Donor's Tax on Share Sales: Fair Market Value and Donative Intent

The Supreme Court's 2014 decision in Philippine American Life and General Insurance Company v. Secretary of Finance and Commissioner of Internal Revenue (G.R. No. 210987) clarifies two important points for taxpayers: when a sale of shares at a price below book value may trigger donor's tax, and which court has jurisdiction to review certain BIR rulings. The case is a practical reminder that even genuine commercial transactions can carry tax consequences under Philippine law.

The Facts of the Case

Philamlife owned nearly half of the outstanding shares of PhilamCare, a health maintenance organization. In 2009, the company decided to divest from the industry and sold its shares through a competitive bidding process. STI Investments emerged as the highest bidder, and the shares were sold for about PhP 104 million.

After paying the capital gains tax and documentary stamp tax, Philamlife sought a BIR ruling confirming that the sale was not subject to donor's tax. The company argued that the transaction was conducted at arm's length, in the ordinary course of business, and without any donative intent.

The BIR's Position

The Commissioner of Internal Revenue denied the request. The BIR noted that the selling price was lower than the book value of the shares based on PhilamCare's 2008 financial statements. Citing the provision of the National Internal Revenue Code (NIRC) on transfers for less than adequate and full consideration, the BIR ruled that the difference between the fair market value and the selling price was deemed a gift subject to donor's tax.

The BIR applied its implementing rules, which define the fair market value of unlisted shares as their book value as shown in financial statements nearest to the date of sale. The Secretary of Finance affirmed this ruling.

The Jurisdictional Issue

A significant part of the decision concerns procedure. Philamlife appealed to the Court of Appeals, which dismissed the case for lack of jurisdiction, ruling that the Court of Tax Appeals (CTA) should hear the matter.

The Supreme Court agreed. Under Section 7 of Republic Act No. 1125, the CTA has exclusive appellate jurisdiction over "other matters arising under the National Internal Revenue Code." While the NIRC gives the Secretary of Finance power to review the Commissioner's interpretations of tax laws, the Court held that appeals from the Secretary's rulings should go to the CTA, not the Court of Appeals.

The Court also addressed the concern that the CTA cannot rule on the validity of revenue regulations. Citing its ruling in City of Manila v. Grecia-Cuerdo, the Court held that the CTA has the power to issue writs of certiorari in cases within its appellate jurisdiction. This means the CTA can now rule on the validity of a revenue regulation when that issue arises in a tax case before it.

Donative Intent Is Not Required

On the substantive issue, the Court made a crucial point: the absence of donative intent does not exempt a transaction from donor's tax. The NIRC provision on transfers for less than adequate and full consideration states that when property is transferred for less than adequate and full consideration, the difference between the fair market value and the consideration is "deemed a gift."

This is a donation by fiction of law. Even if the parties had no intention to make a gift, the law treats the price difference as one. The Court also held that the implementing rules do not alter the NIRC provision but merely set the parameters for determining fair market value.

The Court rejected the argument that the revenue memorandum circular was being applied retroactively. The circular merely called for the strict application of the NIRC provision, which was already in force when the sale occurred.

Practical Takeaways

• Book value matters for unlisted shares. For shares not traded on a stock exchange, the BIR uses book value as the fair market value. Selling below book value can trigger donor's tax on the difference, even in a legitimate arm's length transaction.

• Donative intent is irrelevant under the deemed gift rule. The law deems the price difference a gift regardless of the parties' intentions. Taxpayers should not assume that a bona fide business transaction is automatically exempt.

• Competitive bidding does not guarantee exemption. Even a sale through open bidding can result in donor's tax if the price falls below the BIR's determined fair market value.

• Know the correct forum for appeals. Rulings of the Commissioner on tax interpretations are reviewed by the Secretary of Finance, but appeals from the Secretary's decision go to the Court of Tax Appeals, not the Court of Appeals.

• The CTA can now address validity issues. Taxpayers can raise the invalidity of a revenue regulation before the CTA when it is incidental to a tax dispute, thanks to the Court's ruling on the CTA's certiorari power.

This article is general information and not legal advice. For your specific situation, consult a lawyer or ask ASG Legal AI.