Facts and Issues: Corporation X holds an investment in shares of stocks in Corporation Y.

Corporation X and Corporation Z are related parties. Corporation X wants to transfer the said
investments to Corporation Z. The shares are not listed in the stock exchange. What are the tax
implications of the planned transfer?

Opinion:
Substantive basis of transfer

A corporation is an artificial being created by operation of law, having the right of succession and the
powers, attributes, and properties expressly authorized by law or incidental to its existence (Sec 2.
Revised Corporation Code). The law grants a corporation many legal rights. These are the corporate
powers which are the means by which a corporation accomplishes its business purposes and may be
expressly, though not exclusively, in the Corporation Code or it’s Articles of Incorporation. The
purposes of a corporation are the business objectives set forth in its Articles of Incorporation. It has
the same powers as an individual to do all things necessary or convenient to carry out its business
and affairs. Corporations exercise implied powers to perform all other lawful acts reasonably
necessary to accomplish the business purpose. These implied powers are typically construed broadly,
though some acts may be beyond the purposes and powers of the corporation. Limits on corporate
powers may include statutory restrictions, and equitable limitations to protect the public, minority
shareholders, or creditors.  Trust fund doctrine and ultra vires doctrine are among the limitations
intended to protect its shareholders and creditors.

Among the corporate powers of a corporation under the Revised Corporation Code is to purchase,
receive, take or grant, hold, convey, sell, lease, pledge, mortgage, and otherwise deal with such real
and personal property, including securities and bonds of other corporations, as the transaction of the
lawful business of the corporation may reasonably and necessarily require, subject to the limitations
prescribed by law and the Constitution (Sec. 35 p.g. RCC).

Transactions between related parties are governed by a special provision of the law. Section 32 of the
Revised Corporation Code reads:

SEC. 32. Contracts Between Corporations with Interlocking Directors. – Except in cases of fraud,
and provided the contract is fair and reasonable under the circumstances, a contract between two (2)
or more corporations having interlocking directors shall not be invalidated on that ground alone:
Provided, That if the interest of the interlocking director in one (1) corporation is substantial and the
interest in the other corporation or corporations is merely nominal, the contract shall be subject to the
provisions of the preceding section insofar as the latter corporation or corporations are concerned.
Stockholdings exceeding twenty percent (20%) of the outstanding capital stock shall be considered
substantial for purposes of interlocking directors.

The requirement in order for a transaction between related corporations to be valid is prescribed
under Section 31 of RCC which reads:

SEC. 31. Dealings of Directors, Trustees or Officers with the Corporation. – A contract of the
corporation with (1) one or more of its directors, trustees, officers or their spouses and relatives within
the fourth civil degree of consanguinity or affinity is voidable, at the option of such corporation, unless
all the following conditions are present:
(a) The presence of such director or trustee in the board meeting in which the contract was approved
was not necessary to constitute a quorum for such meeting;
(b) The vote of such director or trustee was not necessary for the approval of the contract;
(c) The contract is fair and reasonable under the circumstances;
(d) In case of corporations vested with public interest, material contracts are approved by at least two-
thirds (2/3) of the entire membership of the board, with at least a majority of the independent directors
voting to approve the material contract; and
(e) In case of an officer, the contract has been previously authorized by the board of directors.
Where any of the first three (3) conditions set forth in the preceding paragraph is absent, in the case
of a contract with a director or trustee, such contract may be ratified by the vote of the stockholders
representing at least two-thirds (2/3) of the outstanding capital stock or of at least two-thirds (2/3) of
the members in a meeting called for the purpose: Provided, That full disclosure of the adverse interest
of the directors or trustees involved is made at such meeting and the contract is fair and reasonable
under the circumstances.

So long as the requirements provided by law are met, transfer between related parties will remain
valid.

Tax Implications

The case problem above calls on whether the transfer shall be subjected to capital gains tax or to
donor’s tax along with the determination of the value to be used for transfer tax purposes. The tax
liability will depend on the Corporation X mode of transfer and whether or not the transaction is bona
fide, at arm length and donative intent is present.

On December 17, 2017, President Rodrigo R. Duterte, signed into law Package 1 of the
Comprehensive Tax Reform Program (CTRP) also known as Tax Reform for Acceleration (TRAIN) as
Republic Act No. 10963. The Law took effect on January 1, 2018. The TRAIN aims to make the
Philippine Tax System simpler, fairer, and more efficient to promote investments, create jobs, and
reduce poverty. This law includes amendment to several provisions of the National Internal Revenue
Code of 1997 on personal income taxation, passive income for both individual and corporations,
estate tax, donor’s tax, value-added tax, excise tax, documentary stamp tax, and tax administration,
among others.

Capital Gains Tax

For sale of shares of stock of a domestic corporation not listed in the stock exchange and held as
capital asset, the tax is based on net capital gains. This means that the cost of the shares of stock
sold and incidental selling expenses are to be deducted from the selling price for capital gains tax
purposes. The tax rate is 15% of the net capital gains.

For valuation purposes, Revenue Regulation (RR) 06-2013, provides that the Adjusted Net Asset
Method shall be used for shares of stock not listed whereby all assets and liabilities are adjusted to
fair market values. The net of adjusted asset minus the liability values is the indicated value of the
equity.

Donor’s tax

Under the TRAIN law, the donor’s tax rate is 6% of the net gifts in excess of 250,000.00 made during
a calendar year.

RR No. 12-2018, as amended by RR No. 17-2018, provides that the valuation of gifts in the form of
property shall follow rules set in Section 5 of RR No. 12-2018 and the reckoning point of the valuation
shall be the date when the donation is made. Section 5 provision on valuation of shares of stock not
trade in stock exchange reads:

In case of shares of stocks, the fair market value shall depend on whether the shares are listed or
unlisted in the stock exchange. Unlisted common shares are valued on their book value while unlisted
preferred shares are valued at par value. In determining the book value of common shares, appraisal
surplus shall not be considered as well as the value assigned to preferred shares, if there is any. On
this note, the valuation of unlisted shares shall be exempt from the provisions of RR No. 06-2013, as
amended.
Transfer for insufficient consideration

The TRAIN law amended Section 100 of the National Internal Revenue Code which imposes donor’s
tax on the transfer of property for less than adequate or full consideration in money or money’s worth.
The amendment provides an exception to the general rule. In this case, a transaction that is bona fide,
at arm’s length, and free from any donative intent will be considered made for an adequate and full
consideration, even if the selling price is lower than the established fair market value (FMV).

In 2019, the Bureau of Internal Revenue issued Revenue Memorandum Circular (RMC) No. 30-2019,
clarifying the application of Sec. 100 to the sale of shares not traded in stock exchange. RMC No. 30-
2019 provides that, when shares of stock not traded on stock exchange are sold for less than FMV,
the excess of the FMV over the selling price shall be treated as a gift subject to donor’s tax, except for
when it is sold at arm’s length and free of any donative intent.
RMC No. 30-2019 emphasized that the issue of whether the transaction is arm’s length is a question
of fact and not of law. The parties must present proof of business purpose to fall within the exception
to the rule on the imposition of donor’s tax on transfer of shares for less than its FMV. Thus, the facts
claimed by the parties must be adequately established by supporting documents. The decision on
whether the parties have sufficiently proven the business purpose is solely subject to the discretion of
the BIR.

Curiously, when we talk about “arm’s length” and “unrelated and independent parties” what comes to
mind (especially for a transfer pricing practitioner) is Revenue Regulations (RR) 2-2013, the
“Philippine Transfer Pricing Regulations,” issued in 2013. RR 2-2013 provides guidelines in applying
the arm’s length principle for transactions between related parties. The arm’s length principle requires
related party transactions to be made under comparable conditions and circumstances as a
transaction with an independent party.

Supreme Court Decided Case

The Philippine American Life and General Insurance Company vs. Secretary of Finance and
the Commissioner of Internal Revenue (GR 210987, November 24, 2014)

Facts:

Petitioner The Philippine American Life and General Insurance Company (Philamlife) used to own
Class A shares in Philam Care Health Systems, Inc.(PhilamCare), representing 49.89% of the latter's
outstanding capital stock. In 2009, petitioner, in a bid to divest itself of its interests in the health
maintenance organization industry, offered to sell its shareholdings in PhilamCare through competitive
bidding. On September 24, 2009, petitioner's Class A shares were sold based on the prevailing
exchange rate at the time of the sale, to STI Investments, Inc., who emerged as the highest bidder.

After the sale was completed and the necessary documentary stamp and capital gains taxes were
paid, Philamlife filed an application for a certificate authorizing registration/tax clearance with the
Bureau of Internal Revenue (BIR) Large Taxpayers Service Division to facilitate the transfer of the
shares. Months later, petitioner was informed that it needed to secure a BIR ruling in connection with
its application due to potential donor's tax liability. In compliance, petitioner, requested a ruling to
confirm that the sale was not subject to donor's tax, pointing out, in its request, the following: that the
transaction cannot attract donor's tax liability since there was no donative intent and, ergo, no taxable
donation, citing that the shares were sold at their actual fair market value and at arm's length; that as
long as the transaction conducted is at arm's length — such that a bona fide business arrangement of
the dealings is done in the ordinary course of business — a sale for less than an adequate
consideration is not subject to donor's tax; and that donor's tax does not apply to sale of shares sold
in an open bidding process.
However, respondent Commissioner of Internal Revenue (Commissioner) denied Philamlife's request
through BIR Ruling No. 015-12. As determined by the Commissioner, the selling price of the shares
thus sold was lower than their book value based on the financial statements of PhilamCare as of the
end of 2008. As such, the Commissioner held, donor's tax became imposable on the price difference
pursuant to Sec. 100 of the NIRC.

Issue: Whether or not the price difference in petitioner's adverted sale of shares in PhilamCare
attracts donor's tax.

Ruling: The price difference is subject to donor's tax

Petitioner's substantive arguments are unavailing. The absence of donative intent, if that be the case,
does not exempt the sales of stock transaction from donor's tax since Sec. 100 of the NIRC
categorically states that the amount by which the fair market value of the property exceeded the value
of the consideration shall be deemed a gift. Thus, even if there is no actual donation, the difference in
price is considered a donation by fiction of law.

Note: This ruling was promulgated prior to the passage of TRAIN LAW. TRAIN LAW made an
amendment to SEC 100 of the NIRC. The amendment provides an exception to the general rule. In
this case, a transaction that is bona fide, at arm’s length, and free from any donative intent will be
considered made for an adequate and full consideration, even if the selling price is lower than the
established fair market value (FMV).

Summary

The planned transfer of shares of stocks held by Corporation X in Corporation Y to Corporation Z will
be subjected to either capital gains tax or donor’s tax or both depending on the circumstances.

Capital Gains Tax

A transfer of shares of stock is usually subjected to 15% capital gains tax based on net capital gains
absent any showing that the transfer is in the nature of donation. The law is clear that a bona fide, at
arm’s length, and free from any donative intent will be considered made for an adequate and full
consideration and thus it will not be subjected to donor’s tax.
The formula for the computation of capital gains tax is:
CGT = (Selling Price Less Acquisition cost and incidental expenses) * 15%

Donor’s Tax
If the transfer is by way of donation, the transaction is taxed at 6% donor’s tax.
The formula for computation of donor’s tax is:

Net Gifts made in taxable year* 6%

Net Gifts= FMV of Donated Property Less 250,000

Transfer for Insufficient Consideration

If the transfer is made through sale of the shares but the selling price is below the fair market
value and there is showing of donative intent, the transaction will be subjected to both capital gains
tax and donor’s tax with the following computation:

CGT= Selling Price Less Acquisition cost and incidental expenses * 15%

Donor’s Tax= Value of Donation less 250,000 * 6%

Value of Donation is equal to the difference between fair market value and the selling price.

We hope that we will able to clarify the tax implications of the planned transfer.