Admittedly, taxation is one of the complicated topics we encounter not only in the corporate world, but also in our daily lives. While we can say that it is simply and primarily a system of funding, the purpose of which is to raise revenues for the government, it does tend to get more complicated in practice. As much as lawmakers want it to be comprehensible and simple, there are always considerations of equity, efficiency and enforceability that can make taxation more complex. For this reason, gray areas in taxation cannot be avoided.
During my undergraduate years, whenever I encounter complicated or confusing problems, be it in accounting, audit or taxation, my professors would usually refer me back to the fundamentals. I believe this remains to be applicable, even now that I work as a tax professional.
Recently, the Department of Finance (“DOF”) issued Revenue Regulations (“RR”) No. 20-2020, amending certain provisions of RR No. 6-2013 and RR No. 6-2008 relative to the definition of fair market value (FMV) as it applies to transfers of shares of stocks not listed and traded in the local stock exchange.
Back to the Basics
In accounting fundamentals, fair market value is the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants, at measurement date (Philippine Financial Reporting Standards No. 13). Simply put, it is the price that a willing buyer and seller would agree upon, assuming both parties have reasonable knowledge of relevant facts.
Measuring the FMV by accounting standards involves the application of a hierarchy which categorizes the inputs (i.e. several factors such as the quoted price in the market as well as the company’s performance among its industry) used in valuation. This hierarchy gives the highest priority to a quoted price in the active market, which is usually the most reliable and available measurement of FMV. On the other hand, lowest priority is given to inputs which are unobservable – this usually finds application where there is little to no market data for the assets being valued at the time of measurement.
For stocks which are not actively traded in the stock exchange, the information ordinarily available will be the entity’s own data. Hence, one way to measure FMV is to refer to the book value of the unlisted shares as shown in the financial statements nearest to the date of sale. However, the book value per the financial statements may not necessarily be the most accurate way to measure the stock’s value. After all, there are a number of factors that may not be reflected in the financial statements although these also drive stock value or performance.
Meanwhile, the Philippine Tax Code does not provide a single way to determine FMV. In RR No. 2-1982, the FMV of unlisted shares generally meant the book value of the shares nearest the valuation date. It was also prima facie considered as the share’s FMV. However, the issuance also allowed the valuation of shares at lower than their book values. In such cases, the issuance merely required the justification and evidencing of the deviation. Among the factors considered to be relevant in the valuation of shares of stock of closed corporations are general economic outlook, industry specific- business conditions, market price of stocks of corporations engaged in the same or similar line of business, and difficulty in liquidating the assets. If there were previous sales/exchanges of the unlisted shares, the price at which these shares exchanged hands should be taken or considered as its FMV. In this sense, this 1982 issuance acknowledges that stock value may be driven by factors that may not be necessarily evident in the financial statements.
However, when RR No. 6-2008 was issued, the FMV of unlisted shares was deemed exclusively to be the book value as shown in the duly certified financial statements. This method of valuation was then revised in RR No. 6-2013, when the BIR prescribed the “adjusted net asset” method to determine the FMV of unlisted shares. Briefly, the adjusted net asset method adjusts the book value of the company’s assets by comparing it against the highest appraisal value among those provided by the BIR, provincial or city assessors, and independent appraisers. The liabilities are then subtracted from the net adjusted asset to determine the indicated value of the shares.
RR No. 6-2013, however, caused a stir. Among the concerns raised are the additional costs in obtaining appraisal reports as well as the legal basis for using the above methods in taxing the resulting gains. As well, both methods in RR No. 6-2008 and 6-2013 gave rise to concerns over the methods’ alignment with basic accounting principles – as mentioned, although the book value provides tangible data on a company’s financial performance, there are a gamut of intangibles driving stock value which may not necessarily be found in the financial statements. The same can be said of the adjusted net asset method, which merely adjusts the value of the assets based on the highest among the appraised values as determined by the CIR, provincial or city assessors or independent appraisers. In this sense, the exclusive use of either the book value and adjusted net asset method may unnecessarily skew the FMV of the unlisted shares – sometimes to the prejudice of the taxpayer.
In RR No. 20-2020, the DOF abandoned the adjusted net asset method provided under the previous RR No. 6-2013 in order to align the FMV computation of unlisted shares with the basic taxation and accounting principles. It also partially reverts to the previous definitions of FMV of unlisted shares, as follows:
1. 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 market value.
2. For preferred shares of stock, the liquidation value, which is equal to the redemption price of the preferred shares as of balance sheet date nearest to the transaction date, including any premium and cumulative preferred dividends in arrears, shall be considered as fair market value.
3. In case there are both common and preferred shares, the book value per common share is computed by deducting the liquidation value of the preferred shares from the total equity of the corporation and dividing the result by the number of outstanding common shares as of balance sheet date nearest to the transaction date.
Moreover, RR No. 20-2020 also provides that the book or the liquidation value, as applicable, need not be adjusted to include any appraisal surplus from any corporate property not reflected or included in the latest audited financial statements.
Based on this, the DOF seems to be taking strides to define FMV based on basic accounting standards. It alludes to basic book value as a prima facie evidence of FMV, instead of simply mandating book value to be the exclusive measure. There seems to be an acknowledgment that while FMV can be measured based on the company’s own data, such as the book value as per the financial statements, there are still several factors that may drive the share’s value. Hence, while the book value is the presumed FMV of the unlisted share, the DOF seems to have given taxpayers some room to justify any divergence. For preferred shares, the valuation is pegged at liquidation value, which tries to measure based on the value of the underlying assets instead of just its historical cost. To this degree, the issuance acknowledges the priority of the preferred shares in the liquidation process, and likewise adjusts measurement to consider the valuation of the underlying assets. While there may still be debates over whether such modes of measuring FMV are reliable, we can see some progress as the DOF seeks to align tax valuation policies with basic accounting principles.
Mary Armi G. Milanes is a Supervisor from the Tax Group of KPMG R.G. Manabat & Co. (KPMG RGM&Co.), the Philippine member firm of KPMG International.
This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.
The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or KPMG RGM&Co. For comments or inquiries, please email firstname.lastname@example.org.