CAPITAL GAINS TAXATION
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 share-swap pursuant to a plan of merger or consolidation, the shareholders of the acquired corporation will
be integrated in the acquiring corporation. The shares of the acquired corporations will be called in for
replacement with shares of the acquiring corporation.
In effect, the transaction merely involves a replacement of shares of stocks of the shareholders of the
absorbed corporation with them being simply integrated as shareholders of the acquiring corporation.
Illustration
Mr. Santiago was required to surrender his Carranglan Inc. shares in exchange for Baler shares with total fair
value of P 1,200,000 pursuant to the merger of Carranglan Inc. and Baler Inc. The Carranglan shares were
previously purchased by Mr. Santiago for P 1,000,000.
Fair value of Baler shares received (selling price)
Less: Cost of Carranglan shares exchanged
Indicated gain
P 1,200,000
1,000,000
P 200,000
Analysis:
 The P 200,000 indicated gain is not taxable as the exchange involves stocks for stocks.
 Similarly, an indicated loss shall not likewise be recognized.
 The P 1,000,000 tax basis of the Carranglan shares given shall be carried over as the substituted basis
of the Baler shares received.
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 which amount to at least 51% of the total 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.
Illustration
Mr. Gapan exchanged his shares in Cabanatuan Corporation costing P 2,000,000 in exchange for the shares of
Dinaglan Corporation with a fair value of P 1,800,000. The transfer resulted in Mr. Gapan acquiring 51%
ownership (corporate control) in Dingalan Corporation.
Total consideration received or selling price
Less: Cost of Cabanatuan stocks exchanged
Indicated loss
P 1,800,000
2,000,000
(P 200,000)
Analysis:
 The P 200,000 indicated loss shall not be recognized. Any indicated gain shall not also be recognized.
The law views initial acquisition of corporate control by not more than 5 persons as an investing
transaction rather than an income generating transaction. The tax basis of the Dingalan shares
received shall be P 2,000,000, the same as the tax basis of the Gapan shares exchanged.
Exchange not solely for stocks
In 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.
Illustration 1: Cash and property received exceed indicated gain
Assume that pursuant to the plan of merger between Carranglan Inc. and Baler Inc., Mr. Santiago was
required to surrender his Carranglan Inc. shares costing P 1,000,000 in exchange for Baler shares with total
fair value of P 900,000 plus P 100,000 cash and P 200,000 worth of goods.
Total consideration received or selling price
(P 900,000 + P 100,000 + P 200,000)
Less: Cost of stocks exchanged
Indicated gain
P 1,200,000
1,000,000
P 200,000
The amount of cash and other properties received is considered realization of gains to the extent of the
indicated gain. The excess amount of cash and other properties received is a return of capital. Hence,
Realization return on capital
(to the extent of the indicated gain)
Return of capital
(in excess of the indicated gain)
Total cash and other properties received
P 200,000
100,000
P 300,000
Note: The P 200,000 gain shall be reported as a capital gain. The substituted basis of the Baler shares
received in the exchange shall be:
Basis of the Carranglan shares exchanged
Add: Basis of other properties exchanged
Less: RETURN OF CAPITAL
Basis of Baler shares received
P 1000,000
0
100,000
P 900,000
Regulatory Formula on Tax Substituted Basis
The regulations prescribe the following formula in computing the tax basis of properties arising from the taxfree exchanges:
Tax basis of OLD shares exchanged
Add: Gain recognized on the transfer
Less: Cash or other properties received
Tax basis of NEW shares received
P xxx
xxx
xxx
P xxx
The substituted basis of the Baler shares received may be computed following the foregoing regulatory
formula as follows:
Tax basis of Carranglan shares exchanged
Add: Gain recognized on the transfer
Less: Cash or other properties received
Tax basis of Baler shares received
P 1,000,000
200,000
300,000
P 900,000
Illustration 2: Indicated gain exceeds cash and other properties received
Assume that pursuant to the plan of merger between Carranglan Inc. and Baler Inc., Mr. Santiago was
required to surrender his Carranglan Inc. shares costing P 1,000,000 ion exchange for Baler shares with total
fair value of P 1,050,000 plus P 150,000 cash.
Total consideration received or selling price
(P 1,050,000 + P 150,000)
Less: Cost of stocks exchanged
Indicated gain
P 1,200,000
1,000,000
P 200,000
Analysis:
 The indicated gain is recognized to the extent of the cash and/or other properties receives.
The indicated gain is considered as follows:
Realized gain
(up to the value of cash and other properties received)
Unrealized return on capital
(in excess of the value of cash and other properties received)
Total indicated gain
P 150,000
50,000
P 200,000
The substituted tax basis of the Baler shares received shall be:
Basis of the Carranglan shares exchanged
Add: Basis of other properties exchanged
Less: Return of capital
Basis of the Baler shares received
P 1,000,000
0
0
P 1,000,000
Alternative solution:
Tax basis of Carranglan shares exchanged
Add: Gain recognized on the transfer
Less: Cash and other properties received
Tax basis of the Baler shares received
P 1,000,000
150,000
150,000
P 1,000,000
Minimum public float requirement of publicly listed corporations
Listed corporations are mandatorily to maintain a minimum public ownership under Philippine Stock Exchange
(PSE) regulations.
The minimum public ownership if the HIGHER of;
1. The 10% of issued and outstanding shares; and
2. The minimum public ownership required by the SEC or the PSE
Noncompliance 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 15% capital gains and not to the 60% of 1% stock transaction tax.
Comprehensive illustrations
Illustration 1: Sale by a security dealer
Benjie, a security dealer, sold various domestic stocks for P 1,200,000, net selling expenses. These stocks
were acquired at a cost P 800,000.
a. Compute the net gain.
b. What is the classification of the said stocks?
c. Is this subject to capital gains tax or regular tax?
Illustration 2: Sale of domestic bonds
Carlo, not a dealer of security, sold domestic bonds directly to a buyer at a net gain of P 200,000. He is not a
dealer of domestic bonds.
a. What is the classification of the said bonds?
b. Is this subject to capital gains tax or regular tax?
Illustration 3: Exchange of stocks for other securities
Debbie, an NRA-NETB, exchanged her domestic stocks costing P 300,000 for bonds with a fair value of P
400,000.
Analysis:
 The P 100,000 capital gains is subject to capital gains tax since it is not a share-for share swap
pursuant to a plan of merger or consolidation.
 The same rule applies for share-for-share swap not pursuant to a plan of merger or consolidation.
 Non-resident persons not engaged in business in the Philippines such as NRA-ETBs and NRFCs are
subject to the capital gains tax and are required to file the capital gains tax return.
Illustration 4: Issuance of stocks
Hokage Inc., a domestic corporation, issued 10,000 P 10 par value ordinary shares in exchange for a vacant
lot owned by Orochimaru Inc. the vacant lot has a fair value of P 500,000.
Compute the capital gains tax.
Analysis:
 The transaction involves issue by Hokage Inc. of its own shares of stocks. These stocks do not
represent investment in the shares of another corporation.
 The share premium of P 400,000 [P500,000 – (P10,000 x P10)], is part of Hokage’s corporate capital,
NOT an income. Hence, it is NOT subject to capital gains tax.
Illustration 5: Sale of stocks ex-dividend
Ms. Pearl bought 10,000 shares of Zuma, a domestic corporation, at P10/shares. On February 14, 2016, Zuma
declared a dividend of P 2/share with record date of March 20, 2016 and payment date of April 20, 2016. On
April 2, 2016, Ms. Pearl sold all the shares for P 15 per share directly to a buyer. The selling expenses were p
5,000.
The shareholder’s right to dividend accrues at the date of declaration. The stocks may pass through different
hands anytime. However, those who are registered as shareholders of the corporation at record date shall
receive the dividends.
Between the date of record and the date of payment, stocks are said to be selling ex-dividend. The
seller receives the dividend. The price of the stocks on those dates includes only the selling price of the
stocks.
Thus, the capital gain shall be normally computed as follows:
Total selling price (P15 x 10,000)
Less: Cost of stocks and expenses (P10 x 10,000 + P 5,000)
Capital gains
P 150,000
105,000
P 45,000
In this case, the dividends to be received by Ms. Pearl shall be subject to the 10% final tax to be withheld
by Zuma Corporation.
Illustration 6: Sale of stocks dividend-on
Ms. Pearl owns 10,000 P 10 par value shares of Zuma, a domestic corporation. On February 14, 2016, Zuma
declared a dividend of P 2 per share with record date of March 20, 2016 and payment date of April 20, 2016.
On February 18, 2016, she sold all the shares for P 15 per share directly to Mr. Lover. The selling expenses
were P 4,000.
Between the date of declaration and the date of record, stocks are said to be selling dividend-on;
that is, the buyer shall receive the dividends. The selling price of stocks on these dates includes both the
price of the stocks and the dividends on the stocks.
Thus, the capital gains of Ms. Pearl on the disposition of the stocks dividend-on shall be determined as follows:
Total selling price (P15 x 10,000)
Less: Cost and expenses (P10 x 10,000 + 4,000)
Net dividend receivable (P2 x 10,000 x 90%)
Capital gains
P 150,000
104,000
18,000
P 28,000
It should be noted that the dividends to be received by Pearl is net of the 10% final withholding tax on
dividends of individual taxpayers.
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. At the date of record, the corporate buyer will be
listed as shareholder in the corporate books and will not subjected to the 10% dividend tax.
Assuming the same data under illustration 6, the capital gain shall be computed as follows:
Total selling price (P15 x 10,000)
Less: Cost and expenses (P10 x 10,000 + 4,000)
Net dividend receivable (P2 x 10,000 x 100%)
Capital gains
P 150,000
104,000
20,000
P 26,000
Note that the individual seller effectively realizes the entire dividend income under the cloak of dividend
exemption of the 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. The individual seller shall report the P 20,000 domestic
dividend in gross income subject to regular income 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, such as
a. Foreign governments and foreign government-owned and controlled corporations.
b. Qualified employee trust funds
SALE, EXCHANGE AND OTHER DISPODITION OF REAL PROPERTY CLASIFIED AS CAPITAL ASSET
LOCATED IN THE PHILIPPINES
The sale, exchange, and other disposition of real property capital assets 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. Fair market value, as shown in the schedule of the market values of the Provincial and City Assessors.
Normally, only land has zonal value but not both land and improvements have fair value market value in the
provincial or Assessor’s Office.
For lands, the capital gains tax is 6% of whichever is the highest of the selling price (bid price in the case of
foreclosure sales), zonal value, or Provincial or City Assessor’s fair value.
Note that independent appraisal valuation, the fair value commonly used in financial reporting, is not used in
the computation of the capital gains tax.
Illustration 1 – Land only
Terry sold a vacant agricultural land for P 5,000,000. The land was previously purchased by Terry at P
4,000,000 and had an appraisal value of P 8,000,000 and zonal value of P 7,000,000. The property had a fair
value of P 6,000,000 in Provincial Assessor’s Office and an assessed value of P 2,400,000.
Analysis:
The highest of the selling price (P 5,000,000), zonal value (P 7,000,000) and assessor’s fair value (P
6,000,000) is the P 7,000,000 zonal value. Hence, the capital gains tax would be computed P
7,000,000 x 6%; hence P 420,000.
Illustration 2 – Land and Improvement
Anjo sold his residential house and lot for P 5,000,000. Anjo purchased the lot when it was worth P 1,000,000
and constructed on it house at a total cost of P 2,500,000.
The following fair value details were available for the property:
Lot
House
BIR VALUATION
Zonal value
P 4,000,000
n/a
ASSESSOR’S VALUATION
Fair value
Assessed value
P 3,500,000
P 800,000
2,000,000
1,200,000
Selling price
Land
House (improvement)
Total fair value (HIGHER)
Multiply by: CGT rate
Capital gains tax
P 5,000,000
Zonal value
P 4,000,000
0
Assessor’s fair value
P 3,500,000
2,000,000
Fair value
P 4,000,000
2,000,000
P 6,000,000
6%
P 360,000
Illustration 3
A real property dealer sold a condo unit costing P 1,200,000 to a client for P 1,500,000. The unit has a fair
value of P 1,800,000 at the date of sale.
Analysis:
The capital gains tax is nil (zero). The condo unit is an ordinary asset to a realty dealer, lessor or developer.
The actual gain of P 300,000 (P 1,500,000 – P 1,200,000) is an ordinary gain subject to regular income 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 for purposes of this legal requirement is referred to as the “Certificate Authorizing Registration
(CAR)”.
End of Part 3
Reference: INCOME TAXATION by Sir Rex Banggawan CPA, MBA 2019 EDITION
DO NOT REPRODUCE
NOT FOR SALE!