Lecture notes in Taxation 2 - Business and Transfer Taxation PDF

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TAX 2 – Transfer TaxationTransfer refers to any transmission of property from one person to another A person maybe natural(individuals) or a juridical person (corporation, partnership or joint venture)Types of Transfers: 1. Bilateral – transmission of property for a consideration (referred to as one...

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TAX 2 – Transfer Taxation Transfer refers to any transmission of property from one person to another A person maybe natural(individuals) or a juridical person (corporation, partnership or joint venture) Types of Transfers: 1. Bilateral – transmission of property for a consideration (referred to as onerous transaction or exchanges: Ex: Sales – exchange for money Barter – exchange of property for another property Tax Rules on Sales and Barters

Consideration Less: Cost of property given Realized gain

P 1,000 (600) P 400

If the seller is Business Not Business This is subject to Business tax No tax Income tax

Income tax

2. Unilateral – transmission of property without consideration (referred to as gratuitous or simply, transfers). The right or privilege to transfer Is subject to “transfer tax”. Types of Unilateral Transfers a. Donation – gratuitous transfer of property from living donor to a donee.(donation Inter vivos) b. Succession – transfer of property of a deceased person upon his death to his heirs. The decedent’s properties transfer to his successors either by operation of the law or by virtue of a written will. Transfer is caused by the death of the original owners, hence, this is called donation mortis causa. Comparison between Inter Vivos and Mortis Causa transfer Inter Vivos Mortis Causa Transferor Living donor Decedent Nature Voluntary Involuntray Reason Gratuity Death Scope of transfer of property Only properties All properties of the selected by donor decedent at death Property given Gif Estate Transferee Donee Heir Transfer Tax Donor’s tax Estate tax Timing of valuation of donation Date of Donation Date of death 3. Complex – transfers for less than full and adequate consideration. These are sales made at prices which are significantly lower than the Fair Value of the property sold. Tax rules: a. Adequate consideration: Deemed pure exchanges and are subject to income tax, not to transfer tax b. Less than full and adequate consideration: transaction is split into two components, transfer element and exchange element Illustration: Fair Value P 50,000 This is subject to Gratuity(indirect donation) 20,000 Transfer tax Transfer element Consideration(SP) 30,000 Less: Cost or tax basis 10,000 Realized Gain 20,000 Income tax Exchange element The transfer element is generally considered as an inter vivos donation, but it is a donation mortis causa if: a. sale is made in contemplation of death of the seller b. the title to the property is agreed to be transferred upon the death of the seller RATIONALE of Transfer Taxation 1. Tax evasion or minimization theory – exchanged may be intentionally priced to evade or minimize taxes, to avoid this loophole, the gratuity is subject to tax.

2. Tax recoupment theory – Even without deliberate intent to evade income tax, transfers have a natural effect of decreasing future income tax collections of the govt. Illustration: Mr. A owns a P10M property, earning a 10% annual income(subject to RIT) or P1M yearly income. He divided the entire properties to his 5 children. Each child received P5M property and each child earns a roughly P200,000 yearly income. Note that the split of the properties will result to lesser tax collection by the govt. BECAUSE of the progressive tax imposed upon individuals. To recoup on future losses in income taxes caused by transfers, the gov’t. taxes the transfer of the properties. 3. Tax Benefit Theory – this is the most dominant rationalization of transfer taxation. When a person transfers property by donation or succession, the gov’t. is a party in the orderly transfer of property to the done or heir. This is made possible by government laws which enforce or effectuate donation and succession. 4. The State Partnership Theory - The govt. is an indirect partner behind all forms of wealth accumulation. Since the government ensures a civilized and orderly society where wealth accumulation and commercial undertaking, the govt, should take its fair share by taxing the transfer of the wealth to other persons . 5. Wealth Redistribution Theory – equitable distribution of wealth is widely accepted as an element of social progress and stability. Taxation is a common tool in redistributing wealth to society. 6.

Ability to pay Theory – The ability to transfer property is an indication of an ability to pay tax. Comparison of two types of transfer tax Donor’s Tax Estate Tax Subject transfer Inter-vivos Mortis Causa Nature Annual One time tax Taxpayer Donor Decedent Who actually pay Donor himself Executor, administrator or heirs in behalf the tax of the decedent

Nature of Transfer taxes 1. Privilege tax – Imposed because the transferor (donor or decedent) is exercising a privilege in the form of assistance rendered by the government in effecting the transfer of properties. 2. Ad valorem tax – the amount of tax is dependent on the value of the properties transferred, thus, valuation of property transferred is needed in order to determine the tax liability. 3. Proportional tax – under the TRAIN LAW, , transfer tax is at flat rate of 6% of net estate or gif. 4. National tax – levied by the national government, LGUs are pre-cluded from imposing the same. 5. Direct tax – it cannot be shifed 6. Fiscal tax – this is in support of the government Classification of Transfer Taxpayers and their extent of Taxation 1. Resident OR Citizens – taxable on global transfers of properties 2. Non-Resident Aliens - taxable on Philippine transfers of property The citizenship of juridical persons is determined by incorporation tests. Corporations are not subject to Estate Tax, only on donors tax Situs of Taxation: Transfer occur in the location of the property. In mortis causa, properties are transferred at the place they are located at the point of death of the decedent, not the place of decedent’s death. Likewise, properties transferred inter-vivos in the place where they are located at the date of donation, not in the place the donor executed the deed of donation. General Rule in Transfer Taxation Taxpayer Inter-vivos Resident or Citizen Global donation Non-resident Philippine donation Estate - properties of decedent at the point of death

Mortis causa Global Estate Philippine Estate

Properties Located in the Philippines: 1. Interest in a domestic business a. Shares, obligations, or bonds issued by any corporation or sociedad anonima organized or constituted in the Philippines in accordance with its law. b. Shares or rights in nay partnership, business or industry established in the Philippines 2. Foreign securities, under certain conditions a. Shares, obligations, or bonds issued by any foreign corporation 85% of the business of which is located in the Phils. b. Shares, obligations, or bonds issued by any foreign corporation if such share, obligations, or bonds have acquired business situ in the Phils. 3. Franchise exercisable in the Philippines 4. Any personal property, whether tangible or intangible, located in the Philippines. Reciprocity rule on Non-resident Aliens The intangible personal properties of non-resident aliens are exempt from Philippines transfer taxes provided that the country in which such alien is a citizen also exempts the intangible personal properties of a Filipino nonresidents thein from transfer taxes. Classifying Donation as Inter-vivos or Mortis causa If Gratuitous transfer of ownership occurs Type of Transfer During lifetime of the transferor Inter-vivos Upon death of Decedent Mortis causa Donation inter-vivos are valued at the date of donation Donation Mortis causa are valued at the date of death of the decedent Exceptional rules on the transfers Transfer in contemplation of death Transfer intended to take effect at death Incomplete transfer

Inter-vivos No No Yes

Mortis causa Yes Yes Yes

Transfer in contemplation of death A donation that is inspired or motivated by the thought of death of the decedent is a donation mortis causa, if inspired by the motives associated with life, it is a donation inter-vivos. The motive of inter vivos transfer is very important in determining whether it is actually an inter vivos or a mortis causa transfer. The donor’s motive is established out of the wordings of the deed of donation prepared by the donor to effect the donation. The evaluation of the decedent’s motive is done in particular when the decedent made a donation just several months prior to his death and had a severe illness, suffering from critical injury, or of too advanced age. Motives associated with life: 1. To reward services rendered 2. To relieve the donor of the burden of management of the property 3. To save on income tax 4. To see children financially independent 5. To see children enjoy property while decedents still lives 6. To settle family disputes. Transfer intended to take effect upon death A donation that is made on the decedent’s last will and testament is a donation mortis causa.. the last will and testament is a document on how the decedent desire his properties will be distributed. Incomplete transfer This involves the transmission or delivery of properties from one person to another, but ownership is not transferred at the point of delivery. The actual transfer of ownership will take effect in the future upon the happening of certain future event or satisfaction of certain conditions. These transfers are subject to tax in the future when the actual transfer of ownership occurs. Types of incomplete transfer and how are they completed 1. Conditional Transfer a. Fulfillment of the condition by the transferee or b. Waiver of the condition by the transferor 2. Revocable Transfer a. Waiver by the transferor to exercise his right of revocation b. The lapse of his reserved right to revoke 3. Transfer with reservation of title to property until death – completed upon the death of the decedent

Timing of Taxation of Incomplete Transfer Revocable and conditional transfers that are completed during the lifetime of the transferor constitute donations inter vivos subject to donor’s tax at the fair value of the property at the date of their completion or perfection. Revocable transfers and conditional transfers that are pre-terminated by the death of the transferor shall be subject to estate at the point of death of the transferor. Complex Incomplete Transfers These are transfers made with less than full and adequate consideration. Similar to complex transfers, the gratuity component of the complex transfers is subject to the appropriate type of transfer tax. Test of taxability of Complex Incomplete Transfer 1. The incomplete transfer must have been paid for less than full and adequate consideration at the date of delivery of the property. 2. At the completion of the transfer, the property must not have decrease in value below the consideration paid. Valuation of complex incomplete transfer Mortis causa FV at death less consideration upon transfer

Inter-vivos FV at completion or perfection of donation less consideration upon transfer

Example: Type of donation Inter-vivos Mortis causa

At Transfer Selling Price Fair Value P 4,000 P 10,000 4,000 10,000

FV at death P 15,000 15,000

The donations is computed as P10,000 – P 4,000 P15,000 – P 4,000

Non-taxable transfers: 1. Void Transfers – these are prohibited by law or those that do not conform to legal requirement. No transfer of ownership therefore not subject to transfer tax Examples: Donations a. not owned by owner b. between spouses c. which do not manifest all essential requisites to validity such as donations refused by done d. that do not conform to formal requirements such as oral donation of real properties. 2. Quasi-transfers – transmission pf properties that will never involve transfer of ownership. Thse are not taxable. Examples: Transmission of the property a. By the usufructuary to the owner of the naked title b. By a trustee to the real owner c. From the first heir to the second heir in accordance with the desire of a predecessor

Succession is a mode of acquisition by virtue of which the property, rights and obligations to the extent of the value of the inheritance, of a person are transmitted through his death to another or others either by his will or by operation of the law(Art 774, Civil Code) The inheritance includes all property, rights, and obligations of a person which are not extinguished by his death. (Art 776) The rights and succession are transmitted from the moment of the death of the decedent. The decedent is a deceased or dead person. Types of Succession 1. Testate or Testamentary Succession – that which results from designation of an heir, made in a will executed in the form prescribed by law. Last Will and Testament – a written document made by the person to designate or specify the recipient of his properties upon death Testate – a person who died with a will Testator – a person who died with a written will

2. Legal or Intestate Succession – when the decedent dies without a will or with an invalid one, the distribution of the estate should be in accordance with the default provision of the Civil Code on succession. 3. Mixed Succession - Transmission of the decedent properties shall be partly by virtue of a written will and partly by operation of law WILL A will is an act whereby a person is permitted, with the formalities prescribed by law, to control to a certain degree the disposition of this estate, to take effect afer his death (Art. 783, Ibid). A will is an expression of the decedent's desire as to how his properties will be distributed afer his or her death. The making of a will is a strictly personal act; it cannot be lef in whole or in part of the discretion of a third person, or accomplished through the instrumentality of an agent or attorney. (Art 784, Ibid.) Types of will 1. Holographic will - a will which is entirely written, dated, and signed by the hand of the testator himself 2. Notarial will — a notarized will signed by the decedent and witnesses 3. Codicil - a supplement or addition to a will, made afer the execution of a will and annexed to be taken as a part thereof, by which disposition made in the original will is explained, added to, or altered (Art 825, Ibid.) Every will must be acknowledged before a notary public by the testator and the witnesses. A holographic will need not be witnessed. A codicil needs to be executed as in the case of a will to be valid. Nature of Succession Succession is a gratuitous transmission of property from a deceased person in favor of his successors. Succession involves only the net properties of the decedent. The heirs will inherit what remains of the decedent's property afer satisfying the decedent's indebtedness and obligations including 'the estate tax. The heirs shall not inherit the debt of the decedent. ELEMENTS of Succession 1. Decedent — the general term applied to the person whose property is transmitted through succession, whether or not he lef a will. If he lef a will, he is also called the testator (Art 775, Ibid.). 2. Estate - the property, rights and obligations of the decedent not extinguished by his death. This is also referred to as the "inheritance" of the decedent. 3. Heirs - a person called to the succession either by the provision of a Will or by operation of law (Art 782). WHO ARE THE HEIRS? Heirs under intestate succession In intestate succession, the heirs shall be the following in descending order of priority: 1. Compulsory heirs 2. Relatives up to fifh degree of consanguinity 3. Republic of the Philippines The law identified certain persons which it designated as "compulsory heirs”. These are the persons who will inherit the estate by default. Only by their absence shall the estate be partitioned to other relatives. In the absence of relatives, the estate will go the government. Types of compulsory heirs 1. Primary heirs: Legitimate children and their direct descendants 2. Secondary heirs: Legitimate/illegitimate parents and ascendants 3. Concurring heirs: The surviving spouse and illegitimate descendants Definition of terms 1. Legitimate children are those born out of a legal marriage. 2. Direct descendants refer to children or, in their absence, grandchildren. 3. Legitimate parents refer to biological parents. 4. Illegitimate parents are adopting parents to an adopted child. 5. The surviving spouse is the widow or widower of the decedent. 6. Illegitimate descendants are illegitimate children. Note: Under the Revised Family Code, adoptive parents can now qualify as secondary heirs sharing 50:50 with biological parents....