Tax-free exchange transactions (“Tax-Free Exchange”) under Section 40 (C)(2) of the 1997 National Internal Revenue Code (“Tax Code”), as amended by Republic Act (“RA”) No. 11534 (otherwise known as “CREATE”), may now be implemented without securing a prior ruling from the Bureau of Internal Revenue (“BIR”).
Parties in a Tax-Free Exchange were previously required by the BIR, through Revenue Memorandum Ruling No. 1-2002, to first secure a tax ruling before availing the tax exemption. However, the requirement of securing a ruling for a tax-free exchange transaction was declared void by the Supreme Court in 2020 in the case of Commissioner of Internal Revenue v. Lucio Co, et al. (GR No. 241424) since the Tax Code did not provide such requirement. Section 10 of CREATE then amended Section 40©(2) of the Tax Code by expressly providing that no confirmation or prior tax ruling availing tax exemption (“prior tax ruling”) is required.
In implementing Section 40(C)(2) of the Tax Code, as amended, the BIR initially issued Revenue Regulations (“RR”) No. 5-2021, which provided that the tax exemption can be availed of even without a prior tax ruling, subject to a post-transaction audit of the BIR. The BIR then issued Revenue Memorandum Circular (“RMC”) No. 19-2022 to clarify this by, among others, reiterating a post-transaction audit of Tax-Free Exchanges and continuing the effectivity of BIR issuances relating to Tax-Free Exchanges before CREATE. RMC No. 19-2022, however, provides that parties in a Tax-Free Exchange have the option to request for a ruling or an opinion on the tax exemption from the Law and Legislative Division of the BIR National Office.
The post-transaction audit of a Tax-Free Exchange will be conducted by the concerned revenue district office (“RDO”) based on existing revenue issuances on tax audit and assessment, which commences with the BIR’s issuance of a notice and letter of authority and culminates upon its issuance of a final decision on disputed assessment. In case the transaction does not qualify as a Tax-Free Exchange based on the RDO’s audit, the parties will be required to pay the corresponding taxes, interest, penalty, and surcharge. However, any transfer of title over the properties will remain valid because such audit findings of the BIR will not invalidate the certificate authorizing registration (“CAR”).
Since the BIR will conduct an audit, parties in a Tax-Free Exchange are expected to present documents proving that the transaction they entered into qualified as Tax-Free Exchange under Section 40(C)(2) of the Tax Code, as amended. RMO No. 19-2022 stated that it is incumbent upon the parties to show compliance with the requirements set forth under the law and existing revenue issuances when availing of the tax exemption. RMO No. 32-2001, which is an issuance confirmed by RMO No. 19-2022 to be still effective, may be used as basis in determining what documents to prepare because it used to provide the requirements in securing a tax ruling.
In view of the foregoing, parties may now immediately progress to the next step after executing the relevant contracts or agreements of a Tax-Free Exchange and proceed with the transfer of titles over the properties (including the application for CAR) involved in the Tax-Free Exchange. However, parties should keep in their records documents proving compliance with the requirements of the law and revenue issuances on the Tax-Free Exchange in preparation for the post-transaction audit of the BIR.
