Capital Gains and Passive Income

Capital Gains Taxation

• Capital Gains Taxation is discussed in relation to the date 25 JANUARY 2025.

Returnable Income

• Compensation income from being an employee is considered returnable income.
• Income from trade, business, or the practice of a profession is returnable income.
• Gains from the sale of ordinary assets, net capital gains from the sale of "other capital," and other taxable income not subject to Final Tax (FT) and Capital Gains Tax (CGT) fall under returnable income.
• Income taxes for returnable income are filed via the Income Tax Return.

Passive Income (Final Tax)

• Passive income is earned without any active action on the part of the taxpayer.
• Dividends, interest income on bank deposits, royalties, prizes, and winnings are considered passive income, and are subject to final tax.

Capital Gains (Capital Gains Tax)

• Capital gains arise from the sale of two types of capital assets.
• The two types of capital assets are real property in the Philippines classified as a capital asset and shares of domestic corporations, provided the seller or taxpayer is not a dealer in securities.
• Income taxes for capital gains are filed via the Final Tax "CGT".

Classification of Taxpayer's Properties: Ordinary Assets

• Ordinary Assets include assets used in business.
• Assets held for sale, such as inventory, are ordinary assets.
• Assets held for use, such as supplies, and items of property, plant, and equipment like buildings, property improvements, and equipment, are ordinary assets.

Classification of Taxpayer's Properties: Capital Assets

• Include any asset other than ordinary assets.
• Personal (non-business) assets of individual taxpayers are capital assets.
• Business assets of any taxpayers are capital assets and can categorized as financial or intangible.
• Financial assets are cash, receivables, prepaid expenses, and investments.
• Intangible assets are patents, copyrights, leasehold rights, and franchise rights.

Asset Classification Rules

• A property purchased for future use in business is considered an ordinary asset, even if the intended purpose is thwarted by circumstances beyond the taxpayer's control.
• Discontinuing the active use of property does not alter its character previously established as a business property.
• Real properties used, being used, or previously used in the trade of the taxpayer are considered ordinary assets.

Asset Classification Rules for Real Estate Businesses

• Properties classified as ordinary assets when used in business by a taxpayer not in the real estate business automatically convert to capital assets if proof shows they haven't been used for more than 2 years prior to a taxable transaction.
• A depreciable asset is an ordinary asset, irrespective of whether it is fully depreciated or if there was a failure to take depreciation during the period of ownership.
• Real properties used by an exempt corporation in its exempt operations are considered capital assets.
• The classification of property transferred by sale, barter, exchange, inheritance, donation, or declaration of property dividends hinges on whether the acquirer uses it in business.
• For real property that is subject to involuntary transfer with events such as expropriation and foreclosure sale, the involuntariness of such sale has no effect.
• Changes in business from real estate to non-real estate do not change the classification of previously held ordinary assets.

Illustration: Property Previously Used in Business

• Mr. Alfonso has a building previously used as an office and subject to depreciation.
• In July 1, 2021, Mr. Alfonso shifted his business operations, relocating his office to another city and abandoning the original office.
• If Mr. Alfonso is not engaged in the real estate business, the building is a capital asset.
• If Mr. Alfonso is engaged in the real estate business, the building is an ordinary asset.

Illustration: Building Purchased for Branch Sales Office

• On June 1, 2021, Mr. Alfonso purchased a building to be used as a branch sales office.
• Stayed idle as of December 31, 2024, because of an ongoing civil war.
• If Mr. Alfonso is not engaged in real estate, the building is an ordinary asset.
• If Mr. Alfonso is engaged in real estate, the building is also an ordinary asset.

Disposal of Property by Donation

• Juan, a realty dealer, donated house and lot inventory to his son and daughter.
• Juan donated one house and lot to his son as a dowry for his upcoming marriage, which his son shall use as his family residence.
• Juan donated another house and lot as initial capital to his daughter, who will commence a realty leasing business.
• The asset donated to Juan's son is classified as a capital asset.
• The asset donated to Juan's daughter is classified as an ordinary asset.

Illustration: Exempt Non-Business Operation

• Bantay Tanda Foundation possesses Building A-1, which it uses for its non-profit operations.
• Bantay Tanda Foundation leases out Building A-2 to various commercial lessees.
• Building A-1 is classified as a capital asset.
• Building A-2 is classified as an ordinary asset.

Types of Gains on Dealings in Properties

• Ordinary gain is derived from ordinary assets.
• Capital gain is derived from capital assets.

Gains Subject to CGT

• Capital gains on the sale of domestic stocks, sold directly to the buyer, are subject to CGT.
• Capital gains on the sale of real properties not used in business are subject to CGT.

Scope of Capital Gains Taxation

• Gains on dealings in capital assets are subject to specific tax rates.
• Gains from sale, exchange, and other disposition of domestic stocks directly to buyer are taxed at 15%.
• Gains from sale, exchange, and other disposition of real property in the Philippines are taxed at 6%.
• Gains from other capital assets are taxed at the regular income tax (RIT).

Capital Gain on Sale of Domestic Stocks Directly to Buyer

• Evidence of ownership or rights to ownership in a domestic corporation are regardless of its features.

Modes of Disposing Domestic Stocks

• Through the Philippine Stock Exchange (PSE), stock transaction tax stands at 60% of 1% of the selling price, effective from January 1, 2018.
• It can be disposed directly to the buyer.

Illustration: Stock Transaction Tax for Non-Dealers

• Mr. San Juan, who is not a dealer in stocks, sold stock investments through the PSE.
• On 04/05/2020, AC stocks were sold for P4,000,000.00 with a cost of P3,700,000.00, resulting in a gain of P300,000.00.
• On 04/05/2020, SMB stocks were sold for P3,000,000.00 with a cost of P3,200,000.00, resulting in a loss of P200,000.00.
• Total selling price amounts to P7,000,000.00, with a total cost of P6,900,000.00.
• The total gain is P100,000.00.
• Calculated as Selling Price x Transaction Tax Rate (P7,000,000 x 60% x 1%) = P42,000.

Illustration: Dealer in Stocks

• Mr. San Juan, a dealer in stocks, sold stock investments through the PSE.
• The stock transaction tax is None.

CGT on Sale of Domestic Stocks Directly to Buyer: Nature of the CGT

• The CGT is a universal tax.
• The CGT is an annual tax.

CGT on Sale of Domestic Stocks Directly to Buyer: Net Gain

• Calculated as the Selling price less the Basis of stocks disposed, Selling expenses and Documentary stamp tax on the sale.

Selling Price

• Denotes the cash sale or total consideration received per deed of sale.
• If consideration is partly in money and partly in property, SP = money + fair value of property received.
• For exchanges, SP = the fair value of the property received

Illustration

• Mr. Real sold stocks and, in exchange, received a building with a tax basis of P2,000,000 and a fair value of P2,500,000, goods worth P100,000 and P400,000 cash.
• The selling price calculation is as follows: Fair value of building received (P2,500,000) plus Fair value of goods received (P100,000) plus Cash (P400,000) sums to a Total of P3,000,000.

Tax Basis of Stocks: Acquired Through Purchase

• Then the tax basis is the cost, according to:
• Specific identification.
• Moving average method.
• First-in, first-out method.

Tax Basis of Stocks Acquired From Other Means

• If acquired by the devise, bequest, or inheritance, tax basis is the fair value at the time of death of the decedent.
• If acquired by gift, the tax basis is the lower of the fair market value at the time of the gift and the basis in the hands of the donor or the preceding owner not acquiring it by gift.
• If acquired for inadequate consideration, the tax basis is the amount paid by the transferee.
• If acquired under tax-free exchanges, the tax basis is the substituted basis of the stocks.

Illustration: Cost of Acquisition

• Mrs. Excellence purchased 1,000 shares of Bacolod Corporation for P100,000
• Paid the broker's commission of P1,000Stocks were subject to a chattel mortgage for P10,000 which Mrs. Excellence assumed.
• Cash Paid (P100,000) plus Obligations assumed on the property purchased (P10,000) plus Direct acquisition costs – broker's commission (P1,000) totals P111,000 in Tax basis.

Illustration: Costing Procedures

• Mr. Online has purchases and sales of El Dorado Corporation stocks.
• He had purchases on January 1 for 10,000 shares at P10.00, with a total cost of P100,000.00, March 1 at 5,000 shares for P11.03 at a cost of P55,150.00, March 23 at 20,000 shares for P12.00 at a cost of P240,000.00
• April 4, He sold P25,000 stocks for P15.00.
• Shares sold were those bought on March 1 and March 23, then specific identification is the applicable method.
• March 1 purchase of 5,000 shares for P 55,150, 20,000 shares purchased March 23 purchase for P240,000
• The cost of 25,000 shares sold (March 1 and 23 purchase) is P295,150, the Cost of remaining 10,000 stocks (January 1 Purchase ) is P100,000.
• Gain = (25,000 x P15) – 295,150, resulting in P79,850.

Illustration: Mr Online Cannot Not Identify Shares

• Retains detailed records of the purchase and sale of the stocks, using the moving average method.
• January 1 Purchase 10,000, March 1 Purchase 5,000, March 23 Purchase 20,000 that comes up to 35,000 shares with a combined cost of P395,150.
• Cost of shares sold is 25,000 equals P282,250 (The shares cost of 25,00 for the moving average equals 11.29).
• Cost of ending shares is 10,000 = P112,900.

Illustration: No Detailed Records

• Mr, Online cannot identify actual shares sold or maintain records of transactions in the shares of El Dorado,
• In this case he resorts to the First-in, first-out method.
• the cost of the shares sold shall be presumed coming from the cost of the first 25,000 shares bought on January 1 March 1 and March 23.
• The combined totals is equals to P275,150

Acquisition by Gratuitous Title

• In March 2021, Mrs. REO received by way of donation shares of stocks of Taal Corporation from her father, Don Bosco.
• Don Bosco acquired the shares by donation in June 2007 from his own mother, Dona Karena, who bought the shares for P400,000 in April 2004.
• The shares had a fair value of P700,000 in June 2007 and P2,500,000 in March 2021.
• Dona Karena basis the last preceding owner shall be used, at its original price
• Assuming the shares were acquired by Mrs. REO from her father via donation in March 2001, and the shares shall be the lower of P400,000 and P2,500,000
• The Mrs. REO is inherited from his father who is the legal transfer that died in March 2021, then its shares are assessed at 2,500,000 at the date the transfer of death or of Don Bosco.
• Assuming the shares were bought by Mrs. REO from Don Bosco for only P1,200,000, the basis of the shares to Mrs. REO becomes shall be P1,200,000, which is the actual price paid for them.

Stocks Sold for Inadequate Consideration

• The excess of the fair value of the stocks over the selling price is a gift, subject to donor's tax if intended by the seller as a donation.

Illustration: Shares Sold for Discounted Price to Friend

• A seller sold domestic stocks directly to a friend for P500,000 when the fair value was P650,000.
• The tax basis of the shares is P300,000, excluding P10,000 in expenses at the date of sale.
• With the shares marketable and many buyers at fairer value is P500,000.00 selling at discounted rate to a friend is an indirect taxable service:
• Therefore the shares value now at: Fair value of P650,000, Selling price 500,000 and the cost subtracted form the expenses: P300,000 is the cost on transfer for capital gains tax.
• Hence at P150,000 transfers is subject to higher taxes which goes to his friend for donation to the sales and gratuity of donor is on taxes.

Shares Sold For Immediate Cash

• The shares the have fair value of P650,000 and the seller in desperate need of capital and Immediate selling price is P500,000
• In this case, the P200,000 gain is capital gains tax which is taxable even if selling prices lower. This discount shall be added not gratuity from donor so is not subject the donor tax.

Capital Gains Tax Rate

• Under the TRAIN and CREATE laws, the rate is simplified to a flat 15%.

Tax Compliance

• Transactional capital gains tax uses BIR Form 1707.
• Annual capital gains tax uses BIR Form 1707A.

No Loss Scenario

• No capital gains tax is payable in the final return if all consolidated transactions during the year resulted in a gain, due to the flat 15% tax.

With Loss Scenario

• Best to offset any transactions where losses occurred,
• Residual payable must be settled.
• No tax payment should be made on a loss is intra-period loss is carried-over to be used for the next same turn

With Loss Scenario Demonstration

• Individual taxpayer sold these transactions with cost and tax payments

Gains On Sale

• When gains on sale is domestic stocks is sold in stalls the capital gains tax may also be paid in stalls of both:
• Selling price exceeding P1,000
• The initial payment is not to exceed 25% the selling price.

Illustration: Capital Gains

• The sells sells domestic stocks, when they sell with contract to pay in installs.
• Payment is under 1,000 than has selling price stall and when the price does not exceed to 25% the selling price
• Tax is 15% which can paid in stalls.
• And it needs to determine based on ratio paid vs, total debt to determine % paid per installment, in case of collateral its based on collaterals vs actual cash sold ratio %

Sale Of Capital Asset Located In Philippine

• Sales are exchanges and when are disposed class as located in the Philippines
• Subject to the tax of the sales price to 6% fair
• The Bureau of Internal Revenue is 6% of all the fair market located:
• Values Zones
• Fair Market Value

Illustration 1: Land Sale

• Land in an agricultural town it, it was 4,000 to begin then in zone value 7000, has property worth on tax.
• Assessed value of the province is always has the capital gains is tax to the province
• Capital gets taxed at 7,000,000 at 6% and assessed value is P420,00.

Illustration 2: Combination Land And Dwelling

• Anjo the one sold his land total to 5,000 now sold one of P2,000 total total construction cost of 2500
• Bureau of Internal Revenue =Fair vs Assissed Market
• Assessed Price Value is usually the lowest
• P5,000,000 vs the higher Fair value in the total which gives you P360 in taxable

Zone With Applicability in Philippines

• Individuals must follow: ALL is within Philippines and domestic is taxed only.
• Outside not taxed and its not applicable

That said, if you require any further assistance, do not hesitate to contact me.