Module 5 - Capital Asset VS Ordinary Asset Capital Gains TAX-1 PDF

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INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE Department of Accountancy INCOME TAXATION

2nd Sem 2020-2021

MODULE 5 CAPITAL ASSET VS ORDINARY ASSET CAPITAL GAINS TAX CAPITAL ASSETS (SECTION 39 OF THE TAX CODE AND RR 77-2003) 2003) 1. Capital assets shall refer to all real properties held by a taxpayer, whether or not connected with his trade or business, and which are not included among the real properties considered as ordinary assets under Sec. 39(A)(1) of the Code. 2. Ordinary assets shall refer to all real properties specifically excluded from the definition of capital assets under Sec. 39(A)(1) of the Code, namely: a. Stock in trade of a taxpayer or other real property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year; or b. Real property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business; or c. Real property used in trade or business (i.e., buildings and/or improvements) of a character which is subject to the allowance for depreciation provided for under Sec. 34(F) of the Code; or d. Real property used in trade or business of the taxpayer. 1. Taxpayers engaged in the real estate business are: e. real estate dealers f. real estate developers, and/or g. real estate lessors. 2. “Taxpayers not engaged in the rreal eal estate business” - shall refer to persons other than real estate dealers, real estate developers and/or real estate lessors. RULES IN DETERMINING CAPITAL OR ORDINARY AS ASSET SET a) ORDINARY ASSETS OF taxpayers engaged in the real estate business: 1. All real properties acquired by the real estate dealer 2. All real properties acquired by the real estate developer, whether developed or undeveloped as of the time of acquisition 3. All real properties of the real estate lessor, whether land, building and/or improvements, which are for lease/rent or being offered for lease/rent, or otherwise for use or being used in the trade or business 4. All real properties acquired in the course of trade or business by a taxpayer *habitually engaged in the sale of real property shall be considered as ordinary assets. NOTES NOTES: Registration with the HLURB or HUDCC as a real estate dealer or developer shall be sufficient for a taxpayer to be considered as habitually engaged in the sale of real estate. *consummation during the preceding year of at least six (6) taxable real estate sale transactions, regardless of amount A property purchased for future use in the business, even though this purpose is later thwarted by circumstances beyond the taxpayer’s control, does not lose its character as an ordinary asset. Nor does a mere discontinuance of the active use of the property change its character previously established as a business property. 1. 2. If taxpayer is engaged in real estate business, all real properties are ordinary asset even if idle or abandoned (conversion is not allowed)

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INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE Department of Accountancy INCOME TAXATION

2nd Sem 2020-2021

b) In the case of taxpayer not engaged in the real estate business, real properties, whether land, building, or other improvements, wh which ich are used or being used or have been previously used in trade or business of the taxpayer shall be considered as ordinar ordinaryy assets assets. AUTOMATIC CONVERSION Properties classified as ordinary assets for being used in business are automatically converted into capital assets upon showing of proof that the same have not been used in business for more than two (2) years prior to the cconsummation onsummation of the taxable transactions involving said properties. c) In the case of taxpayers who changed its real estate business to a non-real estate business, real properties held by these taxpayers shall remain to be treated as ordinary assets. d) In the case of taxpayers who originally registered to be engaged in the real estate business but failed to subsequently operate, all real properties acquired by them shall continue to be treated as ordinary assets. e) Real properties formerly forming part of the stock in trade of a taxpayer engaged in the real estate business, or formerly being used in the trade or business of a taxpayer engaged or not engaged in the real estate business, which were later on abandoned and became idle, shall continue to be treated as ordinary assets. f) Real properties classified as capital or ordinary asset in the hands of the seller/transferor may change their character in the hands of the buyer/transferee. The classification of such property in the hands of the buyer/transferee shall be determined in accordance with the following rules: 1.

2.

3.

Real property transferred through succession or donation to the heir or donee who is not engaged in the real estate business with respect to the real property inherited or donated, and who does not subsequently use such property in trade or business, shall be considered as a capital asset in the hands of the heir or donee. Real property received as dividend by the stockholders who are not engaged in the real estate business and who do not subsequently use such property in trade or business, shall be considered as a capital asset in the hands of the recipients even if the corporation which declared the real property dividends is engaged in real estate business. The real property received in an exchange shall be treated as ordinary asset in the hands of the case of a tax-free exchange by taxpayer not engaged in real estate business to a taxpayer who is engaged in real estate business, or to a taxpayer who, even if not engaged in real estate business, will use in business the property received in exchange.

g) In the case of involuntary transfers of real properties, including expropriations or foreclosure sale, the involuntariness of such sale shall have no effect on the classification of such real property in the hands of the involuntary seller, either as capital asset or ordinar ordinaryy asset as the case may be. . h) Real properties acquired by banks through foreclosure sales are considered as their ordinary assets. However, banks shall not be considered as habitually engaged in the real estate business EXERCISES: Realty dealer Stock IND IND in Employee Developer/lessor Dealer Engaged practice of in trade profession Land under name of

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INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE Department of Accountancy INCOME TAXATION

taxpayer not used in business (idle) Land - collects parking fees Office building Home Furniture House and lot (family home) Service vehicle Personal car Personal computer Office equipment Shares of stock in DC Net capital gain Net capital loss Limitation on deduction of capital losses Holding period Holding period DOES NOT apply to:

2nd Sem 2020-2021

The excess of capital gain over capital loss The excess of capital loss over capital gain Capital losses shall be allowed only to the extent of capital gains The length of time the asset was held by the taxpayer. It covers the period from the date of acquisition to the date of sale. 1. Corporate taxpayers 2. Ordinary assets 3. Real properties classified as capital asset 4. Shares of stocks not listed in the Stock Exchange

Rule on Holding Period Individual Taxpayers Non-Individual Taxpayers a. Short term capital gain or loss (capital asset has 100% 100% been held for not more than 12 months) b. Long term capital gain or loss (capital asset has 50% 100% been held for more than 12 months) EXERCISES: 1. Nicanor sold the following properties in 2019: Properties Sold Date Acquired Date Sold Gain (Loss) Motor vehicle 7-14-2017 1-14-2019 200,000 Office printer 7-1-2018 1-5-2019 40,000 Personal Mac Laptop 2-14-2018 2-14-2019 160,000 Home Television 6-21-2018 7-24-2019 (20,000) Personal books 11-30-2018 1-31-2019 (10,000) Idle land 3-1-2018 1-2-2019 2,500,000 The net capital gain or loss shall be computed as follows: Properties Sold Holding Period % Gain (Loss) Motor vehicle Long-term 50% 100,000 Office printer N/A Personal Mac Laptop Long-term 50% 80,000 Home Television Long-term 50% (10,000) Personal books Short-term 100% (10,000) Idle land N/A NET CAPITAL LOSS CARRY Net capital loss is carried over to the succeeding year and shall be

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2nd Sem

INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE Department of Accountancy INCOME TAXATION

OVER

2020-2021

deemed as a short-term loss i.e. as if held for not more than 12 months. Amount to be carried over is up to the extent of capital gain

EXERCISES: Nicanor has made available the following information information:: 2015 2016 Net capital gain (loss) (3,000) 2,000

2017 1,000

2018 (1,000)

2019 2,000

Reportable income DETERMINATION OF AMOUNT AND RECOGNITION OF GAIN O OR R LOSS (A) Computation of Gain or Loss. – The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis or adjusted basis for determining gain, and the loss shall be the excess of the basis or adjusted basis for determining loss over the amount realized. The amount realized from the sale or other disposition of property shall be the sum of money received plus the fair market value of the property (other than money) received. (B) Basis for Determining Gain or Loss from Sale or Disposition of Property. – the basis of property shall be: 1. Purchase - Acquisition cost 2. Inheritance - Fair market price or value as of the date of acquisition 3. Gift/Donation – shall be the same as if it would be in the hands of the donor OR the last preceding owner by whom it was not acquired by gift, except that if such basis is greater than the fair market value of the property at the time of the gift then, for purposes of determining loss, the basis shall be such fair market value 4. Acquired for less than an adequate consideration in money or money’s worth – amount paid by the transferee for the property Exercises: Compute the Gain or Loss 1. Acquired by purchase: Nicanor bought a car amounting to Php 1,000,000.00. He sold the same for Php 100,000. 2. Nicanor inherited a car valued at the time of inheritance Php 1 Million. Currently, the market value is appraised at Php 3 Million. He sold the car for Php 5 Milllion. 3. Nicanor received a laptop valued at Php 100,000.00 by way of donation from JV. JV purchased the laptop at Php 120,000.00. Nicanor sold the property at Php 150,000.00. 4. Nicanor purchased a watch for only Php 100,000.00 where the fair market value of which is Php 500,000.00. He sold the property for Php 1,000,000.00 1 2 3 4 Selling price COST Gain (Loss) NOTES: 1. If a problem stated date of acquisition, and date of disposition, holding period is implied. 2. General Rule: If FMV is higher than Selling Price, there is implied donation. Exception, if it is made in the ordinary course of business (TRAIN Law). SHARES OF STOCKS NOT TRADED IN STOCK EXCHANGE Capital gains tax - Final tax rate of 15% for net capital gains realized dur during ing the taxable year from the sale, barter, exchange or other disposition of shares of stock in a domestic corporation not traded through the stock exchange.

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INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE Department of Accountancy INCOME TAXATION

Formula: Selling Price Cost Net Capital Gain CGT rate Capital gains tax

2nd Sem 2020-2021

xxx xxx xxx 15% xxx

Note: For Foreign Corporation, the rate is: Not over Php 100,000 – 5% On any amount in excess of Php 100,000 - 10% DETERMINATION OF AMOUNT AND RECOGNITION OF GAIN O OR R LOSS FOR UNLISTED SHARE SHARESS 1. Determination of Selling Price Price. —In determining the selling price, the following rules shall apply: 1. In the case of cash sale, the selling price shall be the total consideration per deed of sale. 2. If the total consideration of the sale or disposition consists partly in money and partly in kind, the selling price shall be sum of money and the fair market value of the property received. 3. In the case of exchange, the selling price shall be the fair market value of the property received. 4. In case the fair market value of the shares of stock sold, bartered, or exchanged is greater than the amount of money and/or fair market value of the property received, the excess of the fair market value of the shares of stock sold, bartered or exchanged over the amount of money and the fair market value of the property, if any, received as consideration shall be deemed a gift subject to the donor’s tax under Sec. 100 of the Tax Code, as amended unless it is a bona fide sale, at arms-length and with no donative intent (TRAIN Law). 2. Definition of COST (see above) 3. Definition of “fair market value” of the Shares of Stock Stock. —For purposes of this Section, “fair market value” of the share of stock sold shall be: (3.1) In the case of listed shares which were sold, transferred, or exchanged outside of the trading system and/or facilities of the Local Stock Exchange, the closing price on the day when the shares are sold, transferred, or exchanged. When no sale is made in the Local Stock Exchange on the day when the listed shares are sold, transferred, or exchanged, the closing price on the day nearest to the date of sale, transfer or exchange of the shares shall be the fair market value. (3.2) In the case of shares of stock not listed and traded in the local stock exchanges, the value of the shares of stock at the time of sale shall be the fair market value. 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 prima facie fair market value. (Net asset or Equity divided by Outstanding Shares) 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.

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INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE Department of Accountancy INCOME TAXATION

2nd Sem 2020-2021

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 outstanding common shares as of the balance sheet date nearest to the transaction date. Note: Adjusted Net Asset M Method ethod no longer applies under Revenue Regulations No. 20-2020. Exercises: Compute the Capital Gains Tax 1. Acquired by purchase: Nicanor bought shares of stock of a DC amounting to Php 1,000,000.00. He sold the same for Php 100,000. 2. Nicanor inherited shares of stocks from a DC valued at the time of inheritance Php 1 Million. Currently, the market value is appraised at Php 3 Million. He sold the shares of stocks for Php 5 Million. 3. Nicanor received shares of stocks from a DC valued at Php 100,000.00 by way of donation from Zac. Zac purchased the shares of stocks at Php 120,000.00. Nicanor sold the shares of stocks at Php 150,000.00. 4. Nicanor purchased shares of stocks for only Php 100,000.00 where the fair market value of which is Php 500,000.00. He sold the same for Php 1,100,000.00 1 2 3 4 Selling price COST Capital Gain (Loss) Capital gains tax DST NOTE NOTE: Sale of shares of stock is subject to documentary stamp tax (DST): Rates: 1. With PAR VALUE: One peso and Fifty centavos (P1.50) on each Two hundred pesos (P200), or fractional part thereof of the par value of such stock. 2. Without PAR VALUE: Fifty percent of the documentary stamp tax paid upon the original issue of said stock EXEMPT TRANSACTIONS: 1. Dealer in securities, regularly engaged in the buying and selling of securities 2. An entity exempt from the payment of income tax under existing investment incentives and other special laws 3. An individual or non-individual exchanging real property solely for shares of stocks resulting in corporate control TAX-FREE EXCHANGE Requisites for non-recognition of gain or loss in tax-free exchange: 1. The transferee is a corporation; 2. The transferee exchanges its shares of stock for property/ies on the transferor; 3. The transfer is made by a person, acting alone or together with others, not exceeding four persons; and 4. As a result of the exchange, the transferor, alone or together with others, not exceeding four, gains control of the transferee Illustration No. 1: Assuming that Corporation ABC was incorporated in 2010 to engaged in the real estate business. Its authorized capital stock is Php100,000,000 divided into 1,000,000 shares at Php100 par value while its outstanding capital stock is Php30,000,000 divided into

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