Baniqued & Baniqued

January 9, 2007 BIR RULING [DA-009-07] DA213-02 Baniqued & Baniqued Suite 803, 8/F Jollibee Centre San Miguel Avenue Pasig City Attention: Atty. Laura Victoria A.S. Yuson-Layug Atty. Suzette A. Celicious-Sy and Atty. Kathleen L. Saga Gentlemen : This refers to your letter dated December 22, 2006 stating that your client, Continental Operating Corporation (COC) [now Fortune Cement Corporation], is a corporation organized and existing under Philippines laws; that it is engaged in the manufacture and sale of Portland Cement and allied or derivative products; that in its books of accounts as of December 31, 2005, COC reflected as part of its Property, Plant and Equipment, a "Construction in Progress" account; that this account consists of amounts spent for civil works, machineries, equipment and spare parts that were intended to make up Line 3 of COC's cement manufacturing plant; that Line 3 of COC's cement manufacturing plant was meant to augment the capacity of another existing production line within the plant; that while Line 3 was in the process of construction, all costs incurred were charged to COC's "Construction in Progress" account; that inasmuch as Line 3 was still in the process of completion and had not, of yet, been put to operational use, COC, pursuant to international accounting standards, did not subject the Properties to depreciation; that due to poor market conditions and discouraging sales forecasts on account of inadequate prospects for future construction activities, construction of Line 3 was temporarily discontinued; that the Properties comprising Line 3, however, were available for use as temporary replacement machinery and equipment of spare parts for COC's other production line when necessary; and that subsequently, COC received an offer from an independent third party to purchase the Properties comprising Line 3. Based on the foregoing representations, you now request confirmation of your opinion that the Properties comprising the "Construction in Progress" account, which were intended for use in the cement manufacturing business of COC upon completion of construction, are considered ordinary assets and any gain or loss arising from the sale of the Properties constitutes ordinary gain or loss subject to 35% corporate income tax under Section 27 of the Tax Code of 1997, as amended. In reply thereto, please be informed that Section 39 of the Tax Code of 1997 defines capital assets as property held by the taxpayer (whether or not connected with his trade or business), but does not include the following: 1. stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year; 2. property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business; 3. property used in trade or business of a character which is subject to allowance for depreciation provided in Subsection (F) of Section 34; or 4. real property used in the trade or business of the taxpayer. It is clear that the above definition of capital asset is negative in nature. Thus, if the asset is one of those mentioned in the exceptions, needless to say, it is an ordinary asset. In the case of Tuason, Jr. v. Lingad, 58 SCRA 170 (1974) , the Supreme Court set the criteria in examining and evaluating whether or not a property is an ordinary asset or a capital asset, which criteria was later adopted by the BIR in BIR Ruling No. DA213-02 dated November 21, 2002 , to wit: (i) the purpose for which the property was acquired; (ii) the purpose for which the property was subsequently held; (iii) the extent to which improvements were made to the property; (iv) the frequency, number and continuity of sale; (v) the extent and nature of the transactions involved; (vi) the ordinary business of the taxpayer; (vii) the extent of advertising, promotion or other activities used in soliciting buyers for the sale of the property; (viii) the listing of property with brokers; (ix) the purpose for which the property was held at the time of sale. Under the foregoing circumstances, COC had all along intended to use the Properties comprising Line 3 in its cement manufacturing operations to augment the capacity of its existing production lines. However, in view of poor market conditions, it was in COC's best interest to optimize capital outlay and temporarily discontinue the construction of Line 3. In the meantime, the Properties were available for use as back-up machinery, equipment and spare parts in the event required by COC's other existing production line within the Plant. Indeed, the construction of Line 3 was undertaken pursuant to, and was fully intended for use in, COC's cement manufacturing business. Accordingly, the Properties comprising Line 3 of COC's cement manufacturing plant, which Properties are classified as Property, Plant and Equipment and reflected under the "Construction in Progress" account of COC's Balance Sheet as of December 31, 2005, constitute property used in trade or business of a character which is subject to allowance for depreciation and needless to say, are ordinary assets. Moreover, although the Properties were never depreciated inasmuch as Line 3 was still in the process of completion and had yet to be used in business, the Properties nonetheless fall within the classification of 'property used in the trade or business of a character which is subject to the allowance for depreciation' within the meaning of Section 39 of the Tax Code of 1997. The phrase "used in the trade or business" means property that is 'devoted to the trade or business' and 'includes property purchased with a view to its future use in the business even though this purpose is later thwarted by circumstances beyond the taxpayer's control. ( Carter-Colton Cigar Co. v. Commissioner of Internal Revenue, 9 TC 219, Alamo Broadcasting Co. v. Commissioner of Internal Revenue, 15 TC 534, and Spindler v. Commissioner of Internal Revenue, TC Memo 1963-202 ). It should be emphasized, however, that in Carter-Colton Cigar Co. v. Commissioner of Internal Revenue, 9 TC 219 , the taxpayer's intent to use a property in business at the time of acquisition determined the classification of such property as an ordinary asset. In the aforesaid case, Carter-Colton Cigar Co. purchased unimproved real estate with intention of erecting thereon a building to be occupied by it. Plans and specifications were prepared, but the original purpose was later abandoned on account of economic dislocation in connection with the depression which occurred at that time. The United States Tax Court held that the property was 'used in the trade or business' of the taxpayer and the loss sustained on its sale was an ordinary loss. HcDSaT Likewise, in Alamo Broadcasting Co. v. Commissioner of Internal Revenue, supra , the United States Tax Court said: "The evidence does not sustain respondent's determination that petitioner had no intention of making use of the diesel at the time of purchase. We have no doubt that petitioner was primarily interested in acquiring XENT's high-powered transmitter when it negotiated for the Mexican station. But whatever the principal motivation may have been, the testimony clearly establishes that up to and beyond the date of acquisition petitioner planned to employ the XENT diesel as a source of either primary or auxiliary power at its proposed new site. Even after petitioner learned that permission had been obtained to export the XENT transmitter from Mexico but not the diesel, it continued to entertain the hope that it would later prove possible to bring out the power unit. It was only in view of the mounting caretaking and legal expenses incurred in connection with it that petitioner eventually decided in 1946 to dispose of the diesel for whatever price it could realize on an immediate sale. This proved to be a total consideration of $4,125 paid by the purchasers. The nature of petitioner's loss is governed by our determination that petitioner purchased the diesel with the intent of using it in its new facility. The loss properly falls within the provisions of Section 117(A) as a loss incurred on the sale of property 'used in the trade or business'. We have previously held that 'used in the trade or business' and includes property purchased with a view to its future use in the business even though this purpose is later thwarted by circumstances beyond the taxpayer's control. Ibid . It fully intended to use the diesel as a source of either primary or auxiliary power until it became evident that the cost of keeping a caretaker with the equipment in Mexico and of defending the lawsuits that occurred in respect to the property were rapidly consuming its investment in the property. Since petitioner could not determine when, if ever, permission might be obtained to export the diesel, it decided to dispose of it rather than incur additional expense. Although no depreciation was taken or allowed on the diesel, it nevertheless falls within the classification of property 'of a character which is subject to the allowance for depreciation' within the meaning of Section 17(j). see the P. Dougherty Co., 5 T.C. 791, affd., 159 Fed. (2d) 269." Furthermore, in Spindler v. Commissioner of Internal Revenue, supra , the United States Tax Court in considering the loss on the lapse of the option and on the subsequent expenditures as an ordinary loss and not a loss on the sale of a capital asset said: "The property does not have to be in actual use as rental property during the year of sale. Carter-Colton Cigar Co., 9 T.C. 219. The phrase 'used in the trade or business' means, as was said in Alamo Broadcasting Co., 15 T.C. 534, property that is 'devoted to the trade or business' and includes 'property purchased with a view to its future use in the business even though this purpose is later thwarted by circumstances beyond the taxpayer's control.' It is without dispute that petitioner and his associate secured the option with the intention of improving the land with a building to be built for a tenant if one could be secured. They expended money for a survey and a retaining wall and tried to interest prospective tenants. Their efforts failed so they allowed the option to lapse and petitioner suffered the loss in issue. Viewing the option as an acquisition which is what section 1234(9) directs, we hold the property was used in the trade or business of petitioner within the meaning of section 1221(2), and section 1231(a), supra , and the loss on the lapse of the option viewed as a sale was an ordinary loss and not the loss on the sale of a capital asset. Under similar facts in Carter-Colton Cigar Co., supra , we held unimproved realty so purchased had the character of property used in the trade or business during the planning stages. . . " Inasmuch as the Properties comprising COC's Line 3, which Properties were acquired/constructed for the purpose of being used in COC's cement manufacturing business, are considered as used in trade or business of a character which is subject to depreciation allowance and, needless to say, are ordinary assets. WHEREFORE, in view of the foregoing , this Office hereby confirms your opinion that any gain or loss arising from the sale of the Properties constitutes ordinary gain or loss subject to 35% corporate income tax under Section 27 of the Tax Code of 1997. DSATCI This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service