Puno and Puno

January 29, 2007 BIR RULING [DA-044-07] 196; 373-87; 429-88; 329-92; DA-152-02; DA-203-03; DA-576-06 Puno and Puno 12th Floor, East Tower Philippine Stock Exchange Centre Exchange Road, Ortigas Center Pasig City Attention: Atty. Regis V. Puno Atty. Ma. Elizabeth E. Peralta-Loriega Gentlemen : This refers to your letter dated October 25, 2006 requesting confirmation of your opinion that the Deed of Exchange of Real Property dated 07 December 2005 executed by and between Pasay-HongKong Realty Development Corporation (PHRDC) and the Philippine Reclamation Authority (PRA) is not subject to the corporate income tax, capital gains tax or creditable withholding tax and neither is the Amended Deed of Exchange of Real Property dated 02 October 2006 subject to Documentary Stamp Tax (DST). The pertinent portion of your request states as follows: "PHRDC is a corporation duly organized and existing under the laws of the Philippines with principal office address at the 15TH Floor, PSBank Tower, Senator Gil Puyat Avenue, Makati City, Metro Manila. Its primary purpose and core business activity is real estate development. PRA, on the other hand, is a government infrastructure agency, created under Presidential Decree No. 1084, with principal office address at 7th and 8th Floors, Legaspi Towers 200, Paseo de Roxas, Makati City. Pursuant to its charter, PRA is authorized and empowered to reclaim lands and to develop, improve, acquire, administer, deal in, subdivide, dispose, lease and sell the same to individuals or entities. PRA may also enter into contracts and loan agreements with private, public or foreign entities and to exercise the right to eminent domain in the name of the Republic of the Philippines. In furtherance of its mandate, PRA began constructing the northern portion of the Roxas Boulevard canal in partial implementation of the Boulevard 2000 Integrated Framework Plan. In the course of the project, PRA inadvertently appropriated approximately 16,346 square meters (m 2 ) of land located in the area known as "Central Business Park Island A" ("CBP-IA"), owned by and registered under the name of PHRDC. Parenthetically, another PRA project, the construction of the EDSA Extension Road, likewise encroached upon an approximately 107 m 2 portion of CBP-IA, also owned by and registered in the name of PHRDC. Consequently, on November 28, 1998, PRA and PHRDC entered into a Memorandum of Agreement ("MOA"), whereby PRA agreed to replace the affected PHRDC-owned lots with PRA-owned lots of equal value, to be determined based on the appraisal reports of two (2) independent appraisal companies. In this relation, the highest appraised values of PHRDC's 16,346 m 2 and 107 m 2 lots, as of September 2005, are PhP23,300.00/m 2 and PhP30,000.00/m 2 , respectively. The combined highest appraisal value of the two affected properties is thus, PhP367,725,800.00. PRA intended to replace the affected lots with equally valued lots in its property known as superblock B, likewise located in CBP-IA. The highest appraised value of the lots in superblock B, as of September 2005, is PhP36,000.00/m 2 . Accordingly, the aforecited highest appraised values of the PHRDC lots will correspond to the value of an approximately 10,214.6 m 2 lot in superblock B in the amount of Php367,725,600.00 On the basis of all of the foregoing, PRA and PHRDC executed the Deed, whereby the two parties implemented the exchange of the subject properties by formally ceding, transferring and conveying to each other their respective properties. However, upon subsequent examination by the concerned parties, an error was discovered in the quoted technical description of one of the lands subject of the executed Deed. To correct said mistake, PRA and PHRDC executed the Amended Deed, now containing an accurate technical description of the subject property but without any additional consideration other than those agreed upon based on the Deed." It was further represented that both PRA and PHRDC have paid the documentary stamp tax on the Deed of Exchange of Real Property dated December 7, 2005. PRA paid its DST liability on the transfer of its property in the amount of P5,515,887.00 on January 10, 2006 while PHRDC paid its DST liability on the transfer of its property in the amount of P5,515,884.00 on November 6, 2006. In support of your request, you submitted to this Office the following documents, viz : aSEHDA a) Special Power of Attorney executed by PHRDC in favor of Puno & Puno Law Offices as its authorized representative for the purpose; b) Articles of Incorporation of PHRDC; c) Memorandum of Agreement dated November 26, 1998; d) Deed of Exchange of Real Property dated December 7, 2005; e) Amended Deed of Exchange dated October 2, 2006; f) Documentary Stamp Tax Return of PRA dated January 11, 2006; and g) Documentary Stamp Tax Return of PHRDC dated November 6, 2006. In reply, please be informed that: I. Doctrine of Involuntary Conversion. The execution of the Deed of Exchange of Real Property between PHRDC and PRA, conveying real property in favor of PHRDC, in substitution for the parcels of land involuntarily ceded by PHRDC to PRA to give way to the two projects of PRA, namely Boulevard 2000 Integrated Framework Plan and the construction of the EDSA Extension Road partakes the nature of an involuntary conversion. The doctrine of involuntary conversion of property was relied upon by this Office in BIR Ruling No. 373-87 dated November 23, 1987 and BIR Ruling No. 429-88 dated September 2, 1988 and reiterated in BIR Ruling No. 329-92 dated November 18, 1992. The Involuntary Conversion of Property Doctrine, as explained in BIR Ruling No. 329-92, is quoted thus: "xxx xxx xxx In reply, please be informed that the aforementioned expropriation of MJC's real property is embraced under the involuntary conversion of property doctrine which this Office relied upon in BIR RULING NO. 373-87, dated November 23, 1987, in the case of the MERCURY GROUP OF COMPANIES. This ruling was reiterated in BIR RULING NO. 429-88, dated September 2, 1988: "The excess of the amount of the insurance proceeds over the net book value of the insured assets is not taxable income to the corporation, it having been used in restoring the burned assets. The rule is, where insurance proceeds are actually reinvested in similar property, no gain is recognized. (Herder v. Helvering, 23 AFTR, p. 322)" The aforesaid Herder v. Helvering case is a discussion of the Involuntary Conversion of Property Doctrine in determining whether or not a gain from the involuntary conversion of a property may be recognized as realized income subject to income tax to the recipient, theft or seizure, its expropriation or condemnation, or the threat or imminence thereof. "Involuntary Conversion if property (as a result of its destruction, in whole or in part, theft or seizure, or an exercise of the power of requisition or condemnation or the threat or imminence thereof) is compulsorily or involuntarily converted into property similar or related in service or use to the property so converted, or into money which is forthwith in good faith . . . expended in the acquisition of other property, or in the acquisition of a control of a corporation owning such other property, or in the establishment of a replacement fund, no gain or loss shall be recognized. If any part of the money is not so expended the gain, if any, shall be recognized, but in an amount not in excess of the money so expended. (MERTENS, Chap. 20, 121, Vol. 3, pp. 337-338)" The facts in the Herder v. Helvering case were: On January 15, 1934 fire destroyed the milling property owned by the partnership of George Herder and R.L. Williams. For this loss, the partnership received $50,000 as fire insurance proceeds. This amount was immediately distributed to the partners, being pro-rated in accordance with their respective interest in the partnership, namely, two-thirds to George Herder, and one-third to R.L. Williams. George Herder received $33,333.67 under such distribution and that $19,199.50 thereof represented his portion of the total amount received by the partnership in excess of the adjusted cost basis of the property at the time of its destruction. The court held the said gain ($19,199.50) is not a realized income, hence, not subject to income tax, ( supra ) pursuant to the rule that no realized income may be recognized from a compulsory or involuntary conversion of a property. This doctrine is one of the several doctrines enunciated by the Courts in the U.S.A. that explain the meaning of the term "income" and "realization of income". xxx xxx xxx The foregoing discussion was affirmed and reiterated by this Office in BIR Ruling No. DA-158-2002 dated September 12, 2002 and BIR Ruling No. DA-203-03 dated June 30, 2003. BIR Ruling No. DA-203-03, is quoted thus: "In BIR Ruling No. DA-158-2002 dated September 12, 2002 involving adjacent property of the instant case, wherein a Deed of Exchange was executed by and between Manila Bay Development Corporation (MBDC) and PEA, whereby the latter conveyed real property in favor of MBDC, in substitution for the parcels of land involuntarily ceded by MBDC to PEA pursuant to the Boulevard 2000 Integrated Framework Plan, this Office ruled that the conveyance in favor of MBDC partakes the nature of involuntary conversion. The said ruling continues by stating that: xxx xxx xxx ". . . the applicability of the involuntary conversion of property doctrine is apparent when MBDC was required to cede certain portions of its parcel of land located in the Boulevard Reclamation Area to PEA pursuant to the Boulevard 2000 Integrated Framework Plan which was approved by no less than then President of the Philippines, Fidel V. Ramos. As payment for the lands required to be ceded by MBDC to PEA, PEA's lands also in the same area were transferred to MBDC. HDTSCc "In view of the foregoing, this Office is of the opinion as it hereby holds that the gain, if any, on the involuntary conversion of MBDC's property is not recognized as realized income, hence, not subject to income tax. . . . xxx xxx xxx This Office again upheld the application of the Doctrine of Involuntary Conversion in BIR Ruling No. DA-576-2006 dated September 22, 2006. It was held in the said ruling that the absence of an actual expropriation does not affect the applicability of the Doctrine of Involuntary Conversion. The BIR ruled that execution of a Memorandum of Agreement and the willingness of a private entity to convey, surrender and transfer ownership and possession of its property in favor of DPWH falls within the purview of the Doctrine of Involuntary Conversion and no taxable gain may be derived by the private entity from the exchange. BIR Ruling No. DA-576-2006 is quoted thus: "The surrender of relocation lots by FBDC directly in favor of the affected residents is necessary to implement the 1997 MOA entered into by all the parties. As noted, the 1997 MOA is necessary to the implement the KALAYAAN VIADUCT PROJECT. As a rule, a public works project of the Government could only be implemented through the expropriation of the affected residential lots as well as the relocation lots from FBDC. In the instant case, expropriation proceeding is no longer necessary in view of the 1997 MOA, wherein the affected residents signified their willingness to convey, surrender and transfer the ownership and possession of their respective lots to DPWH provided they are replaced by lots of the same size and they can be compensated for the cost of the improvements existing on their respective lots. On the side of FBDC, the surrender of relocation site is in consideration of the improved public road access to its Taguig properties. Indeed, the KALAYAAN VIADUCT PROJECT can only be implemented by way of involuntary conversion of properties of the lot owners with that of FBDC relocation sites. Accordingly, following the tax implications arising from the application of the doctrine of involuntary conversion, no taxable gain may be derived by the residents and by FBDC pursuant to the implementation of the KALAYAAN VIADUCT PROJECT." Applying the aforecited rulings to the case at bar, this Office is of the opinion as it hereby holds that the execution by PRA and PHRDC of a Deed of Exchange does not negate the fact that the transaction falls within the purview of the Doctrine of Involuntary Conversion and consequently, the exchange of properties between PRA and PHRDC is not subject to the corporate income tax under Section 27 (A) of the Tax Code of 1997 or to the capital gains tax imposed under Section 27 (D) (5) of the same Code nor to the creditable withholding tax imposed under Revenue Regulations No. 2-98, as amended. II. Documentary Stamp Tax on the Amended Deed of Exchange. As a rule, any conveyance of real property is subject to DST under Section 196 of the Tax Code of 1997. An exception is when a deed is executed to merely correct or rectify an error in a previously executed deed or instrument. Thus, in BIR Ruling DA-188-97 dated April 21, 1997, two parties executed a Deed of Absolute Sale over a certain party. The capital gains tax (CGT) and DST were paid for the transaction, the corresponding certificate authorizing registration (CAR) was issued by the BIR and the transfer was registered with the Register of Deeds. Almost a year later, the parties discovered that the property subject of the sale was incorrectly stated in the deed as Lot 6-A instead of the correct Lot 6-C. To correct the mistake, the same parties executed a Contract of Rescission with Deed of Absolute Sale specifying that the property sought to be sold is Lot 6-C and not Lot 6-A. The parties likewise manifested that there would be no additional consideration for the new Deed of Sale. In ruling that the executed instrument was not subject to either the CGT or DST, the BIR held that: "In reply, please be informed that since the sale transaction is without any monetary consideration and considering further that the execution of the same is merely to correct the mistake in the designation of the lot in question, this Office is of the opinion as it hereby holds that the aforementioned sale of realties covering TCT No. 197506 and TCT No. 197508 between you and your brother, Eduardo D. Virata is not subject to the capital gains tax imposed under Section 21(e) of the Tax Code nor to the creditable withholding tax imposed under Revenue Regulations No. 12-94 implementing Section 50 (b) of the Tax Code, as amended. Furthermore, the said Contract of Rescission with Deed of Absolute Sale is not likewise subject to the documentary stamp tax imposed under Section 196 of the Tax Code, as amended. However, the said deed shall be subject to the P15.00 documentary stamp tax imposed under Section 188 of the same Code." Applying the aforecited rulings to the case at bar, this Office is of the opinion as it hereby holds that the Amended Deed of Exchange of Real Properties between PRA and PHRDC is not subject to the documentary stamp tax imposed under Section 196 of the Tax Code, as amended. However, the said deed shall be subject to the P15.00 documentary stamp tax imposed under Section 188 of the same Code. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be ascertained that the facts are different, then this ruling shall be considered as null and void. Very truly yours, (SGD.) JOSE MARIO C. BUAG Commissioner of Internal Revenue