Dear Attorney,

I hope this letter finds you well. I am writing to seek clarification on a matter related to capital gains tax calculation in the Philippines. Specifically, I would like to inquire whether the purchase costs of a capital asset are deducted from the selling price when computing capital gains.

To provide some context, I am involved in a situation where I may need to sell an asset that was acquired several years ago. I understand that capital gains tax is imposed on the sale, exchange, or other disposition of capital assets, but I would appreciate your legal guidance on whether the original purchase price, including any related acquisition costs (e.g., legal fees, brokerage fees, etc.), can be deducted before arriving at the net capital gain for tax purposes. Additionally, I am curious about any other expenses that might be considered in calculating the net gain.

Your expert advice would be invaluable as I navigate this process. Thank you for your attention to this matter, and I look forward to your insights.

Sincerely,
A Concerned Asset Holder

Capital Gains and the Deduction of Purchase Costs from Capital Assets in the Philippines

Under Philippine law, the taxation of capital gains is governed by several legal frameworks, with the primary regulations found in the National Internal Revenue Code (NIRC). Specifically, capital gains tax is levied on the sale, transfer, or disposition of capital assets, as defined by the NIRC. This article will comprehensively examine the deduction of purchase costs from capital assets in calculating capital gains, including the relevant legal provisions, guidelines, and practices under Philippine tax law. Additionally, we will address related concerns, such as allowable deductions and tax exemptions.

1. Definition of Capital Assets

Capital assets are broadly defined under Section 39 of the NIRC as property held by the taxpayer, whether or not connected with the taxpayer's trade or business, but excluding stock in trade, inventory, and property used in the taxpayer's trade or business. Examples of capital assets include real property, shares of stock in domestic corporations, bonds, and certain intangible assets.

Importantly, capital assets are distinguished from ordinary assets, which are those used in a taxpayer’s trade or business, such as equipment, inventory, or raw materials. This distinction is crucial because the taxation rules differ for capital and ordinary assets, with capital gains subject to specific tax rates.

2. Calculation of Capital Gains

Capital gains tax is computed by determining the difference between the selling price (or fair market value, whichever is higher) and the acquisition cost of the asset, as outlined under Section 24 (D) of the NIRC. The key elements in calculating capital gains are:

Selling Price/Fair Market Value: The higher of the actual selling price or the fair market value (FMV) at the time of the sale.
Acquisition Cost: The cost of purchasing the asset, which may include the purchase price as well as incidental costs directly related to the acquisition.

To compute capital gains:

[ \text{Capital Gain} = \text{Selling Price} - \text{Acquisition Cost} ]

3. Are Purchase Costs Deducted from a Capital Asset?

In the calculation of capital gains, the acquisition cost includes not only the purchase price of the asset but also any ancillary or incidental costs incurred in the acquisition of the asset. These costs are essential in reducing the taxable capital gain, and Philippine tax law allows for their deduction.

The costs that can be deducted from the selling price to arrive at the net capital gain include:

Original Purchase Price: The price paid for the asset at the time of acquisition.
Legal Fees: Fees paid for legal services related to the acquisition, such as the preparation and execution of contracts.
Brokerage Fees: Fees paid to brokers or agents who facilitated the purchase.
Documentary Stamp Taxes: The tax paid on the sale or transfer of property, which is part of the acquisition cost.
Transfer Taxes: Taxes paid to transfer the property title from the seller to the buyer.
Notarial Fees: Fees paid for the notarization of documents required for the acquisition of the asset.
Registration Fees: If applicable, fees paid to government agencies for the registration of the property in the buyer’s name.

These purchase-related costs can significantly reduce the taxable capital gain and should be carefully accounted for in any transaction. In other words, when calculating the capital gain on the sale of a capital asset, the purchase costs can be deducted from the selling price before the capital gains tax is applied.

However, it is crucial to ensure that proper documentation is maintained to substantiate these deductions. Receipts, contracts, and official receipts for fees paid should be retained to support the deductions in case of an audit by the Bureau of Internal Revenue (BIR).

4. Specific Tax Rates Applicable to Capital Gains

The capital gains tax rates in the Philippines vary depending on the type of asset sold. There are distinct tax regimes for the following two categories of capital assets:

Real Property (Non-Dealer Transactions): Under Section 24(D)(1) of the NIRC, the capital gains tax on the sale of real property located in the Philippines by individuals, estates, and trusts is 6% of the gross selling price or current fair market value, whichever is higher. In this case, deductions of purchase costs are not explicitly provided for in the computation of the capital gains tax because the 6% tax is based on the gross selling price or FMV, without consideration of acquisition costs.
Shares of Stock in a Domestic Corporation: Capital gains derived from the sale of shares of stock not traded through the stock exchange are subject to a 15% capital gains tax, as per Section 24(C) of the NIRC. For this category of assets, the net capital gain is determined by deducting the acquisition cost (including incidental purchase costs) from the selling price.

It is important to note that shares of stock traded on the Philippine Stock Exchange (PSE) are subject to a stock transaction tax of 0.6% of the gross selling price, rather than a capital gains tax.

5. Other Allowable Deductions and Considerations

Beyond the purchase costs, certain other expenses may be deducted from the selling price when calculating capital gains. These deductions include:

Improvements or Capital Expenditures: Any substantial improvements made to the asset that increase its value may be added to the acquisition cost. For example, renovations to a property or structural enhancements that increase its fair market value would be considered a capital expenditure and could be deducted when calculating the capital gain.
Depreciation: In the case of assets used in business or held for investment purposes, the cost of depreciation over the asset's useful life can reduce the acquisition cost. Depreciation applies to buildings, machinery, and other tangible capital assets that wear out over time.
Selling Expenses: Expenses related to the sale of the asset, such as marketing, advertising, and broker's fees, can also be deducted from the gross selling price to reduce the taxable gain.

6. Documentation and Record-Keeping Requirements

For taxpayers seeking to deduct acquisition costs and other expenses from the selling price of a capital asset, proper documentation is essential. The BIR requires taxpayers to maintain sufficient records to support their claims of deductions. These records include:

Original purchase agreements or contracts.
Receipts for legal, notarial, and brokerage fees.
Receipts for registration and transfer taxes.
Proof of payment for improvements or renovations to real property.

Failure to maintain proper documentation can result in the disallowance of deductions during a tax audit, leading to a higher taxable capital gain.

7. Conclusion

In conclusion, under Philippine tax law, the costs incurred in purchasing a capital asset can generally be deducted from the selling price when calculating capital gains, provided these costs are properly documented. The original purchase price, along with related acquisition expenses such as legal fees, documentary stamp taxes, and brokerage fees, can all reduce the taxable capital gain, thus lowering the capital gains tax liability.

However, for the sale of real property, the application of the 6% capital gains tax on the gross selling price or fair market value does not allow for the deduction of acquisition costs. On the other hand, for shares of stock in a domestic corporation not traded on the stock exchange, the 15% capital gains tax is based on the net capital gain, allowing for deductions of acquisition costs.

Taxpayers should maintain proper records of all costs related to the purchase and improvement of the asset to ensure that deductions are allowed during tax computation. Consulting with a tax professional or legal advisor is always advisable to ensure compliance with all tax regulations and to maximize potential deductions.