SHARES of a company may be redeemed for a number of reasons. Redemption of shares can be an obligation under a buy-sell agreement to purchase stock. Companies also buy back shares in order to increase price or to retire preferred stock so as to dispense with the payment of dividends. Generally, stock redemption may also be viewed as a means of returning capital to investors or as an alternative to dividends.
Because of its close resemblance to the nature of dividends, some countries have taken the position of taxing any redemption premium (i.e., the difference between the redemption price and the cost of the shares redeemed) as dividends and not as capital gains, if certain criteria are met.
In the Philippines, the rules on the tax treatment of such premium may not be as definite and straightforward, which may be the reason why such has been the subject of a recent Court of Tax Appeals (CTA) En Banc decision. In the CTA case entitled Commissioner of Internal Revenue (CIR) vs. Goodyear Philippines, Inc. (“Goodyear”) dated Aug. 14, the BIR argued that the amount in excess of the original subscription price paid by Goodyear should not be treated as mere premium, but as accumulated dividends in arrears of the redeemed preferred shares, hence, subject to 15% final withholding tax on dividends. The CTA ruled that the premium shall be treated as capital gain or loss and shall not be considered dividends subject to dividend tax.
The capital gain or loss treatment applied to the redemption of shares was principally anchored on Revenue Regulations (RR) No. 6-2008, where the BIR consolidated the rules on the taxation of shares sold, bartered, exchanged, or otherwise disposed of. Under the RR, the tax consequences of the redemption will depend on the intention of the issuing company to either retire the shares or to hold it in treasury, as summarized below:
a) Redemption of shares for cancellation or retirement -- The difference between the redemption price and the original cost of the preferred shares shall be treated as capital gain or capital loss, and shall be subject to the regular income tax rates imposed under the Tax Code.
b) Redemption of shares held in treasury -- If the shares are listed and transferred through the trading system and/or facilities of the Local Stock Exchange, the stock transaction tax shall; Otherwise, the transaction shall be subject to the 5% and 10% net capital gains tax.
(If the shareholder is a resident of a country with which the Philippines has an existing tax treaty, subject to certain qualifications, exemption from income tax may be available.)
Although the RR seems to be clear on the capital gains or loss treatment, in this case, the CIR was keen to treat the inclusion of the accrued dividends in the redemption price as payment of dividends, and impose the dividends tax.
However, the court ruled that the net capital gain does not meet the definition of dividends under the Tax Code thus should not be taxed as such. Per definition, dividends should be paid out of earnings and profits but the court noted that Goodyear did not declare and pay dividends as the company did not have unrestricted retained earnings to cover any dividend declaration. Dividends should also be a recurring return on the shares.
The court went further in saying that there is only one provision in the Tax Code which treats as dividends the gain derived from redemption or buy back of shares. It is only in cases of redemption of shares previously issued as stock dividends that the difference between the par value and the redemption price may be treated as dividends.
The transaction in the above case took place in 2008 and was still appealed by the BIR to the CTA En Banc in 2013. The appeal seems contrary to a 2012 ruling issued where the BIR held that the net capital gain realized by a nonresident foreign corporation (domiciled in the Netherlands) from the redemption of preferred shares is exempt from income tax under the capital gains provision of the Philippines-Netherlands tax treaty. The BIR, in this case, did not consider the premium as taxable dividends.
One can surmise that the tax treaty exemption was properly applied in the 2012 ruling but the BIR did not appear to find the circumstances in the 2008 transaction to be the same as in the 2012 ruling. Thus, while the CTA has already confirmed that treaty exemption should apply on share redemptions regardless of whether it is pegged to include unpaid and accrued dividends, taxpayers may find it prudent to consider the potential risk when redeeming their shares.
Reynaldo E. Maniego III is an assistant manager at the tax services department of Isla Lipana & Co., the Philippine member firm of the PwC network. You may send inquiries or feedback to reynaldo.e.maniego.iii@ph.pwc.com
source: Businessworld
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