Finally, tax-free exchange of property | Inquirer Business

Finally, tax-free exchange of property

/ 07:23 AM November 22, 2022

Our tax laws provide for tax-free exchange of property, where a maximum of four people may transfer property (either shares of stock or real property) to a corporation in exchange for shares of stock, resulting in the transferors gaining control of the corporation. The law provides that no gain shall be recognized such that certain taxes are also not assessed.

In general, there are two kinds of tax-free exchange: (1) merger or consolidation and (2) transfer to a controlled corporation.


Businesses may decide to utilize such transfers to maximize efficiency and operations by performing (a) mergers or consolidations, (b) acquisition of a controlled corporation, (c) acquisition of all or substantially all properties of another corporation, (d) recapitalization, and (e) reincorporation.

Transfers of property to a controlled corporation under the tax-free provision have sometimes been associated with tax and estate planning or avoidance of a higher rate of taxation.


These tax-free transfers are exempt from capital gains tax, creditable withholding tax, income tax, donor’s tax, value added tax, and documentary stamp taxes on the conveyance of real property and shares of stocks.

Notably, the tax-free nature is actually not perpetually tax-free, but simply a deferment or suspension of the taxes which are to be assessed and paid should the property transferred be sold or transferred subsequently.

The tax-free exchange provision is found in Sec. 40(c)(2) of Republic Act No. 8424 or the 1997 National Internal Revenue Code (Tax Code) which provides that – No gain or loss shall be recognized if property is transferred to a corporation by a person(s), not exceeding four, in exchange for stock or unit of participation in such corporation which as a result of such exchange the person(s) gains control of the corporation. Control being holding least 51 percent of total voting power of all classes of stocks entitled to vote.

Because of the tax-free nature of the transfer, the Bureau of Internal Revenue (BIR) has certainly not made it easy for taxpayers to avail themselves of this provision. It had issued regulations requiring that taxpayers must apply and secure a ruling or certification from the BIR as a requirement for the tax-free exchange. Without this BIR Ruling or certification, the BIR will not issue the Certificate Authorizing Registration (CAR) which is required for the transfer and registration of ownership of shares of stock and certificates of titles to property, and shall consider any such transaction as taxable.

Taxpayers who have undergone this process are all too familiar with the time, effort, and expense that this process entails. Notably, a few years back there was even a period involving several years where the BIR did not issue any ruling or certification or, made it very difficult to obtain one, effectively putting a pause to this provision of law.

Two recent developments have finally given life to the spirit and words of the law, as Congress had intended for it to be.

In 2020, the Supreme Court decided the case of Commissioner of Internal Revenue vs. Lucio Co, et al. (G.R. No. 241424, February 24, 2020) where it declared that since the Tax Code does not require a prior confirmatory ruling the for availment by the taxpayer of the tax-free exchange under Sec. 40 (C)(2) of the Tax Code, the BIR should not impose the additional requirements of securing a ruling or certification as it had done via Revenue Regulations No. 18-2001, Revenue Memorandum Order Nos. 32-2001 and 17-2002.


Then, on April 11, 2022, the Corporate Recovery and Tax Incentives for Enterprises Act or CREATE law (Republic Act No. 11535) took effect where the tax-free exchange provision in the Tax Code was affirmed with two important additions to Sec. 40 (C)(2). These are: 1.) No prior confirmatory or tax ruling from the BIR is required, and 2.) The tax-free exchange transfer will result in the transferor gaining control or maintaining control of the recipient corporation.

The original provision of the Tax Code provided that the transferor gains control of the corporation which suggests that if the transferor was already in control of the corporation before the transfer, it may not qualify as a tax-free exchange. The law has now clarified that transfers which result in continued control of the corporation by the transferor also qualify as a tax-free exchange.

As a result of the foregoing developments, the BIR has come out with Revenue Memorandum Circular No. 19-2022 on Feb 4, 2022 confirming that:

a. No BIR tax ruling is required for the availment of the tax-free exchange of property under the Tax Code, as amended by the CREATE law.
b. Taxes are deferred or suspended and any gain or loss shall be recognized when the properties or shares are subsequently transferred.
c. The substituted valuation of the properties transferred and shares received are to be established and monitored in order that in their subsequent sale or disposition, they shall be taxed properly.
d. The transfer of properties in exchange for shares of stock shall be exempt from capital gains tax, creditable withholding tax, income tax, donor’s tax, value added tax, and documentary stamp taxes on the conveyance of real property and shares of stocks. However, original issuance of shares of stock of the corporation in exchange for the properties transferred shall be subject to the DST.
e. Reporting requirements are set such as including in the income tax return of the parties the facts of non-recognition of gain or loss on the exchange and annotation on the certificates of shares and of titles the original or historical cost of acquisition of the property.
f. The Revenue District Office of the BIR shall conduct a post-audit of the transaction
g. While the certification or ruling is no longer required, taxpayers may still request for an opinion from the BIR.

Aside from the welcome changes above, there have been recent developments and changes to our tax environment which are worth mentioning.

1. The TRAIN law which took effect last Jan 1, 2018 changed the rate of inheritance and estate taxes from the graduated rate of 5 percent to 20 percent to a single flat rate of 6 percent. (Republic Act No. 10963).

2. There is still the Estate Tax Amnesty with the extended deadline of until June 14, 2023 and the estates of those who died on or before Dec 31, 2017 can avail of the rate of 6 percent of the net estate without penalties. (Republic Act No. 11213, RR No. 6-2019, Republic Act No. 11569, and RR No. 17-2021)

3. The TRAIN law also simplifies the donor’s tax schedule which was previously from 2 percent to 15 percent to a single rate of 6 percent of total gifts in excess of P250,000.

4. All the foregoing considered, the capital gains taxes for the sale of capital assets which are real estate remains at 6 percent. On the other hand, the CREATE law has increased the capital gains tax on sales of shares of stock not traded in the stock exchange from 5 percent and 10 percent to a flat rate of 15 percent.

The foregoing changes harmonized the previous tax laws and rates, which to some extent influenced people to avail of the tax-free exchange of property under the Tax Code. With the rationalization of the tax rates, some people, particularly those who considered tax-free exchanges mainly as a form of estate planning, may no longer find the need to resort to the tax-free exchange provision in the Tax Code.

(The author, Atty. John Philip C. Siao, is a practicing lawyer and founding partner of Tiongco Siao Bello & Associates Law Offices, a Professor at the MLQU School of Law, and an Arbitrator of the Construction Industry Arbitration Commission of the Philippines. He may be contacted at [email protected] The views expressed in this article belong to the author alone.)

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