Tax Articles

Valuation of Shares of Stock

By Atty. Fulvio D. Dawilan

Fulvio D. Dawilan Managing Partner   +632 8403 2001 loc.310 This email address is being protected from spambots. You need JavaScript enabled to view it. View Profile

As a rule, net capital gains realized from the sale, barter, exchange, or other disposition of shares of stock in a domestic corporation, except those sold or disposed of through the stock exchange, are subject to the capital gains tax of 15%. Unless exemption or special rules are applicable, this rule uniformly applies regardless of whether the shareholder is an individual or corporation, foreign or domestic, citizen or non-citizen.

In arriving at the capital gain, the costs associated with the acquisition of the shares shall be deducted from the selling price. Thus, the two important information in determining the taxable net capital gain are the selling price and the cost—so important that they may give rise to disputes between the taxpayer and the tax authorities if not fully substantiated.

For the cost, as long as there are documents to support the subscription or purchase price and other related costs, these should suffice for purposes of deductibility. Hence, it is prudent to preserve the related documents, as these may be needed years later when the shares are disposed.

The rule related to selling price is another important matter. For this, the rules had been changing. Prior to 2008, the fair market value (FMV) of the shares was considered to be the selling price of the shares transferred or exchanged. And the book value of the shares was prima facie considered as the FMV. The book value was then used as the selling price in computing the capital gain if it was higher than the actual consideration. In other words, net capital gains were computed based on the actual consideration/selling price or the FMV/book value, whichever is higher, less the costs. Hence, the excess of the FMV/book value of the shares over the actual selling price were effectively captured in computing the net capital gain. No other taxes were attached, even if selling prices were lower than the book value.

This treatment of the excess FMV over the actual selling price and the determination of the FMV changed starting in 2008. The excess of the FMV/book value of the shares over the actual consideration is no longer considered in computing the net capital gain. For purposes of computing the net capital gain, the selling price shall be the total consideration based on the sales document. The FMV of the shares is not considered when computing the net capital gain.

But the FMV is still relevant in the sale of shares. In case the FMV of the shares sold is greater than the selling price, the excess is deemed a gift subject to another type of tax, which is the donor’s tax. In essence, if the selling price is indeed inadequate in comparison to the actual value, there is in effect a gift equivalent to the difference.

And what is considered the FMV of the shares? Prior to the current rule, the FMV of the shares was required to be determined based on the Adjusted Net Asset Method. Under this method, all the assets and liabilities are adjusted to their fair market values. The net of adjusted assets minus the liability values is the indicated value of the equity. Hence, a reference needs to be made to the adjusted (appraised) assets and liabilities of the company that issued the shares.

In 2020, that method of determining the FMV was abandoned. Our existing regulations provide for the basis of the FMV of the shares. For common shares of stock, the book value based on the latest available financial statements duly certified by an independent public accountant prior to the date of sale but not earlier than the immediately preceding taxable year, shall be considered as the prima facie fair market value. For preferred shares of stock, the liquidation value shall be considered as fair market value. The book value need no longer be adjusted to include any appraisal surplus not included in the financial statements to determine the FMV of the shares.

Hence, while the role of the FMV of shares in a sale transaction and the method of its determination have been changing, one thing remains clear: it is still relevant. Now, it is determined by simply referring to the book value based on the late audited financial statement. To avoid the possible imposition of donor’s tax on the sale of the shares, the selling price should at least be equal to or higher than the book value of the shares sold. Otherwise, this may attract a donor's tax.

Still, I believe that this deemed donation should be applied in relation to the qualification provided in the Tax Code—that a sale, exchange, or other transfer of property made in the ordinary course of business will be considered as made for an adequate and full consideration. This means that there is still no donation, despite the inadequacy in price versus the book value, if the sale is done in the ordinary course of business, free from donative intent. There could still be deviation from the book value of the shares as the FMV, provided that there are justifications.