TAX Ch 12 - Lecture notes 1 PDF

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CHAPTER 12INTRODUCTION TO TRANSFER TAXATIONWHAT IS TRANSFER?Transfers refer to any transmission of property from one person to anotherA person may be a natural person such as individuals or a juridical person created by law such as corporation, partnership or joint ventures.Types of transfers: Bilat...

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CHAPTER 12 INTRODUCTION TO TRANSFER TAXATION

WHAT IS TRANSFER? Transfers refer to any transmission of property from one person to another A person may be a natural person such as individuals or a juridical person created by law such as corporation, partnership or joint ventures.

Types of transfers: 1. Bilateral transfers 2. Unilateral transfers 3. Complex transfers

BILATERAL TRANSFERS Bilateral transfers involve transmission of property for a consideration. They are referred to as onerous transactions or exchanges.

Examples: 1. Sale- exchange of property for money 2 Barter- exchange of property for another property Taxation Rules on Sales or Barter

If the seller is Business

Not business this is subject to

Consideration

P 1,000

Less cost of Property given

(600)

Realized gain

P 400

UNILATERAL TRANSFERS

Business tax

No tax

Income tax

Income tax

Unilateral transfers involve the transmission of property by a person without consideration. They are commonly referred to as gratuitous transaction or simply, transfers.

Types of Unilateral Transfer 1. Donation "Donations" is the gratuitous transfer of property from a living donor to a donee. Since it is made between iiving persons, it is called donation inter vivos. 2. Succession "Succession" is the gratuitous transfer of the properties of the deceased person upon his death to his heirs. When a person dies, his legal identity including proprietary rights are extinguished. His properties will be gratuitously transferred to his successors either by operation of law or by virtue of a written will Succession is a donation of all the properties of the decedent caused by his death. Hence, it is called donation mortis causa.

Comparison between inter vivos vs. mortis causa Inter vivos

Mortis causa

Living donor

Decedent

Nature

Voluntary

Involuntary

Reason

Gratuity

Death

Only properties selected by the donor

All properties of the decedent at death

Transferor

Scope of the transfer of properties

Property given

Gif

Estate

Transferee

Donee

Heir

Transfer tax

Donor's tax

Estate tax

Date of donation

Date of death

Timing of valuation of donation

COMPLEX TRANSFERS

Complex transfers are 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.

What constitutes an adequate consideration? There is no fixed quantitative rule on what constitutes an adequate consideration. The determination of whether or not a consideration is adequate requires consideration of the facts and the circumstance surrounding the sale. The adequacy of the price is influenced by the liquidity or the availability of willing buyers of the concerned property. Hence, a discount of 20% to highly saleable goods like gold would be construed as gif due to its relative liquidity while this may not be the case in selling big real estates.

Tax rules on transfers for adequate consideration Transfers for adequate consideration are deemed pure exchanges and are subject to income tax, not to transfer tax.

Transfer for less than adequate and full consideration Transfers for less than full and adequate consideration are split into its components: transfer element and exchange element. The transfer element is subject to transfer tax while the realized gain on the exchange element is subject to income tax. Illustration Assume a property with a fair value of PS0,000 and tax basis of P10,000 is sold for merely P30,000 Fair value

P 50,000

Gratuity (Indirect donation)

20,000

Consideration of selling price

P30,000

Less: Cost or tax basis

10,000

Realized gain

P 20,000

This is subject to Transfer tax

Income tax

The transfer element is generally considered as inter-vivos donation, but it is a donation mortis-causa if: a. The sale is made in contemplation of the death of the seller, or b. If title to the property is agreed to be transferred upon the death of the seller.

RATIONALE TRANSFER OF TAXATION 1. 2. 3. 4. 5. 6.

Tax evasion or minimization theory Tax Recoupment theory Benefit received theory State partnership theory Wealth redistribution theory Ability to pay theory

The Tax Evasion or Minimization Theory Exchange may be intentionally priced to evade or minimize income taxes.The indirect donation in an exchange is actually a lost gain which will evade Taxation. To plug this tax loophole, the government subjects to the gratuity to tax. However, it is not taxed in the absence of donative intent on part of the seller such as when the sale is made in the normal course of business.

The Tax Recoupment Theory Even without a deliberate intent to evade income tax, transfers have a natural effect of decreasing future income tax collections of the government.

Illustration Alison has P10,000,000 properties which earn 10% or P1,000,000 yearly income. Desiring to make his 5 children become financially independent, he divided his entire properties to them. Each child received P2,000,000 properties. Each child earns roughly P200,000 on the donated properties. Note that the split of the properties and the spread of the income to several taxpayers will result in lesser tax collection to the government because of the progressive tax imposed upon individuals. The same effect would result if Mr. Alison transfers his property to his children through succession. To recoup on future losses in income taxes caused by transfers, the government taxes the transfer of the properties.

The Benefit Received Theory

When a person transfers property by donation or succession, the government is a party in the orderly transfer of the property to the donee or heir. This is made possible by government laws which enforce or effectuate donation and succession. The transferor is actually exercising a privilege to transfer his property under government security of an effective and orderly transmission under its laws which define and effect donation or succession. Without these laws, the transfer could not have been convenientily possible. Exercising this special privilege to transfer property either inter-vivos or mortis cuasa is a benefit to the transferor. In accordance with the benefit received theory, the transfer should be taxed. The benefit received theory is the most dominant rationalization of transfer taxation.

The State Partnership Theory The state ensures a civilized and orderly society where commercial undertaking and wealth accumulation flourish. The government therefore is an indirect partner behind all forms of wealth accumulation by any person within the state. Thus, when a person transters part or the whole of his wealth, the government should take its fair share by taxing the transfer of the wealth to other persons.

Wealth Redistribution Theory Equitable distribution of wealth is widely accepted as an elements of social progress and stability. Societies with inequities in wealth distribution are normally associated with high social unrest, lawlessness, insurgencies, wars and chaos. Thus, governments strive toward equitable wealth distribution as basic policy, taxation is a common tool redistributing wealth to society. When one transfers his wealth, the transfer will be taxed so that the part of the wealth will be redistributed to benefit society. Ability to Pay Theory No one could gratuitously give what he could not afford. The ability to transfer property is an indication of an ability to pay tax. Hence, the transfer is subject to tax.

COMPARISON OF THE TWO TYPES OF TRANSFER TAX Donor's tax

Estate tax

Subject transfer

Inter-vivos

Mortis causa

Nature

Annual tax

One-time tax

Taxpayer Who actually pay the tax?

donor

Decedent

The donor himself

Executor, administration or heirs in behalf of the decedent

NATURE OF THE TRANSFER TAX 1. Privilege tax Transfer tax is a form of privilege tax rather than a form of penalty tax. It is imposed because the transferor (Donor or decedent) is exercising a privilege in a form of assistance rendered by government in affecting the tranfer or properties by way of donatio or succession. 2. Ad Valorem Tax The amount of transfer tax is dependent on the value of the properties transferred. Thus, valuation of the property transferred is needed in order to determine the amount of the tax. 3. Proportional tax Transfer taxes under the TRAIN law are imposed at flat 6% of the net estate or gif. 4. National tax Transfer taxes are levied by the national government. Local Government Units (LGUs) are legally precluded from imposing the same. 5. Direct tax Transfer taxes cannot be shifed. The tranferor-donor or transferor-decedent is the one subject to tax. 6. Fiscal tax Transfer Fiscal taxes are levied to raise money for the support of the government

CLASSIFICATION OF TRANSFER TAXPAYERS AND THEIR EXTENT OF TAXATION 1. Residents or Citizens- such as: a. Resident citizens b. Resident aliens c Non-resident citizens These are taxable on global transfers of property.

2. Non-resident Aliens These are taxable on Philippine transfers of property

The citizenship of juridical persons is determined by the incorporation tests. Juridical persons that are organized in the Philippines are considered Philippine citizens. Those organized abroad are considered aliens. In donor's taxation, the term resident citizen or alien includes domestic or resident foreign corporation. Obviously, corporations are not subject to estate taxation.

SITUS OF TRANSFER Transfers occur in the location of the property. Properties are transferred mortis causa in the place where they are located at the point of death. They are not transferred at the place where the decedent died. Likewise, properties are transferred inter-vivos in the place where they are located at the date of donation. They are not transferred at the place where the donor executed the deed of donation. Examples: 1. A resident alien who has P10M properties in the Philippines and P40M properties in Japen died in an airplane crash in Malaysia. The 10M properties is deemed transferred Mortis causa in the Philippines while the P40M properties is also deemed transferred Mortis causa at Japan. 2. While in Korea, a non-resident Filipino donated his car in Japan worth P5,000,000 to his American best friend. The P5M car is deemed transferred inter-vivos in Japan.

GENERAL RULE IN TRANSFER TAXATION Taxpayers

Inter-vivos

Mortis causa

Resident or citizens

Global donation

Global estate

Non-resident aliens

Philippine donation

Philippine estate

Global donation means properties donated wherever situated across the globe. Estate means properties of the decedent at the point of death. Global estate means properties of the decedent wherever situated across the globe at the point of death. Illustration 1 Mr. Mario, an American residing in the Philippines, donated a car in Mexico to a friend and a motorbike in the Philippines to his brother in America. Since the taxpayer is a resident both the donation of a car abroad and the donation of a motorbike in the Philippines are subject to transfer tax. Since the donor is living, the transfers are donations inter-vivas subject to donor's tax.

Illustration 2 Juan, a non-resident Filipino citizen, died leaving a building in the United States and an agricultural land in the Philippines for his heirs. Since the taxpayer is a citizen, the transfer mortis causa of the building in the US and the agricultural land in the Philippines is subject to Philippine estate tax.

Illustration 3 Mr. Kounoman, a Japanese citizen residing in Japan, donated a parcel of land in Japan to a resident Filipino friend. He also donated his investment in the shares of stocks of a Philippine corporation to his Japanese sister. Since the donor is neither a Philippine resident nor a citizen, only the donation of domestic shares of stock in the Philippines is subject to transfer tax. Also, since the donor is living at the date of donation, the transfer is a donation inter-vivos subject to donor's tax

Illustration 4 Mr. Ti Wong, a Chinese citizen residing in Hong Kong, died leaving a building in Hong Kong and a a car in the Philippines. The donor is neither a resident nor a citizen. Only the car in the Philippines is subject to transfer tax. Since thw transfer is effected by death, it is a donation Mortis causa subject to estate tax.

PROPERTIES LOCATED IN THE PHILIPPINES The following properties are considered 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 laws b. Shares or rights in any 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 Philippines b. Shares, obligations, or bonds issued by any foreign corporation if such shares, obligations, or bonds have acquired business situs in the Philippines

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 Philippine transfer taxes provided that the country in which such alien is a citizen also exempts the intangible personal properties of Filipino non-residents therein from transfer taxes.

Examples of intangible properties: 1. Financial assets     

Cash Receivables or credit Investment in bonds Shares of stock in a corporation Interest in a partnership

2. Accounting intangible assets     

Patent Franchise Leasehold right Copyright Trademark

It must be pointed out that bills and coins (i.e, cash) are mere representation of purchasing power. They are intangibles rather than tangible assets. Illustration 1 Mr. Shino, a Japanese citizen, donated the following properties in the Philippines: 1. Car 2. Cash in bank 3. Shares of stocks of a domestic corporation Under Japanese laws, non-resident Filipinos are exempt on transfers of intangible properties in Japan.

Since the reciprocity exemption applies, Mr. Shino is subject to donor's tax only on the donation of the car. The donation of the intangibie personal properties such as cash and shares of stocks are exempt.

Illustration 2 Assuming the same data in the preceding problem, except that Mr. Shino died leaving those properties in the Philippines. The Japanese governmment do not tax intangible properties of non-resident Filipinos thereon to estate tax. Only the tangible property-car would be subject to estate tax.

Illustration 3 Mr. Park, a Korean citizen residing in the Philippines, died leaving P5M cash, P3M interest in a business and a P10M condo unit in the Philippines. Under Korean laws, Filipino non-residents therein are exempt from transfer taxation. All of these wil be subject to estate tax since reciprocity exemption applies only to non-resident aliens to the exclusion of resident aliens

CLASSIFYING DONATION AS INTER-VIVOS OR MORTIS CAUSA The timing of the gratuitous transfer of ownership or legal title over property to another determines the classification of the transfer. If gratuitous transfer of ownership occurs

Type of transfer Inter-vivos

During the lifetime of the transferor

Mortis causa

Upon death of the decedent

If ownership over property is voluntarily transferred by the owner during his lifetime, this is donation inter-vivos. If the owner retained ownership until the moment of his death, death will transfer it his successors in interest. This transfer is donation mortis causa. Illustration Don Juanico has a hotel and a commercial building as his only properties. He promised to donate the hotel to son, Juan and the building to son, Juanito. He was able to donate the hotel to Juan when the same was worth P40M. While finalizing the deed of donation of the building for Juanito, Don Juanico met an accident and died. The hotel and the building has fair value of P45M and P50 at the date of death of Don Jaunico. A year afer his death, the properties have fair values of P48M and P52M, respectively. The transfer of the hotel is a donation inter-vivos. The same shall be valued at P40M and shall be subject to donor's tax. Don Juanico still owns the commercial building upon his death, the same is a transfer mortis causa. The same shall be valued at P50M and shall be subject to estate tax. Note: 1. Donation inter-vivos are valued at the date of donation. 2. Donation Mortis causa are valued at the date of death of the decedent. Exceptional rules or transfers

Inter-vivos

Mortis causa

1. Transfer in contemplation of death

X

✓

2. Transfer intended to take effect at death

X

✓

3. Incomplete transfers

✓

✓

TRANSFER IN CONTEMPLATION OF DEATH A donation that is inspired or motivated by the thought of death of the decedent is donation mortis causa. If the donation is inspired by motives associated with life, it is donation inter-vivos.

The motive of donation is the determining factor The motive of an 1nter-viv0s transter is very important in determining whether it is actually an intervivos transfer 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. Thought of death The presence of express wordings in the deed of donation which indubitably manifest that the donation is inspired by the decedent's thought of death will quality a donation as a donation mortis causa.

Illustration On his death bed, Don Pedro made a written donation saying "Death is imminent upon me, would like to ensure that Pablo will have my sports car as his legacy. For this, I am donating iy car to him." Though the donation is made during the lifetime of Don Pedro, the donation is inspired by the thought of death. This is a transfer mortis causa subject to estate tax upon Don Pedro's death

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 a critical injury, or of too advanced age. Transfers in contemplation of death actualy pass ownership over the property to the transferee at the date of donation but the same is taxable to estate tax not to donor's tax because it is a donation mortis causa.

Motives associated with life: The following motives preciudes a transfer from being classified as one in contemplation of death: 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 the property while the decedent still lives 6. To settle family ...