REVISED SHARE VALUATION RULES: A WELCOME DEVELOPMENT
By: Atty. Euney Marie Mata-Perez on August 27,2020.
Taxpayers recently received some good news on how capital gains tax on the sale of unlisted shares of stocks is now calculated. This came in the form of the Bureau of Internal Revenue’s (BIR) issuance of Revenue Regulations (RR) 20-2020, which revised the valuation rules set by RR 6-2013. RR 20-2020 states that the book value (BV) of common shares, as shown in the latest audited financial statements (AFS) of the issuing company, that were issued prior to the transaction shall be considered their prima facie fair market value (FMV). It also prescribes how to calculate the BV of preferred shares.
The National Internal Revenue Code, as amended (Tax Code), prescribes that, when determining any net capital gains for unlisted shares that would be subject to any capital gains tax, the cost of the shares shall be deducted from the higher of the selling price or the shares’ FMV. However, unlike in the valuation of real property, the Tax Code does not prescribe how the FMV of unlisted shares of stock is determined. (For real property, the Tax Code says that, for purposes of computing any internal revenue tax, the value of the property shall be the higher of the zonal value, as determined by the Commissioner of Internal Revenue [CIR] or the market value as shown in the schedule of values of the provincial or city assessors). This gave the CIR the power to determine how to value shares of stock, especially those not listed on any stock exchange.
RR 6-2008, which details the consolidated rules on the sale or disposition of shares of stock held as capital assets, prescribed that the FMV of unlisted shares of stocks shall be the BV of such shares as shown in the AFS nearest to the date of sale. Note that it used “shall,” indicating that the rule is mandatory. It did not provide any exception.
RR 2-82 — the old regulations — on the other hand, prescribed that the BV of the unlisted shares nearest to the valuation or transaction date “shall be prima facie considered” as their FMV. In using the term prima facie, RR 2-82 allowed for deviation from the use of BV in certain instances, provided that supporting evidence is shown. RR 2-82 enumerated these circumstances, which include economic outlook in general, financial condition of the business, difficulty in liquidating assets and earning capacity. RR 2-82 thus recognized that the BV in the AFS may not truly reflect the real fair value of the shares in some cases. The Covid-19 pandemic would have justified such a deviation because many businesses suffered. Thus, the BV as of Dec. 31, 2019 — the end of the prior taxable year — no longer reflects the current real value of the business or the shares issued.
In RR 6-2013, the BIR modified the rule and mandated the use of an “adjusted net asset” method, where the underlying assets of the issuing company were required to be adjusted to “FMV.” In this regard, if the company has real assets, RR 6-2013 prescribed that these shall be appraised and their value in the books adjusted to the higher of the FMV as determined by the CIR, the FMV as shown in the assessors’ schedule, and the FMV of the real assets as determined by an independent appraiser.
The use of this method was controversial. It resulted in the taxation of unrealized gain, or gains that do not yet add real value to the seller, since the properties appraised are yet to be sold when the shares are sold. It was also viewed to have resulted in double taxation, since the FMV of the underlying properties (the higher of the FMVs as shown in BIR zonal values or the FMVs determined by the provincial or city assessors) will also be used when such properties are ultimately sold. Lastly, the appraisal of underlying properties entails additional costs and prejudices small or minority stockholders who may want to sell their shares but have the burden of paying the appraisal costs of all the real assets of the issuing company.
Now RR 20-2020 provides that, for common shares of stock, the BV based on the latest available AFS prior to the date of sale, but not earlier than the immediately preceding taxable year, shall be considered as their prima facie FMV. It is noteworthy that RR 20-2020 reverted to the use of prima facie as embodied in RR 2-82, although it did not enumerate the instances when deviation from the use of the BV could arise. But certainly, this opens up the possibility that the BV per AFS may not be considered the only proper benchmark in determining the FMV of unlisted shares.
RR 20-2020 also provides that for preferred shares of stock, the liquidation value, which is equal to the redemption price of the preferred shares as of the balance sheet date nearest to the transaction date, including any premium and cumulative preferred dividends in arrears, shall be considered as their FMV. It also provides that if there are common shares and preferred shares, the BV per common share is computed by deducting the liquidation value of the preferred shares from the total equity of the corporation and dividing the result by the number of outstanding common shares as of balance sheet date nearest to the transaction date.
Indeed, the issuance of RR 20-2020 is a most welcome development.