Dear Atty. Gab,

Musta Atty! I hope you can shed some light on a situation my family is facing. Last year, my siblings (there are three of us in total) and I decided to formalize our small family business. We transferred a piece of land that we co-owned into a new corporation we set up, “Hizon Family Ventures Inc.” In exchange for the land, the corporation issued shares to the three of us. Before this, we didn’t own any shares in this new company, of course. After the transfer, the three of us became the sole shareholders, collectively owning 100% of the company.

At the time, our accountant advised us that we needed to pay Capital Gains Tax (CGT) on the transfer of the land, treating it like a sale. We followed the advice and paid a significant amount in CGT, thinking it was the correct procedure. However, recently, a business associate mentioned that certain transfers of property to a corporation in exchange for shares might be tax-free, especially if it results in gaining control of the company.

Now we’re confused and worried. Did we make a mistake paying the CGT? If the transaction was indeed tax-exempt, is there any way for us to recover the taxes we paid? We acted in good faith based on the advice given, but we don’t want to have paid taxes unnecessarily, especially since the amount was quite substantial for our starting business. We would really appreciate your guidance on whether we might be entitled to a refund and what steps we should consider. Maraming salamat po!

Sincerely,
Maria Hizon

Dear Maria,

Musta Atty! Thank you for reaching out and sharing your situation. I understand your concern about potentially paying Capital Gains Tax (CGT) unnecessarily on the transfer of your family’s land to your new corporation, Hizon Family Ventures Inc.

Based on your description, there’s a strong possibility that the transaction qualifies as a tax-exempt exchange under Philippine law. Specifically, the National Internal Revenue Code (NIRC) provides that no gain or loss (and therefore no CGT) is recognized when property is transferred to a corporation by a person or group (up to five persons) solely in exchange for shares, resulting in that person or group gaining control of the corporation. Since you and your two siblings transferred the land and collectively gained 100% control of the new corporation, your transaction appears to fit the criteria for this tax exemption. The fact that you already paid the CGT doesn’t prevent you from seeking a refund if it was paid erroneously.

When Swapping Property for Shares Doesn’t Trigger Tax

The situation you described touches upon a specific provision in our tax laws designed to facilitate corporate structuring and transfers without immediate tax consequences, provided certain conditions are met. This principle is primarily governed by Section 40(C)(2) of the National Internal Revenue Code (NIRC) of 1997, as amended.

This section allows for what is commonly known as a tax-free exchange. The law explicitly states:

“(C) Exchange of Property. –
x x x x
“No gain or loss shall also be recognized if property is transferred to a corporation by a person in exchange for stock or unit of participation in such a corporation of which as a result of such exchange said person, alone or together with others, not exceeding four (4) persons, gains control of said corporation: Provided, That stocks issued for services shall not be considered as issued in return for property.” (Section 40(C)(2), NIRC of 1997, as amended)

This means that if you transfer property (like the land you mentioned) to a corporation, and in return, you receive shares of that corporation, any potential gain you might have realized from the increase in the value of the property is not taxed at the time of the exchange. The key conditions are: (1) Property is transferred; (2) It’s exchanged solely for shares in a corporation; (3) The transferor (or a group of up to five transferors, like you and your siblings) gains ‘control’ of the corporation as a result of this exchange.

The term ‘control’ is crucial here and is specifically defined by the law:

In relation thereto, Section 40(C)(6)(c) of the same Code defines the term “control” as “ownership of stocks in a corporation possessing at least fifty-one percent (51%) of the total voting power of all classes of stocks entitled to vote.”

In your case, you and your two siblings (a total of three persons) transferred land to Hizon Family Ventures Inc. and received 100% of the shares in return. Since three persons are well within the limit of five, and 100% ownership clearly constitutes ‘control’ (being more than the required 51%), your transaction squarely fits the requirements outlined in Section 40(C)(2). Therefore, no CGT should have been due on the transfer.

It’s important to note that jurisprudence confirms this applies even if the transferors gain further control, not just initial control. The focus is on the collective control achieved by the small group of transferors after the exchange.

“Since the term “control” is clearly defined as “ownership of stocks in a corporation possessing at least fifty-one percent of the total voting power of classes of stocks entitled to one vote” x x x the exchange of property for stocks x x x clearly qualify as a tax-free transaction under paragraph 34 (c) (2) [now Section 40(C)(2)] of the same provision.” (As cited in CIR v. Co, G.R. No. 241424, referencing the principle from CIR v. Filinvest Dev’t. Corp.)

You mentioned being advised to pay CGT and only later learning about the potential tax exemption. This leads to the question of whether you needed prior approval or a ruling from the Bureau of Internal Revenue (BIR) to avail of this exemption. The Supreme Court has clarified that a prior confirmatory ruling is not a prerequisite for the tax exemption itself, nor is it required to claim a refund for erroneously paid taxes based on such an exemption.

“The BIR should not impose additional requirements not provided by law, which would negate the availment of the tax exemption. x x x Instead of resorting to formalities and technicalities, the BIR should have made its own determination of the merits of respondents’ claim for exemption in respondents’ administrative application for refund.” (CIR v. Co, G.R. No. 241424)

This means your failure to secure a BIR ruling before the transaction or before paying the tax does not prevent you from claiming the exemption now and seeking a refund. The basis for the refund is the erroneous payment itself, stemming from the transaction qualifying under Section 40(C)(2).

Practical Advice for Your Situation

• Verify the Transaction Details: Confirm that the transfer involved only the land in exchange for shares, with no other consideration (like cash) received. The exemption applies to exchanges solely for stock.
• Gather Documentation: Collect all relevant documents, including the Deed of Exchange or Transfer, the corporate documents of Hizon Family Ventures Inc. (Articles of Incorporation, Stock Ledgers showing share issuance), proof of the land transfer (title transfer), and importantly, the proof of CGT payment (tax returns, receipts).
• Check the Prescriptive Period: Under Section 229 of the NIRC, claims for refund of erroneously paid taxes must be filed with the BIR within two (2) years from the date of payment. Ensure you are still within this timeframe. Act quickly if the deadline is approaching.
• File Administrative Claims: Each sibling who paid CGT must file a formal written claim for refund with the Revenue District Office (RDO) where the tax was paid. Clearly state the grounds for the refund (i.e., tax-exempt exchange under Section 40(C)(2) NIRC) and the amount claimed.
• Prepare for BIR Review: The BIR will likely examine your claim and documents to verify that all conditions for the tax-free exchange were met. Be ready to provide further information if requested.
• Consider Judicial Claim if Necessary: If the BIR denies your claim or fails to act on it within 180 days (though inaction allows filing earlier depending on the two-year limit), you may need to file a Petition for Review with the Court of Tax Appeals (CTA) within 30 days from denial or before the two-year period expires, whichever comes first.
• Consult a Tax Professional: While this information provides guidance, navigating the refund process can be complex. It’s highly advisable to engage a tax lawyer or accountant experienced in handling BIR refund claims to assist you with the filing and follow-up.

It seems you have a strong basis to claim a refund for the CGT paid, given that your transaction aligns well with the requirements for a tax-free exchange under Philippine law. The key is to act within the two-year prescriptive period and properly substantiate your claim with the BIR. The principles discussed here are based on established provisions of the NIRC and interpretations affirmed by Philippine jurisprudence.

Should you have further questions or need assistance with the refund process, please feel free to reach out.

Sincerely,
Atty. Gabriel Ablola

For more specific legal assistance related to your situation, please contact me through gaboogle.com or via email at connect@gaboogle.com.

Disclaimer: This correspondence is provided for informational purposes only and does not constitute legal advice. For specific legal guidance tailored to your situation, please schedule a formal consultation.