TAX-FREE EXCHANGES OF PROPERTIES PURSUANT TO SECTION 40(C)(2) OF THE NATIONAL INTERNAL REVENUE CODE (NIRC) OF 1997, AS AMENDED
Tax-free exchanges refer to those instances enumerated in Section 40(C)(2) of the NIRC of 1997, as amended, that are not subject to Income Tax, Capital Gains Tax, Documentary Stamp Tax and/or Value-added Tax, as the case may be.
In general, there are two kinds of tax-free exchange: (1) reorganization; and (2) transfer to a controlled corporation.
In the first instance, no gain or loss shall be recognized on a corporation or on its stock or securities if such corporation is a party to a reorganization and exchanges property in pursuance of a plan of reorganization solely for stock or securities in another corporation that is a party to the reorganization. A reorganization is defined as:
(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; or
(b) The acquisition by one corporation, in exchange solely for all or a part of its voting stock, or in exchange solely for all or part of the voting stock of a corporation which is in control of the acquiring corporation, of stock of another corporation if, immediately after the acquisition, the acquiring corporation has control of such other corporation whether or not such acquiring corporation had control immediately before the acquisition; or
(c) The acquisition by one corporation, in exchange solely for all or a part of its voting stock or in exchange solely for all or part of the voting stock of a corporation which is in control of the acquiring corporation, of substantially all of the properties of another corporation. In determining whether the exchange is solely for stock, the assumption by the acquiring corporation of a liability of the others shall be disregarded; or
(d) A recapitalization, which shall mean an arrangement whereby the stock and bonds of a corporation are readjusted as to amount, income, or priority or an agreement of all stockholders and creditors to change and increase or decrease the capitalization or debts of the corporation or both; or
(e) A reincorporation, which shall mean the formation of the same corporate business with the same assets and the same stockholders surviving under a new charter.
In the second instance, no gain or loss shall be recognized if property is transferred to a corporation by a person, alone or together with others, not exceeding four (4) persons, in exchange for stock or unit of participation in such a corporation of which as a result of such exchange the transferor or transferors, collectively, gains or maintains control of said corporation.
Section 40(C)(2) to 40(C)(6) of the NIRC of 1997, as amended.
TAX TREATMENT OF EXCHANGES OF PROPERTIES MADE PURSUANT TO SECTION 40(C)(2) OF THE NIRC, AS AMENDED
The transfers of properties in exchange for shares of stocks made pursuant to Section 40(C)(2) of the NIRC, as amended, shall be exempt from the following taxes:
a. Capital Gains Tax (CGT);
b. Creditable Withholding Tax (CWT);
c. Income Tax (IT);
d. Donor’s Tax (DT);
e. Value-Added Tax (VAT); and
f. Documentary Stamp Tax (DST) on conveyances of real properties and shares of stocks
However, the original issuance of shares in exchange for the properties transferred shall be subject to the DST under Section 174 of the same Code.
PROCEDURES AND COMPLIANCE REQUIREMENTS:
A. VENUE FOR THE ISSUANCE OF THE CERTIFICATE AUTHORIZING REGISTRATION (CAR)
For purposes of the issuance of the CAR for the transferred properties pursuant to the tax-free reorganization/exchange, the parties to the transaction shall submit the documentary requirements to the Revenue District Office (RDO) having jurisdiction over the place where the property is located, in case of a real property, or in case of shares of stock, the RDO where the issuing corporation is registered.
In case the transaction involves transfer of multiple real properties and/or shares of stocks situated in various locations covered by different RDOs, the CAR shall be processed with the RDO having jurisdiction over the place where the transferee corporation is registered.
The CAR should specify, among others, that the transaction involved is a tax-free exchange under Section 40(C)(2) of the NIRC of 1997, as amended, the date of transaction, and the substituted basis of the properties subject therefor.
B. CONDUCT OF POST-TRANSACTION AUDIT
Following issuance of the corresponding CAR on the transactions falling under Section Section 40(C)(2) of the NIRC of 1997, as amended, the concerned RDO shall conduct a post-audit of said transactions pursuant to existing revenue issuances on tax audit and assessment, to determine the taxability thereof.
If after audit, the transaction is found to be not entitled to the tax deferment treatment under Section 40(C)(2) of the NIRC of 1997, as amended, the transaction shall be subject to the applicable taxes, plus interest, penalty and surcharge. However, the result of the audit shall not invalidate the CAR previously issued for the transfer of the properties.
The parties to the transaction are duty bound to prove compliance with the conditions laid down by the law and the requirements set forth under existing revenue issuances in the availment of the tax exemption.
C. PRIOR BIR CONFIRMATION OR TAX RULING
In all the instances of tax free-exchanges under Section 40(C)(2) of the NIRC of 1997, as amended, a prior Bureau of Internal Revenue (BIR) confirmation or tax ruling shall not be required for purposes of availing the tax exemption. The concerned parties can implement the transaction including, but not limited to, the issuance of the Certificate Authorizing Registration (CAR) by the concerned RDO.
The taxpayer, however, is not precluded from requesting a ruling/legal opinion with the Law and Legislative Division (LLD) of the National Office in order to clarify legal issue/s that may affect the transactions made pursuant to Section 40(C)(2) of the NIRC of 1997, as amended, including the taxability of such transaction. The LLD shall evaluate whether or not the request involves question/s of law that would merit the issuance of a ruling. Otherwise, it shall endorse the request to the concerned RDO for appropriate action.
CHECKLIST OF REQUIRED DOCUMENTS (click here)
Related Revenue and Other Issuances.
Revenue Memorandum Circular No. 19-2022 (Providing Clarification and Guidance on Section 8 of Revenue Regulations (RR) No. 5-2021 on the Tax-Free Exchanges of Properties Under Section 40(C)(2) of the National Internal Revenue Code (Tax Code) of 1997, as Amended by Republic Act (RA) No. 11534 or the CREATE.)
Revenue Regulations (RR) No. 18-2001 (Guidelines on the Monitoring of the Basis of Property Transferred and Shares Received, Prescribing Penalties for Failure to Comply with such Guidelines, and Authorizing the Imposition of Fees for the Monitoring Thereof)
Revenue Memorandum Rulings (RMR) 1-2001 (Tax Consequences of Tax-free Exchange of Property for Shares of Stock of a Controlled Corporation)
Revenue Memorandum Order (RMO) No. 32-2001 (Guidelines Implementing RR 18-2001 on the Monitoring of the Basis of the Property Transferred & Shares of Stock Received Pursuant to Section 40(C)(2) of the Tax Code of 1997, Revising & Updating the Requirements & Conditions Precedent to the Non-Recognition of Gain or Loss in Transactions Falling Thereunder, & Prescribing the Forms Therefor)
Revenue Memorandum Rulings (RMR) 02-02 (Determination of Substituted Basis of Property Transferred and Shares Received, Pursuant to Section 40(C)(5) of the National Internal Revenue Code of 1997)
Revenue Regulations (RR) No. 010-11 (Amending Certain Provisions of Revenue Regulations No. 16-2005 as Amended by Revenue Regulations No. 4-2007, otherwise known as the Consolidated Value-added Tax Regulations of 2005, as Amended)
Revenue Memorandum Order (RMO) No. 09-2014 (Requests for Rulings with the Law and Legislative Division) provides the guidelines in the processing of requests for rulings with the Law and Legislative Division.