue issuances on tax audit and assessment, to determine the taxability thereof.
If after audit, the transaction is found to be not entitled to the tax deferment treatment under Section 40(C)(2) of the Tax Code, as amended by CREATE, the transaction shall be subject to the applicable taxes, plus interest, penalty and surcharge. However, the result of the audit shall not invalidate the CAR previously issued for the transfer of the properties.
The parties to the transaction are duty bound to prove compliance with the conditions laid down by the law and the requirements set forth under existing revenue issuances in the availment of the tax exemption.
In all the foregoing, the taxpayer is not precluded from requesting a ruling/legal opinion with the Law and Legislative Division (LLD) of the BIR National Office in order to clarify legal issue/s that may affect the transactions made pursuant to Section 40(C)(2) of the 1997 Tax Code, as amended, including the taxability of such transaction.
The LLD shall evaluate whether or not 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.