The Defense of Arm's Length

The Defense of Arm's Length

by Karen S Baquiran


Capital gains tax (CGT) is imposed on the net capital gains realized during the taxable year from the sale of shares of stocks in a domestic corporation not traded in the stock exchange. In general, net capital gains are computed by deducting the basis of the property sold from the selling price of the shares. For individuals, whether citizens or aliens, and domestic corporations, a final tax rate of 15% shall be imposed on such net capital gains. For foreign corporations, whether engaged or not engaged in trade or business, a 5% or 10% final tax rate shall be imposed depending on whether the net capital gain exceeds PHP 100,000. Based on this, it can generally be said that the correlation between the selling price and the CGT is that, the higher the declared selling price, the higher the tax that you have to pay. Conversely, a lower selling price means a lower tax payment. 

the defense of arm's length

The natural response of some entities to this correlation is to lower their selling prices in order to minimize the CGT liability. To address this, the Tax Code makes the taxpayer additionally liable for donor’s taxes under Section 100, which section provides that “where property, other than real property referred to in Section 24(D), is transferred for less than an adequate and full consideration in money or money's worth, then the amount by which the fair market value of the property exceeded the value of the consideration shall be deemed a gift, and shall be included in computing the amount of gifts made during the calendar year.” Essentially, what the provision states is that if the BIR determines that the selling price is lower than the fair market value (FMV) of the share, the difference shall be deemed a gift subject to donor’s tax.

With the passage of the TRAIN law, however, Section 100 has been amended to provide an exception to the payment of donor’s tax. It provides that a taxpayer shall be exempted from paying donor’s tax if the sale, exchange or other transfer or property is made in the ordinary course of business. That is, the sale or transfer is a transaction which is a bona fide, at arm’s length, and free from any donative intent. If this is the case, the relevant transfer will be considered as one made for an adequate and full consideration so that donor’s tax will not be imposed upon the difference.

In connection with this, the BIR issued Revenue Memorandum Circular (RMC) No. 30-2019 on 28 February 2019 in order to clarify Section 100 relating to the sale of shares of stock not traded or listed. Under said issuance, the determination of whether the sale of shares of stock not listed and traded is at arm’s length amount is a question of fact. As such, the RMC states that it is incumbent upon the party seeking to apply the exception to prove that the sale involves no irregularity between unrelated and independent parties. It is also necessary for the taxpayer to prove that there is no intent to evade tax and defraud the Government of the tax due upon such transaction. Further, it provides that the appreciation of such evidence will have to be made in accordance with its relation and relevance to the transaction on a case-to-case basis.

The concept of arm’s length is not specifically defined in our Tax Code; however, it is usually referred to when dealing with transfer pricing between associated enterprises. Under the Transfer Pricing Guidelines embodied in Revenue Regulation (RR) No. 02-13, the arm’s length principle requires transactions between related parties to be made under comparable conditions and circumstances as transactions with independent parties. Under said Guidelines, the factors that can be taken into consideration to determine arm’s length prices are the nature of the property or services provided between the parties, functional analysis of the transactions and parties, contractual terms, and economic conditions.

It is worth-noting, however, that there are no such guidelines for sales of shares of stock not traded or listed in the stock exchange. At best, for purposes of defining what arm’s length, reliance can be made on case law. Even then, the recent issuance by the BIR states that the determination and appreciation is factual and on a case by case basis.

The question now arises on the quality and quantity of evidence that must be presented in order to prove that the sale of shares of stock is at arm’s length. What standards may be used by taxpayers to ascertain that the sale of shares of stock is one that is valued fairly? Will the guidelines as provided in RR No. 02-2013 be reliable? Under what circumstances will the BIR find it acceptable for the selling price of shares to be lower than market value? In entering share sale transactions, it might be good for the taxpayers to be properly guided on the determination of an acceptable selling price. Otherwise, the determination of what is arm’s length will become subjective and the acceptability of the facts and evidence to be presented by the taxpayer will be left to the appreciation of the officer reviewing the transaction.

Given this leeway, it may be wise for the BIR to revisit the RMC and see how they can provide parameters or clearer guidelines to help taxpayers.

Karen S. Baquiran is a Supervisor from the Tax Group of KPMG R.G. Manabat & Co. (KPMG RGM&Co.), the Philippine member firm of KPMG International. KPMG RGM&Co. has been recognized as a Tier 1 tax practice and Tier 1 transfer pricing practice by the International Tax Review.

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 or

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