One of the main considerations of businesses on whether or not to pursue a reorganization is the potential delay caused by the processing of the regulatory requirements to complete a tax-free transaction.
To recall, the recognition of gains or losses in determining income taxes is merely deferred for these tax-free exchange or TFE transactions. Any gain or loss will be recognized when the properties or shares are subsequently transferred. Consequently, there is a need to properly monitor the substituted basis of the properties transferred through TFE transactions to avoid any potential tax leak. Thus, the Bureau of Internal Revenue imposes regulatory safeguards to monitor the substituted basis of properties transferred through TFE transactions.
One of the regulatory safeguards previously imposed by BIR to monitor the substituted basis was the requirement to obtain confirmatory rulings on the tax-free nature of the transaction from BIR. A confirmatory ruling was previously required before parties to a TFE transaction could obtain a Certificate Authorizing Registration. The CAR is necessary to allow the registration of the title of properties to the name of the transferee. However, securing the confirmatory ruling has been considered, in certain cases, to be a time-consuming process that has caused delays in implementing reorganizational projects.
In Commissioner v. Lucio L. Co, et. al. (G.R. No. 241424, 26 February 2020), the Supreme Court held that a confirmatory ruling is not a pre-requisite or a condition for a transaction to be considered a TFE transaction. This decision was validated in CREATE, which now clearly provides that a confirmatory ruling is not a requirement for transactions to qualify as tax-free.
Pursuant to this new provision in CREATE, BIR issued Revenue Regulation No. 5-21 on 08 April 2021. The said regulation states that parties can implement their TFE transaction and obtain a CAR without a tax ruling. The transaction will, however, be subject to a post-transaction audit.
The BIR further issued Revenue Memorandum Circular No. 19-2022 on 5 February 2022 which authorized its Revenue District Offices or RDOs to process and issue CARs for TFE transactions without a confirmatory ruling. As part of the application for a CAR, the parties need to submit a sworn certification/affidavit by the transferor of the acquisition cost and the original or the adjusted basis (as the case may be) of each property to be transferred. The application for CAR shall be filed in the RDO (1) having jurisdiction over the place where the property is located, in case of real property; (2) where the issuing corporation is registered, in the case of shares of stock; and (3) having jurisdiction over the place where the transferee corporation is registered, in case the transaction involves the transfer of multiple real properties and/or shares of stock situated in various jurisdictions covered by different RDOs. Note that it is the taxpayers’ duty to prove their compliance with the conditions and the requirements to avail of the tax exemption.
Following the issuance of the CAR, the RDO is tasked to conduct an audit to determine whether or not the transaction properly qualifies as a TFE. If the transaction is determined not to qualify as a TFE transaction, the parties shall be required to pay the appropriate taxes, plus interest, penalty, and surcharge. This notwithstanding, the CAR previously issued shall not be invalidated. To mitigate the exposure to interest, penalty, and surcharge, parties may seek clarification of any legal issue/s that may affect the nature of the transaction as a TFE. For this purpose, the parties may seek a ruling/legal opinion from the Law and Legislative Division of the BIR National Office.
It is hoped that these streamlined processes for availing of tax exemptions for TFE transactions will attenuate any apprehension of businesses seeking to efficiently reorganize their business structure.
***
For more of Dean Nilo Divina’s legal tidbits, please visit www.divinalaw.com. For comments and questions, please send an email to cabdo@divinalaw.com.