BIR Ruling [DA-031-03]

February 3, 2003 BIR RULING [DA-031-03] Rev. Regs. No. 2 144-97 Joaquin Cunanan & Co. 29th Floor Philamlife Tower 8767 Paseo de Roxas 1226 Makati City Attention: Atty. Alexander B. Cabrera Partner, Tax Services Department Gentlemen : This refers to your letter dated October 9, 2002 requesting on behalf of your client, Shangri-la Plaza Corporation (SLPC), for a confirmation that the current net book value of the building or improvement can be amortized over the remaining term of the lease. It is represented that SLPC is a corporation duly organized and existing under Philippine laws. It was incorporated mainly to invest in, purchase, own, hold, lease and operate the Shangri-la Plaza Shopping Complex located at EDSA corner Shaw Boulevard, Mandaluyong City. Further, SLPC is 78.72% subsidiary of EDSA Property Holdings, Inc. (EPHI). On January 6, 1993, SLPC entered into a 25-year lease agreement with its parent company, EPHI (formerly Shangri-la Properties, Inc.), for the use of the land where the Shangri-la Plaza Shopping Complex (building) is located. It is embodied in the lease agreement that the building shall be transferred to EPHI at the end of the 25-year lease period. The contract does not contain stipulations on automatic renewal. Currently, the building is being depreciated for a period of 45 years parallel to the remaining corporate life of SLPC from the time the shopping complex was constructed. As of December 31, 2001, the remaining estimated useful life of the building is 36 years out of its 45 years estimated useful life. SLPC intends to shorten the depreciable life of its building from 45 to 25 years to correspond to the lease term. In reply, please be informed that the current net book value of the building or improvement can be amortized over the remaining term of the lease based on the following grounds: 1. Under Section 74 of Revenue Regulations No. 2, otherwise known as the Income Tax Regulations, leasehold improvements may be amortized over the term of the lease. Said provision pertinently reads: ". . . The cost borne by a lessee in erecting buildings or making permanent improvements on ground of which he is lessee is held to be a capital investment and not deductible as a business expense. In order to return to such taxpayer his investment in capital, an annual deduction may be made from gross income of an amount equal to the cost of such improvements divided by the number of years remaining of the term of lease, and such deduction shall be in lieu of a deduction for depreciation . If the remainder of the term of lease is greater than the probable life of the buildings erected, or of the improvements made, this deduction shall take the form of an allowance for depreciation." (Emphasis supplied) . . . 2. The regulations is also consistent with Generally Accepted Accounting Principles (GAAP) which provide that if there is no reasonable certainty that the lessee will obtain ownership of the asset by the end of the lease term, the asset should be fully depreciated over the shorter period of the lease or its useful life. (Par. 19 of the International Accounting Standards No. 17, superseding the lease accounting provisions of Statement of Financial Accounting Standards No. 6 - GAAP on Property and Equipment). IcHTED The taxpayer is generally required to report his income in accordance with the method of accounting regularly employed in keeping the books of such taxpayer (Section 43, Tax Code). Hence, even the rules of GAAP will require the taxpayer in this case to depreciate the property over the remaining term of the lease as this is shorter than the useful life of the asset, subject to the proper adjusting entries on depreciation expense, which shall be made during the year the adjustment on the depreciable life of the building was made, and further, that there shall also be a corresponding income recognition on the part of the lessor-parent corporation pursuant to the allowable method adopted, considering that the building will be transferred to the latter at the end of the lease. 3. The Income Tax Regulations allow revisions in the estimated useful life of the asset and that undepreciated portion of the cost be spread over the re-estimated life of the property. Section 109 of Revenue Regulations No. 2 pertinently reads: ". . . Whatever plan or method of apportionment is adopted must be reasonable and must have due regard. to operating conditions during the taxable period. While the burden of proof must rest upon the taxpayer to sustain the deductions taken by him, such deductions must not be disallowed unless shown by clear and convincing evidence to be unreasonable. The reasonableness of any claim for depreciation shall be determined upon the conditions known to exist at the end of the period for which the return is made. If it develops that the useful life of the properly will be longer or shorter than the useful life as originally estimated under all the then known facts, the portion of the cost or other basis of the property not already provided for through depreciation allowances should be spread over the remaining useful life of the property as re-estimated in the light of the subsequent facts, and depreciation deductions taken accordingly . (Emphasis supplied) . . ." The aforequoted provision was also used as basis by the Bureau in BIR Ruling No. 144-97 dated December 29, 1997, in allowing Goodyear Philippines, Inc. to adopt in computing its depreciation expense, for both tax and financial accounting purposes, the estimated remaining useful life after rehabilitation of the assets. In view of all the foregoing, the taxpayer's intention to shorten the depreciable life of the building from 45 to 25 years is justifiable, subject to the above-stated requirement for adjusting entries on depreciation expense by the lessee-subsidiary corporation and income recognition by the lessor-parent corporation. Thus, SLPC may amortize the current book value of the building over the remaining useful life of the lease. 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 Duty Commissioner Legal and Inspection Group