TAX FREE EXCHANGE (“TFE”)

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.

Legal basis: Section 40(C)(2) to 40(C)(6) of the NIRC of 1997, as amended.

Transaction Covered: Under Section 40(C)(2) of the Tax Code, as amended by CREATE law

There are two kinds of tax-free exchange:

(1) reorganization; and (2) transfer to a controlled corporation.

In reorganization, no gain or loss shall be recognized on a corporation or on its stock or securities if such
corporation is a party to a reorganization and exchanges property in pursuance of a plan of reorganization
solely for stock or securities in another corporation that is a party to the reorganization.

The types are enumerated under Section 40(C)(2) of the Tax Code, as amended.

In transfer to a controlled corporation, no gain or loss shall be recognized if property is transferred to a

corporation by a person, alone or together with others, not exceeding four (4) persons, in exchange for stock or
unit of participation in such a corporation of which as a result of such exchange the transferor or transferors,
collectively, gains or maintains control of said corporation.

For purposes of tax-free exchanges of properties, “control” shall mean ownership of majority (at least 51%) of
the total voting power of all classes of stocks entitled to vote.

Tax Treatment of Exchange of Properties:

The transfers of properties in exchange for shares of stocks made pursuant to Section 40(C)(2) of the NIRC, as
amended, shall be exempt from the following taxes:

a. Capital Gains Tax (CGT);

b. Creditable Withholding Tax (CWT);
c. Income Tax (IT);
d. Donor’s Tax (DT);
e. Value-Added Tax (VAT); and
f. Documentary Stamp Tax (DST) on conveyances of real properties and shares of stocks

However, the original issuance of shares in exchange for the properties transferred shall be subject to the DST
under Section 174 of the same Code.
PROCEDURE AND REQUIREMENTS:
 1. ISSUANCE OF THE CERTIFICATE AUTHORIZING REGISTRATION (CAR)

Mandatory requirement for the issuance of CAR can be found in the link below:
https://www.bir.gov.ph/images/bir_files/internal_communications_2/RMCs/2022%20RMCs/RMC%20No.%2019-
2022%20Annex%20B.pdf

The correct BIR RDO that handles the Tax-Free Exchange depends on what asset is involved.

1. A Tax-Free Exchange of property should be governed by the BIR RDO where the property is located.
2.A Tax-Free Exchange of stock would be governed by the BIR RDO where the issuing corporation is registered.

If the transfer involves multiple real properties and/or shares of stocks in various locations under different
RDOs, the CAR shall be processed with the RDO of the place where the transferee corporation is registered.

2. CONDUCT OF POST-TRANSACTION AUDIT

1. The transactions are subject to a post-transaction audit by the local Revenue District Office of the BIR.

2. If the transaction is not upheld as a TFE by the RDO’s audit, then the parties will have to pay the taxes, plus
interest, penalty, and surcharge.

3. Still, a transfer of title effected on the properties will remain valid no matter the result of the audit.

Since the BIR subsequently audits the TFE, parties will have to present documents proving that the transaction
qualified as TFE.
How to Determine Substituted Basis? 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.

1. For stocks and securities:

Original basis of the property (Refers to the cost of the property)

Less: Money received, if any; or Fair Market Value of the property received, if any
Plus: The amount treated as dividend of the shareholder, if any; or the amount of gain that was recognized on
the exchange, if any.

2. For property transferred in the hands of the transferee

Original basis in the hands of the transferor plus The amount of the gain recognized to the transferor on the
transfer.