BIR Ruling [DA-062-06]

February 28, 2006 BIR RULING [DA-062-06] 24 (D) (1); 106 (A) (1) (a); DA 332-03; VAT Ruling 034-01 San Miguel Corporation 40 San Miguel Avenue Mandaluyong City Attention: Mr. Alfredo R. Villacorte Vice-President & Tax Manager Gentlemen : This refers to your letter dated August 8, 2005 requesting for a ruling, to wit: "We would like to seek your ruling on the facts and circumstances briefly described in the succeeding paragraphs. The San Miguel Group, compose of San Miguel Corporation and its subsidiaries (hereinafter referred to collectively as "SMG"), are engaged in business of, among others, manufacturing and selling of food, beverages and packaging materials. SMG has a large marketing and distribution network wherein products manufactured are sold to various dealers, wholesalers and retailers (hereinafter referred to as "Customers") on cash or on credit. For sales on credit, Customers are required to give security or collateral, i.e. real property, which are conveyed by way of real estate mortgage. In the event that Customers failed to pay under the agreed terms and conditions, the security or collateral will be foreclosed either judicially or extra-judicially. At the public auction of the foreclosed real property, SMG participates in the bidding. In the event that SMG becomes the highest bidder in the auction sale, the Sheriff will award to SMG said real property through the issuance of Certificate of Sale. As legal requirements, the SMG will observe the one-year redemption period for the mortgagor to redeem the foreclosed real property. If the mortgagor fails to redeem, SMG executes an affidavit consolidating unto itself the ownership of the real property, and the Sheriff issues a Final Deed of Sale. Thereafter, SMG sells the foreclosed real property. Queries: 1. Is documentary stamps tax under Section 196 of the NIRC on the foreclosure sale due within five (5) days after from the close of the month when the redemption period of one (1) year lapsed or within five (5) days after the close of the month when the real property was awarded to SMG as the winning bidder through the issuance by the sheriff of a Certificate of Sale? 2. Assuming that the real property foreclosed is not used in trade or business by the mortgagor, is the capital gains tax on the foreclosure sale due within thirty (30) days from the day the redemption period of one (1) year lapsed, or within thirty (30) days from the day the real property was awarded to SMG as the winning bidder through the issuance by the Sheriff of a Certificate of Sale? 3. Assuming that the real property foreclosed is used in trade or business by the mortgagor, when should the income or loss from the foreclosure sale be declared for income tax purposes, and consequently, when should the withholding of the tax be made? Is it in the taxable year when the redemption period of one (1) year lapsed, or is it in the year when the real property was awarded to SMG as the winning bidder through issuance by the Sheriff of a Certificate of Sale? 4. If the reckoning day for the payment of the documentary stamps tax and capital gains or regular income tax is the day the real property was awarded to SMG as the winning bidder through the issuance by the Sheriff of a Certificate of Sale, what are the consequences if the real property is redeemed by the mortgagor? Will the documentary stamps tax and capital gains or regular income tax previously paid be refunded considering that no sale or transfer of real property has been realized and no gain has been derived by the mortgagor? 5. Is the subsequent sale by SMG of the real property acquired through foreclosure sale described above exempt from value added tax pursuant to Section 109 (W) renumbered to by RA 9337 of the NIRC? We reply as follows: At the outset, Act 3135, as amended by Act 4118, was passed into law to regulate the sale of property under special powers annexed to real estate mortgages. Thus, Section 6 of Act 3135 provides: "Sec. 6. In all cases in which an extra-judicial sale is made under the special power hereinbefore referred to, the debtor, his successors in interest or any judicial creditor or judgment creditor of said debtor, or any person having a lien on the property subsequent to the mortgage or deed of trust under which the property is sold, may redeem the same at any time within the term of one year from and after the date of the sale ; and such redemption shall be governed by the provisions of sections four hundred and sixty four to four hundred and sixty-six, inclusive of the Code of Civil Procedure, in so far as these are not inconsistent with the provisions of this Act." (emphasis supplied) Corollary to this, Section 24(D)(1) of the Tax Code of 1997 (then Section 21(e) of the 1977 Tax Code, as amended), states: (D) Capital Gains from Sale of Real Property . (1) In General . The provisions of Section 39(B) notwithstanding, a final tax of six percent (6%) (then 5%) based on the gross selling price or current fair market value as determined in accordance with Section 6(E) of this Code, whichever is higher, is hereby imposed upon capital gains presumed to have been realized from the sale, exchange, or other disposition of real property located in the Philippines, classified as capital assets, including pacto de retro sales and other forms of conditional sales, by individuals, including estates and trusts: Provided , that the tax liability, if any, on gains from sales or other dispositions of real property to the government or any of its political subdivisions or agencies or to government-owned or controlled corporations shall be determined either under Section 24(A) or under this Subsection, at the option of the taxpayer. AHacIS The phrase "other form of conditional sales" under then Section 21(e) of the 1977 Tax Code (now Section 24(D)(6) of the 1997 Tax Code, as amended) was interpreted by the Bureau of Internal Revenue to include foreclosure sales. As such, foreclosure sales of real properties classified as capital assets were subjected to capital gains and documentary stamp taxes. Subsequently, the Tax Code of 1997 introduced capital gains tax on sale of capital assets by corporations as provided for in Section 27(D)(5) thereof, to wit: "(5) Capital Gains Realized from the Sale, Exchange or Disposition of Lands and/or Buildings . A final tax of six percent (6%) is hereby imposed on the gains presumed to have been realized on the sale, exchange or disposition of lands and/or buildings which are not actually used in the business of a corporation and are treated as capital assets, based on the gross selling price or fair market value as determined in accordance with Section 6(E) of this Code, whichever is higher, of such lands and/or buildings." Effectively, the imposition of capital gains tax on sale, exchange or disposition of capital asset by a corporation has been aligned with Section 24(D)(1) of the 1997 Tax Code in respect to foreclosure sales of capital assets owned by individuals. As such, foreclosure sales initiated by individuals or corporations are covered by Revenue Regulations No. 8-98. However, said Revenue Regulations No. 8-98 does not prescribe the time of payment for taxes due on such foreclosure sales. On the other hand, while Revenue Regulations No. 4-99 prescribes the time of payment of capital gains tax and documentary stamp tax on extra-judicial foreclosure sales of capital assets initiated by banks, finance and insurance companies, the same is silent on foreclosure sales initiated by individuals and other corporations in general. Specifically, Sections 3 and 4 thereof, provide, viz: "SEC. 3. Capital Gains Tax. (1) In case the mortgagor exercises his right of redemption within one year from the issuance of the certificate of sale, no capital gains tax shall be imposed because no capital gains has been derived by the mortgagor and no sale or transfer of real property was realized . . . . (2) In case of non-redemption, the capital gains on the foreclosure sale imposed under Sec. 24(D)(1) and 27(D)(5) of the Tax Code of 1997 shall become due based on the bid price of the highest bidder but only upon the expiration of the one-year period of redemption provided for under Sec. 6 of Act No. 3135, as amended by Act No. 4118, and shall be paid within thirty (30) days from the expiration of the said one-year redemption period. SEC. 4. Documentary Stamp Tax. (1) In case the mortgagor exercises his right of redemption, the transaction shall only be subject to the P15.00 documentary stamp tax imposed under Sec. 188 of the Tax code of 1997 because no land or realty was sold or transferred for a consideration. (2) In case of non-redemption, the corresponding documentary stamp tax shall be levied, collected and paid by the person making, signing, issuing, accepting, or transferring the real property wherever the document is made, signed, issued, accepted or transferred where the property is situated in the Philippines; Provided, That whenever one party to the taxable document enjoys exemption from the tax, the other party thereto who is not exempt shall be the one directly liable for the tax. The tax return prescribed under the Code shall be filed within ten (10) days ( now five (5) days pursuant to RR 6-2001 ) after the close of the month following the lapse of the one-year redemption period, and the tax under Sec. 196 of the Tax Code of 1997 shall be paid based on the bid price at the same time the aforesaid return is filed. Several requests reached the Bureau to have RR 4-99 be made applicable to individuals and other corporations in general. Indeed, several rulings applied this regulations because of the fact that in an extrajudicial foreclosure sale governed by Act No. 3135, as amended, and effected by a mortgagee other than a bank, quasi-bank or trust entity, the mortgagor or his successors-in-interest is allowed to redeem the property from the purchaser within one-(1) year from the date of registration of the certificate of sale. aEIcHA In respect to the propriety of imposing the 6% capital gains tax on foreclosure sales, the Court of Tax Appeals (CTA) in the case of Spouses Alfredo & Imelda Diaz vs. Bureau of Internal Revenue , C.T.A. Case No. 6244, March 5, 2003, made the following pronouncements: "It is to be noted that while the Tax Code imposes a 6% capital gains tax on conditional sales of property, including mortgage foreclosure sales, it must be stressed that the said conditional transactions presuppose transfer of interest or ownership over the subject properties. This is the reason why in cases 'where the right of redemption of the mortgagor exists, the certificate of title of the mortgagor shall not be cancelled yet instead only a brief memorandum shall be annotated at the back of the certificate of title, and the cancellation of the title and the subsequent issuance of a new title in favor of the purchaser/highest bidder depends on whether the mortgagor shall redeem or not the mortgaged property within one (1) year from the issuance of the certificate of sale.' (page 106, The National Internal Revenue Code Annotated, De Leon 2000 Edition) . The Court of Tax Appeals concluded that Revenue Regulations No. 4-99 has curbed the inequity of imposing a capital gains tax even before the expiration of the redemption period based on its opinion that there is yet no transfer of title and no profit or gain is realized by the mortgagor at the time of foreclosure sale but only upon expiration of the redemption period. In short, the CTA itself has stated that it is not the transfer per se that is subject to the 5% capital gains tax but the profit or gain presumed to have been realized by the seller/mortgagor. This Office cannot, however, fully agree that the imposition of capital gains tax on transfer, sale or disposition of real property requires the determination of gains/profits realized from the transaction. In both Sections 24(D)(1) and 27(D)(5), it is presumed that gains have been realized on sales, transfer or disposition of real property. It is worth mentioning, however, that foreclosure sale is but a remedy given to the mortgagee for the recovery of the amount loaned or, in the case of SMG, the value of the product which was the consideration of the mortgage. Additionally, in foreclosure sale, there is yet no actual transfer of the mortgaged real property until after the expiration of the one-year redemption period as provided in RA n 3135 and title thereto is consolidated in the name of the mortgagee in case of non-redemption. In the interim, the mortgagor is given the option whether or not to redeem the real property. The issuance of the Certificate of Sale does not by itself transfer ownership. There has to be a Deed of Absolute Sale to effect transfer of title over realty. Therefore, in cases of foreclosure sales initiated by mortgagees which are not considered banks, finance and insurance companies, although not covered by Revenue Regulations 4-99, the capital gains tax likewise becomes due only in cases of non-redemption and only upon expiration of the one-year redemption period because the same principle applies that there is yet no transfer of title and no profit or gain is realized by the mortgagor at the time of foreclosure sale but only upon expiration of the one-year redemption period. In view of foregoing discussion, hereunder enumerated are the answers to your queries: 1. Pursuant to Section 196 of the Tax Code of 1997, documentary stamp tax shall be levied, collected and paid by the person making, signing, issuing, accepting, or transferring the real property wherever the document is made, signed, issued, accepted or transferred where the property is situated in the Philippines. Whenever one party to the taxable document enjoys exemption from the tax, the other party thereto who is not exempt shall be the one directly liable for the tax. The tax return prescribed under the Code shall be filed within five (5) days after the close of the month following the lapse of the one-year redemption period (Revenue Regulations No. 6-2001 dated July 31, 2001). 2. The certificate of sale given to the purchaser at the time the foreclosure sale is made, is different and distinct from the final deed, which is delivered at the expiration of the period of redemption, since the former is not intended to operate as an absolute transfer of the property, but merely to identify the property, price paid, and the date when the right of redemption expires. In other words, it is but a mere memorial of the fact that a purchase was made by the person named in the certificate, as the buyer ( Yap vs. Intermediate Appellate Court , G.R. No. 68464 dated March 22, 1993). Considering that the transfer is not perfected until the execution and delivery of the sheriff's final deed of sale after the expiration of the one (1) year redemption period, and considering further that the registration of the certificate of sale is a mere ministerial act by which an instrument is sought to be inscribed in the records of the Registry of Deeds and annotated at the back of the certificate of title covering the land subject of the instrument, it is, therefore, safe to conclude that the mere sale of the property in extrajudicial foreclosure sale under Act 3135, as amended by Act 4118, and the corresponding registration of the certificate of sale in the Office of the Registry of Deeds is not subject to the capital gains tax prescribed in Section 24 (D)(1) nor to the documentary stamp tax imposed under Section 196, both of the 1997 Tax Code. HaIATC In case of non-redemption, however, the capital gains tax on the foreclosure sale imposed under Section 24 (D)(1) shall become due and shall be paid within thirty (30) days after the expiration of the redemption period. In this connection, Revenue Memorandum Order (RMO) No. 41-91, dated November 11, 1991, provides that generally taxes on the sale, exchange or other disposition of real property are based on the gross selling price, fair market value or zonal value of the real property, whichever is higher. In the event of a sale of real property effected through a public bidding, such as an extrajudicial foreclosure sale, the actual consideration appearing in the Deed of Sale shall be an acceptable tax base in the computation of taxes. ( BIR Ruling No. DA-332-2003 ) 3. In case the real property foreclosed is used in trade or business, the income or loss as a result of the foreclosure of the same, shall be reported at the end of the year during which the one-year period to redeem expired. Clearly, it is only after the expiration of the redemption period, and the option to redeem was not exercised, when the gain or loss is realized. Corollary to the provision that the foreclosure sale of the capital asset is subject to capital gains tax, the foreclosure sale of real property classified as ordinary asset is subject to the creditable withholding tax imposed under Revenue Regulations No. 2-98, as amended. The expanded withholding tax shall be paid within ten (10) days following the month after the expiration of the one (1) year redemption period, provided, however, that taxes withheld in December shall be remitted on or before January 15 of the following year. (Revenue Regulations No. 6-2001 dated July 31, 2001) 4. As discussed above, the payment of documentary stamp and capital gains taxes in cases of foreclosure sale shall be made upon the expiration of the one-year redemption period, and on the day specified under Revenue Regulations No. 6-2001 in the case of documentary stamp tax and within thirty (30) days in the case of capital gains tax. In respect to the possibility of refund of taxes previously paid, this Office cannot yet rule on the propriety of the same in the absence of more detailed facts. 5. Section 109(P) of R.A. No. 9337 [Sec. 109(w) of the Tax Code of 1997] provides: "Sec. 109. Exempt Transactions . (1) Subject to the provisions of Subsection (2) hereof, the following transactions shall be exempt from the value-added tax: xxx xxx xxx (P) Sale of real properties not held for sale to customers or held for lease in the ordinary course of trade or business, or real property utilized for low-cost and socialized housing as defined by Republic Act 7279, otherwise known as the Urban Development and Housing Act of 1992, and other related laws, residential lot valued at One million five hundred thousand pesos (P1,500,000.00) and below house and lot, and other residential dwellings valued at Two million five hundred thousand pesos (P2,500,000.00) and below: Provided , That not later than January 31, 2009 and ever three (3) years thereafter, the amounts herein stated shall be adjusted to their present values using the Consumer Price Index, as published by the National Statistics Office (NSO). In this respect, we have to take into consideration the company that will sell the foreclosed property. If the foreclosed property will be sold by one of the companies of SMG which is engaged in realty business and the property has already been listed in the inventory that is held primarily for sale to customers, then such sale will be subject to VAT. (RMC No. 3-96; Sec. 4.100-1; RR 7-95; VAT Ruling No. 002-96, May 9, 1996) On the other hand, if the real property that will subsequently be sold by SMG or any of its companies was not held primarily for sale to customers or held for lease in the ordinary course of its business, the same is not subject to VAT pursuant to the abovementioned provision of the Tax Code and its implementing rules and regulations. ( VAT Ruling No. 034-2001 dated June 13, 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.) JAMES H. ROLDAN Assistant Commissioner Legal Service n Note from the Publisher: Written as "RA" in the original document.