Determining the capital gain from sale of shares

Determining the capital gain from sale of shares of stock

by Catherine C. Quilantang

 

This is a sequel to the article published last week discussing the newly issued Revenue Regulations (RR) No. 6-2008 which consolidates the income tax rules for shares of stock classified as capital asset.

 

As mentioned, the new regulation did not merely consolidate the existing income tax rules but also introduced new rules intended to clarify once and for all the treatment of certain transactions. This issue focuses on the changes in the determination of the selling price of shares of stock.

Under the new regulations, the following rules shall apply in determining the selling price of the shares disposed:

• In case of cash sale — the selling price is the total consideration as indicated in the deed of sale;
• If the consideration is partly in money and partly in kind — the selling price is the cash or money received plus the fair market value of the property received;
• In case of exchanges — the selling price is the fair market value of the property received.
• If the fair market value of the shares of stock disposed is higher than the amount of amount and/or fair market value of the property received, the excess of the fair market value of the shares of stock disposed over the amount of money and the fair market value of the property, if any, received as consideration shall be deemed a gift subject to the donor’s tax.

 

Although the rule on the imposition of the gift tax on sales for less than the fair market value is already provided in the Tax Code (Sec. 100), this had not been applied on sale of shares because RR No. 2-82, as amended (Taxation of Sales of Shares of Stocks Classified as Capital Asset), already provides that the selling price of the shares of stock shall not be less than the fair market value of the shares of stocks transferred or exchanged.

 

As defined in the new regulations, the fair market value in the case of listed shares not traded through the Local Stock Exchange shall be the closing price on the day when the shares are sold, transferred, or exchanged. When no sale is made in the Local Stock Exchange, the closing price on the day nearest to the date of sale, transfer or exchange of the shares is taken. In the RR 2-82, amended, the fair market value is the highest closing price.

For shares of stock not listed and traded through the Local Stock Exchange, it was clarified in the new regulation that the fair market value is the book value of the shares of stock as shown in the financial statements duly certified by an independent certified public accountant nearest to the date of sale.

The regulation illustrated the case of a corporation using calendar year as accounting period. When its shares were sold on March 31, 2008, the audited financial statements for calendar year 2007 have not yet been issued. The regulations rule that the book value of the shares sold shall be based on the unaudited financial statements for taxable year 2007. However, once the audited 2007 financial statements is issued, adjustment to the book value shall be made for any difference.

 

The new regulation, however, did not retain the condition under RR 2-82 allowing for a fair market value lower than the book value under certain conditions. Under RR 2-82, a lower fair market value may be justified based on various factors affecting the valuation of shares of stock of closed corporations as enumerated in the regulation. Sufficient evidence should however be submitted to support such lower fair marke t value.

On the other hand, the cost basis for determining the capital gains or losses if acquired by purchase is still the same. However, aside from the shares acquired by purchase, the new regulation has specifically provided for the cost basis for shares of stock acquired by devise, bequest or inheritance, acquired by gift and those acquired for inadequate co nsideration.

 

T here were no changes introduced on the rules on the determination of the substituted basis of shares in tax-free exchanges pursuant to Section 40(C)(2) of the Tax Code.

Taxpayers should be aware that RR 6-08 did not merely consolidate the existing income tax rules on the sale, exchange or disposition of shares of stocks held as capital assets. There were new rules that were introduced. As these supersede the rules provided in the previously issued regulations, these should be followed.

(The author is a senior tax manager at Punongbayan & Araullo, a member firm within Grant Thornton International Ltd. For comments and inquiries, please e-mail the author or call 886-5511.)