BIR Ruling [DA-017-03]

January 22, 2003 BIR RULING [DA-017-03] Secs. 27 (A); 39 (A) (1); RR 2-98; 196 BIR Ruling No. 079-96 dated July 24, 1996 Royal Tatung Ceramic Corporation Formerly Royal Porcelain Corporation 704 Del Monte Avenue Quezon City Attention: Mr. Benny Chua Gentlemen : This refers to your letter dated November 23, 2001 requesting for a ruling on the tax implications relative to the foreclosure sale of several real properties and equipment, owned by Royal Tatung Ceramic Corporation (Royal Tatung) and Ty Liao & Chiang Development Corporation (Ty Liao), both held on September 20, 2001, to which the Philippine National Bank (PNB) and First e-Bank Corporation [formerly Private Development Corporation of the Philippines] were the highest bidders. Documentary evidence submitted disclosed that Royal Tatung and Ty Liao are both domestic corporations duly registered with the Securities and Exchange Commission (SEC); that Royal Tatung is engaged primarily in the business of manufacturing, buying, and selling of products of all kinds, particularly but not limited to ceramics, porcelain wares, tablewares, earthenwares, and other allied products; that Royal Tatung is the absolute and registered owner of several real properties and more particularly described as follows: Old TCT No. New TCT No. (Ty Area (sq.m.) Location Liao) First Contract 14020 101762 198 Quezon City 14021 101763 3,467 Quezon City 260341 101764 2,046.8 Quezon City 260342 101765 2046.8 Quezon City 260343 101766 2,046.8 Quezon City 260344 101767 2,046.8 Quezon City 260345 101768 2,046.8 Quezon City 30653 101769 7,696 Quezon City 260340 101770 8,331 Quezon City 45019 101771 12,797 Quezon City 42,723 sq.m. Second Contract RT-35826 N-139201 10,530 Quezon City 260336 N-139204 8,330 Quezon City 260337 N-139203 8,331 Quezon City 260338 N-139202 8,331 Quezon City 260339 N-139205 8,331 Quezon City 43,853 sq.m. First Contract: Deed of Absolute Sale that on December 22, 1993, a Deed of Absolute Sale was executed by and between Royal Tatung and Ty Liao whereby the former sold to the latter the first ten (10) of the above-mentioned real properties for and in consideration of P30,418,776.00 for which the documentary stamp tax in the amount of P589,327.00 has been paid as evidenced by the Authority to Accept Payment bearing serial number 1150165, to which the corresponding transfer certificates of title were issued in the name of Ty Liao as previously indicated. Second Contract: Deed of Absolute Sale On December 27, 1994, another Deed of Absolute Sale was executed by Royal Tatung conveying to Ty Liao the remaining five (5) parcels of land in the table above, excluding all the improvements thereon, on installment, for and in consideration of P52,623,600.00, subject to the following terms of payment: 1) Upon execution thereof P12,623,600.00 2) 1 year after execution thereof 10,000,000.00 3) 2 years after execution thereof 5,000,000.00 4) 3 years after execution thereof 5,000,000.00 5) 4 years after execution thereof 5,000,000.00 6) 5 years after execution thereof 5,000,000.00 7) 6 years after execution thereof 5,000,000.00 8) 7 years after execution thereof 5,000,000.00 P52,623,600.00 that it was further agreed that the taxes (including the capital gains tax) and registration fee shall be for the account of the buyer, Ty Liao; that on the same date, the corresponding documentary stamp tax was paid in the amount of P789,354.00 as evidenced by the Authority to Accept Payment bearing serial number 1863144. TIHCcA Third Contract: Contract of Lease On January 27, 1995, a Contract of Lease was entered into by and between Ty Liao, as Lessor and Royal Tatung, as Lessee, whereby the Lessor as the duly registered owner of fifteen (15) parcels of land located in Quezon City with a total area of 86,576 square meters, leased the said premises to the Lessee for a term of one (1) year starting from January 1, 1995 until December 31, 1995 renewable at the option of the Lessee; that the Lessee shall pay the Lessor a monthly rental within the first five (5) days of each month based on the rate of P3.00 per square meter or a total of P259,728.00 per month; that pursuant to the said Lease Contract, the Lessee is authorized and shall have the right to make any and all improvements it may deem proper or necessary on the leased premises; that the permanent improvements shall automatically belong to the Lessor at the termination or expiration of the Lease Contract; that if on the other hand, the termination or expiration of the Contract is due to the breach by the Lessor, the latter shall pay the Lessee the fair market value of such permanent improvements upon the termination or expiration of the said Contract. Fourth Contract: Mortgage Trust Indenture On June 6, 1995, a Mortgage Trust Indenture (Mortgage) was executed by Royal Tatung and Ty Liao, as Borrowers-Trustors/Mortgagors (jointly referred to as the "Company") in favor of Private Development Corporation of the Philippines, as Trustee; that in the said Mortgage, the PNB agreed to grant certain credit accommodations in favor of the Company in the aggregate amount of US$7,000,000.00; that the Company has entered into a Credit Line Agreement with PDCP in the amount of P50,000,000.00; that as security for the performance and payment of its obligations, the Company mortgaged certain properties in favor of the Trustee, acting in such capacity for the benefit of all creditors, with each creditor receiving a mortgage participation certificate evidencing its interests in the mortgage; and that the corresponding documentary stamp tax on the said mortgage has been paid in the amount of P461,210.00; that the Mortgage Trust Indenture and its Mortgage Participation Certificates were constituted to secure the payment of loans in the total principal amount of P32,000,000.00 for First e-Bank Corporation and P176,988,957.04 for PNB; that as of March 31, 2001, the outstanding obligations of Royal Tatung to the Mortgage Indenture Creditors with respect to the aforestated loans, now long overdue, which Royal Tatung has failed to pay, is in the aggregate amount of P241,137,221.89, inclusive of interest, but exclusive of penalties and agreed attorney's fees, broken down as follows: Creditors Outstanding Loan Interest Total First e-Bank (formerly P32,000,000.00 P4,346,222.22 P36,346,222.22 PDCP Development Bank, Inc.) Philippine National 50,185,871.22 5,683,047.31 55,868,918.53 Bank-TR Philippine National 3,000,000.00 299,822.91 3,299,822.91 Bank-RCL Philippine National 123,803,085.82 21,819,172.41 145,622,258.23 Bank-TL Total P208,998,957.04 P32,148,264.85 P241,137,221.89 that the terms and conditions of the aforestated Mortgage Trust Indenture and its Mortgage Participation Certificates having been violated, the Trustee, on behalf of the Mortgage Trust Indenture Creditors through its authorized representative, respectfully requested that the properties be sold at public auction for the satisfaction of the obligations above-described; that the Mortgage Trust Indenture and its Mortgage Participation Certificates cover fifteen (15) parcels of land, together with all the buildings, machinery, equipment and other improvements existing thereon; that on July 31, 2001, a Notice of Extra-Judicial Sale of Real Property was issued against Royal Tatung and Ty Liao by Ex-Officio Sheriff, Mercedes S. Gatmaytan, of the Regional Trial Court of Quezon City docketed as FRE No. 3919 which announced that on September 4, 2001 at 10:00 o'clock the above-mentioned real properties were to be sold at public auction to the highest bidder, whereas, on August 30, 2001, a Notice of Extra-Judicial Sale of Personal Property was likewise issued by the same Ex-Officio Sheriff, Mercedes S. Gatmaytan, which announced that all the machinery and equipment covered by the Chattel Mortgage executed on August 9, 1994, were sold at public auction to the highest bidder; that at the public auction held on September 4, 2001, the Ex.-Officio Sheriff of Quezon City sold the above-mentioned real properties to PNB and First e-Bank Corporation, as the highest bidders, in the amount of P174,728,030.98; and that finally, on September 20, 2001, the Ex-Officio Sheriff of Quezon City, through Mr. Rolando G. Acal, sold at public auction the machinery and equipment in the total sum of P66,409,190.91 to PNB and First e-Bank Corporation as the highest bidder. In reply thereto, please be informed that our opinion is based on the provisions of the Tax Code of 1997 and existing regulations and tax issuances applicable to the taxation of income arising from the foreclosure sale. 1. Income Tax Under Section 27(A) of the Tax Code of 1991, an income tax of 32% is imposed upon the taxable income derived during each taxable year from all sources within and without the Philippines by every corporation organized and existing under the laws of the Philippines. Thus, the taxable base is net income. Considering that the above-mentioned properties are classified as ordinary assets, the sale thereof by virtue of an extra-judicial sale to PNB and First e-Bank Corporation should be considered as ordinary gain taxable in full. The term "Ordinary Income" includes any gain from the sale or exchange of property which is not a capital asset or property described in Section 39(A)(1). Any gain from the sale or exchange of property which is treated or considered, under other provisions of the said Title, as ordinary income shall be treated as gain from the sale or exchange of property which is not a capital asset as defined in Section 39(A)(1). The term "ordinary loss" includes any loss from the sale or exchange of property which is not a capital asset. Any loss from the sale or exchange of property which is treated or considered, under other provisions of Title II, as ordinary loss shall be treated as loss from the sale or exchange of property which is not a capital asset. (Sec. 22(Z), Tax Code of 1997) DacTEH Under the accrual basis of accounting, income is recognized when the earning process is completed or virtually completed. Thus, for taxpayers following the accrual basis, in general, income must be recognized in the taxable year in which it was earned, regardless of whether or not payment thereof has been collected. Accordingly, Royal Tatung and Ty Liao should record income in the period of the foreclosure sale, i.e. , September 4 and 21, 2001, because that was when both Royal Tatung and Ty Liao were believed to have earned the revenues rather than in the period that the cash payments were received. 2. Withholding Tax Withholding of tax at source is a mode of tax collection whereby the income payor who is at the same time a duly constituted withholding agent is obliged by law to deduct a certain percentage from income payments made. Withholding agents include any juridical person or individual with respect to payments made pursuant to his business activities and the sale, transfer and exchange of real property. Under Revenue Regulations No. 2-98, as amended by Revenue Regulations No. 6-2001, a creditable withholding tax of 6% based on the gross selling price/total amount of consideration or the fair market value determined in accordance with Section 6(E) of the Code, whichever is higher, paid to the seller/owner for the sale, transfer or exchange of real property, other than capital asset, shall be imposed upon the withholding agent/buyer, where the seller/transferor is not habitually engaged in the real estate business. (Sec. 3(J) of Revenue Regulations No. 2-98, as amended by Sec. 3(J)(C) of Revenue Regulations No. 6-2001) In general, since the properties involved in the said extra-judicial foreclosure sale are ordinary assets, the sale on September 4 and 20, 2001 to PNB and First e-Bank Corporation as the highest bidders, shall be subject to 6% withholding tax based on the gross selling price or the fair market value, whichever is higher, which tax shall be deducted and withheld by the buyer/payor. But the income recipient is still required to file an income tax return as prescribed in Section 52 of the Tax Code of 1997, to report the income and/or pay the difference between the tax withheld and the tax due on the income. Considering that the sale thereof is by virtue of a foreclosure sale, the basis, for purposes of the withholding tax, shall be the bid price of P174,030.98 and P66,409,190.91 respectively, for real property mortgage and chattel mortgage (Revenue Regulations No. 4-99) . However, it should be emphasized that since the gain, if any, from the said sale has already been reflected in the income tax return of Ty Liao in the year of sale, there is indeed substantial compliance with the withholding tax requirements under Revenue Regulations No. 2-98, as amended by Revenue Regulations No. 6-2001. (BIR Ruling No. 079-96 dated July 24, 1996) . Accordingly, the aforesaid transaction is no longer subject to the creditable withholding tax prescribed in Revenue Regulations No. 2-98, as amended, except for the corresponding deficiency taxes. 3. Documentary Stamp Tax Section 196 of the Tax Code of 1997 provides that on all conveyances, deeds, instruments, or writings, whereby any land, tenement or other realty sold shall be granted, assigned, transferred or otherwise conveyed to the purchaser, or purchasers, or to any other person or persons designated by such purchaser of purchasers, there shall be collected a documentary stamp tax, at the rate of approximately 1.5% based on the consideration contracted to be paid for such realty or on its fair market value determined in accordance with Section 6(E) of the said Code, whichever is higher. ADECcI In the instant case, since the above transaction is a foreclosure sale, the basis for the documentary stamp tax shall be paid based on the bid price of the highest bidder at the same time the aforesaid return is filed, pursuant to Section 4 of Revenue Regulations No. 4-99. In fine, since Ty Liao has reflected and declared in its income tax return whatever amount received as the bid price in the extra-judicial foreclosure sale when the full payment thereof was received, PNB and first e-Bank Corporation are not required to withhold any amount from the bid price as there is already substantial compliance with the withholding tax requirement prescribed in Revenue Regulations No. 2-98, as amended by Revenue Regulations No. 6-2001. 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.) JOSE MARIO C. BUAG Deputy Commissioner Legal & Inspection Group