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By: Euney Marie J. Mata-Perez on September 26,2019

IN sale of shares outside the facilities of the stock exchange, gain is calculated by deducting cost from the higher of the selling price or the fair market value of the shares sold. Unlike valuation of land, our National Internal Revenue Code (Tax Code) does not contain any express provision prescribing how to determine fair market value of shares of stock of corporations for taxation purposes. This gave the tax authorities some leeway in determining share valuation.

In financial parlance, “fair market value” is commonly known as the “arm’s length price.” It is generally the price at which buyers and sellers with a reasonable knowledge of pertinent facts and not acting under any compulsion are willing to do business. (Merriam Webster). Thus, in the case of listed shares sold, transferred, or exchanged outside the facilities of our stock exchange, the closing price on the day when the shares are sold, transferred, or exchanged, is deemed to be their fair market value.

However, our present valuation rules on sale of unlisted shares of stock imposes requirements which may not truly reflect the real value or fair market value of the shares.

Revenue Regulations (RR) 6-2008 (The Consolidated Regulations Prescribing the Rules on the Taxation of Sale, Barter, Exchange or Other Disposition of Shares of Stock Held As Capital Assets) prescribe that the book value of unlisted shares of stock, as shown in the financial statements duly certified by an independent certified public accountant nearest to the date of sale, shall be the fair market value. With the use of the word “shall,” the book value per financial statements became the mandatory and sole basis for determining the fair market value of the shares.

RR 6-2008, however,was amended by RR 6-2013. RR 6-2013 prescribes that for purposes of determining fair market value of unlisted shares, the adjusted net asset method shall be used whereby all assets and liabilities are adjusted to fair market values. And if there are underlying real assets, such assets shall be valued based on appraised values.

On the other hand, under RR 2-82 (the old regulations governing sale of shares), the book value of the unlisted shares is only prima facie evidence of their fair market value. It means that the book value of the shares is not a mandatory or the sole indicator of the share values. Such RR allows the taxpayer to justify deviation from the book value in share valuation due to other reasons such as nature of business and financial history of the enterprise, economic outlook in general, financial condition of the business, earning capacity of the company, existence of corporate debts in favor of controlling shareholders, difficulty in liquidating the assets, market price of similar stocks, restrictive agreements impairing inalienability, etc. Thus, the valuation prescribed in RR 2-82 is more reasonable because it considers other several factors which affect valuation but are not reflected in the financial statements.

In any case, the appraised values of the underlying assets is not also the sole and correct indicator of the intrinsic and real value of shares of stock sold. In other words, the requirement of pegging the value of the unlisted shares of stock at the book value, or even the adjusted book value under the adjusted net asset method is a myopic method of calculating share valuation, which results in taxing unrealized income and double taxation. It also pegs share valuation based on standards which may not really be the correct indicators of what is the fair market value or the real, or intrinsic value of the unlisted shares of stock being sold or bought. More importantly, it prejudices stockholders, especially the minority stockholders.

When purchasing shares of stock, a buyer buys into a company, or a business, taking into consideration several factors, not just the value of the assets of the company. It is for this reason that in valuing a company, valuation experts look at several factors and use various valuation methods such as the so-called enterprise value and discounted cash flow methods, among others. None of these valuation methods used by valuation experts use the appraised values of the underlying assets of a company.

The use of the so-called adjusted net asset method prescribed by RR 6-2013 also results in the taxation of unrealized gain, or gains which do not yet add real value to the seller. Gains are realized (and thus, should be taxed) only when there is a separation from capital of something with exchangeable value, resulting in the receipt of income or inflow of wealth. The properties appraised are not being sold when the shares are sold.

Also, using the adjusted net asset method results in double taxation, since the fair market value of the underlying properties (the higher of the fair market values as shown in BIR zonal values or the fair market values determined by the provincial or city assessors) will also be used when such properties are being sold ultimately. It should also be stressed that it is only when such properties are sold, that there is “separation from capital” and their real gains are realized. Therefore, it should only be at that point that the gains from sale of the properties should be taxed.

Lastly, the appraisal of underlying properties entails additional costs. It prejudices small or minority stockholders who may want to sell their shares, but will have the burden of paying the appraisal costs of all the real assets of the issuing company.

On the basis of the above, this author believes that it is about time our BIR revisits and reviews RR 6-2013 and the method of share valuation it prescribes.

Revisiting BIR rules on valuation of unlisted shares of stock

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Euney Marie J. Mata-Perez

Mark Anthony P. Tamayo

Gerardo Maximo V. Francisco