BIR Ruling [DA-040-03]

February 10, 2003 BIR RULING [DA-040-03] Secs. 27 (D) (5) & 39 (A) (1) 27-2002, 166-81 SGV & Co. 6760 Ayala Avenue 1226 Makati City Attention: Atty. W.U. Villanueva Tax Division Gentlemen : This refers to your letter dated October 8, 2002 requesting for our confirmation of your opinion (1) that the proposed dacion of the undeveloped lots of Alsons Land Corporation to its creditors is subject to 6% capital gains tax (CGT) pursuant to Section 27(D)(5) of the Tax Code of 1997; (2) that the Deed of Dacion en Pago is subject to documentary stamp tax (DST) of 1.5% based on the consideration or value received or paid for the property, which in effect is the amount of obligation that is extinguished, or on its fair market value whichever is higher, pursuant to Section 196 of the Tax Code of 1997; and (3) that the said dacion is exempt from 10% value-added tax (VAT) pursuant to Section 109(w) of the Tax Code of 1997. It is represented that your client, Alsons Land Corporation ("ALC"),is a domestic corporation and is engaged primarily in real estate development; that ALC owns several undeveloped real properties; that these undeveloped real properties are idle pieces of property consisting in parcels of land for subdivision development; that ALC used such properties as collateral for its outstanding loans with several banks; that ALC and its creditor-banks propose to enter into an agreement to fully settle the former's obligations by means of dacion en pago ,with the creditor-banks acquiring the undeveloped subdivision lots. In reply, please be informed that your opinion is hereby confirmed as follows: 1 The proposed transfer via dacion en pago of undeveloped lots by ALC shall be treated as a sale of capital assets subject to capital gains tax (CGT) of 6% under Section 27(D)(5) in relation to Section 39(A)(1) of the Tax Code of 1997. ( BIR Ruling No. 166-81 dated September 3, 1981; DA-217-99 dated April 12, 1999; DA-397-2000 dated November 20, 2000; DA-010-02 dated January 29, 2002; DA-009-2002 dated January 28, 2002 ). It is necessary to first determine the character of the real property being sold. Thus, if the real property is a land or building which is not actually used in the business of the seller-corporation and is treated as a capital asset, as that term is defined in Section 39(A) of the 1997 Tax Code, then a final tax of six percent (6%) shall be imposed on the gain presumed to have been realized on its sale, exchange or disposition of such land or building based on the gross selling price or fair market value as determined in accordance with Section 6(E) of the Tax Code of 1997, whichever is higher of such land and/or building. (Sections 27(D)(5); Tax Code of 1997]. This rule applies, whether or not the seller-corporation is engaged in real estate business. On the other hand, it is only when the real property being sold is an ordinary asset that the withholding tax rates imposed under Section 2.57.2 of Revenue Regulations No. 2-98, as amended, shall apply. The rate of withholding tax will depend on whether, first, the seller is exempt or taxable, second, whether the seller is habitually engaged in real estate business or not; and third, if the seller is habitually engaged in real estate business, the gross selling price, as that term is defined in the above-mentioned Revenue Regulations. ( BIR Ruling No. 27-02 dated July 3, 2002 ) (Emphasis ours.) The undeveloped lots, which ALC seeks to convey to its creditor-banks by way of a dacion en pago ; are idle and unproductive lands of a real estate developer not primarily held for sale to its customers in that ordinary course of its business. Thus, the same are properly classified and taxed as capital assets pursuant to Sections 27(D)(5) and 39(A)(1) of the Tax Code of 1997. aCASEH Dacion en pago is a special mode of payment recognized under Article 1245 of the New Civil Code. Under the same provision of law, this undertaking partakes of the nature of a sale. In dacion transactions and for tax purposes, the outstanding balance of the loan must be considered as the selling price for purposes of computing the taxes due thereon. ( BIR Ruling No. 459-88 dated September 19, 1988 and BIR Ruling No. 123-86 dated July 23, 1986 ). Thus, the proposed dacion of the undeveloped lots by ALC is subject to capital gains tax at the rate of 6% of the balance of the loan obligation or the fair market value of the property, whichever is higher. 2. The Deed of Dacion en Pago ,embodying the dacion transaction, is subject to documentary stamp tax (DST) based on the consideration or value received or paid for the property, which in effect is the amount of obligation that is extinguished, or on its fair market value whichever is higher, pursuant to Section 196 of the Tax Code of 1997. This tax is payable by either party to the said sale. ( BIR Ruling Nos. 459-88 of September 19, 1988 and DA-049-2000 dated January 21, 2000 ). 3. The proposed dacion of ALC's undeveloped lots is not subject to the 10% value added tax (VAT) inasmuch as the said properties are neither being held primarily for sale or lease to its customers nor used in the ordinary course of its trade or business in accordance with Section 109(w) of the Tax Code of 1997. TaDAIS 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, Commissioner of Internal Revenue By: (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group