Taxation Reviewer 6

Part 6

I. SALE OR EXCHANGE OF PROPERTY

A. CAPITAL ASSETS

Sec. 39, NIRC - Capital Assets: The term “capital assets” means property held by the taxpayer (whether or not connected with his trade or business), but does NOT include stock in trade by the taxpayer, or other property of a kind which would properly be included in the inventory of a taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property used in the trade or business, of a character which is subject to the allowance for depreciation provided in subsection F of 34, or real property used in trade or business of the taxpayer

1. Definition of capital asset

RR NO. 7-2003, Dec. 27, 2002
Guidelines in determining whether a real property is capital or ordinary asset
Providing the Guidelines in Determining Whether a Particular Real Property is a Capital Asset or an Ordinary Asset Pursuant to Section 39(A)(1) of the National Internal Revenue Code of 1997 for Purposes of Imposing the Capital Gains Tax under Sections 24(D), 25(A)(3), 25(B) and 27(D)(5), or the Ordinary Income Tax under Sections 24(A), 25(A) & (B), 27(A), 28(A)(1) and 28(B)(1), or the Minimum Corporate Income Tax (MCIT) under Sections 27(E) and 28(A)(2) of the same Code

Scope. — Pursuant to Section 244 of the National Internal Revenue Code of 1997 (Code), these Regulations are hereby promulgated to implement Sec. 39(A)(1), providing for the purpose the guidelines in determining whether a particular real property is a capital asset or an ordinary asset.

SECTION 2. Definition Of Terms. — For purposes of these Regulations, the following terms shall be defined as follows:
a. Capital assets shall refer to all real properties held by a taxpayer, whether or not connected with his trade or business, and which are not included among the real properties considered as ordinary assets under Sec. 39(A)(1) of the Code.
b. Ordinary assets shall refer to all real properties specifically excluded from the definition of capital assets under Sec. 39(A)(1) of the Code, namely:
1. Stock in trade of a taxpayer or other real property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year; or
2. Real property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business; or
3. Real property used in trade or business (i.e., buildings and/or improvements) of a character which is subject to the allowance for depreciation provided for under Sec. 34(F) of the Code; or
4. Real property used in trade or business of the taxpayer.
Real properties acquired by banks through foreclosure sales are considered as their ordinary assets. However, banks shall not be considered as habitually engaged in the real estate business for purposes of determining the applicable rate of withholding tax imposed under Sec. 2.57.2(J) of Revenue Regulations No. 2-98, as amended.
c. Real property shall have the same meaning attributed to that term under Article 415 of Republic Act No. 386, otherwise known as the "Civil Code of the Philippines."
d. Real estate dealer shall refer to any person engaged in the business of buying and selling or exchanging real properties on his own account as a principal and holding himself out as a full or part-time dealer in real estate.
e. Real estate developer shall refer to any person engaged in the business of developing real properties into subdivisions, or building houses on subdivided lots, or constructing residential or commercial units, townhouses and other similar units for his own account and offering them for sale or lease.
f. Real estate lessor shall refer to any person engaged in the business of leasing or renting real properties on his own account as a principal and holding himself out as lessor of real properties being rented out or offered for rent.
g. Taxpayers engaged in the real estate business shall refer collectively to real estate dealers, real estate developers, and/or real estate lessors. Conversely, the term "taxpayers not engaged in the real estate business" shall refer to persons other than real estate dealers, real estate developers and/or real estate lessors. A taxpayer whose primary purpose of engaging in business, or whose Articles of Incorporation states that its primary purpose is to engage in the real estate business shall be deemed to be engaged in the real estate business for purposes of these Regulations.

SECTION 3. Guidelines in Determining Whether a Particular Real Property is a Capital Asset or Ordinary Asset. —
a. Taxpayers engaged in the real estate business. — Real property shall be classified with respect to taxpayers engaged in the real estate business as follows:
1. Real Estate Dealer. — All real properties acquired by the real estate dealer shall be considered as ordinary assets.
2. Real estate Developer. — All real properties acquired by the real estate developer, whether developed or undeveloped as of the time of acquisition, and all real properties which are field by the real estate developer primarily for sale or for lease to customers in the ordinary course of his trade or business or which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year and all real properties used in the trade or business, whether in the form of land, building, or other improvements, shall be considered as ordinary assets.
3. Real Estate Lessor. — All real properties of the real estate lessor, whether land and/or improvements, which are for lease/rent or being offered for lease/rent, or otherwise for use or being used in the trade or business shall likewise be considered as ordinary assets.
4. Taxpayers habitually engaged in the real estate business. — All real properties acquired in the course of trade or business by a taxpayer habitually engaged in the sale of real estate shall be considered as ordinary assets. Registration with the HLURB or HUDCC as a real estate dealer or developer shall be sufficient for a taxpayer to be considered as habitually engaged in the sale of real estate. If the taxpayer is not registered with the HLURB or HUDCC as a real estate dealer or developer, he/it may nevertheless be deemed to be engaged in the real estate business through the establishment of substantial relevant evidence (such as consummation during the preceding year of at least six (6) taxable real estate sale transactions, regardless of amount; registration as habitually engaged in real estate business with the Local Government Unit or the Bureau of Internal Revenue, etc.).
A property purchased for future use in the business, even though this purpose is later thwarted by circumstances beyond the taxpayer's control, does not lose its character as an ordinary asset. Nor does a mere discontinuance of the active use of the property change its character previously established as a business property.
b. Taxpayer not engaged in the real estate business. — In the case of a taxpayer not engaged in the real estate business, real properties, whether land, building, or other improvements, which are used or being used or have been previously used in the trade or business of the taxpayer shall be considered as ordinary assets. These include buildings and/or improvements subject to depreciation and lands used in the trade or business of the taxpayer.
A depreciable asset does not lose its character as an ordinary asset, for purposes of the instant provision, even if it becomes fully depreciated, or there is failure to take depreciation during the period of ownership.
Monetary consideration or the presence or absence of profit in the operation of the property is not significant in the characterization of the property. So long as the property is or has been used for business purposes, whether for the benefit of the owner or any of its members or stockholders, it shall still be considered as an ordinary asset. Real property used by an exempt corporation in its exempt operations, such as a corporation included in the enumeration of Section 30 of the Code, shall not be considered used for business purposes, and therefore, considered as capital asset under these Regulations.
Real property, whether single detached; townhouse; or condominium unit, not used in trade or business as evidenced by a certification from the Barangay Chairman or from the head of administration, in case of condominium unit, townhouse or apartment, and as validated from the existing available records of the Bureau of Internal Revenue, owned by an individual engaged in business, shall be treated as capital asset.
c. Taxpayers changing business from real estate business to non-real estate business. — In the case of a taxpayer who changed its real estate business to a non-real estate business, or who amended its Articles of Incorporation from a real estate business to a non-real estate business, such as a holding company, manufacturing company, trading company, etc., the change of business or amendment of the primary purpose of the business shall not result in the re-classification of real property held by it from ordinary asset to capital asset. For purposes of issuing the certificate authorizing registration (CAR) or tax clearance certificate (TCL), as the case may be, the appropriate officer of the BIR shall at all times determine whether a corporation purporting to be not engaged in the real estate business has at any time amended its primary purpose from a real estate business to a non-real estate business.
d. Taxpayers originally registered to be engaged in the real estate business but failed to subsequently operate. — In the case of subsequent non-operation by taxpayers originally registered to be engaged in the real estate business, all real properties originally acquired by it shall continue to be treated as ordinary assets.
e. Treatment of abandoned and idle real properties. — Real properties formerly forming part of the stock in trade of a taxpayer engaged in the real estate business, or formerly being used in the trade or business of a taxpayer engaged or not engaged in the real estate business, which were later on abandoned and became idle, shall continue to be treated as ordinary assets. Real property initially acquired by a taxpayer engaged in the real estate business shall not result in its conversion into a capital asset even if the same is subsequently abandoned or becomes idle.
Provided however, that properties classified as ordinary assets for being used in business by a taxpayer engaged in business other than real estate business as defined in Section 2(g) hereof are automatically converted into capital assets upon showing of proof that the same have not been used in business for more than two (2) years prior to the consummation of the taxable transactions involving said properties.
f. Treatment of real properties that have been transferred to a buyer/transferee, whether the transfer is through sale, barter or exchange, inheritance, donation or declaration of property dividends.
Real properties classified as capital or ordinary asset in the hands of the seller/transferor may change their character in the hands of the buyer/transferee. The classification of such property in the hands of the buyer/transferee shall be determined in accordance with the following rules:
1. Real property transferred through succession or donation to the heir or donee who is not engaged in the real estate business with respect to the real property inherited or donated, and who does not subsequently use such property in trade or business, shall be considered as a capital asset in the hands of the heir or donee.
2. Real property received as dividend by the stockholders who are not engaged in the real estate business and who do not subsequently use such real property in trade or business shall be treated as capital assets in the hands of the recipients even if the corporation which declared the real property dividend is engaged in real estate business.
3. The real property received in an exchange shall be treated as ordinary asset in the hands of the transferee in the case of a tax-free exchange by taxpayer not engaged in real estate business to a taxpayer who is engaged in real estate business, or to a taxpayer who, even if not engaged in real estate business, will use in business the property received in the exchange.
g. Treatment of real property subject of involuntary transfer. — In the case of involuntary transfers of real properties, including expropriation or foreclosure sale, the involuntariness of such sale shall have no effect on the classification of such real property in the hands of the involuntary seller, either as capital asset or ordinary asset, as the case may be.

2. Definition of Income

Sec 22 (z) the term “ordinary income” includes any gain from sale or exchange of property which is not a capital asset. Any gain from the sale or exchange of property which is treated or considered under other provisions of this title, as “ordinary income” shall be treated as gain from the sale or exchange of property which is not a capital asset as defined in sec 39 A.

Calasanz v.CIR 144 SCRA 664 (October 9, 1986)

Facts: Ursula Calasanz inherited from her father an agricultural land. Improvements were introduced to make such land saleable and later in it was sold to the public at a profit. The Revenue examiner adjudged Ursula and her spouse as engaged in business as real estate dealers and required them to pay the real estate dealer’s tax.

Issue: Whether or not the gains realized from the sale of the lots are taxable in full as ordinary income or capital gains taxable at capital gain rates?

Held: The activities of Calasanz are indistinguishable from those invariably employed by one engaged in the business of selling real estate. One strong factor is the business element of development which is very much in evidence. They did not sell the land in the condition in which they acquired it. Inherited land which an heir subdivides and makes improvements several times higher than the original cost of the land is not a capital asset but an ordinary asses. Thus, in the course of selling the subdivided lots, they engaged in the real estate business and accordingly the gains from the sale of the lots are ordinary income taxable in full.

3. Net capital gain, net capital loss

Net Capital Gain-means the excess of the gains from the sales or exchanges of capital assets over the losses from such sales or exchanges.

Net Capital Loss-means the excess of the losses from sales or exchanges of capital assets over the gains from such sales or exchanges.

4. Ordinary loss

Ordinary loss- includes any loss from the sale or exchange of property which is not a capital asset.

5. Percentage Taken into Account

Percentage Taken into Account- in the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net capital gain, net capital loss, and net income:
a. one hundred percent (100%) if the capital asset has been held for not more than 12 months
b. fifty percent (50%) if the capital asset has been held for more than12 months

6. Limitation on Capital Loss

Limitation on Capital Loss - Losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from such sales or exchanges.

A. DETERMINATION OF GAIN OR LOSS FROM SALE OR TRANSFER OF PROPERTY

1. Computation of gain or loss

Sec 40, NIRC: computation of gain or loss: the gain from sale or other disposition of property shall be the excess of the amount realized therefrom over the basis or adjusted basis for determining gain, and the loss shall be the excess of the basis or adjusted basis for determining loss over the amount realized. The amount realized from the sale or other disposition of property shall be the sum of money received plus the fair market value of the property received.

2. Cost or Basis for Income Tax Purposes

The basis of property shall be-
a. the cost thereof in the case of property acquired on or after March 1, 1913, if such property was acquired by purchase
b. the fair market price or value as of the date of acquisition, if the same was acquired by inheritance
c. if the property was acquired by gift, the basis shall be the same as if it would be in the hands of the donor, except if that if such basis is greater than the fair market value of the property at the time of the gift, then for the purpose of determining loss, the basis shall be such fair market value
d. if the property was acquired for less than an adequate consideration in money or money’s worth, the basis is the amount paid by the transferee for the property

3. Exchange of Property – Tax-free exchange

General rule: upon exchange or sale of property, the entire amount of the gain or loss, as the case may be, shall be recognized.

Exception: no gain or loss shall be recognized if in pursuance of a plan of merger or consolidation-
a. a corporation, which is a party to a merger or consolidation, exchanges property solely for stock in a corporation, which is a party to the merger or consolidation
b. a shareholder exchanges stock in a corporation, which is a party to the merger or consolidation, solely for the stock of another corporation also a party to the merger or consolidation
c. a security holder of a corporation, which is a party to the merger of consolidation exchanges his securities in such corporation, solely for stock or securities in another corporation, a party to the merger or consolidation.

i. Merger or Consolidation

BIR Ruling No. 383-87, Nov. 25, 1987
This is a ruling as to whether the merger of Delta Farms, Inc. (DFI) and Evergreen Farms, Inc. (EFI) qualifies as a tax-exempt re-organization under Section 35(c)(2) of the Tax Code, as amended.
It is represented that DFI and EFI are both domestic corporations duly registered to engage in agricultural development projects in the Philippines; that 70% of the equity of both corporations are owned by Mr. Juanito R. Ignacio (Ignacio) while 30% thereof, belongs to Philippine Packing Corporation (PPC) which is another domestic corporation and its four (4) individual nominees who are merely holders of one qualifying share each; that prompted by the desire of both companies to achieve efficiency and economy of operation by reducing administrative and operating costs and to strengthen DFI, a merger has been proposed wherein EFI shareholders will exchange all their EFI shares solely for shares in DFI; that as a result of the merger, DFI will be the surviving corporation which will continue to be owned 70% by Ignacio and 30% by PPC, with EFI then ceasing to exist, that based on the Audited Financial Statements of EFI as of March 31, 1987, since the net worth of EFI is P16,338,495.00, EFI stockholders shall receive the equivalent amount in DFI shares of stock or P163,384.95 DFI shares with a par value of P100.00 per share; that considering that 809,750 shares of EFI with a par value of P10.00 per share are issued and outstanding, one (1) DFI share shall be issued for approximately 4.9561EFI shares; that Ignacio shall receive 114,369.41 DFI shares for his 566,825 EFI shares, while PPC shall receive 40,015.48 DFI shares for its 242,925 EFI shares (including the four (4) qualifying shares in the names of its four (4) nominees; that in order to avoid fractional shares, Ignacio and PPC agree that the latter shall waive in favor of the former its fractional share, with the additional payment by Ignacio of P5.00 to complete one (1) whole share, that the Articles of Incorporation of DFI shall simultaneously be amended to increase its authorized capital stock by P40 million, or from P10 million to P50 million, and at least 25% of which increase or P16,338,500.00 equivalent to 163,385 shares shall be issued as aforementioned in exchange for the 809,750 outstanding shares of EFI worth of P16,338,495.00 and the additional payment in cash of P5.00 as aforementioned, that after the effective date of the merger, all EFI stockholders will become DFI stockholders, and that simultaneous with the merger the Articles of Incorporation of the surviving corporation, DFI shall be amended and its name shall be Evergreen Farms, Inc. immediately after the effectivity of the merger.

RULING: The above reorganization is a merger within the contemplation of Section 35(c)(2) and (5(b) of the Tax Code because a corporation (DFI) acquired all of the properties of another corporation (EFI) solely for stocks, the transaction undertaken being for a bona fide business purpose and not solely for the purpose of escaping the burden of taxation.
Accordingly, the transfer by EFI of all its assets and liabilities to DFI solely, in exchange for the latter's shares of stock shall not give rise to the recognition of gain or loss pursuant to Section 35(c)(2) of the Tax Code. No gain or loss shall be recognized to EFI upon the distribution of DFI shares to EFI stockholders in complete redemption of their stocks under Section 35(c)(2) of the Tax Code. No gain or loss shall be recognized to EFI stockholders upon the exchange of their stocks solely for DFI stocks under Section 35(c)(2) of the Tax Code.
The basis of the assets received by DFI shall be the same as it would be in the hands of EFI. The basis of DFI stocks received by the stockholders of EFI shall be the same as the basis of the EFI stocks surrendered in exchange therefor.
If the total liabilities to be assumed by DFI upon effective merger date exceed the historical or original acquisition cost (cost basis) of the assets transferred by EFI, the excess shall be recognized as gain of EFI.
It is understood, however, that upon the subsequent sale or exchange of the assets or shares of stocks acquired by the parties, the gain derived from such sale or exchange shall be subject to income tax.
The abovementioned transactions shall not be subject to the gift tax as there is no intention to donate on the part of any of the parties.
However, in order that the above-described reorganization can be considered a merger under Section 35(c)(2) of the Tax Code, the parties to the merger should comply with the following requirements:
A. The plan of reorganization should be adopted by each of the corporations, parties thereto, the adoption being shown by the acts of its duly constituted responsible officers and appearing upon the official records of the corporation. Each corporation, which is a party to the reorganization, shall file, as part of its return for the taxable year within which the reorganization occurred, a complete statement of all facts pertinent to the non-recognition of gain or loss in connection with the reorganization, including:
(1) A copy of the plan of reorganization, together with a statement executed under the penalties of perjury showing in full the purposes thereof and in detail all transactions incident to or pursuant to the Plan.
(2) A complete statement of the cost or other basis of all property, including all stocks or securities, transferred incident to the plan.
(3) A statement of the amount of stock or securities and other property or money received from the exchange, including a statement of all distributions or other disposition made thereof. The amount of each kind of stock or securities and other property received shall be stated on the basis of the fair market value thereof at the date of the exchange.
(4) A statement of the amount and nature of any liabilities assumed upon the exchange, and the amount and nature of any liabilities to which any of the property acquired in the exchange is subject.
B. Every taxpayer, other than a corporation a party to the reorganization, who received stock or securities and other property or money upon a tax-free exchange in connection with a corporate reorganization shall incorporate in his income tax return for the taxable year in which the exchange takes place a complete statement of all facts pertinent to the non-recognition of gain or loss upon such exchange including:
(1) A statement of the cost or other basis of the stock or securities transferred in the exchange; and
(2) A statement in full of the amount of stock or securities and other property or money received from the exchange, including any liabilities assumed upon the exchange, and any liabilities to which property received is subject. The amount of each kind of stock or securities and other property (other liabilities assumed upon the exchange) received shall be set forth upon the basis of the fair market value thereto at the date of the exchange.
C. Permanent records in substantial form shall be kept by every taxpayer who participates in a tax-free exchange in connection with a corporate reorganization showing the cost or other basis of the transferred property or money received (including any liabilities assumed on the exchange, or any liabilities to which any of the properties received were subject), in order to facilitate the determination of gain or loss from a subsequent disposition of such stock or securities and other property received from the exchange.
In addition to the foregoing requirements, permanent records in substantial form must be kept by the corporations participating in the merger showing the information listed above in order to facilitate the determination of gain or loss from a subsequent disposition of the stock received as a consequence of the merger.

COMMISSIONER v. RUFINO, L-33665-68

Facts: The private respondents were the majority stockholders of the defunct Eastern Theatrical Co. It had an original capital stock of P500,000.00, which was increased in 1949 to P2,000,000.00, divided into 200,000 shares at P10.00 per share, and was organized to engage in the business of operating theaters, opera houses, places of amusement and other related business enterprises, more particularly the Lyric and Capitol Theaters in Manila. The President of this corporation (hereinafter referred to as the Old Corporation) during the year in question was Ernesto D. Rufino.
They are also the majority and controlling stockholders of another corporation, the Eastern Theatrical, Inc. This corporation is engaged in the same kind of business as the Old Corporation. The General-Manager of this corporation (hereinafter referred to as the New Corporation) at the time was Vicente A. Rufino.
In a special meeting of stockholders of the Old Corporation on December 17, 1958, to provide for the continuation of its business after the end of its corporate life, and upon the recommendation of its board of directors, a resolution was passed authorizing the Old Corporation to merge with the New Corporation by transferring all its business, assets, goodwill, and liabilities to the latter, which in exchange would issue and distribute to the shareholders of the Old Corporation one share for each share held by them in the said Corporation.
It was expressly declared that the merger of the Old Corporation with the New Corporation was necessary to continue the exhibition of moving pictures at the Lyric and Capitol Theaters even after the expiration of the corporate existence of the former, in view of its pending booking contracts, not to mention its collective bargaining agreements with its employees.
The aforesaid transfer was eventually made by the Old Corporation to the New Corporation, which continued the operation of the Lyric and Capitol Theaters and assumed all the obligations and liabilities of the Old Corporation beginning January 1, 1959.
The Bureau of Internal Revenue examined later, resulting in the petitioner declaring that the merger of the aforesaid corporations was not undertaken for a bona fide business purpose but merely to avoid liability for the capital gains tax on the exchange of the old for the new shares of stock. Accordingly, he imposed the deficiency assessments against the private respondents.

Held: The Court of Tax Appeals did not err in finding that no taxable gain was derived by the private respondents from the questioned transaction. There was a valid merger although the actual transfer of the properties subject of the Deed of Assignment was not made on the date of the merger. The Court finds no impediment to the exchange of property for stock between the two corporations being considered to have been effected on the date of the merger. That, in fact, was the intention, and the reason why the Deed of Assignment was made retroactive to January 1, 1959. Such retroaction provided in effect that all transactions set forth in the merger agreement shall be deemed to be taking place simultaneously on January 1. 1959, when the Deed of Assignment became operative. The certificates of stock subsequently delivered by the New Corporation to the private respondents were only evidence of the ownership of such stocks. Although these certificates could be issued to them only after the approval by the SEC of the increase in capitalization of the New Corporation, the title thereto, legally speaking, was transferred to them on the date the merger took effect, in accordance with the Deed of Assignment. Our ruling then is that the merger in question involved a pooling of resources aimed at the continuation and expansion of business and so came under the latter and intendment of the National Internal Revenue code, as amended by the above-cited law, exempting from the capital gains tax exchanges of property effected under lawful corporate combinations.
The basis consideration, of course, is the purpose of the merger, as this would determine whether the exchange of properties involved therein shall be subject or not to the capital gains tax. The criterion laid down by the law is that the merger "must be undertaken for a bona fide" business purpose and not solely for the purpose of escaping the burden of taxation."

ii. Transfer of “substantially all” the assets

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’.

iii. Transfer of Property for Shares of Stocks

RMR No. 1-2001, 29 November 2001
Tax Consequences of Tax-Free Exchange of Property for Shares of Stock of a Controlled Corporation
This Revenue Memorandum Ruling is issued to consolidate, provide, clarify and harmonize the existing guidelines on the tax consequences of a non-recognition transaction consisting of a tax-free exchange of property for shares of stock under Section 40(C)(2) of the Tax Code of 1997. This Revenue Memorandum Ruling shall apply solely and exclusively to, and may be relied upon only in situations in which the facts are substantially similar to the facts stated below, but subject to the principles of substance over form.
I. FACTS
1. A domestic corporation (the "Transferor") owns certain property, consisting, for example, of the following:
1.1 Land encumbered by a real estate mortgage (REM);
1.2 Buildings;
1.3 100 shares of stock in G Corporation with a par value of P10 per share;
1.4 50 shares of stock in D Corporation without par value;
1.5 Unsecured receivables;
1.6 Loans to Q ("Borrower/Mortgagor"), secured by a real estate mortgage;
1.7 Cash.
2. X Corporation (the "Transferee") is a domestic corporation.
3. The Transferor transfers the property to the Transferee. In exchange, the Transferee issues shares to the Transferor out of the unissued portion of its existing authorized capital stock, or, if such existing authorized capital stock is insufficient, out of shares from an increase in the Transferee's authorized capital stock. The Transferor does not receive any money or property other than the aforementioned shares of the transferee.
4. The property transferred by the Transferor-corporation constitutes less than 80% of the Transferor's assets, including cash.
5. In addition to the transfer of the property, the Transferee assumes liabilities of the Transferor. However, the sum total of the amount of liabilities assumed, plus the amount of the encumbrance or REM on the Land (as stated in Section 40(C)(4) of the Tax Code of 1997 — "liabilities to which the property is subject") do not exceed the basis of the property transferred.
6. The shares are neither issued in payment for services, nor for settlement of an outstanding liability that arises from the performance of services rendered by the Transferor to the Transferee.
7. As a result of the above-mentioned transfer, the Transferor acquires at least 51% of the total outstanding capital stock of the Transferee entitled to vote.
II TAX CONSEQUENCES
1. Income tax. The Transferor shall not recognize any gain or loss on the transfer of the property to the Transferee. Consequently, the Transferor will not be subject to capital gains tax, income tax, or to creditable withholding tax on the transfer of such property to the Transferee. Neither may the transferor recognize a loss, if any, incurred on the transfer. The last paragraph of Section 40(C)(2) and (6)(c) of the Tax Code of 1997 state:
"No gain or loss shall also be recognized if property is transferred to a corporation by a person in exchange for stock or unit of participation in such corporation of which as a result of such exchange said person, alone or together with others, not exceeding four (4) persons, gains control of said corporation: Provided, That stocks issued for services shall not be considered as issued in return for property."
"(c) The term "control", when used in this Section, shall mean ownership of stocks in a corporation possessing at least fifty-one percent (51%) of the total voting power of all classes of stocks entitled to vote."
In addition, the assumption of liabilities or the transfer of property that is subject to a liability does not affect the non-recognition of gain or loss under Section 40(C)(2) of the Tax Code of 1997, since in this case, the total amount of such liabilities does not exceed the basis of the property transferred. Section 40(C)(4) of the Tax Code of 1997 states:
"(4) Assumption of liability. —
(a) If the taxpayer, in connection with the exchanges described in the foregoing exceptions, receives stock or securities which would be permitted to be received without the recognition of the gain if it were the sole consideration, and as a part of the consideration, another party to the exchange assumes a liability of the taxpayer, or acquires from the taxpayer property, subject to a liability, then such assumption or acquisition shall not be treated as money and/or other property, and shall not prevent the exchange from being within the exceptions.
(b) If the amount of the liabilities assumed plus the amount of the liabilities to which the property is subject exceed the total amount of the adjusted basis of the property transferred pursuant to such exchange, then such excess shall be considered as a gain from the sale or exchange of a capital asset or of property which is not a capital asset, as the case may be."
In addition, the Transferee is not subject to income tax on its receipt of the property as contribution to its capital, even if the value of such property exceeds the par value or stated value of the shares issued to the Transferor. Section 55 of Revenue Regulations No. 2 ("Income Tax Regulations") states:
"Section 55. Acquisition or disposition by a corporation of its own capital stock. — . . . . The receipt by a corporation of the subscription price of shares of its capital stock upon their original issuance gives rise to neither taxable gain nor deductible loss, whether the subscription or issue price be in excess of, or less than the par or stated value of such stock.
However, stocks shall not be issued for a consideration less than par or issued price thereof. (Section 62, Corporation Code of the Philippines)
2. Donor's tax. The Transferor is not subject to donor's tax, regardless of whether the value of the property transferred exceeds the par/stated value of the Transferee shares issued to the Transferor, there being no intent to donate on the part of the Transferor.
3. Value added tax. The Transferor is not subject to value-added tax ("VAT") on the transfer of the property if it is not engaged in a business that is subject to the VAT under Title IV of the Tax Code of 1997. Even if the Transferor is engaged in an activity that is subject to VAT, it is nonetheless not subject to VAT on the transfer of the property to the Transferee, since the Transferor gains control of the Transferee. Section 4.100-5(b)(1) of Revenue Regulations No. 7-95, as amended states:
"(b) Not subject to output tax. — The VAT shall not apply to goods or properties existing as of the occurrence of the following:
1) Change of control of a corporation by the acquisition of the controlling interest of such corporation by another stockholder or group of stockholders, Example: transfer of property to a corporation in exchange for its shares of stock under Section 34(c)(2) and (6)(c) of the Code [now 40(C)(2) and (6)(c) of the Tax Code of 1997].
4. Documentary stamp tax. The documentary stamp tax consequences of the transfer are as follows:
4.1 Either the Transferor or the Transferee is subject to documentary stamp tax as follows:
4.1.1 On the transfer of real property (Section 196, Tax Code of 1997) — P15 on each P1,000 or fractional part thereof, based on the higher of: (i) the consideration contracted to be paid for such real property, and (ii) the fair market value as determined in accordance with Section 6(E) of the Tax Code of 1997.
4.1.1.1 The "consideration contracted to be paid for such real property" shall be computed in accordance with the following rules. "Stock in a corporation is a valuable consideration for the transfer of real property." (Section 177, Revenue Regulations No. 26) Therefore, the consideration for the real property shall be computed as the par/stated value of the Transferee shares issued to the Transferor in exchange for such property plus the value of such property in excess of such par/stated value recognized in the books of the Transferee as premium, additional capital contribution, or donated surplus, or the like. For instance, if the value of the property is P1,000,000, but only shares with an aggregate par value of P250,000 are issued, there being a premium above par of P750,000, which the Transferee records as additional capital contribution, donated surplus, or the like, the consideration is P1,000,000 (that is, par value of P250,000 + premium of P750,000).
4.1.1.2 On the other hand, the fair market value of the property as determined in accordance with Section 6(E) of the Tax Code of 1997 whichever is higher between (1) the fair market value as determined by the Commissioner (that is, zonal value), and (2) the fair market value as shown in the schedule of values of the Provincial and City Assessors.
4.1.1.3 The value of the improvements thereon shall be based on the formula provided under Revenue Audit Memorandum Order (RAMO) No. 1-2001 but shall not be lower than the fair market value in the Tax Declaration in the year of exchange.
According to the said RAMO, the value of the improvement shall be determined by deducting the zonal value of the land from the total selling price/consideration per Deed of Exchange. Thus, if the total selling price/consideration per Deed of Exchange is P1,000,000.00 and the zonal value of the land is P600,000.00, then the value of the improvement is P400,000.00.
The fair market value of the improvement shall be determined per latest tax declaration at the time of its sale or disposition (in this particular case, the exchange of such property). If the tax declaration was issued three (3) or more years prior to the date of sale or disposition, the Transferor shall be required to submit a certification from the city/municipal assessor as to the fact that such tax declaration is the latest tax declaration covering the real property. Absent such certification, the Transferor must secure a copy of the latest tax declaration duly certified by the assessor.
4.1.2 On the transfer of shares of stock held by the Transferor (Section 176, Tax Code of 1997) —
4.1.2.1 The transfer of the shares of G Corporation, which have a par value, is subject to documentary stamp tax of P1.50 on each P200 or fractional part thereof of the par value of such shares.
4.1.2.2 The transfer of the shares of D Corporation, which are without par value, is subject to the documentary stamp tax of 25% of the documentary stamp tax that was paid when those shares were originally issued.
4.1.3 Transfer of mortgage (Section 198, in relation to Section 195, Tax Code of 1997) — The transfer of the real estate mortgage, as a consequence of the transfer of the loan to Q ("Borrower/Mortgagor"), is subject to documentary stamp tax at the following rate:
(a) When the amount secured does not exceed five thousand pesos (P5,000) — twenty pesos (P20);
(b) On each five thousand pesos (P5,000), or fractional part thereof in excess of five thousand pesos (P5,000), an additional tax of ten pesos (P10).
4.2 The Transferee is subject to documentary stamp tax on the original issuance of its shares (Section 175, Tax Code of 1997), at the following rate, depending on whether such shares are par or no-par shares:
4.2.1 If the Transferee's shares are with par value, the documentary stamp tax is imposed at the rate of P2 on each P200 or fractional part thereof of the par value of such shares, regardless of whether the shares are issued at par value or for a premium (that is, for a consideration in excess of par value).
4.2.2 If the Transferee's shares are without par value, the documentary stamp tax is imposed at the rate of P2 on each P200 or fractional part thereof of the actual consideration paid for such shares.
5. Time of Payment of Taxes. The time for the payment of the documentary stamp tax liabilities, whether the taxpayer is an e-filer or not, shall be as follows:
5.1 With respect to the transfer of property mentioned in 4.1, above, the documentary stamp tax shall be paid on or before the fifth (5th) day after the close of the month when the deed of assignment/transfer transferring such property was executed, made, signed, accepted, or transferred (Section 5, Revenue Regulations No. 6-2001).
5.2 With respect to the original issuance of shares mentioned in 4.2, above, the documentary stamp tax shall be paid on or before the fifth (5th) day after the close of the month of —
5.2.1 Approval of SEC registration, in case of original incorporation;
5.2.2 Approval of the increase in authorized capital stock, in case the shares issued to the Transferee come from the increase in authorized capital stock of the Transferee; or
5.2.3 Execution of the deed of assignment/transfer of the property for which the Transferee's shares are issued, in case the shares issued to the Transferor come from the unissued portion of the Transferee's existing authorized capital stock.

iv. Administrative requirements in case of Tax-free Exchanges

RMO 32-2001, 29 NOV. 2001
Prescribing the new conditions & requirements of tax-free exchange
Guidelines Implementing Revenue Regulations No. 18-2001 on the Monitoring of the Basis of the Property Transferred and Shares of Stock Received.
In order to facilitate the monitoring of the basis of properties transferred and shares received in an exchange transaction, and in the determination of whether a transaction involving the transfer of properties by individual/s or corporation/s in exchange for shares of stock of another corporation or unit of participation in a partnership, as well as a transaction involving a merger or consolidation, is a tax-free exchange that falls under Section 40(C)(2), in relation to Section 40(6)(b) and (c) of the Tax Code of 1997, the requirements hereunder stated must be complied with by both transferor(s)/absorbed corporation and transferee/surviving/consolidated corporation.
I. DOCUMENTATION REQUIREMENTS
A. BIR Certification/Ruling —
Any application to be filed with the Law Division for a BIR Certification/Ruling on the tax consequence of the exchange of properties described hereunder shall be made in a form which the BIR will provide for the purpose under the cover of a transmittal letter providing a brief overview of the transaction that contains all the material facts of the exchange transaction, and shall be accompanied by three (3) copies of each of the following documents:
(1) In the case of transfer of property to a controlled corporation/partnership —
(a) Deed of Transfer/Assignment/Exchange;
(b) Duly registered Articles of Incorporation or Partnership with SEC of the transferor corporation and transferee corporation/partnership, and By-Laws;
(c) Copies of the Transfer Certificates of Title/Condominium Certificates of Title/Certificates of Stock to the properties to be transferred pursuant to the tax-free exchange, as certified by the appropriate Registrar of Deeds or Corporate Secretary, as the case may be;
(d) Copies of the latest Tax Declaration of the properties to be transferred pursuant to the tax-free exchange, as certified by the appropriate local government unit's Assessor. It is understood that any improvement is separately declared and therefore, covered by a Tax Declaration distinct from the Tax Declaration on the land. Further, if the tax declaration was issued three (3) or more years prior to the exchange transaction, the Transferor shall include in the certification by the local government unit's Assessor that such declaration is the latest tax declaration covering the real property;
(e) Certification of the fair market value or zonal value of the real property involved in the exchange. The zonal value shall be certified, as a general rule, by the Chief, Asset Valuation Division at the 10th Floor, BIR National Office. However, the Revenue District Officer or the Revenue Regional Director can also issue the certification whenever access to the latest schedule of zonal values is electronically available to them.
(f) Sworn certification by the individual transferor or in the case of a juridical person, by the Chief Financial Officer or his equivalent as to the basis of the property to be transferred. The original or adjusted basis, as the case may be, of each real property/share of stock/or other property transferred must be itemized in the certification, instead of a single lump sum in order to enable the Registrar of Deeds or the corporate secretary, as the case may be, to annotate the substituted basis on the reverse side of the Transfer/Condominium Certificate of Title to the real property involved or of the Certificate of Stock, and in order to facilitate the determination of gain or loss from a subsequent disposition of real properties/shares of stock and other properties received in the exchange.
(g) Sworn statement of the amount and nature of any liabilities assumed upon the exchange, and the amount and nature of any liabilities to which any of the properties acquired in the exchange is subject. The proper officer to issue the statement shall be the Chief Financial Officer or his equivalent and confirmed by the President or the Chief Executive Officer or Country Chairman or their equivalent;
(h) Audited Financial Statements of Transferor-corporation, as of the transaction date.
(2) In the case of Merger or Consolidation —
(a) The documents stated in (1) above;
(b) Plan of Corporate Merger or Consolidation;
(c) Statement of the amount and nature of the assets to be transferred by the absorbed corporation to the surviving/consolidated corporation.
(d) Articles of Incorporation duly registered with SEC of the merged or consolidated corporation; and
(e) Audited Financial Statements duly submitted or to be submitted to the SEC in connection with the application for merger or consolidation.
The material facts in the submitted documents, including an analysis of their bearing on the issues and a specification of the applicable provisions thereof, must be stated also in the covering letter.
B. No Application/Request for Certification-Ruling will be processed unless the foregoing requirements are complied with in all respects.
C. In the case of executed and/or completed transactions, either original executed and notarized copies or certified true copies of the above-mentioned documents must be submitted, together with proof of payment of the applicable documentary stamp taxes on the transactions. In the case of issuance of shares/unit of participation by the transferee, the due dates for the payment of the corresponding documentary stamp tax prescribed under Revenue Memorandum Order No. 8-98 dated February 10, 1998, as amended by Revenue Regulations No. 6-2001 and 12-2001 dated July 31, 2001 and September 7, 2001, respectively, shall apply.
D. Records to be kept and information to be filed. —
The parties to the transaction shall comply with the pertinent provisions of Revenue Regulations No. 18-2001 dated November 13, 2001, regarding the records to be kept and information to be filed in connection with the tax-free exchange, provided that, any violation thereof, including the failure of the parties to present proof of annotation of the substituted basis within the period provided in Section 7 of such Regulations shall be referred to the Prosecution Division for appropriate action.
II. FORM OF REQUEST FOR RULING AND CERTIFICATION
To the extent applicable, the request for certification-ruling shall be prepared and submitted in the form provided in Annex "A" hereof under the heading "Application and Joint Certification". For this purpose, soft copies of the Form shall be available either from the Taxpayers' Information and Education Division at the Ground Floor, BIR National Office Building or from the Law Division at the 7th Floor of the same building.
If the application is to be signed and submitted not by the taxpayer himself, but only by his authorized representative, the appropriate special power of attorney shall be submitted with the application for a certification-ruling. Otherwise, the request shall not be accepted by the BIR. In the case of a juridical person, the corporate secretary shall issue a sworn statement that the signing officer (i.e., at the very least, the Chief Financial Officer) has been authorized by the Board of Directors to represent the company and has personal knowledge of the facts of the exchange transaction.
III. PROCESSING AND CERTIFICATION FEE
The taxpayer/applicant shall pay the applicable processing and certification fee as provided in Revenue Regulations No. 18-2001 dated November 13, 2001, before filing of the request for certification-ruling. The applicant must submit proof of payment of the processing and certification fee, with the original presented, upon filing of the application for certification-ruling with the Law Division. Otherwise, the application shall not be accepted for processing.
The processing and certification fee shall accordingly be adjusted if additional transfer certificates of title/condominium certificates of title/certificates of stock are submitted for processing.
IV. DECLARATION UNDER OATH
Declarations in the application and joint certification form, the documents to be submitted, and the facts represented in support of the requested certification-ruling, including the covering letter, shall be sworn under oath, under penalties of perjury, by the taxpayer himself, or, in the case of a juridical person, by the Chief Financial Officer or his equivalent who has personal knowledge of the facts to be true, correct and complete. Actual submission of the application/request and follow-up thereof may be done by an authorized representative, clothed with a special power of attorney, and subject to the provisions of Revenue Regulations No. 15-99 dated July 16, 1999 on accreditation of tax agents
V. ISSUANCE OF CERTIFICATE AUTHORIZING REGISTRATION (CAR)/TAX CLEARANCE (TCL)
The CAR/TCL for the real property or share of stock/unit of participation/interest involved in the exchange shall be issued by the Revenue District Officer (RDO) or by the Authorized Internal Revenue Officer (AIRO), on the basis of the certification-ruling issued by the Commissioner or his duly authorized representative to the effect that the transaction qualifies as a tax-free exchange or corporate reorganization under Section 40(C)(2) of the Tax Code of 1997. The necessary proof of payment of appropriate documentary stamp taxes must also be presented.
The CAR/TCL to be issued shall specify, among others, that the transaction involved is a tax-free exchange under Section 40(C)(2) of the Tax Code of 1997; the date of exchange; the original or adjusted basis as represented by the taxpayer, and substituted basis of the properties as stated in the certification or ruling issued by the Bureau of Internal Revenue.

v. De Facto Merger

RMR NO. 1-2002, APRIL 25, 2002
Tax consequences of de facto merger
This Revenue Memorandum Ruling is issued to consolidate, provide, clarify and harmonize the existing guidelines on the tax consequences of a de facto merger under Section 40(C)(2) and (6)(b) of the Tax Code of 1997. This Revenue Memorandum Ruling shall apply solely and exclusively to, and may be relied upon only in, situations in which the facts are substantially similar to the facts stated below, but subject to the principle that for such transaction to be considered a de facto merger within the purview of Section 40(C)(2) in relation to 40(6)(b) of the Tax Code of 1997, the same must be undertaken for a bona fide business purpose and not solely for the purpose of escaping the burden of taxation.
I Facts
1. A domestic corporation (the "Transferor") owns certain property, consisting, for example, of the following:
1.1 Land encumbered by a real estate mortgage (REM);
1.2 Buildings;
1.3 100 shares of stock in G Corporation with a par value of P10 per share;
1.4 50 shares of stock in D Corporation without par value;
1.5 Unsecured receivables;
1.6 Loans to Q ("Borrower/Mortgagor"), secured by a real estate mortgage;
1.7 Cash.
2. The property transferred by the Transferor constitutes at least 80% of the Transferor's assets, including cash.
3. The Transferor transfers the property to the Transferee. In exchange, the Transferee issues shares to the Transferor out of the unissued portion of its existing authorized capital stock, or, if such existing authorized capital stock is insufficient, out of shares from an increase in the Transferee's authorized capital stock. The Transferor does not receive any money or property other than the aforementioned shares of the transferee.
4. In addition to the transfer of the property, the Transferee assumes liabilities of the Transferor. However, the sum total of the amount of liabilities assumed, plus the amount of the encumbrance or REM on the Land (as stated in Section 40(C)(4) of the Tax Code of 1997 — "liabilities to which the property is subject") do not exceed the basis of the property transferred.
II. GENERAL PRINCIPLES
1. A de facto merger involves the acquisition by one corporation of all or substantially all the properties of another solely for stock. Section 40(C)(6)(b) of the Tax Code of 1997 states:
"The term "merger" or "consolidation," when used in this Section, shall be understood to mean:
(i) the ordinary merger or consolidation; or
(ii) the acquisition by one corporation of all or substantially all the properties of another corporation solely for stock: Provided, That for a transaction to be regarded as a merger or consolidation within the purview of this Section, it must be undertaken for a bona fide business purpose and not solely for the purpose of escaping the burden of taxation: Provided, further, That 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: Provided, finally, That 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."
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 stock, 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 of 1997, 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 in a transfer to a controlled corporation, the Transferors may either be a corporation or an individual, and (2) in a de facto merger, there is no requirement that the transferor gains control (that is, 51% of the total voting powers of all classes of stocks of the Transferee entitled to vote) of the Transferee as a prerequisite 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 of the properties of the Transferor.
III TAX CONSEQUENCES
1. Income tax. The Transferor shall not recognize any gain or loss on the transfer of the property to the Transferee. Consequently, the Transferor will not be subject to capital gains tax, income tax, nor to creditable withholding tax on the transfer of such property to the Transferee. Neither may the Transferor recognize a loss, if any, incurred on the transfer.
In addition, the assumption of liabilities or the transfer of property that is subject to a liability does not affect the non-recognition of gain or loss under Section 40(C)(2) of the Tax Code of 1997, since in this case, the total amount of such liabilities does not exceed the basis of the property transferred. Section 40(C)(4) of the Tax Code of 1997 states:
"(4) Assumption of liability. —
(a) If the taxpayer, in connection with the exchanges described in the foregoing exceptions, receives stock or securities which would be permitted to be received without the recognition of the gain if it were the sole consideration, and as a part of the consideration, another party to the exchange assumes a liability of the taxpayer, or acquires from the taxpayer property, subject to a liability, then such assumption or acquisition shall not be treated as money and/or other property, and shall not prevent the exchange from being within the exceptions.
(b) If the amount of the liabilities assumed plus the amount of the liabilities to which the property is subject exceed the total amount of the adjusted basis of the property transferred pursuant to such exchange, then such excess shall be considered as a gain from the sale or exchange of a capital asset or of property which is not a capital asset, as the case may be."
Moreover, the Transferee is not subject to income tax on its receipt of the property as contribution to its capital, even if the value of such property exceeds the par value or stated value of the shares issued to the Transferor: Section 55 of Revenue Regulations No. 2 ("Income Tax Regulations") states:
"Section 55. Acquisition or disposition by a corporation of its own capital stock. — . . . The receipt by a corporation of the subscription price of shares of its capital stock upon their original issuance gives rise to neither taxable gain nor deductible loss, whether the subscription or issue price be in excess of, or less than the par or stated value of such stock.
However, stocks shall not be issued for a consideration less than par or issued price thereof. (Section 62, Corporation Code of the Philippines)
2. Donor's tax. The Transferor is not subject to donor's tax, regardless of whether the value of the property transferred exceeds the par/stated value of the Transferee shares issued to the Transferor, there being no intent to donate on the part of the Transferor.
3. Value-added tax. The Transferor is not subject to value-added tax ("VAT") on the transfer of the property if it is not engaged in a business that is subject to the VAT under Title IV of the Tax Code of 1997. Even if the Transferor is engaged in an activity that is subject to VAT, it is nonetheless not subject to VAT on the transfer of the property to the Transferee. Section 4.100-5(b)(1) & (3) of Revenue Regulations No. 7-95, as amended states:
"(b) Not subject to output tax. — The VAT shall not apply to goods or properties existing as of the occurrence of the following:
1) Change of control of a corporation by the acquisition of the controlling interest of such corporation by another stockholder or group of stockholders, Example: transfer of property to a corporation in exchange for its shares of stock under Section 34(c)(2) and (6)(c) of the Code [now 40(C)(2) and (6)(c) of the Tax Code of 1997].
3) Merger or consolidation of corporations. The unused input tax of the dissolved corporation as of the date of merger or consolidation shall be absorbed by the surviving or new corporation."
Thus, since a de facto merger is considered within the definition of a merger under Section 40(C)(6) of the Tax Code of 1997, the transfer of the property by the Transferor to the Transferee shall not be subject to VAT. However, the second sentence of Section 4.100-5(b)(3), supra, is inapplicable in de facto mergers, and therefore, the Transferor's unused input tax cannot be absorbed by or transferred to the Transferee. The above sentence contemplates only a statutory merger or consolidation that, by operation of law, results in a "dissolved corporation" and a "surviving or new corporation".


4. Cost Or Basis In Tax-Free Exchanges

RR 18-2001, 13 NOV. 2001
Guidelines on monitoring basis of Property in Tax-free exchange
Basis. — A. Substituted Basis of Stock or Securities Received by the Transferor. — The substituted basis of the stock or securities received by the transferor on a tax-free exchange shall be as follows:
1. The original basis of the property, stock or securities to be transferred;
2. Less: (a) money received, if any, and (b) the fair market value of the other property received, if any;
3. Plus: (a) the amount treated as dividend of the shareholder, if any, and (b) the amount of any gain that was recognized on the exchange, if any.
However, the property received as 'boot' shall have as basis its fair market value. The term "boot" refers to the money received and other property received in excess of the stock or securities received by the transferor on a tax-free exchange.
If the transferee of property assumes, as part of the consideration to the transferor, a liability of the transferor or acquires from the latter property subject to a liability, such assumption or acquisition (in the amount of the liability) shall, for purposes of computing the substituted basis, be treated as money received by the transferor on the exchange.
Finally, if the transferor receives several kinds of stock or securities, the Commissioner is authorized to allocate the basis among the several classes of stocks or securities.
B. Substituted Basis of the Transferred Property in the Hands of the Transferee. The substituted basis of the property transferred in the hands of the transferee shall be as follows:
(a) the original basis in the hands of the transferor;
(b) Plus: the amount of the gain recognized to the transferor on the transfer.
C. The Original Basis of Property to be Transferred. The original basis of the property to be transferred shall be the following, as may be appropriate:
(a) The cost of the property, if acquired by purchase on or after March 1, 1913;
(b) The fair market price or value as of the moment of death of the decedent, if acquired by inheritance;
(c) The basis in the hands of the donor or the last preceding owner by whom the property was not acquired by gift, if the property was acquired by donation.
If the basis, however, is greater than the fair market value of the property at the time of donation, then, for purposes of determining loss, the basis shall be such fair market value; or,
(d) The amount paid by the transferee for the property, if the property was acquired for less than an adequate consideration in money or money's worth.
(e) The adjusted basis of (a) to (d) above, if the acquisition cost of the property is increased by the amount of improvements that materially add to the value of the property or appreciably prolong its life less accumulated depreciation.
(f) The substituted basis, if the property was acquired in a previous tax-free exchange under Section 40(C)(2) of the Tax Code of 1997.
D. Basis for Determining Gain or Loss on a Subsequent Sale or Disposition of Property Subject of the Tax-free Exchange.
The substituted basis as defined in Section 40(C)(5) of the Tax Code of 1997, and implemented in Section 2.A and 2.B above, shall be the basis for determining gain or loss on a subsequent sale or disposition of property subject of the tax-free exchange.
Submission of Information on the Basis of Properties. — The parties to a tax-free exchange of property for shares under Section 40(C)(2) of the Tax Code of 1997 who are applying for confirmation that the transaction is indeed a tax-free exchange shall, together with such information as the Commissioner of Internal Revenue may require, submit the following:
(a) A sworn certification on the basis of the property to be transferred pursuant to such exchange. The basis of each real property/share of stock or other property transferred must be itemized in the certification in order to enable the BIR to determine the basis for subsequent disposition and to make it possible for the Register of Deeds or the corporate secretary, as the case may be, to annotate the information on such basis for each property/share of stock on the reverse side of the Transfer Certificate of Title/Condominium Certificate of Title of the real property involved, or of Certificate of Stock. The sworn declaration must be executed by the transferor himself, or in case the transferor is a juridical entity, by an official with rank of no less than the Chief Financial Officer or his equivalent. The Commissioner of Internal Revenue is authorized to prescribe the form in which such sworn declaration shall appear.
(b) Certified true copies of the Transfer Certificates of Title and/or Condominium Certificates of Title of the real properties to be transferred;
(c) Certified true copies of the corresponding latest Tax Declaration of the real properties to be transferred. It is understood that any improvement is separately declared and therefore, covered by a Tax Declaration distinct from the Tax Declaration on the land. Further, if the tax declaration was issued three (3) or more years prior to the exchange transaction, the Transferor shall include in the certification by the local government unit's Assessor that such tax declaration is the latest tax declaration covering the real property;
(d) Certified true copies of the certificates of stocks evidencing shares of stock to be transferred; and
(e) Certified true copy of the inventory of other property/ies to be transferred.
No certification/ruling will be issued by the Bureau of Internal Revenue unless the foregoing requirements, in addition to such other documents that the Commissioner of Internal Revenue may require, are submitted.
Information to be Contained in Certification/Ruling by the Bureau of Internal Revenue. — All certifications or rulings issued by the Bureau of Internal Revenue confirming that an exchange of property for shares complies with the provisions of Section 40(C)(2) of the Tax Code of 1997 shall include a statement on the substituted basis of the property transferred.
Conditions for the Issuance of Certificate Authorizing Registration (CAR) or Tax Clearance (TCL). — The CAR/TCL for the real property or share of stock/unit of participation/interest involved in the exchange shall be issued by the Revenue District Officer/Authorized Internal Revenue Officer on the basis of the certification or ruling to be issued in triplicate by the Commissioner or his duly authorized representative to the effect that the transaction qualifies as a tax-free exchange under Section 40(C)(2) of the Tax Code of 1997.
The CAR/TCL to be issued shall specify, among others, that the transaction involved is a tax-free exchange under Section 40(C)(2) of the Tax Code of 1997; the date of exchange; and the substituted basis of the properties as stated in the certification or ruling issued by the Bureau of Internal Revenue.

5. Assumption of Liability in Tax free Exchanges

a. If the taxpayer receives stock or securities which would be permitted to be received without the recognition of the gain if it were the sole consideration, and as part of the consideration, another party to the exchange assumes a liability of the taxpayer, subject to a liability, then such assumption or acquisition shall not be treated as money and or property, and shall not prevent the exchange from being within the exceptions.
b. If the amount of the liabilities assumed plus the amount of the liabilities to which the property is subject exceed the total of the adjusted basis of the property transferred pursuant to such exchange, then such excess shall be considered as a gain from the sale or exchange of a capital asset or of property which is not a capital asset. Sec 40 ( c ) (4), NIRC

6. Business Purpose

Gregory v. Helvering, 293 U.S. 465

Facts: Petitioner in 1928 was the owner of all the stock of United Mortgage Corporation. For the sole purpose of procuring a transfer of these shares to herself in order to sell them for her individual profit, and, at the same time, diminish the amount of income tax which would result from a direct transfer by way of dividend, she sought to bring about a 'reorganization' under section 112(g) of the Revenue Act of 1928. To that end, she caused the Averill Corporation to be organized under the laws of Delaware on September 18, 1928. Three days later, the United Mortgage Corporation transferred to the Averill Corporation the 1,000 shares of Monitor stock, for which all the shares of the Averill Corporation were issued to the petitioner. On September 24, the Averill Corporation was dissolved, and liquidated by distributing all its assets, namely, the Monitor shares, to the petitioner. No other business was ever transacted, or intended to be transacted, by that company. Petitioner immediately sold the Monitor shares for $133,333. 33. She returned for taxation, as capital net gain, the sum of $76,007.88, based upon an apportioned cost of $57,325.45. It is not disputed that if the interposition of the so-called reorganization was ineffective, petitioner became liable for a much larger tax as a result of the transaction.
The Commissioner of Internal Revenue, being of opinion that the reorganization attempted was without substance and must be disregarded, held that petitioner was liable for a tax as though the United corporation had paid her a dividend consisting of the amount realized from the sale of the Monitor shares. In a proceeding before the Board of Tax Appeals, that body rejected the commissioner's view and upheld that of petitioner. Upon a review of the latter decision, the Circuit Court of Appeals sustained the commissioner and reversed the board, holding that there had been no 'reorganization' within the meaning of the statute. 69 F.(2d) 809. Petitioner applied for a writ of certiorari, which the government, considering the question one of importance, did not oppose.

Held: The writ was granted. Section 112 of the Revenue Act of 1928 deals with the subject of gain or loss resulting from the sale or exchange of property. Such gain or loss is to be recognized in computing the tax, except as provided in that section. The provisions of the section, so far as they are pertinent to the question here presented, follow:
'Sec. 112. ... (g) Distribution of Stock on Reorganization. If there is distributed, in pursuance of a plan of reorganization, to a shareholder in a corporation a party to the reorganization, stock or securities in such corporation or in another corporation a party to the reorganization, without the surrender by such shareholder of stock or securities in such a corporation, no gain to the distributee from the receipt of such stock of securities shall be recognized. ...
'(i) Definition of Reorganization. As used in this section ...
'(1) The term 'reorganization' means ... (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred. ... '
It is earnestly contended on behalf of the taxpayer that since every element required by the foregoing subdivision (B) is to be found in what was done, a statutory reorganization was effected; and that the motive of the taxpayer thereby to escape payment of a tax will not alter the result or make unlawful what the statute allows. It is quite true that if a reorganization in reality was effected within the meaning of subdivision ( B), the ulterior purpose mentioned will be disregarded. The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted. But the question for determination is whether what was done, apart from the tax motive, was the thing which the statute intended. When subdivision (B) speaks of a transfer of assets by one corporation to another, it means a transfer made 'in pursuance of a plan of reorganization' (section 112(g) of corporate business; and not a transfer of assets by one corporation to another in pursuance of a plan having no relation to the business of either, as plainly is the case here. Putting aside, then, the question of motive in respect of taxation altogether, and fixing the character of the proceeding by what actually occurred, what do we find? Simply an operation having no business or corporate purpose-a mere device which put on the form of a corporate reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of corporate shares to the petitioner. No doubt, a new and valid corporation was created. But that corporation was nothing more than a contrivance to the end last described. It was brought into existence for no other purpose; it performed, as it was intended from the beginning it should perform, no other function. When that limited function had been exercised, it immediately was put to death.
In these circumstances, the facts speak for themselves and are susceptible of but one interpretation. The whole undertaking, though conducted according to the terms of subdivision (B), was in fact an elaborate and devious form of conveyance masquerading as a corporate reorganization, and nothing else. The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction upon its face lies outside the plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.

7. Payment of Capital Gains Tax and DST on an extra-judicial foreclosure of banks

RR No. 4-99, 9 March 1999
Further Amending Revenue Memorandum Order No. 29-86 dated September 3, 1986, as Amended by Revenue Memorandum Order No. 16-88 dated April 18, 1988, Relative to the Payment of Capital Gains Tax and Documentary Stamp Tax on Extra-Judicial Foreclosure Sale of Capital Assets Initiated by Banks, Finance and Insurance Companies
Foreclosure of Mortgage Provision Under Presidential Decree No. 1529, Otherwise Known as "Property Registration Decree". — Section 63 of P.D. No. 1529, otherwise known as the "Property Registration Decree" provides as follows:
Foreclosure of Mortgage. — (a) If the mortgage was foreclosed judicially, a certified copy of the final order of the court confirming the sale shall be registered with the Register of Deeds. If no right of redemption exists, the certificate of title of the mortgagor shall be cancelled, and a new certificate issued in the name of the purchaser.
Where the right of redemption exists, the certificate of title of the mortgagor SHALL NOT BE CANCELLED, but the certificate of sale and the order confirming the sale shall be registered by a BRIEF MEMORANDUM thereof made by the Register of Deeds upon the certificate of title. In the event the property is redeemed, the certificate or deed of redemption shall be filed with the Register of Deeds, and a brief memorandum thereof shall be made by the Register of Deeds on the certificate of title of the mortgagor.
If the property is not redeemed, the final deed of sale executed by the sheriff in favor of the purchaser at a foreclosure sale shall be registered with the Register of Deeds; whereupon the title of the mortgagor shall be cancelled, and a new certificate issued in the name of the purchaser.
(b) If the mortgage was foreclosed extrajudicially, a certificate of sale executed by the officer who conducted the sale shall be filed with the Register of Deeds who shall make a brief memorandum thereof on the certificate of title.
In the event of redemption by the mortgagor, the same rule provided for in the second paragraph of this section shall apply.
In case of non-redemption, the purchaser at foreclosure sale shall file with the Register of Deeds, either a final deed of sale executed by the person authorized by virtue of the power of attorney embodied in the deed of mortgage, or his sworn statement attesting to the fact of non-redemption; whereupon, the Register of Deeds shall issue a new certificate in favor of the purchaser after the owner's duplicate of the certificate has been previously delivered and cancelled.
It is clear from the above provision of the "Property Registration Decree" that where the right of redemption of the mortgagor exists, the certificate of title of the mortgagor shall not be cancelled yet even if the property had already been subjected to foreclosure sale, BUT INSTEAD only a brief memorandum shall be annotated at the back of the certificate of title, and the cancellation of the title and the subsequent issuance of a new title in favor of the purchaser/highest bidder depends on whether the mortgagor shall redeem or not the mortgaged property within one year from the issuance of the certificate of sale. Thus, no transfer of title to the highest bidder can be effected yet until and after the lapse of the one-year period from the issuance of the said certificate of sale.
Capital Gains Tax. —
(1) In case the mortgagor exercises his right of redemption within one year from the issuance of the certificate of sale, no capital gains tax shall be imposed because no capital gains has been derived by the mortgagor and no sale or transfer of real property was realized. A certification to that effect or the deed of redemption shall be filed with the Revenue District Office having jurisdiction over the place where the property is located which certification or deed shall likewise be filed with the Register of Deeds and a brief memorandum thereof shall be made by the Register of Deeds on the Certificate of Title of the mortgagor.
(2) In case of non-redemption, the capital gains tax on the foreclosure sale imposed under Secs. 24(D)(1) and 27(D)(5) of the Tax Code of 1997 shall become due based on the bid price of the highest bidder but only upon the expiration of the one-year period of redemption provided for under Sec. 6 of Act No. 3135, as amended by Act No. 4118, and shall be paid within thirty (30) days from the expiration of the said one-year redemption period.
Documentary Stamp Tax. —
(1) In case the mortgagor exercises his right of redemption, the transaction shall only be subject to the P15.00 documentary stamp tax imposed under Sec. 188 of the Tax Code of 1997 because no land or realty was sold or transferred for a consideration.
(2) In case of non-redemption, the corresponding documentary stamp tax shall be levied, collected and paid by the person making, signing, issuing, accepting, or transferring the real property wherever the document is made, signed, issued, accepted or transferred where the property is situated in the Philippines; Provided, That whenever one party to the taxable document enjoys exemption from the tax, the other party thereto who is not exempt shall be the one directly liable for the tax. The tax return prescribed under the Code shall be filed within ten (10) days after the close of the month following the lapse of the one-year redemption period, and the tax due under Sec. 196 of the Tax Code of 1997 shall be paid based on the bid price at the same time the aforesaid return is filed.
Tax Clearance Certificate/Certificate Authorizing Registration. — In case of non-redemption, a tax clearance certificate (TCC) or Certificate Authorizing Registration (CAR) in favor of the purchaser/highest bidder shall only be issued upon presentation of the capital gains and documentary stamp taxes returns duly validated by an authorized agent bank (AAB) evidencing full payment of the capital gains and documentary stamp taxes due imposed under Secs. 3 and 4 of these Regulations on the sale of the property classified as capital asset. The AAB must be located at the Revenue District Office having jurisdiction over the place where the property is located.

C. Losses from Wash Sales of Stock and Securities

SEC. 32., NIRC Gross Income. —
"(A) General Definition. — Except when otherwise provided in this Title, gross income means all income derived from whatever source, including (but not limited to) the following items:
"(1) Compensation for services in whatever form paid, including, but not limited to fees, salaries, wages, commissions, and similar items;
"(2) Gross income derived from the conduct of trade or business or the exercise of a profession;
"(3) Gains derived from dealings in property;
"(4) Interests;
"(5) Rents;
"(6) Royalties;
"(7) Dividends;
"(8) Annuities;
"(9) Prizes and winnings;
"(10) Pensions; and
"(11) Partner's distributive share from the net income of the general professional partnership.
"(B) Exclusions from Gross Income. — The following items shall not be included in gross income and shall be exempt from taxation under this Title:
"(1) Life Insurance. — The proceeds of life insurance policies paid to the heirs or beneficiaries upon the death of the insured, whether in a single sum or otherwise, but if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income.
"(2) Amount Received by Insured as Return of Premium. — The amount received by the insured, as a return of premiums paid by him under life insurance, endowment, or annuity contracts, either during the term or at the maturity of the term mentioned in the contract or upon surrender of the contract.
"(3) Gifts, Bequests, and Devises. — The value of property acquired by gift, bequest, devise, or descent: Provided, however, That income from such property, as well as gift, bequest, devise, or descent of income from any property, in cases of transfers of divided interest, shall be included in gross income.
"(4) Compensation for Injuries or Sickness. — Amounts received, through Accident or Health Insurance or under Workmen's Compensation Acts, as compensation for personal injuries or sickness, plus the amounts of any damages received, whether by suit or agreement, on account of such injuries or sickness.
"(5) Income Exempt under Treaty. — Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines.
"(6) Retirement Benefits, Pensions, Gratuities, etc. —
"(a) Retirement benefits received under Republic Act No. 7641 and those received by officials and employees of private firms, whether individual or corporate, in accordance with a reasonable private benefit plan maintained by the employer: Provided, That the retiring official or employee has been in the service of the same employer for at least ten (10) years and is not less than fifty (50) years of age at the time of his retirement: Provided, further, That the benefits granted under this subparagraph shall be availed of by an official or employee only once. For purposes of this Subsection, the term 'reasonable private benefit plan' means a pension, gratuity, stock bonus or profit-sharing plan maintained by an employer for the benefit of some or all of his officials or employees, wherein contributions are made by such employer for the officials or employees, or both, for the purpose of distributing to such officials and employees the earnings and principal of the fund thus accumulated, and wherein it is provided in said plan that at no time shall any part of the corpus or income of the fund be used for, or be diverted to, any purpose other than for the exclusive benefit of the said officials and employees.
"(b) Any amount received by an official or employee or by his heirs from the employer as a consequence of separation of such official or employee from the service of the employer because of death, sickness or other physical disability or for any cause beyond the control of the said official or employee.
"(c) The provisions of any existing law to the contrary notwithstanding, social security benefits, retirement gratuities, pensions and other similar benefits received by resident or nonresident citizens of the Philippines or aliens who come to reside permanently in the Philippines from foreign government agencies and other institutions, private or public.
"(d) Payments of benefits due or to become due to any person residing in the Philippines under the laws of the United States administered by the United States Veterans Administration.
"(e) Benefits received from or enjoyed under the Social Security System in accordance with the provisions of Republic Act No. 8282.
"(f) Benefits received from the GSIS under Republic Act No. 8291, including retirement gratuity received by government officials and employees.
"(7) Miscellaneous Items. —
"(a) Income Derived by Foreign Government. — Income derived from investments in the Philippines in loans, stocks, bonds or other domestic securities, or from interest on deposits in banks in the Philippines by (i) foreign governments, (ii) financing institutions owned, controlled, or enjoying refinancing from foreign governments, and (iii) international or regional financial institutions established by foreign governments.
"(b) Income Derived by the Government or its Political Subdivisions. — Income derived from any public utility or from the exercise of any essential governmental function accruing to the Government of the Philippines or to any political subdivision thereof.
"(c) Prizes and Awards. — Prizes and awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement but only if:
"(i) The recipient was selected without any action on his part to enter the contest or proceeding; and
"(ii) The recipient is not required to render substantial future services as a condition to receiving the prize or award.
"(d) Prizes and Awards in Sports Competition. — All prizes and awards granted to athletes in local and international sports competitions and tournaments whether held in the Philippines or abroad and sanctioned by their national sports associations.
"(e) 13th Month Pay and Other Benefits. — Gross benefits received by officials and employees of public and private entities: Provided, however, That the total exclusion under this subparagraph shall not exceed Thirty thousand pesos (P30,000) which shall cover:
(i) Benefits received by officials and employees of the national and local government pursuant to Republic Act No. 6686;
(ii) Benefits received by employees pursuant to Presidential Decree No. 851, as amended by Memorandum Order No. 28, dated August 13, 1986;
(iii) Benefits received by officials and employees not covered by Presidential Decree No. 851, as amended by Memorandum Order No. 28, dated August 13, 1986; and
(iv) Other benefits such as productivity incentives and Christmas bonus: Provided, further, That the ceiling of Thirty thousand pesos (P30,000) may be increased through rules and regulations issued by the Secretary of Finance, upon recommendation of the Commissioner, after considering, among others, the effect on the same of the inflation rate at the end of the taxable year.
"(f) GSIS, SSS, Medicare and Other Contributions. — GSIS, SSS, Medicare and Pag-Ibig contributions, and union dues of individuals.
"(g) Gains from the Sale of Bonds, Debentures or other Certificate of Indebtedness. — Gains realized from the sale or exchange or retirement of bonds, debentures or other certificate of indebtedness with a maturity of more than five (5) years.
"(h) Gains from Redemption of Shares in Mutual Fund. — Gains realized by the investor upon redemption of shares of stock in a mutual fund company as defined in Section 22(BB) of this Code.

RR-2
Sec. 131. Losses from wash sales of stock and securities – (a) A taxpayer cannot deduct any loss claimed to have been sustained from the sale or other disposition of stock or securities, if, within a period beginning thirty days before the date of such sale or disposition and ending thirty days after such date (referred to in this section as the sixty-one-day period), he has acquired (by purchase or by an exchange upon which the entire amount of gain or loss was recognized by law), or has entered into a contract or option so to acquire, substantially identical stock or securities. However, this prohibition does not apply in the case of a dealer in stock or securities if the sale or other disposition of stock or securities is made in the ordinary course of its business as such dealer.
(b) Where more than one loss is claimed to have been sustained within the taxable year from the sale or other disposition of stock or securities, the provisions of this section shall be applied to the losses in the order in which the stock or securities the disposition of which resulted in the respective losses were disposed of (beginning with the earliest disposition). If the order of disposition of stock or securities disposed of at a loss on the same day cannot be determined, the stock or securities will be considered to have been disposed of in the order in which they were originally acquired (beginning with earliest acquisition).
(c) Where the amount of stock or securities acquired within the sixty-one-day period is less than the amount of stock or securities sold or otherwise disposed of, then the particular shares of stock or securities the loss from the sale or other disposition of which is not deductible shall be those with which the stock or securities acquired are matched according to the following rule:
The stock or securities acquired will be matched in accordance with the order of their acquisition (beginning with the earliest acquisition) with an equal number of shares of stock, or securities sold or otherwise disposed of.
(d) Where the amount of stock or securities acquired within the sixty-one-day period is not less than the amount of stock or securities sold or otherwise disposed of, then the particular shares of stocks or securities the acquisition of which resulted in the non-deductibility of the loss shall be those with which the stock or securities disposed of are matched in accordance with the following rule:
The stock or securities sold or otherwise disposed of will be matched with an equal number of the shares of stock or securities acquired in accordance with the order of acquisition (beginning with the earliest acquisition) on the stock securities acquired.
(e) The acquisition of any share of stock or any security which results in the non-deductibility of a loss under the provisions of this section shall be disregarded in determining the deductibility of any other loss.
(f) The word “acquired” as used in this section means acquired by purchase or by an exchange upon which the entire amount of gain or loss was recognized by law, and comprehends cases where the taxpayer has entered into a contract or option within the sixty-one-day period to acquire by purchase or by such an exchange.


D. Exemption from Capital Gains Tax of Certain Individuals from the Sale or Exchange of Principal Residence

Sec. 24, NIRC. Income Tax Rates.
(D) Capital Gains from Sale of Real Property. —
"(1) In General. — The provisions of Section 39(B) notwithstanding, a final tax of six percent (6%) based on the gross selling price or current fair market value as determined in accordance with Section 6(E) of this Code, whichever is higher, is hereby imposed upon capital gains presumed to have been realized from the sale, exchange, or other disposition of real property located in the Philippines, classified as capital assets, including pacto de retro sales and other forms of conditional sales, by individuals, including estates and trusts: Provided, That the tax liability, if any, on gains from sales or other dispositions of real property to the government or any of its political subdivisions or agencies or to government-owned or -controlled corporations shall be determined either under Section 24(A) or under this Subsection, at the option of the taxpayer;
"(2) Exception. — The provisions of paragraph (1) of this Subsection to the contrary notwithstanding, capital gains presumed to have been realized from the sale or disposition of their principal residence by natural persons, the proceeds of which is fully utilized in acquiring or constructing a new principal residence within eighteen (18) calendar months from the date of sale or disposition, shall be exempt from the capital gains tax imposed under this Subsection: Provided, That the historical cost or adjusted basis of the real property sold or disposed shall be carried over to the new principal residence built or acquired: Provided, further, That the Commissioner shall have been duly notified by the taxpayer within thirty (30) days from the date of sale or disposition through a prescribed return of his intention to avail of the tax exemption herein mentioned: Provided, still further, That the said tax exemption can only be availed of once every ten (10) years: Provided, finally, That if there is no full utilization of the proceeds of sale or disposition, the portion of the gain presumed to have been realized from the sale or disposition shall be subject to capital gains tax. For this purpose, the gross selling price or fair market value at the time of sale, whichever is higher, shall be multiplied by a fraction which the unutilized amount bears to the gross selling price in order to determine the taxable portion and the tax prescribed under paragraph (1) of this Subsection shall be imposed thereon.

RR No. 13-99 as amended by RR No. 14-2000 dated November 20, 2000.
Revenue regulation No. 13-99 as amended by RR No. 14-2000 requires the taxpayer to have actually commenced with the construction of her new principal residence or has actually entered into a contract for the purchase of her new principal residence within eighteen (18) months from the date of sale or disposition with the intention of using the entire proceeds of sale for the acquisition or construction of said principal residence, so that the sale of the principal residence remains exempt from the payment of capital gains tax under section 24 (D) (2) of the NIRC.