Philippines : Beware of Donor's Tax on Share Sales

In the Philippines, a recent case on donor’s tax has reminded me of the peculiarities of the Philippines tax system in regard to share sales.

Background

The case is called Sara Lee.

The taxpayer is a US LLC in the Sara Lee group. It sold its 100% shareholding in a Philippines subsidiary to a third party.

The taxpayer actually made a capital loss on the sale – in other words, its sale consideration was less than its cost base in the shares which were sold.

However, if the numbers were around the other way, such that it made a capital gain, that gain would be exempt from Philippines tax under the capital gains article (Article 14) of the Philippines / US treaty – assuming, of course, that the US LLC qualified as a resident under that treaty.

Donor's tax

But here’s the interesting thing. 

Regardless of whether the US LLC made a capital gain or capital loss on the sale transaction, it might be liable for Philippines donor’s tax.

Donor’s tax is separate from income tax.

It applies whenever property is transferred for a price which is less than the fair market value of the property.

In regard to unlisted shares, the fair market value is deemed to be the book value of the shares, in the balance sheet of the target company (in this Sara Lee case, this would be the Philippines subsidiary which was sold).

Example

Let's assume these numbers :

• The sale consideration for the shares (remember, this is a third party transaction) is $100
• The cost base of the shares is $150
• And the book value of the shares (in the balance sheet of the Philippines target company) is $120

What would happen?

Firstly, there would be a capital loss, computed as $150 minus $100 = $50 capital loss. This would mean that the seller would not be subject to income tax, in the Philippines, on the sale.

And secondly, there would be a “deemed gift”, computed as $120 minus $100 = $20. In other words, the seller would be seen as having given property “worth” $120, for a sale consideration of only $100.

That gift would be subject to donor’s tax at a 30% rate – so, the tax would be $6. And no treaty exemption from that tax, because donor’s tax is not covered by the Philippines / US treaty. And just to emphasise the point : donor’s tax can apply in regard to third party transactions.

That’s one to look out for.

 Please note : The above text is taken from Dbriefs Bytes, 24 February 2017