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Tax to shareholders: Disposition of shares

Questions are often asked regarding the applicable income taxes to shareholders on
their disposition of shares held in a domestic corporation. The confusion is
understandable because of the inconsistency in the position taken by the Bureau of
Internal Revenue (BIR) in this regard, resulting in the changes in the rules.
There are also differences in the taxes imposable on the sale of shares of stocks
depending on whether the seller is a dealer in securities, and whether the shares are
listed and traded in the local stock exchange. If the seller is a dealer in securities, the
shares of stock are treated as ordinary assets, the sale of which is subject to the regular
income tax.
On the other hand, if the seller is not a dealer in securities, the applicable tax rates
would depend on whether the shares of stocks are listed and traded in the local stock
exchange. For shares of stock listed and traded in the local stock exchange, the
transaction is subject to a stock-transaction tax of one-half of 1 percent based on the
selling price or gross value in money of the shares of stocks sold.
If the shares of stock are not listed and traded in the local stock exchange, any gains
realized are subject to tax at the rate of 5 percent on the first P100,000 and 10 percent
on the excess, if any. This tax is commonly referred to as the capital-gains tax. In case
of stockholders, however, who are residents of countries where the Philippines has
existing tax treaties, the capital gains may be exempted from tax if the applicable tax
treaty provides for exemption.
While the Tax Code provides for clear rules, the details of their implementation are
supplied by the tax authorities. Sometimes, even without change in the law being
implemented, the interpretation by the tax authorities changes. For instance, for a long
time, the selling price for purposes of computing the net capital gains subject to capital-
gains tax shall be the fair-market value of the shares disposed, especially so if this is
higher than the actual selling price. For unlisted shares of stock, the fair-market value is
its book value. It is not the fair-market value of the property received in exchange. Thus,
the transferor of shares could end up paying a capital- gains tax even if his share is
actually sold at a loss.
Is there really basis for this? In every sale transaction, the gain is measured by the
excess of the money and/or the value of the property received over the cost of the
property given up in exchange. Revenue Regulations (RR) 6-2008 fixed the rule by
providing that the selling price shall be the money and/or the fair-market value of the
property received. While the new rule added a twist on the taxation of disposition of
shares, it would seem that this is more in consonance with the concept of net gain.
Another area of concern is the taxation related to the shares surrendered by a
shareholder to the corporation upon complete or partial liquidation (including
redemption). The gain realized from the surrender is generally referred to as the
liquidating gain. The BIR has been consistent in its position that when a shareholder
surrenders his or her stock and, in exchange, receives money or property from the
corporation, a transaction takes place which is no different in its essence from a sale of
the same stock to a third party. In effect, liquidating gain is to be treated as the gain from
the sale or exchange of shares.
If this is akin to a sale of shares, would the liquidating gain then be subject to the 5-
percent or 10-percent capital-gains tax? Unfortunately, in a number of earlier rulings, the
BIR had issued a contradictory position. In many cases, it had ruled that the liquidating
gain is subject to the ordinary income tax. But in other cases, the liquidating gains are
subject to the 5-percent/10-percent capital-gains tax. This inconsistency was reconciled
in a subsequent ruling where the BIR ruled that the liquidating gain, while characterized
as a gain from sale or exchange of shares, is subject to the ordinary income-tax rate.
This has since been carried in subsequent rulings and now incorporated in RR 6-2008.
It is expected that the BIR would continually review the existing tax rules to identify areas
for possible revision. In relation to disposal of shares, there are still some areas which
are not clearly defined. One of this is the correct definition of book value of the shares
involved. The current definition of the book value per share in RR 6-2008 is so general
that it is usually the source of contention between the taxpayer and the revenue
examiners. Maybe this should be further clarified in the light of the fluctuation in the
values of assets and liabilities by reason of the new accounting rules. In the absence of
such clarification, revenue officers should be expected to follow the definition as
provided in RR 6-2008.