LECTURE NOTES

NOTE: THIS NOTE IS NOT YET UPDATED IN THE LIGHT OF THE AMENDMENTS
UNDER THE CREATE LAW. PLEASE READ THE CREATE LAW. WE WILL TAKE UP THE
AMENDMENTS AS WE DISCUSS THIS TOPIC.

TAXATION 1
Atty. Arnel A. dela Rosa, CPA, REB, REA

INCOME TAXATION

GAINS AND LOSSES FROM DEALINGS IN PROPERTY

(SEC. 40 and related provisions of NIRC)

A. MEASURE OF GAIN AND LOSS FROM SALE AND EXCHANGE OF PROPERTY

General Rule on the recognition of gain or loss upon the sale or exchange of property
The general rule is that the entire amount of the gain or loss, as the case maybe, shall be
recognized. [Sec. 40(C)(1)]

Exceptions to the General Rule

1. Transactions where gains and losses are not recognized (Tax Free Exchanges) a.
Exchange of property where the property received is not substantially different from
the property disposed of (Sec. 140, RR 2-40);
b. Exchange of property solely in kind in pursuant of corporate mergers and
consolidation [Sec. 40(C)(2)]
c. Exchange of by a person of his property for stock in a corporation as a result of
which said person alone or together with others not exceeding 4 persons, gains
control of the said corporation [Sec. 40(C)(2), last paragraph]

2. Transactions where gain is recognized but not the losses

a. Transactions between related taxpayers [Sec. 36(B)]
b. Illegal transactions (Sec. 96, RR 2-40)
c. Exchanges of property not solely in kind in pursuance of a corporate merger and
consolidation [Sec. 40(C)(3)]

Factors relevant in determining gain or loss from the disposition of property

1. Basis of property disposed of which in general is the cost at which the taxpayer acquired
the property;
2. Adjustments to the basis which may either take the form of additions (capital
 expenditures) or recoveries (depreciation)
3. Amount Realized from the disposal of the property;
4. Nature and Character of the asset disposed of (whether capital asset or ordinary
asset); and
5. Period during which the property was held by the taxpayer (holding period). The last two
(2) will determine whether the provision of capital gains and losses will apply, and if so,
to what extent.

Computation of gain or loss from the sale or disposition of the property [Sec. 40(A)] 1.
The gain shall be the excess of the amount realized therefrom over the basis or adjusted
basis for determining gain;
2. The loss shall be the excess of the basis or adjusted basis for determining loss over the
amount realized;

Amount Realized
The amount realized from the sale or other disposition of property shall be the sum of money
plus the fair market value of the property (other than money) received.

Cost Basis of the Property Sold or Disposed of for purposes of computing the gain or
loss [Sec. 40(B)]
1. Property acquired by purchase on or after March 1, 1913 – its cost, i.e. its purchase price
plus expenses of acquisition (in relation to Sec. 136, RR No. 2-40);
2. Property acquired by inheritance – fair market value (FMV) as of the date of acquisition;
3. Property acquired by gift – the same as if it would be in the hands of the donors or the
last preceding owner by whom it was not acquired by gift, except that if such basis is
greater than the FMV at the time of the gift, for purposes of determining loss, the basis
shall be the FMV;
4. Property acquired for less than an adequate consideration in money or money’s worth –
the amount paid by the transferee for the property;
5. In case of mergers and consolidation – [Sec. 40(C)(5)] applies

Computation of gain (loss) from sale of property

Amount Realized (Selling Price) xxxxxx

Less: Basis (or adjusted basis) xxxxxx
Gain (loss) from the sale xxxxxx

Computation of gain (loss) from exchange of property

FMV of the property received in exchange xxxxxx

Less: Basis (or adjusted basis) of the property given) xxxxxx
Gain (loss) from the exchange
 B. CORPORATE MERGER AND CONSOLIDATION
Tax Free Exchanges (no gain or loss from exchange of property by a corporation)
[Sec. 40(C)(2)]
1. Exchanges of property in pursuance of a plan of merger or consolidation of corporations;
and
2. Exchanges of property as a consequence of which the taxpayer gains control of
corporation

For tax purposes, state the meaning of the terms “merger” and
“consolidation” The term “merger” or “consolidation” are understood to mean:
(i) ordinary merger (A + B = A or B) or ordinary consolidation (A + B = C); OR (ii) the
acquisition by one corporation of all or substantially all the properties of another
corporation solely for stocks (de facto merger)

Notes:
a. For a transaction to be regarded as merger or consolidation, it must be undertaken for a
bona fide purpose and not for the purpose of escaping the burden of taxation; b. In
determining whether a bona fide business purpose exists, each and every step of the
transaction shall be considered and the whole transaction or series of transactions shall be
treated as a single unit;
c. In determining whether the property transferred constitutes a substantial portion of the
property of the transferor, the term “property” shall be taken to include the cash
assets of the transferor.

What is a De Facto Merger? How is it different from a statutory merger?

See: Revenue Memorandum Ruling (RMR) No. 1-2002
https://www.bir.gov.ph/images/bir_files/old_files/pdf/3098rmr01_02.pdf

A de facto merger involves the acquisition by one corporation of all or substantially all the
properties of another solely for stock, pursuant to Sec.(40)(C)(6)(b) of the Tax Code. The phrase
“substantially all the properties of another corporation” is defined in BIR General Circular No. V
253 dated July 16, 1957 to mean “the acquisition by one corporation of at least 80% of the
assets, including cash, of another corporation”, which has the element of permanence and not
merely momentary holding.

To constitute a de facto merger, the following elements must concur: (1) there must be a
transfer of all or substantially all of the properties of the transferor corporation solely for stocks;
and (2) it must be undertaken for a bona fide business purpose and not solely for the purpose of
escaping the burden of taxation.

One basic difference between a de facto merger and a statutory merger is that the Transferor
is not automatically dissolved in the case of the former. Likewise, there is no automatic transfer
to the Transferee of all the rights, privileges, and liabilities of the Transferor. It is, in fact, in
procedure, similar to a transfer to a controlled corporation under the same Section 40(C)(2) of
the Tax Code, except that at least 80% of the Transferor’s assets, including cash, are
transferred to the Transferee, with the element of permanence and not merely momentary
holding. However, a de facto merger and a transfer to a controlled corporation are different in
that: (1) the
Transferor in a de facto merger is a corporation, while the transferor to a controlled corporation,
the transferor may either be a corporation or an individual; and (2) in de facto merger, there is
no requirement that the transferor gains control (i.e. 51% of the total voting powers of all
classes of stocks of the Transferee entitled to vote) of the Transferee as a pre-requisite to
enjoying the benefit of non-recognition of gain or loss. What is essential in a de facto merger is
that the Transferee acquires all or substantially all the properties of the Transferor.

Case: Premium Tobacco Redrying v. CIR, CTA Case No. 8897, July 18, 2017

In general, how is gain or loss resulting from a Merger or Consolidation (M/C)

treated for income tax purposes?
Under the Tax Code, the transaction may either of these consequences:
a. No gain or loss shall be recognized; or
b. Gain, but not the loss, shall be recognized

In connection with an exchange in pursuance of a plan of M/C, what are the

instances where no gain or loss shall be recognized (Tax-Free Exchanges)
No gain or loss shall be recognized to:
1. A corporation, a party to the M/C, which exchanges its property solely for stock in another
corporation, also a party to the M/C;
2. A shareholder who exchanges stock in a corporation solely in a corporation, a party to the
M/C for the stock of another corporation, also a party to the M/C;
3. A security holder who exchanges his securities in a corporation, a party to the M/C, for
stock or securities in another corporation, also a party to the M/C [Sec. 40(C)(2)]; 4. A
corporation, a party to the M/C, exchanges its property not only for stock but also money
and/or other property of another corporation, also a party to the M/C and distributes such
money and/or other property in pursuance of the plan of M/C [Sec. 40(C)(3)]

Notes: (a) The recognition of gain or loss from the transaction is merely deferred until the
transferor sells or exchanges the stocks acquired.
(b) Tax Consequences of Tax-Free Exchanges are discussed in RMR No. 1-2002

In connection with an exchange in pursuance of a plan of M/C, what are the

instances when only gain, no loss, shall be recognized?
Gain, but not loss, is recognized to:
1. An individual, a shareholder or security holder of a corporation which is a party to the M/C
who exchanges stock or securities in such corporation not only for stock but also for
money and/or property of another corporation, also a party to the M/C;
5. A corporation, a party to the M/C, which exchanges its property not only for stock, but
also for money and/or property of another corporation, a party to the M/C, and does
not distributes such money and/or other property in pursuance of the plan of M/C
[Sec. 40(C)(3)]
Gain or Loss Recognition rules in case a person transfers his property to a
corporation in exchange for stock in such corporation as a result of which, said
person, alone or together with others not exceeding 4, gains control (at least 51%
of the total voting power of all classes of stocks entitled to vote) of the corporation:
1. No gain or loss is recognized if the transfer is solely for stock of the corporation (tax-free
exchange);
2. Gain, but not loss, is recognized if the transfer is not only for stock, but also for money
and/or property

Limitation as to the amount taxable in instances where gain, but not the loss, is
recognized.
1. For the stockholder, security holder, or person making the transfer:
a. The gain, if any, shall be recognized in an amount not in excess of the sum of the
money and the fair market value of the other properties received;
b. As to the shareholders, if the money and/or other property received has the effect
of a distribution of a taxable dividend, there shall be taxed as a dividend an
amount of the gain not in excess of his proportionate share in the undistributed
earnings and profits of the corporation, and the remainder, if any, of the gain
recognized, shall be treated as a capital gain.
2. For the corporation – The amount of gain, if any, shall be recognized in an amount not in
excess of the sum of money and the fair market value of the property received which is
not distributed under the plan of M/C.

Legal Effect if, in an M/C or in a transfer resulting in the acquisition of control of a

corporation, the taxpayer received stock or securities which would be permitted to
be received without recognition of gain if it were the sole consideration and as part
of consideration, the other party to the exchange assumes a liability of the taxpayer
or acquires his property subject to liability [Sec. 40(C)(4)(a)]
In such a situation, the assumption or acquisition shall not be treated as money and/or other
property, and, therefore, any gain or loss would still not be recognized if no money and/or
property was involved in exchange.

Basis of the stock or security received if the exchange is one where neither gain nor
loss may be recognized, for the purpose of determining the gain or loss upon
subsequent sale thereof [SEC. 40(C)(5)(a)
The basis shall be the same as the basis of the property, stock, or security given in exchange,
less cash received and the fair market value of the property received, and increased by the
amount treated as dividend of the shareholder and the amount of any gain that was recognized
on the exchange.

Basis of the property, stock or security given in exchange

Less: Cash and FMV of the Property received in exchange
Add: Dividend and/or gain recognized
Basis of the stock or security received
Additional readings:
RR No. 18-2001: https://www.bir.gov.ph/images/bir_files/old_files/pdf/rr18_01.pdf re
Monitoring Guidelines of the Basis of Property Transferred and Shares Received. RMO No. 32-
2001: https://www.bir.gov.ph/images/bir_files/old_files/pdf/rmo2001-32.pdf RMR No. 2-2002:
https://www.bir.gov.ph/images/bir_files/old_files/pdf/3089rmr02_02.pdf RMO No. 17-2016:
https://www.bir.gov.ph/images/bir_files/internal_communications_3/Full%20Text%20of
%20RM O%202016/RMO%20No.%2017-2016.pdf

De Leon, Discussions on Dealings in Property

Cases for Reading:

CIR v. Rufino, G.R. No. L-33665, 27 February 1987
Delpher Trades v. IAC, 157 SCRA 349
CIR v. Benigo Toda, 438 SCRA 290
CIR v. Dominium Realty and Construction Corp., CTA EB 1713, November 13, 2018

C. CAPITAL GAINS AND LOSSES

Included in the discussions on Allowable Deductions.

D. CAPITAL GAINS TAX ON STOCK TRANSACTION

How are capital gains derived from sale or exchange of stock issued by a Domestic
Corporation taxed? [Sec. 24(C)]
The provision of Section 39(B), notwithstanding, capital gains realized during each taxable year
by individuals or corporations from sale, exchange or disposition of shares of stocks in any
domestic corporation not traded in a local stock exchange are subject to a final tax as follows:
Taxpayer is: Capital Gains Tax Is:

Individual, whether citizen or 15% of the net capital gains during the
resident alien, and non-resident year [Secs. 24(C); 25(A)(3) ]
alien engaged in trade or business
in the PH

Individual who is a non-resident 15% of the net capital gains during the
alien not engaged in trade or year [Sec. 25(B), last sentence]
business in the PH

Alien individuals employed in 15% of the net capital gains during the
R/AHQ, ROHQ, OBU, and year [Sec. 25(E)]
Petroleum Service Contractor
 Domestic Corporation 15% of the net capital gains during the
year [Sec. 27(D)(2)]

Resident Foreign Corporation

Net capital gains is Not Over P100K -

5% Any amount In excess of P100K –
10%
[Sec. 28(A)(7)(c)

Non-resident Foreign Corporation Net capital gains is Not Over P100K -

5% Any amount In excess of P100K –
10%
[Sec. 28(B)(5)(c)

However, if the stock is listed and traded through the local stock exchange, the tax of 6/10 of
1% of the gross selling price or gross value of stock sold, disposed, or exchanged.
(Sec. 127) (this is classified as Other Percentage Tax, rather than an income tax)

Notes: Stocks classified as capital asset mean all stocks and securities held by taxpayers
other than dealer in securities.

In case the gross selling price is lower than the FMV of the shares sold (not traded
through the local exchange), what is the tax effect?
The difference may be “deemed gift” and is subject to donor’s tax (See: Section 100, NIRC;
RMC No. 30-2019)
https://www.bir.gov.ph/images/bir_files/internal_communications_2/RMCs/RMC%20Full
%20Te xt%202019/RMC%20No%2030-2019.pdf

Note: The FMV of unlisted commons share is its Book Value, while the FMV of an
unlisted preferred shares is its Par Value.

For Further Readings:

RR No. 6-2008 https://www.bir.gov.ph/images/bir_files/old_files/pdf/39882rr%20no.
%206- 2008.pdf
RR No. 6-2013 https://www.bir.gov.ph/images/bir_files/old_files/pdf/70201RR%206-2013.pdf

E. CAPITAL GAINS TAX ON DISPOSITION OF REAL PROPERTY

What is the tax treatment of the sale or exchange of real property located in the
Philippines?

If the real property is a capital asset, notwithstanding Section 39(B), it is generally subject to
capital gains tax, a final tax.

If the real property is an ordinary asset, then the ordinary gain is subject to income tax
(consequently, withholding tax), possibly VAT (depending on the gross selling price) and Donor’s
Tax (under Section 100).
How much is the capital gains tax on the sale or exchange of real property classified
as capital asset?
Seller/Taxypayer is: Capital Gains Tax is

Citizen and Resident Aliens, including 6% of the Gross Selling Price or FMV
estates and trusts per Tax Declaration or Zonal Value,
whichever is higher. [Sec. 24(D)]

Note: The law uses the term “gains

presumed to have been realized from sale”;
hence, actual gains need not be computed.

Non-resident alien engaged in trade or Same, [Sec. 25(A)(3)]

business in the Philippines

Individual who is a non-resident alien not Same [Sec. 25(B) last sentence)
engaged in trade or business in the PH

Alien individuals employed in R/AHQ, ROHQ, Same [Sec. 25(E)]

OBU, and Petroleum Service Contractor

Domestic Corporation Same [Sec. 27(D)(5)]

Resident Foreign Corporation Real property located in the Philippines,

regardless of the classification, sold by
a resident FC shall be subject to
creditable withholding tax and income
tax. [Sec. 28(A)(1)]

Note: actual gain be computed.

Non-Resident Foreign Corporation Real property located in the Philippines,

regardless of the classification, sold by
a resident FC shall be subject to final
withholding tax [Sec. 28(B)(1)]

Note: Actual gains need not be computed

since the taxes imposed on NRFC is based
on gross.
Sale of Real Properties Located Outside the Philippines, REGARDLESS OF
CLASSIFICATION: [SEC. 4(f), RR 7-2003]

a. Seller is resident citizen or domestic corporation – subject to normal/regular income tax

b. Seller is a non-resident citizen, alien, or foreign corporation - exempt

Sale or other disposition to the government, its political subdivision or agencies, or

to GOCC by Individual Taxpayer
The tax liability, if any, on gains thereon, shall be determined either:
a. Under Section 24(A) – schedular income tax for citizens/resident alien; or
b. Under Section 24(D) – capital gains tax
- At the option of the taxpayer.
Exemption from CGT – applicable only to natural persons, i.e. individual taxpayers
Individual taxpayer shall be exempt from CGT if the proceeds of the sale of his principal
residence shall be fully utilized in acquiring or constructing a new principal residence
within 18 months from the date of sale or disposition.

Requisites:
a. Seller is a natural person
b. Property sold is his principal residence
c. Proceeds of the sale is fully utilized to acquire or construct new principal residence d.
Full utilization is made within 18 months from date of sale or disposition e. Notice to avail
the tax exemption is given to the CIR within 30 days from the date of sale
f. Tax exemption can be availed once every 10 years

Note: If there is no full utilization of the proceeds of the sale, the portion of the gain
presumed to have been realized (i.e. the unutilized portion) shall be subject to capital
gains tax.

Additional Reading:
Revenue Regulation No. 7-2003
https://www.bir.gov.ph/images/bir_files/old_files/pdf/1344rr07_03.pdf

-End-