INCOME TAXATION | Laws, Principles and Applications

CHAPTER 6
CAPITAL GAINS TAXATION

CLASSIFICATION OF TAXPAYER’S PROPERTIES

1. Ordinary assets – assets used in business, such as:

a. 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
b. Real property held by the taxpayer primarily for sale to customers in the
ordinary course of his trade or business
c. Real property used in trade or business of a character which is subject to
the allowance for depreciation
d. Real property used in trade or business of the taxpayer

Business is habitual engagement in a commercial activity involving the

regular sale of goods or services for a profit. Non-profit entities are not
businesses

Basically, ordinary assets are:

a. Assets held for sale – such as inventory
b. Assets held for use – such as supplies and items of property plant and
equipment like buildings, property improvements, and equipment

2. Capital assets – any asset other than ordinary assets

Basically, capital assets are:

1. Personal (non-business) assets of individual taxpayers
2. Business assets of any taxpayers which are:
a. Financial assets – such as cash, receivables,, prepaid expenses and
investments
b. Intangible assets – such as patent, copyrights, leasehold rights;
franchise rights

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ANALYSISOF PROPERTIES HELD BY TAXPAYERS

Asset classification is relative

The classification of assets or properties as ordinary asset or capital asset does
not depend upon the nature of the property but upon the nature of the
taxpayer’s business and its usage by the business.

Example:
1. A domestic stock is an ordinary asset to a dealer in securities but is a
capital asset to a non-security dealer.

A “dealer in securities” is a merchant of stocks or securities with a registered

place or business, regularly engaged in the purchase of securities and their re-
sale to customers.

2. A vacant and unused lot is an ordinary asset to a taxpayer engaged in

the real estate business such as realty dealer, realty developer, or lessor
but is a capital asset to those not engaged in the real estate business.

Interestingly, the revenue regulations classify real and other properties acquired
(ROPA) by banks as ordinary assets even if banks are not actually engaged in
the realty business. This is an apparent recognition of the fact that ROPA are
normally acquired and sold by banks in their normal course of business.
However, ROPA in the form of domestic stocks held by banks are capital

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assets. Under RR6-2008, “stocks classified as capital assets” means all stocks
and securities held by taxpayers other than dealers in securities.

Asset Classification Rules

A. A property purchased for future use in business is an ordinary asset
even though this purpose is later thwarted by circumstances beyond the
taxpayer’s control.
B. Discontinuance of the active use of the property does not change its
character previously established as a business property.
C. Real properties used, being used, or have been previously used, in trade
of the taxpayer shall be considered ordinary assets.
D. Properties classified as ordinary assets for being used in business by a
taxpayer not engaged in the real estate business are automatically
converted to capital assets upon showing of proof that the same have not
been used in business for more than 2 years prior to the consummation
of the taxable transaction involving such property.
E. A depreciable asset is an ordinary asset even if it is fully depreciated, or
there is a failure to take depreciation during the period or ownership.
F. Real properties used by an exempt corporation in its exempt operations
are considered capital assets. Exempt corporations are not business.
G. The classification of property transferred by sale, barter or exchange,
inheritance, donation, or declaration or property dividends shall depend
on whether or not the acquirer uses it in business.
H. For real properties subject of involuntary transfer such as expropriation
and foreclosure sale, the involuntariness of such sale shall have no effect
on the classification of such real property.
I. Change in business from real estate to non-real estate business shall not
change the classification of ordinary assets previously held.

Taxpayers engaged in real estate business include real estate dealer, real estate
developer, real estate lessor and taxpayers habitually engaged in real estate
business.

Taxpayers habitually engaged in real estate business include those registered

with the HLURB or HUDCC as dealer or developer or those with at least 6
taxable real estate sales transactions in the preceding year.

TYPES OF GAINS ON DEALINGS IN PROPERTIES

1. Ordinary gain – arises from sale, exchange and other disposition
including pacto de retro sales and other conditional sales of ordinary
assets
2. Capital gain – arises from the sale, exchange, and other disposition
including pacto de retro sales and other conditional sales of capital
assets
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Taxation of Gains on Dealings in Properties

Type of gain Applicable taxation scheme

Ordinary gains Regular income tax
Capital gains General rule: Regular income tax
Exception rule: Capital gains tax

CAPITAL GAINS SUBJECT TO CAPITAL GAINS TAX

There are only two types of capital gains subject to capital gains tax:
1. Capital gains on the sale of domestic stocks sold directly to buyer
2. Capital gains on the sale of real properties not used in business

SCOPE OF CAPITAL GAINS TAXATION

Gains on dealings in capital assets Tax Rates

Gain on sale, exchange, and other disposition of 15% capital gains tax
domestic stocks directly to buyer
Sale, exchange, and other disposition of real property 6% capital gains tax
in the Philippines
Gains from other capital assets Regular income tax

Note: The TRAIN law changed the two-tiered tax structure (5% and 10%) capital gains
tax to a flat 15% tax effective January 1, 2018.

CAPITAL GAIN ON THE SALE, EXCHANGE AND OTHER DISPOSITION OF

DOMESTIC STOCKS DIRECTLY TO BUYER

Domestic Stocks
Domestic stocks are evidence of ownership or rights to ownership in a domestic
corporation regardless of its features, such as:
1. Preferred stocks (participative, cumulative, etc.)
2. Common stocks
3. Stock rights
4. Stock options
5. Stock warrants
6. Unit of participation in any association, recreation, or amusement club
(golf, polo or similar clubs)

The capital gains tax covers not only sales of domestic stocks for cash but also
exchange of domestic stocks in kind and other dispositions such as:
1. Foreclosure of property in settlement of debt
2. Pacto de retro sales – sale with buy back agreement

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3. Conditional sales – sales which will be perfected upon completion of

certain specified conditions
4. Voluntary buy back of shares by the issuing corporation – redemption of
shares which may be re-issued and not intended for cancellation

The term other disposition does not include:

1. Issuance of stocks by a corporation
2. Exchange of stocks for services
3. Redemption of shares in a mutual fund
4. Worthlessness of stocks
5. Redemption of stocks for cancellation by the issuing corporation
6. Gratuitous transfer of stocks

Issue of stocks including treasury stocks

The issue of stocks to stockholders by a corporation is a financing transaction
rather than a sale transaction. The excess of fair value received over the par
value of shares issued is an additional capital to the corporation.

Stocks acquired by the corporation from its shareholders, treasury shares,

cannot be considered assets or investments in accounting sense. The excess of
the consideration received in the re-issuance of treasury stocks called treasury
share premium is an additional capital and is not income.

Under US tax rules, treasury shares can be considered as investments if the

corporation trades on its shares as it would in the shares of other corporations.
As such, the treasury share premium is viewed as a capital gain.

Under the NIRC and RR6-2008, however, there is no express provision taxing
treasury share premium. Hence, treasury share premium should not be
subjected to capital gains tax.

Exchange of stocks for services

The exchange or issue of stocks for services cannot be considered as exchange
for property. No gain or loss can be imputed as it involves payment of expense
in kind.

Redemption of shares in a mutual fund

Gains from redemption of shares in a mutual fund are exempted by the NIRC
from income taxation.

Worthlessness of stocks
The value of stocks becoming worthless is considered a capital loss subject to
the rules of regular income tax.

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Redemption of stocks by the issuing corporation

Under RR6-2008, any gain or loss on the mandatory redemption of stocks by
the issuing corporation for the purpose of stock cancellation shall be subject to
the rules of regular income tax. It should be noted, therefore, that the gain by
the investor on redemption of redeemable preferred shares shall be subject to
regular income tax.

Note, however, that this does not include the voluntary buy-back of the shares
by the issuing corporation to be held in treasury which may later on be re-
issued. The gain or loss realized by the investor on voluntary buy-back of
shares by the issuing corporation is taxable under capital gains taxation.

Gratuitous transfer of stocks

The gratuitous transfer of stocks either by way of donation inter-vivos or
donation mortis causa is subject to transfer tax, not to income tax.

MODES OF DISPOSING DOMESTIC STOCKS

Share of stocks may be sold, exchanged or disposed:
1. Through the Philippine Stock Exchange (PSE) or
2. Directly to buyer

TAX ON SALE OF DOMESTIC STOCK THROUGH THE PSE

The sale of domestic stocks classified as capital assets through the PSE is not
subject to capital gains tax. It is subject to a stock transaction tax of 60% of
1% of the selling price effective January 1, 2018. The old law imposed a rate of
50% of 1% on the selling price.

CAPITAL GAINS TAX ON SALE, EXCHANGE, AND OTHER DISPOSITIONS

OF DOMESTIC STOCK DIRECTLY TO BUYER

Nature of the CGT:

1. Universal tax
It applies to all taxpayers disposing stocks classified as capital assets
regardless of classification of the taxpayer. By situs, the on sale of
domestic stocks is within. The tax applies even if the sale is executed
outside the Philippines.

2. Annual tax
It is imposed on the annual net gain on the sale of domestic stocks
directly to buyer.

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The net gain is determined as follows:

Selling price P xxx,xxx

Less:
Basis of stocks disposed P xxx,xxx
Selling expenses xxx,xxx
Documentary stamp tax on the sale* xxx,xxx xxx,xxx
Net capital gain (loss) P xxx,xxx

*The documentary stamp tax is deducted if paid by the seller.

Selling price shall mean:

 In case of cash sale, the total consideration received per deed of sale
 If total consideration is paid partly in money and partly in property, the
sum of money and fair value of property received
 In case of exchanges, the fair value of the property received

Stocks sold for inadequate consideration

The excess of the fair value of the stocks over the selling price is a gift subject
to donor’s tax if so intended by the seller as a donation.

THE CAPITAL GAINS TAX RATE

Tax Rates
NIRC (old law) TRAIN Law
Net gain up to P100,000 5% 15%
Excess net gain above P100,000 10%

The NIRC imposed the two-tiered 5%-10% capital gains tax to all taxpayers
regardless of classification. The TRAIN law simplified the rate to a flat 15% rate
but retained the old two-tiered 5%-10% tax structure for foreign corporations.

Consequently, there are two CGT rates now:

a. Foreign corporation – 5% & 10% CGT
b. Individuals and domestic corporations – 15% CGT

Tax compliance under the old law

There are two aspects of compliance under the previous law:
1. Transactional capital gains tax
2. Annual capital gains tax

TRANSACTIONAL CAPITAL GAINS TAX

The capital gains or losses are required to be reported after each sale,
exchange, and other dispositions through the capital gains tax return, BIR
Form 1707.

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Deadline of the transactional capital gains tax return

The capital gains tax return (BIR Form 1707) shall be filed within 30 days after
each sale, exchange, and other disposition of stocks. If the tax is qualified for
payment under the installment method, the tax is due within 30 days after
each installment.

ANNUALIZED CAPITAL GAINS TAX FOR FOREIGN CORPORATIONS

The CGT is recomputed on the annual net gains then previous tax payments
are treated as tax credit thereto. After such credit, a residual tax due is paid
while excess transactional payment is claimed as tax refund or tax credit.

Deadline of annual capital gains tax return

The annual capital gains tax return, BIR Form 1707-A, shall be filed on or
before the 15th day of the fourth month following the close of the taxable year of
the taxpayer.

ANNUAL CAPITAL GAINS TAX FOR OTHER TAXPAYERS

The change to a 15% flat rate would mean 15% CGT when the transaction
resulted to a gain but would also instantly mean 15% CGT refundable when
the transaction resulted to a loss.

INSTALLMENT PAYMENT OF THE CAPITAL GAINS TAX

When domestic stock is sold in installments, the capital gains tax may also be
paid in installments if the:
a. Selling price exceeds P1,000; and
b. Initial payment does not exceed 25% of the selling price.

SPECIAL TAX RULES IN CAPITAL GAIN OR LOSS MEASUREMENT

1. Wash sales of stocks
2. Tax-free exchanges
a. Exchange of stocks pursuant to a merger or consolidation
b. Transfer of stocks resulting in corporate control

WASH SALES RULE

Wash sale of securities is deemed to occur when within 30 days before and 30
days after the losing sale of securities (also referred to as the 61-day period),
the taxpayer acquired or entered into a contract or option to acquire the same
or substantially identical securities. Capital losses on wash sales by non-
dealers in securities are not deductible against capital gains because they are
effectively unrealized. The taxpayer did totally let go of the shares. The
immediate reacquisition of the shares makes the loss a theoretical or a feigned
loss.

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Securities for purposes of the 61-day rule include stocks and bonds. The wash
sales rule has significance on the recognition of reportable capital losses on
domestic stocks sold directly to buyer.

For the purpose of this rule, substantially identical means that stocks or bonds
of the same class with the same features. A common stock is not substantially
identical to a preferred stock. Participating and non-participating preferred
stocks are not substantially identical.

Rationale of the wash sales rule

The wash sales rule is intended to prevent taxpayers from feigning temporary
losses which could enable them to manipulate their reportable taxable net
gain. Hence, the prohibition against the claim of wash sales is not an absolute
rule but is a form of deferral of loss intended to reflect the economic substance
of the transaction.

The wash sales rule is not applicable to dealers in securities as it is a normal

way of business for them to buy and sell stocks and as a result realize gains or
incur losses within short duration of time.

TAX FREE EXCHANGES

Merger or Consolidation
Stockholders of a domestic corporation may exchange their stocks for the
stocks of another corporation pursuant to a plan of merger or consolidation.

The gains or losses on share-for-share swaps pursuant to a plan of merger or

consolidation will not be recognized for taxation purposes. In a share-swap
pursuant to a plan of merger or consolidation, the shareholders of the acquired
corporation will be integrated in the acquiring corporation. The shares of the
acquired corporations will be called in for replacement with the shares of the
acquiring corporation.

In effect, the transaction merely involves a replacement of shares of stocks of

the shareholders of the absorbed corporation with them being simply
integrated as shareholders of the acquiring corporation.

Initial acquisition of control

No gain or loss shall be recognized if property is transferred to a corporation by
a person in exchange for the stocks or units of participation in such a

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corporation of which as a result of such exchange, said person, alone or

together with others not exceeding four, gains control of said corporation.

“Control” shall mean ownership of stocks in a corporation which amount to at

least 51% of the total voting power of all classes of stocks entitled to vote.

This rule may be relevant only to the capital gains tax of the recognition of
capital gains when stocks are exchanged in the acquisition of corporate control.

Exchange not solely for stocks

In tax-free exchanges, if stocks are exchanged not solely for stocks but with
other consideration such as cash and other properties, the gains but not losses
are recognized up to the extent of cash and other properties received.

Minimum public float requirement of publicly listed corporations

Listed corporations are mandatorily required to maintain a minimum public
ownership under Philippine Stock Exchange (PSE) regulations.

The minimum public ownership is the higher of:

1. The 10% of issued and outstanding shares and
2. The minimum public ownership required by the Securities and Exchange
Commission or the Philippine Stock Exchange.

Non-compliance to the minimum public ownership shall result in the de-listing

of the stocks of the corporation in the PSE. Under RR16-2012, the sale of
listed stocks which fall below their minimum public ownership requirement will
be subject to the 5%-10% capital gains tax and not to the ½ of 1% stock
transaction tax.

Persons not liable to the 15% capital gains tax

1. Dealers in securities
2. Investors in shares of stocks in a mutual fund company in connection
with gains realized upon redemption of stocks in the mutual company
3. All other persons, whether natural or juridical, who are specifically
exempt from national revenue taxes under existing investment incentives
and other special laws, such as:
a. Foreign governments and foreign government-owned and controlled
corporations
b. Qualified employee trust funds

SALE, EXCHANGE, AND OTHER DISPOSITION OF REAL PROPERTY

CLASSIFIED AS CAPITAL ASSET LOCATED IN THE PHILIPPINES
The sale, exchange, and other disposition of real property capital assets in the
Philippines is subject to a tax of 6% of the selling price or the fair value,
whichever is higher.

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Under the NIRC, the fair value of real property is whichever is higher of the:
a. Zonal value, which is the value prescribed by the Commissioner of
Internal Revenue for real properties for purposes of enforcement of
internal laws, and
b. Fair market value, as shown in the schedule of market values of the
Provincial and City Assessors.

Normally, only land has zonal but both land and improvements have fair
market value in the Provincial or Assessor’s Office.

For lands, the capital gains tax is 6% of whichever is the highest of the selling
price (bid price in the case of foreclosure sales), zonal value, or Provincial or
City Assessor’s fair value.

Note that independent appraisal valuation, the fair value commonly used in
financial reporting, is not used in the computation of the capital gains tax.

BIR tax Clearance

No registration of any document transferring real property shall be effected by
the Register of Deeds unless the Commissioner or his duly authorized
representative has certified that such transfer has been reported, and the
capital gains or creditable withholding tax, if any, has been paid.(Sec. 58 (E),
NIRC)

The certificate for purposes of this legal requirement is referred to as the

“Certificate Authorizing Registration (CAR)”.

NATURE OF THE 6% CAPITAL GAINS TAX

a. Presumption of capital gains

The 6% capital gains tax applies even if the sale transaction resulted to a
loss. Gain is always presumed to exist. The basis of taxation is the
selling price or fair value whichever is higher, not the actual gain.

b. Non-consideration to the involuntariness of the sale

The capital gains tax applies even if the sale in involuntary or is forced by
circumstances such as in the case of expropriation sale, foreclosure sale,
dispositions by judicial order, and other forms of forced disposition. It
also applies to conditional sales and pacto de retro sales.

c. Final tax
The capital gains tax shall be withheld by the buyer against the selling
price of the seller and remit the same to the government.

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SCOPE AND APPLICABILITY OF THE 6% CAPITAL GAINS TAX

Location of the property Taxpayers

Individuals Corporations
Within the Philippines All individuals Domestic corporation only
Outside the Philippines Not applicable Not applicable

The 6% capital gains tax is applicable to all individual taxpayers but it applies
only to domestic corporations. The NIRC did not impose final capital gains tax
on foreign corporations. However, in cases where foreign corporations realize
gains from the sale of real property classified as capital assets, the capital gain
shall be subject to the regular income tax.

The sale of real property located abroad is not subject to capital gains tax since
withholding of the capital tax cannot be imposed abroad due to territorial
consideration. Hence, the actual gains realized on the sale, exchange, and
other dispositions of properties abroad are subject to the regular income tax if
the taxpayer is taxable on global income such as resident citizens and domestic
corporations. For all other taxpayers, the capital gain realized abroad is
exempt.

EXCEPTIONS TO THE 6% CAPITAL GAINS TAX

1. Alternative taxation rule
2. Exemption rules
a. Exemption under the NIRC
b. Exemption under special laws

ALTERNATIVE TAXATION
An individual seller of real property capital assets has the option to be taxed at
either:
a. 6% capital gains tax
b. The regular income tax

It should be noted that this is permissible only when:

1. The seller is an individual taxpayer, and
2. The buyer is the government, its instrumentalities or agencies including
government-owned and controlled corporations

Basis of Alternative Taxation

The alternative taxation is intended to ease the burden of government
expropriation where taxpayers may incur losses on the forced expropriation
sale and are still required to pay tax.

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EXEMPTION TO THE 6% CAPITAL GAINS TAX UNDER THE NIRC

The sale, exchange and other disposition of a principal residence for the re-
acquisition of a new principal residence by individual taxpayers is exempt from
the 6% capital gains tax.

Principal residence
Principal residence means the house and lot which is the primary domicile of
the taxpayer. If the taxpayer has multiple residences, his principal residence is
deemed that one shown is his latest tax declaration.

Requisite of exemption:
1. The seller must be a citizen or resident alien.
2. The sale involves the principal residence of the seller-taxpayer.
3. The proceeds of the sale is utilized in acquiring a new principal
residence.
4. The BIR is duly notified by the taxpayer of his intention to avail of the tax
exemption within 30 days of the sale through a prescribed return (BIR
Form 1706) and “Sworn Declaration of Intent.”
5. The reacquisition of the new residence must be within 18 months from
the date of sale.
6. The capital gain is held in escrow in favor of the government.
7. The exemption can only be availed of once in every 10 years.
8. The historical cost or adjusted basis of the principal residence sold shall
be carried over to the new principal residence built or acquired.

It must be emphasized that the sale of principal residence must precede the
acquisition of the new principal residence to be exempt. (BIR Ruling No. 038-
2015)

CAPITAL GAINS TAX EXEMPTION UNDER SPECIAL LAWS

1. Sale of land pursuant to the Comprehensive Agrarian Reform Program
2. Sale of socialized housing units by the National Housing Authority

Sale of land under the Comprehensive Agrarian Reform Program

The sale of agricultural lands by land owners pursuant to the Comprehensive
Agrarian Reform Program of the government shall be exempt from capital gains
tax. Similarly, interest income on the selling price that may have been agreed
by the land owner and the tenant-buyer shall be exempt from income tax.

Sale of socialized housing units by the National Housing Authority

The sale of socialized housing units for the underprivileged and homeless
citizens by the National Housing Authority (NHA) pursuant to the Urban
Development and Housing Act of 1992 is exempt from the capital gains tax.

This exemption is limited to socialized housing units only. The BIR ruled that
the sale of the NHA of commercial lots which is not part of the socialized
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housing project for the poor and homeless is subject to capital gains tax or
regular tax and documentary stamp tax.

To qualify for exemption, the socialized housing units of the NHA must comply
with price ceilings set by the NIRC and other special laws.

PAYMENT OF THE 6% CAPITAL GAINS TAX IN INSTALLMENT

The capital gains tax may be paid in installment if, under the payment terms,
the initial payment does not exceed 25% of the selling price. The “initial
payment” refers to the collections in the taxable year the sale is made.

Deadline for payment of the capital gains tax

The 6% capital gains tax will be filed through BIR From 1706 and is due within
30 days from the date of sale or exchange. For foreclosure sales, it is due
within 30 days from the expiration of the applicable statutory redemption
period. When the tax on the sale is qualified for installment payment, it is due
30 days upon receipt of every installment.

Statutory redemption period on foreclosure sale

Foreclosed properties are subject to a right or redemption by individual
mortgagor within one year counted not from the date of sale but from the time
of registration of the sale in the Office of the Registry of Deeds.
For juridical persons, redemption must be made before the registration of the
certificate of foreclosure sale with the applicable Register of Deeds or within 3
months from foreclosure, whichever is earlier.

DOCUMENTARY STAMP TAX ON THE SALE OF CAPITAL ASSETS

Documentary stamp tax on the sale, exchange, and other dispositions of

domestic stocks directly to a buyer
The sale of domestic stocks is subject to a documentary stamp tax of P1.50 for
every P200 of the par value of the stocks sold. (RA 9243)

Documentary Stamp Tax on the Sale of Real Properties

The sale of real property capital assets is subject to a documentary stamp tax
on the gross selling price or fair market value whichever is higher.

The documentary stamp tax is P15 for every P1,000 and fractional parts of the
tax basis thereof. However, if the government is a party to the sale, the basis
shall be consideration paid.

PENALTIES FOR LATE/NON-FILING OR NON-PAYMENT OF CAPITAL GAINS

TAX
The late filing and payment of capital gains tax at the time or times required by
the law is subject to the same penalties discussed in Chapter 2.

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ENTITIES EXEMPT FROM CAPITAL GAINS TAX

The same lists of entities exempt from final tax in Chapter 5 are likewise
exempt from capital gains tax.

COMPARISON OF THE 6% CGT AND 15% CGT

6% CGT 15% CGT

Tax object Gain on real property Gain on sale of stocks
Basis of the tax Presumed gain Actual gain
Nature of the tax Final tax Self-assessed tax
Frequency of payment Per transaction Transactional and
annual tax

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