“Divestment and exit plans” by Jonald R. Vergara (May 3, 2010)
SUITS THE C-SUITE By Jonald R. Vergara
Business World (05/03/2010)
Many foreign investors in the Philippines are visibly rechanneling their investments after years of riding out their joint ventures.
A number of multinational companies are shifting priorities, opting to concentrate on their core assets or, more simply, to focus on more vibrant markets. Some see the political uncertainty brought about by the forthcoming elections as having a dampening effect on investments in private companies.
Whatever the reason, the divestments that we have recently seen have triggered the implementation of so-called exit plans of these foreign investors.
A standard exit strategy provides a mechanism for just compensation or return of capital, post-termination obligations, dispute resolution, and even tax settlement. Forward-looking investors study the tax implications of their exit plans even before Day One to avoid surprises on the day of reckoning. However, what may have been considered as well-crafted strategic exit plans can be tipped over by ambivalent tax policies and the ever-changing legislative landscape.
Generally, the sale of shares of stock not listed and traded in the stock exchange is subject to capital gains tax (CGT) and documentary stamp tax (DST). DST, which may be shouldered by the buyer, is imposed at the rate of 75 centavos for every P200 or 0.375% of the total par value of the shares sold. For shares without par value, the DST is equivalent to 25% of the tax paid upon original issuance of the shares. The DST return must be filed, and the tax paid, not later than the fifth day of the month following the month when the sale document was executed.
CGT is due on the seller and computed at the rate of 5% on the first P100,000 net capital gain and 10% in excess thereof. The CGT return must be filed and the tax paid within 30 days from signing of the sale document.
Failure to pay the CGT and DST due within the prescribed periods results in penalties, including 25% surcharge of the tax due and interest at the rate of 20% per annum.
Disposing shares is not a simple taxable event. Already complicated as it is, issues that usually crop up include valuation, legal as against beneficial ownership, and the tedious process of securing tax treaty relief for certain investors to avail of the preferential tax rates.
For CGT purposes, net capital gain is the difference between the selling price and the acquisition cost of the shares. The selling price is the fair market value (FMV) which, in the case of unlisted shares, is presumed to be the book value of the shares based on the audited financial statements of the company nearest the date of sale. The acquisition cost is the purchase price plus other costs paid by the seller in acquiring the shares, which must be documented to avoid questions from the Bureau of Internal Revenue (BIR). In most cases, establishing historical cost is easier said than done.
Revenue Regulations (RR) 6-2008 provides that if the FMV of the shares is higher than the consideration received by the seller, the difference shall be deemed a gift subject to 30% donor’s tax. This recent provision in the regulations is a contentious issue for taxpayers. Although the BIR cites Section 100 of the Tax Code as basis, there is reasonable ground to argue that donor’s tax should not apply to a sale transaction conducted purely for business considerations, since there is clearly no intent to donate on the part of the seller.
The Tax Code and RR 6-2008 require that transfer of ownership of shares of stock shall be registered in the books of the corporation only upon the issuance of a tax clearance and Certificate Authorizing Registration (CAR) by the BIR. The Corporate Secretary shall not record the sale in the stock and transfer book, cancel the stock certificate in the name of the seller, nor issue a new certificate to the buyer, unless these clearances are secured. The BIR, however, will not issue the tax clearance and CAR until it is proved that the appropriate taxes are paid or that the transaction is otherwise tax-exempt.
Thus, prior to the issuance of the required BIR clearances and the subsequent entry in the books of the corporation, the transferor is still considered the legal owner of the shares even as the beneficial ownership has effectively been conveyed to the transferee.
The procedure gets more complicated when a non-resident seller claims exemption from CGT pursuant to a tax treaty. Tax treaties, under certain conditions, grant relief from CGT on the gain derived by a non-resident seller of shares in a Philippine company. Revenue Memorandum Order 1-2000 outlines the treaty relief procedure and requires the seller to file the application and complete supporting documents with the BIR’s International Tax Affairs Division (ITAD) at least 15 days before the transaction.
The Court of Tax Appeals has ruled in a number of cases, starting from the Mirant Philippines case in 2005, that availing a tax treaty provision must be preceded by an application filed with the BIR ITAD. Thus, a non-resident will be taxed according to the provisions of the Tax Code, which imposes a 30% tax rate, unless it is shown that the treaty provisions apply and the option to claim the benefits under the treaty has been successfully invoked.
But in a move that has disturbed previous tax rulings on the redemption or buyback of shares by Philippine companies from foreign investors, the BIR last year ruled that the difference between the redemption price and the par value of shares should be subject to dividend tax, since it is considered a distribution of accumulated profits and not a sale subject to capital gain. Prior to the issuance of this ruling to US company Becton Dickinson Infusion Therapy Systems, Inc., the BIR has always treated the income from redemption of shares as capital gain, which may be tax-free provided the requirements for capital gain exemption under the existing relevant treaty are met.
Much as the Philippines would prefer a commitment strategy over an exit strategy from foreign investors, opportunities elsewhere have prompted some multinationals to set their sights on other countries. Foreign capitalists naturally plan their strategy before unloading their stocks and it may be worthwhile to wait for more favorable conditions.
For investors who are in for the long haul, it may be prudent to tweak their exit plans to take into account factors that need to be managed somehow — such as shifting tax policies — even if they are beyond one’s control.
(Jonald R. Vergara is a Tax Senior Director of SGV & Co.)
This article was originally published in the BusinessWorld newspaper. It is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.