Clarifications and guidelines on tax-free exchanges of properties under Section 40 (C)(2) of the Tax Code, as amended by CREATE

(Revenue Memorandum Circular No. 19-2022, February 04, 2022)

This Tax Alert is issued to inform all concerned on the clarifications and guidance on tax-free exchanges of properties under Section 40 (C)(2) of the Tax Code of 1997, as amended by Republic Act No. 11534 (CREATE Act).

Pursuant to Section 40 (C)(2) of the Tax Code of 1997, as amended by CREATE Act, reorganizations and transfer of property to controlled corporations are covered by tax-free exchanges of properties.

Reorganizations include (a) mergers or consolidations, (b) acquisition of a controlled corporation, (c) acquisition of all or substantially all of properties of another corporation, (d) recapitalization, and (e) reincorporation.

The term “control”, when used in a tax free-exchange of properties, shall mean ownership of stocks in a corporation after the transfer of property possessing at least fifty-one percent (51%) of the total voting power of all classes of stocks entitled to vote. The collective and not the individual ownership of all classes of stocks entitled to vote of the transferor or transferors shall be used in determining the presence of control.

Determination of substituted basis

Since in a tax free-exchange, recognition of gain or loss on the exchanges of properties are merely deferred, the substituted basis of the properties transferred and shares received must clearly be established and properly monitored in order that in case of their subsequent sale or disposition, any gain shall be taxed accordingly.

The substituted basis shall be the basis for determining gain or loss on a subsequent sale or disposition of properties subject of the tax-free exchange transactions. As clarified by the BIR, existing rules on the determination of substituted basis shall still be followed. (see full copy of the RMC for detailed rules on substituted basis)

Monitoring of the substituted basis of the properties

For proper monitoring of the substituted basis, the parties to the tax-free exchange/ reorganization should comply with the reporting requirements as set forth under Revenue Regulations No. 18-2001 including but not limited to incorporating in the income tax return of the parties a complete statement of facts pertinent to the non-recognition of gain or loss upon such exchange and annotation in the TCT, CCT and certificates of stock the original or historical cost of acquisition of the properties.

Tax treatment of exchange of properties pursuant to section 40 (C) (2) of the Tax Code

Covered transactions of the tax-free exchanges shall be exempt from capital gains tax, creditable withholding tax, income tax, donor’s tax, value-added tax, and documentary stamp tax (DST) on conveyances of real properties and shares of stocks. However, original issuance of shares in exchange for properties shall be subject to DST.

Venue for the issuance of the Certificate Authorizing Registration (CAR)

CAR shall be processed at 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 shall specify, among others, that the transaction involved is a tax-free, the date of transaction, and the substituted basis of the properties subject.

Parties to the transaction shall submit the documentary requirements (Annex B of RMC 19-2022). https://www.bir.gov.ph/images/bir_files/internal_communications_2/RMCs/2022%20RMCs/RMC%20No.%2019-2022%20Annex%20B.pdf)

Conduct of post-transaction audit

Following the issuance of CAR, the concerned RDO shall conduct a post audit 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, 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.

Option to request for legal opinion

Though a prior BIR ruling is not required, 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, 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.