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Lending a hand during audit season

Lending a hand during audit season by: Christina Panlilio-Ong

For the Audit Division, the last few weeks before submission of audited financial statements (AFS) and filing of income tax returns (ITRs) are frenetic and marked by interminable closing meetings, sleepless nights and a mad rush to file with the Bureau of Internal Revenue (BIR) and Securities and Exchange Commission (SEC).

In support of the auditors during busy season, we in the Tax Division lend a helping hand by reviewing the ITRs and generally, responding to various tax and related queries raised by the client and/or the Audit team.  As a senior tax manager who handles primarily corporate engagements, let me to share my personal experience during the 2009-2010 Audit busy season by discussing some of the tax and corporate issues that I frequently encountered.

Payments for subscription receivable

Under a Deed of Assignment, one corporation received a parcel of land from a stockholder to be applied in full payment of the latter’s subscriptions payable and inquired whether the shares of stock can already be issued.

We explained that in terms of regulatory requirements, it is the policy of the SEC (albeit, there is no formal issuance) that in cases where the payment for shares subscription is not in the form of cash, there is a need to secure confirmation of valuation before the shares of stock can be issued.  Depending on the kind of property being applied as payment for subscription, the SEC will require proof of the value of said properties and confirm such valuation to ensure that the shares are being issued for sufficient consideration, i.e., not watered-down.

However, if the payment to subscriptions payable or to an additional issuance of shares from the unissued portion of the authorized capital stock (and not an increase of capital which requires SEC approval) is by way of cash, securing SEC confirmation of valuation is merely optional. 

In addition to prior SEC approval, a transfer of real property as payment for shares will require securing from the BIR a Certificate Authorizing Registration (CAR)/Tax Clearance which will be presented to the corporate secretary of the issuing corporation as proof that all the applicable taxes have been paid.  This will enable the corporate secretary to issue the shares to the transferor-subscriber. 

Assuming that it does not qualify as a tax-free exchange, the transfer of real property as payment for shares subscription will be subject to income tax, depending on whether the property is considered an ordinary or capital asset.  If the real property is a capital asset, the transfer will be subject to a final tax of 6% based on the gross selling price/transfer value or fair market value (FMV) of the land, whichever is higher.  On the other hand, if the real property is an ordinary asset, any gain from the sale thereof shall form part of the transferor’s taxable income, i.e., gross revenues less allowable business deductions, subject to regular corporate income tax (RCIT) at the rate of 30%.  The transfer will be subject to the applicable creditable withholding tax (based on the gross selling price/transfer value or FMV of the property, whichever is higher) and the tax withheld will be credited against the transferor’s income tax due.

If the real property is a capital asset, no value-added tax (VAT) will be due.  However, if the same is an ordinary asset, the transfer is generally subject to 12% VAT unless it qualifies for exemption under certain conditions.
Whether the real property is a capital or an ordinary asset, the transfer will be subject to documentary stamp tax at the rate of PhP15.00 for every PhP1000, or fractional part thereof, of the consideration or FMV, whichever is higher.  Also, local transfer tax will be due.  The rate that may be imposed by the local government would depend on their respective local ordinances but the rate should not exceed  ½ % to ¾% of 1% of the total consideration for the transfer or of the FMV, whichever is higher.

In the foregoing scenario, since the corporation had yet to obtain SEC approval and secure the CAR, the land received in payment of subscriptions payable was recorded as deposit for future stock subscription (DFS) and the shares corresponding to the subscription receivables were not yet issued.

Additional paid-in capital (APIC)

In their books, certain corporations recorded advances from stockholders; liabilities due and owing to shareholders; or cash that was received without any Board resolution for additional subscription or increase in capital and was booked as DFS.  The clients were considering to convert these advances/liabilities to APIC to enhance their equity position or eventually, to apply the APIC to wipe-out a capital deficit.

We explained that SEC approval of creation/conversion of advances/liabilities to APIC is no longer mandatory.  In effect, the conversion can be done internally by reflecting/re-classing the advances/liabilities as APIC in the AFS, subject to the execution of the following supporting documents: i) Board resolution approving the conversion; and ii) Deed of Assignment of Advances executed by the stockholder-grantor in favor of the company-grantee.  We noted that if the stockholder-grantor is a foreign corporation and the Deed of Assignment will be executed abroad, the Deed will have to be consularized before the Philippine Embassy in the country of execution.

Debt-to-equity conversion through creation of APIC is a capital transaction which is not subject to income tax on the part of the company-grantee and to donor’s tax on the part of the stockholder-grantor. Moreover, since no shares will be issued, the corresponding liability to pay DST on original issuance of shares will not apply. 

We also reminded clients that if they intended to apply the resulting APIC to wipe-out their capital deficit, SEC approval is mandatory and more importantly, SEC will only accept an AFS as proof of the APIC to be applied against the deficit.  Considering the documentary requirements involved, a company considering to create APIC and/or wipe-out its deficit needs to advise its auditors and concerned staff way ahead of the busy season of such plan to afford the parties sufficient time to prepare the supporting documents and secure the required regulatory approvals.   

This article is not intended to be a substitute for professional advice.  For comments and inquiries, you may e-mail the author at Tata.Panlilio@ph.gt.com.  For other tax concerns, please check out our other tax services.