CAPITAL GAINS

TAXATION
Lesson 6
CLASSIFICATION OF TAXPAYER’S PROPERTIES
1. Ordinary assets – assets used in business, such as:
a. Stock in trade of a taxpayer or other real property of a kind which would properly be
included in the inventory of the taxpayer if on hand at the close of the taxable year
b. Real property held by the taxpayer primarily for sale to customers in the ordinary course of
his trade or business
c. Real property used in trade or business of a character which is subject to the allowance for
depreciation
d. Real property used in trade or business of the taxpayer

Basically, ordinary assets are:

a. Assets held for sale – such as inventory
b. Assets held for use – such as supplies and items of property, plant and equipment like
buildings, property improvements, and equipment.
2. Capital assets – any asset other than ordinary assets
Basically, capital assets are:
1. Personal (non-business)assets of individual taxpayers
2. Business assets of any taxpayers which are:
a. Financial assets – such as cash, receivables, investments
b. Intangible assets – such as patent, copyrights, leasehold rights; franchise rights

Asset classification is relative

The classification of assets or properties as ordinary asset does not depend upon the nature of the
property but upon the nature of the taxpayer’s business and its usage by the business.
Revenue regulations classifies real and other properties acquired (ROPA) by banks as ordinary assets
even if banks are not actually engaged in the realty business. However, ROPA in the form of
domestic stocks held by banks are capital assets.
Asset Classification Rules:
A. A property purchased for future use in business is an ordinary asset even though this purpose is later thwarted
by circumstances beyond the taxpayer’s control
B. Discontinuance of the active use of the property does not change its character previously established as a
business property
C. Real properties used, being used, or have been previously used, in trade of the taxpayer shall be considered
ordinary assets
D. Properties classified as ordinary assets for being used in business by a taxpayer not engaged in the real estate
business are automatically converted to capital assets upon showing of proof that the same have not been used
in business for more than 2 years prior to the consummation of the taxable transaction involving such property
E. A depreciable asset is an ordinary asset even if it is fully depreciated, or there is a failure to take depreciation
during the period of ownership
F. Real properties used by an exempt corporation in its exempt operations are considered capital assets
G. The classification of property transferred by sale, barter or exchange, inheritance, donation, or declaration of
property dividends shall depend on whether or not the acquirer uses it in business
H. For real properties subject of involuntary transfer such as expropriation and foreclosure sale, the
involuntariness of such sale shall have no effect on the classification of such real property
I. Change in business from real estate to non-real estate business shall not change the classification of ordinary
assets previously held.
TYPES OF GAINS ON DEALINGS IN PROPERTIES
1. Ordinary gain – arises from the sale, exchange and other disposition including pacto de retro sales
and other conditional sales of ordinary assets
2. Capital gain - arises from the sale, exchange and other disposition including pacto de retro sales and
other conditional sales of capital assets

Taxation of Gains on Dealings in Properties

Type of gain Applicable taxation scheme
Ordinary gains Regular income tax

Capital gains General Rule: Regular income tax

Exception rule: Capital gains tax

CAPITAL GAINS SUBJECT TO CAPITAL GAINS TAX

There are only two types of capital gains subject to capital gains tax:
3. Capital gains on the sale of domestic stocks sold directly to buyer
4. Capital gains on the sale of real properties not used in business
SCOPE OF CAPITAL GAINS TAXATION

Gains on dealings in capital assets Tax Rates

• Gain on the sale, exchange, and other disposition of domestic 15% capital gains tax
stocks directly to buyer

• Sale, exchange, and other disposition of real property in the

Philippines 6% capital gains tax

• Gains from other capital assets

Regular income tax
CAPITAL GAIN ON THE SALE, EXCHANGE AND OTHER DISPOSITION OF DOMESTIC STOCKS
DIRECTLY TO BUYER
Domestic Stocks
Domestic stocks are evidence of ownership or rights to ownership in a domestic corporation
regardless of its features, such as:
1. Preferred stocks (participative, cumulative, etc.)
2. Common stocks
3. Stock rights
4. Stock options
5. Stock warrants
6. Unit of participation in any association, recreation, or amusement club (golf, polo or similar
clubs)
The capital gains tax covers not only sales of domestic stocks for cash but also exchange of domestic
stocks in kind and other dispositions such as:
1. Foreclosure of property in settlement of debt
2. Pacto de retro sales – sale with buy back agreement
3. Conditional sales – sales which will be perfected upon completion of certain specified
conditions
4. Voluntary buy back of shares by the issuing corporation – redemption of shares which may be
re-issued and not intended for cancellation
The term other disposition does not include:
5. Issuance of stocks by a corporation
6. Exchange of stocks for services
7. Redemption of shares in a mutual fund
8. Worthlessness of stocks
9. Redemption of stocks for cancellation by the issuing corporation
10. Gratuitous transfer of stocks
Issue of stocks including treasury stocks
Issuance of these type of shares does not result to income subject to capital gains tax.
Exchange of stocks for services
Issue or exchange of stocks for services cannot be considered as exchange for property. No gain or
loss can be imputed as it involves payment of expense in kind.
Redemption of shares in a mutual fund
Gains from redemption of shares in a mutual fund are exempted by the NIRC, from income taxation.
Worthlessness of stocks
The value of stocks becoming worthless is considered a capital loss subject to the rules of regular
income tax.
Redemption of stocks by the issuing corporation
Any gain or loss on the mandatory redemption of stocks by the issuing corporation for the purpose
of stock cancellation shall be subject to the rules of regular income tax. Therefore, any gain by the
investor on redemption of redeemable preferred shares shall be subject to regular income tax.
However, this does not include the voluntary buy-back of the shares by the issuing corporation to
be held in treasury shares which may later on be re-issued. The gain or loss realized by the investor
on voluntary buy-back of shares by the issuing corporation is taxable under capital gains taxation.
Gratuitous transfer of stocks
The gratuitous transfer of stocks either by way of donation inter-vivos or donation mortis causa is
subject to transfer tax, not to income tax.

MODES OF DISPOSING DOMESTIC STOCKS

Shares of stocks may be sold, exchanged or disposed :
1. Through the Philippine Stock Exchange (PSE) or
2. Directly to buyer
TAX ON SALE OF DOMESTIC STOCKS THROUGH THE PSE

Sale of domestic stocks classified as capital assets Subject to stock transaction tax of 60% of 1% of
the selling price effective January 1, 2018.

Sale of domestic stocks classified as ordinary assets The gain is subject to regular income tax; loss is
reportable as deduction against gross income
under the regular income tax

CAPITAL GAINS TAX ON SALE, EXCHANGE, AND OTHER DISPOSITIONS OF DOMESTIC STOCK
DIRECTLY TO BUYER
Nature of the CGT:
1. Universal tax
It applies to all taxpayers disposing stocks classified as capital assets regardless of classification
of the taxpayer. By situs, the gain on sale of domestic stocks is within. The tax applies even if
the sale is exercised outside of the Philippines.
2. Annual tax
It is imposed on the annual net gain on the sale of domestic stocks directly to buyer.
The net gain is determined as follows:
Selling price P XXX
Less:
Basis of stocks disposed P XXX
Selling expenses XXX
Documentary stamp tax on the sale XXX XXX
Net capital gain (loss) P XXX

The documentary stamp tax is deducted if paid by the seller.

Selling price shall mean:

• In case of cash sale, the total consideration received per deed of sale
• If total consideration is paid partly in money and partly in property, the sum of money and fair
value of consideration received
• In case of exchanges, the fair value of the property received
What is the tax basis of stocks?
 If acquired by purchase, tax basis is the cost of the property which will be determined by the
following methods in descending order of priority:
 Specific identification, if the shares can be specifically identified.
 Moving average method, if books of accounts are maintained by the seller where transaction
of every particular stock is recorded.
 First-in, first out, if the stocks cannot be specifically identified.
 If acquired by devise, bequest, or inheritance, the tax basis is the fair value at the time of death of
the decedent
 If acquired by gift, the tax basis is the lower of the fair market value at the time of gift and the
basis in the hands of the donor or the last preceding owner by whom it was not acquired by gift.
 If acquired for inadequate consideration, the tax basis is the amount paid by the transferee for
the property.
 If acquired under tax-free exchanges, the tax basis is the substituted basis of the stocks.
THE CAPITAL GAINS TAX RATE
Tax Rates

NIRC (old law) TRAIN law

Net gain up to P100,000 5%

15%
Excess net gain above P100,000 10%
The NIRC imposed the two-tiered 5%-10% capital gains tax to all taxpayers regardless of
classification. The TRAIN Law simplified the rate to a flat rate of 15% but retained the old tow-tiered
5%-10% tax structure for foreign corporations.

Consequently, there are two CGT rates now:

a. Foreign corporation – 5% & 10% CGT
b. Individuals and domestic corporations – 15% CGT
TAX COMPLIANCE under the old law
1. Transactional capital gains tax
2. Annual capital gains tax

TRANSACTIONAL CAPITAL GAINS TAX AND ITS DEADLINE

The capital gains or losses are required to be reported after each sale, exchange, and other dispositions
through the capital gains tax return, BIR Form 1707. Capital Gains Tax Return shall be filed within 30 days
after each sale, exchange, and other dispositions of stocks. If the tax is qualified for payment under
installment method, the tax is due within 30 days after each installment.

ANNUALIZED CAPITAL GAINS TAX

The tax on capital gains on the sale, exchange and other disposition of domestic stocks directly to a buyer
is based on the annual net capital gains. The annual net capital gain or loss is computed as transactional
capital gains less transactional capital losses.
Transactional capital gains taxes paid during the year are deducted as tax credit against the annual capital
gains tax due. The excess of the annual capital gains tax due over the sum of the transactional capital
gains taxes paid during the year is a capital gains tax payable. The excess of the sum of the transactional
capital gains tax over the annual capital gains tax due is a capital gains tax refundable.
The annual capital gains tax return, BIR Form 1707-A, shall be filed on or before the 15 th day of the fourth
month following the close of the taxable year of the taxpayer.
ANNUAL CAPITAL GAINS TAX FOR OTHER TAXPAYERS
The change to a 15% flat rate would mean 15% CGT when the transaction resulted to a gain but
would also instantly mean 15% CGT refundable when the transaction resulted to a loss.

INSTALLMENT PAYMENT OF THE CAPITAL GAINS TAX

When domestic stock is sold on installments, the capital gains tax may also be paid in installments if
the
a. Selling price exceeds P1,000,000; and
b. Initial payment does not exceed 25% of the selling price.
Under the installment method, the tax will be paid based on the pattern of collection of the
contract price. The contract price is the total sum of money collectible from the contract. It is
normally the selling price in the absence of any indebtedness on the shares sold.
Formula: Collection / contract price x capital gains tax
SPECIAL TAX RULES IN CAPITAL GAIN OR LOSS MEASUREMENT
1. Wash sales of stocks
2. Tax-free exchanges
a. Exchange of stocks pursuant to a merger or consolidation
b. Transfer of stocks resulting in corporate control

WASH SALES RULE

Wash sale securities is deemed to occur when within 30 days before and 30 days after the losing of
sale of securities (also referred to a the 61-day period), the taxpayer acquired or entered into a
contract or option to acquire substantially identical securities. Capital losses on wash sales by non-
dealers in securities are not deductible against capital gains.
Securities for purposes of the 61-day rule include stocks and bonds. The wash sales rule has
significance on the recognition of reportable capital losses on domestic stocks sold directly to buyer.
Substantially identical means that stocks or bonds of the same class with the same features. A
common stock is not substantially identical to a preferred stock. Participating and non-participating
preferred stocks are not substantially identical.
TAX FREE EXCHANGES
Merger or consolidation
Stockholders of a domestic corporation may exchange their stocks for the stocks of another
corporation pursuant to a plan of merger or consolidation.
The gains or losses on share-for-share swaps pursuant to a plan of merger or consolidation will not
be recognized for taxation purposes. In a share-swap as in the case of merger or consolidation, the
shareholders of the acquired corporation will be integrated in the acquiring corporation. The shares
of the acquired corporation will be called in for replacement with the shares of the acquiring
corporation.
Initial Acquisition of Control
No gain or loss shall also be recognized if property is transferred to a corporation by a person in
exchange for the stocks or units of participation in such a corporation of which as a result of such
exchange, said person, alone or together with others not exceeding four, gains control of said
corporation.
“Control” shall mean ownership of stocks in a corporation at least 51%of the voting power of all
classes of stocks entitled to vote.
This rule may be relevant only to the capital gains tax or the recognition of capital gains when stocks
are exchanged in the acquisition of corporate control.
Exchange not solely for stocks
In a tax-free exchanges, if stocks are exchanged not solely for stocks but with other consideration
such as cash and other properties, the gains but not losses are recognized up to the extent of cash
and other properties received.

Regulatory Formula on Tax Substituted Basis

The regulations prescribe the following formula in computing the tax basis of properties arising
from the tax-free exchanges:
Tax basis of old shares exchanged XXX
Add: Gain recognized on the transfer XXX
Less: Cash or other properties received XXX
Tax basis of new shares received XXX
Minimum public float requirement of publicly listed corporations
Listed corporations are mandatorily required to maintain a minimum public ownership under
Philippine Stock Exchange (PSE) regulations.

The minimum public ownership is the higher of:

1. The 10% of issued and outstanding shares and
2. The minimum public ownership required by the Securities and Exchange Commission or the
Philippine Stock Exchange.

Non-compliance to the minimum public ownership shall result in the de-listing of the stocks of the
corporation in the PSE. Under RR16-2012, the sale of listed stocks which fall below their minimum
public ownership requirement will be subject to the 5%-10% capital gains tax and not to the ½ of 1%
stock transaction tax.
TAX ISSUE: SALE OF STOCKS DIVIDEND-ON TO A CORPORATE BUYER
Dividends may escape taxation when stocks are sold dividend-on by individual taxpayers to a corporate buyer
between the date of declaration and the date of record. This is due to dividend exemption of corporate buyer
who will be registered as shareholder at the date of record.
How should the dividend on the stocks sold be taxed?
Under the NIRC, all income not expressly exempted or not subjected to final tax or capital gains tax must be
included in gross income subject to regular income tax. Hence, the individual seller shall exceptionally report
the domestic dividend in gross income subject to regular tax.
Persons not liable to the 15% capital gains tax
1. Dealers in securities
2. Investors in shares of stocks in a mutual fund company in connection with gains realized upon
redemption of stocks in the mutual company
3. All other persons, whether natural or juridical, who are specifically exempt from national revenue taxes
under existing investment incentives and other special laws
Examples:
a. Foreign governments and foreign government-owned and controlled corporations
b. Qualified employee trust funds
SALE, EXCHANGE, AND OTHER DISPOSITION OF REAL PROPERTY CLASSIFIED AS CAPITAL ASSET
LOCATED IN THE PHILIPPINES
The sale, exchange, and other disposition of real property classified as capital asset in the
Philippines is subject to a tax of 6% of the selling price or the fair value, whichever is higher.
Under the NIRC, the fair value of real property is whichever is higher of the:
a. Zonal value, which is the value prescribed by the Commissioner of Internal Revenue for real
properties for purposes of enforcement of internal revenue laws, and
b. Assessed value, which is the value prescribed by the City or Municipal Assessor’s Office for
purposes of the real property tax.

BIR Tax Clearance

No registration of any document transferring real property shall be effected by the Register of
Deeds unless the Commissioner or his duly authorized representative has certified that such
transfer has been reported, and the capital gains or creditable withholding tax, if any, has been
paid.
The certificate is referred to as the “Certificate Authorizing Registration (CAR)”.
NATURE OF THE 6% CAPITAL GAINS TAX
a. Presumption of capital gains
The 6% capital gains tax applies even if the sale transaction resulted to a loss. Gain is always
presumed to exist. The basis of taxation is the selling price or fair value, whichever is higher,
not the actual gain.
b. Non-consideration to the involuntariness of the sale
The capital gains tax applies even if the sale is involuntary or is forced by circumstances such as
in the case of expropriation sale, foreclosure sale, dispositions by judicial order, and other
forms of forced disposition. It also applies to conditional sales and pacto de retro sales.
c. Final tax
The capital gains tax shall be withheld by the buyer against the selling price of the seller and
remit the same to the government.
SCOPE AND APPLICABILITY OF THE 6% CAPITAL GAINS TAX

Location of the Taxpayers

property
Individuals Corporations

Within the Philippines All individuals Domestic corporation only

Outside the Philippines Not applicable Not applicable

EXCEPTIONS TO THE 6% CAPITAL GAINS TAX

1. Alternative taxation rule
2. Exemption rules
a. Exemption under the NIRC
b. Exemption under special laws
ALTERNATIVE TAXATION
An individual seller of real property capital assets has the option to be taxed at either:
a. 6% capital gains tax, or
b. The regular income tax

This is permissible only when:

1. The seller is an individual taxpayer, and
2. The buyer is the government, its instrumentalities or agencies including government-owned
and controlled corporations

Basis of Alternative Taxation

This is intended to ease the burden of government expropriation where taxpayers may incur losses
on the forced expropriation sale and are still required to pay tax.
EXEMPTION TO THE 6% CAPITAL GAINS TAX UNDER THE NIRC
The sale, exchange and other disposition of a principal residence for the re-acquisition of a new principal
residence by individual taxpayers is exempt from the 6% capital gains tax.
Principal residence
This means the house and lot which is the primary domicile of the taxpayer. If the taxpayer has multiple
residences, his principal residence is deemed the one shown in his latest tax declaration.
Requisites for exemption:
1. The seller must be a citizen or resident alien
2. The sale involves the principal residence of the seller-taxpayer
3. The proceeds of the sale is utilized in acquiring a new principal residence
4. The BIR is duly notified by the taxpayer of his intention to avail of the tax exemption within 30 days of the
sale through a prescribed return (BIR Form 1706) and “Sworn Declaration of Intent”.
5. The reacquisition of the new residence must be within 18 months from the date of sale
6. The capital gain is held in escrow in favor of the government
7. The exemption can only be availed of once in every 10 years
8. The historical cost or adjusted basis of the principal residence sold shall be carried over to the new
principal residence built or acquired
CAPITAL GAINS TAX EXEMPTION UNDER SPECIAL LAWS
1. Sale of land pursuant to the Comprehensive Agrarian Reform Program
2. Sale of socialized housing units by the National Housing Authority

Sale of land under the CARP

The sale of agricultural lands by land owners pursuant to the CARP of the government shall be
exempt from capital gains tax. Similarly, interest income on the selling price that may have been
agreed by the land owner and the tenant-buyer shall be exempt from income tax.
Sale of socialized housing units by the NHA
The sale of socialized housing units for the underprivileged and homeless citizens by the NHA
pursuant to the Urban Development and Housing Act of 1992 is exempt from the capital gains tax.
This exemption is limited to socialized housing units only. The BIR ruled that the sale of the NHA of
commercial lots which is not part of the socialized housing project for the poor and homeless is
subject to capital gains tax or regular tax and documentary stamp tax.
To comply for exemption, the socialized housing units of the NHA must comply with price ceilings
set by the NIRC, and other special laws.
PAYMENT OF CAPITAL GAINS TAX ON INSTALLMENT
The capital gains tax may be paid in installment if, under the payment terms, the initial payment
does not exceed 25% of the ceiling price. The “initial payment” refers to the collections in the
taxable year the sale is made.

Deadline for payment of the capital gains tax

The 6% capital gains tax will be filed through BIR Form 1706 and is due within 30 days from the date
of sale or exchange. Fro foreclosed sales, it is due within 30 days from the expiration of the
applicable statutory redemption period. When the tax on the sale is qualified for installment
payment, it is due 30 days upon receipt of every installment.
Statutory redemption period on foreclosure sale
Foreclosed properties are subject to a right of redemption by individual mortgagor within one year
counted not from the date of sale but from the time of registration of the sale in the Office of the
Registry of Deeds.
For juridical persons, redemption must be made before the registration of the certificate of
foreclosure sale with the applicable Register of Deeds or within 3 months from foreclosure,
whichever is earlier.
DOCUMENTARY STAMP TAX ON THE SALE OF CAPITAL ASSETS
Documentary stamp tax on the sale, exchange, and other disposition of domestic stocks directly
to buyer
The sale of domestic stocks is subject to a documentary stamp tax of P1.50 for every P200 of the par
value of the stocks sold. (RA 9243)
Documentary stamp tax on the sale of real properties
The sale of real property capital assets is subject to a documentary stamp tax on the gross selling
price or fair market value whichever is higher.
The documentary stamp tax is P15 for every P1,000 and fractional parts of the tax basis thereof.
However, if the government is a party to the sale, the basis shall be the consideration paid.
PENALTIES FOR LATE/NON-FILING OR NON-PAYMENT OF CAPITAL GAINS TAX
The late filing and payment of capital gains tax at the time or times required by law is subject same
penalties as discussed.
ENTITIES EXEMPT FROM CAPITAL GAINS TAX
The same lists of entities exempt from final tax are likewise exempt from capital gains tax.
COMPARISON OF THE 6% CGT AND 15% CGT
6% CGT 15% CGT

Tax object Gain on real property Gain on sale of stocks

Basis of the tax Presumed gain Actual gain

Nature of the tax Final tax Self-assessed tax

Frequency of payment Per transaction Transactional and annual tax