BIR Ruling [DA-149-03]

May 6, 2003 BIR RULING [DA-149-03] RR-2.57.2(J); 078-94; 019-96; 013-2001 R.S. Bernaldo & Associates Unit 1810 Cityland Condominium 10 Tower 1 6815 Ayala Avenue cor. H.V. dela Costa Ext. 1200 Makati City Attention: Atty. Rosario S. Bernaldo Managing Partner Gentlemen : This refers to your letter dated January 3, 2002 requesting on behalf of your client, The Regalia Group Corp. ("Regalia"), for confirmation of your opinion, to wit: "1. That the installment buyers are no longer required to withhold any creditable expanded withholding tax on their payments of amortization considering that the said income has already been reported by Regalia in the year of sale which was in 1997. "2. Consequently, the installment buyers is [ sic ] not liable to any deficiency expanded withholding tax on their payments of amortization nor any surcharge or interest for their non-withholding of the tax on any of their payments considering that no implementing Revenue Regulations has so far been promulgated by the Secretary of Finance concerning this type of installment sale transaction." Further, in your letter dated March 17, 2003, you reiterated the above request for confirmation to the effect "that the periodic payments made by individual buyers on the purchases of condominium units from our client are not subject to expanded withholding tax considering that the entire income on the said sales were already reported in the year of sale (1997);" and further still, you manifested the following: "Upon review of the list of buyers submitted to your good office, you noticed that there were corporate buyers of condominium units from our client however, our request is silent on this matter. Thus, we are required to submit herewith a manifestation to this effect. "In compliance thereto, we wound like to inform your good office that our client is only interested in securing a ruling for the individual buyers rather than for the corporate buyers because our client knows for a fact that the latter is subject to withholding tax on its periodic payments. Thus, there is no need to secure a ruling for corporate buyers. This explains why our request is silent about the corporate buyers." BACKGROUND OF THE CASE The Regalia Group Corporation is a corporation duly organized and existing under the laws of the Philippines, with principal address located at the Regalia Park Towers, 150 Tuazon Avenue, Cubao, Quezon City, Philippines. It is engaged in the business of developing and constructing condominium units. Sometime in 1997, Regalia has developed and constructed one condominium project in P. Tuazon Street, Cubao, Quezon City, known as "The Regalia Park Tower." In the same year, Regalia sold one hundred forty four (144) condominium units to various persons on installment basis. In some of these installment sales contracts, the buyers' initial payments in the year of sale exceeded 25% of the selling prices, while in some other contracts, the initial payments in the year of sale did not exceed 25% of the selling price. In both instances, the income from the aforementioned transactions was duly reported by Regalia in its income tax returns in accordance with the accounting method it employed. It did not, however, pay any periodic taxes as it incurred loss on the said year. In the meantime, the aforesaid buyers on installment plan have continued to pay the regular amortization but they have not withheld any creditable withholding tax on their respective payments. Most of the units were sold to individual persons not engaged in trade or business. TAXPAYER'S OPINIONS/ARGUMENTS I. Income on said installment sales were already reported by Regalia in accordance with the accounting method which it employed pursuant to Sections 43 and 49 of the Tax Code of 1997 (then Sections 37 and 42 of the Tax Code, as amended) which provide for the method and manner of computing and reporting income derived from sale of real property on installment basis, to wit: Section 43 of the Tax Code (then Sec. 37) provides that the taxpayer's taxable income " shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer . . ." Likewise, Section 49(B) of the same Tax Code (then Sec. 42) provides that the income derived from the sale of real property on installment basis, may , under rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner, be reported for income tax purposes in the proportion the installment payments actually received in that year, which the gross profit realized or to be realized when payment is computed, bears to the total contract price. It is your opinion that pursuant to the foregoing provisions, the taxpayer has the option whether to report his income from deferred payment sale transactions on installment basis as provided under Section 49 of the Tax Code or report the same in accordance with the accounting method regularly employed in keeping his books of accounts as provided for under Section 43 of the same Tax Code. The foregoing rule is apparent and patent in said Section 49 which uses the word "may" vis--vis reporting income from deferred payment or installment payment sales, regardless of whether or not the buyer's initial payments in the year of sale exceed 25% of the selling price. Based on the above, income from said sale on installment plan was actually recorded and reported in the Income Tax Return (ITR) in the year of sale. In BIR Ruling No. 078-94 dated March 18, 1994, the BIR held that, "in the case of sale of real property on installment plan, if the initial payments in the year of sale exceed 25% of the selling price, the transaction shall be considered 'cash sale', in which case, the seller's income from sale transaction shall be taxable entirely in the year of sale. Considering that the said income had already been reported by the seller in the year of sale, the buyer was no longer required to withhold any creditable expanded withholding tax on his payments of amortization." 1 II. Since most of the buyers on deferred payment sale on installment basis were individual persons not engaged in trade or business, they are not required to withhold any tax with respect to their installment payment. During the year 1997, no specific regulations govern the time or manner of withholding the tax on deferred or installment payment sales of real property, reasons of fairness and equity dictate that the individual buyers not engaged in trade or business who did not make any such withholding on their installment payments, be not subjected to the penalties imposed for failure to withhold the tax. In the absence of a well-defined, duly promulgated and publicized regulations on the subject, ordinary individual buyers on installment sales, particularly, those who are not engaged in trade or business, cannot be said to have been notified of an obligation to withhold, much less be expected to know the fine lines of distinction in taxation, as delineated in private rulings, in respect of when to treat deferred payment as cash sales or installment sales transaction for the purpose of withholding. You further opined that the government suffered no disadvantage considering that, in this particular case, the income from the aforesaid deferred payment/installment sale transactions have already been reported and the corresponding income tax have been paid per the seller's ITR for the year 1997. BIR REPLY In reply, please be informed as follows: 1. Section 34 of the Tax Code of 1997 (then Section 37 of the Tax Code, as amended) prescribes that the taxpayer's taxable income "shall be computed upon the basis of the taxpayer's annual accounting period ( fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayers . . . ." Section 49 of the same Tax Code (then Sec. 42 of the Tax Code, as amended) further provides that income from installment sales " may " be reported for income tax purposes in the manner provided for under the said Section. This law was lifted from the old Federal Income Tax law of the United States. 2 Except for the threshold in the selling price which is denominated in dollar and the percentile rate for the purpose of determining initial payments, the provision of Section 44 of the U.S. Federal Income Tax Law was adopted in then Section 43 of the Philippine Old Tax Code (now Section 49(B) of the Tax Code of 1997). Thus, being of American origin, the doctrine is that the interpretation that it received in the United States is persuasive in the Philippines. 3 The Doctrine of Election was enunciated by the U.S. Supreme Court in the case of Pacific National Co. v. Welch 4 which involved the sale of real property on installment basis. The Court thus held, SIacTE "Under the applicable statutes and regulations, petitioner could have chosen either of two methods for the ascertainment and report of gain or loss on the sales. The Revenue Act of 1928, 45 Stat. 791, establishes both. Defining one, the "deferred payment method," it declares that gross income includes profits from sales, section 22(a), 26 U.S.C.A. 22(a) and note; regulates the computation of gain or loss, section 22(e), 26 U.S.C.A. 22 note; defines gain to be the excess of the amount realized over the basis, sections 111(a), 113, 26 U.S.C.A. 111 note, 113 note; and provides that the "amount realized" shall be the sum of any money received plus the fair market value of property (other than money) received, section 111(c), 26 U.S.C.A. & 111(b) and note, Regulations 74, art. 352. Defining the other, the "installment method," it provides that, in the case of a casual sale or other casual disposition of personal property for a price exceeding $1,000 or in the case of sale or other disposition of real property, if payments received during the taxable year in which the sale was made do not exceed 40 per cent of the selling price, the income may, under regulations prescribed, be returned on the installment method, section 44(b), 26 U.S.C.A 44 note; i.e., the taxpayer may return in any taxable year that proportion of the installment payments actually received in that year which the gross profit realized or to be realized when payment is completed bears to total contract price. See sec. 44(a), 26 U.S.C.A. 44(a) and note. "Regulations 74 permit the vendor to return from installment sales on the straight accrual or cash receipt basis; when so reported the sales are treated as deferred payment sales not on the installment plan. Article 353. In ascertaining the amount of profit or loss from that class of sales; the obligations of the purchaser to the vendor are taken in their fair market value; if they have none, the payments in cash or other property having a fair market value shall be applied against and reduce the basis of the property sold, and, if in excess of such basis, shall be taxable to the extent of the excess. Gain or loss is realized when the obligations are disposed of or satisfied, the amount being the difference between the reduced, basis and the amount realized therefore. Art. 354. "The question is whether, having filed a return according to the deferred payment method, the taxpayer by filing claim for refund is entitled to have the profit from the sales computed on the installment method. Petitioner contends that the installment method alone discloses its income from the sales of lots and that the deferred payment method failed clearly to reflect income. ". . . But that fact has no bearing upon the question whether proper application of the deferred payment method would clearly reflect income for that method permits installments to be taken at market value and, if they have no market value, allows postponement of ascertainment of gain or loss until realized. While petitioner's return may have been in inept application of the deferred payment method, there is nothing in it or the statement of claim for refund that gives any support to the idea that, if rightly applied, that method would not clearly reflect income. "The parties agree that, if allowed to change to the installment method, petitioner would be entitled to a refund in some amount. But that fact has no tendency to discredit the deferred payment method as inapplicable. The amount of the tax for the year in question is only one of many considerations that may be taken into account by the taxpayer when deciding which method to employ. The one that will produce a higher tax may be preferable because of the probable effect on amount of taxes in later years. In case of overstatement and overpayment, the taxpayer may obtain refund calculated according to the method on which the return was made." In view of the above and since the sales in question were executed in the year 1997, the rules obtaining at the time of the sale should apply. The applicable rule, therefore, is Section 175 of Revenue Regulations No. 2 which provides that " deferred-payment sales of real property include (a) agreements of purchase and sale which contemplate that a conveyance is not to be made at the outset, but only after all or a substantial portion of the selling price has been paid, and (b) sales in which there is an immediate 'transfer of title, the vendor being protected by mortgage or other liens as to deferred payments. Such sales either under (a) or (b), fall into two (2) classes when considered with respect to the terms of sale, as follows : "(1) Sales of property on the installment plan , that is, sales which the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable year in which the sale is made do not exceed 25 per cent of the selling price; "(2) Deferred-payment sales not on the installment plan, that is sales in which the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable year in which the sale is made exceed 25 per cent of the selling price ." For the purpose of determining "initial payments" the same " does not include amounts received by the vendor in the year of sale from the disposition to a third person of notes given by the vendee as part of the purchase price which are due and payable in subsequent years. Commission and other selling expenses paid or incurred by the vendor are not to be deducted or taken into account in determining the amount of the "initial payments," the "total contract price" or the "selling price." The term "initial payments" contemplates at least one other payment in addition to the initial payment . (Emphasis supplied) According to U.S. jurisprudence, 5 the said law on installment reporting of income from deferred sale is a mere option or privilege granted by law to the seller. (MERTENS , 15.05) Thus, if the taxpayer-seller does not opt to report his income from deferred payment sale transaction on installment basis as provided under Section 49 of the Code, then he has the other option to report the same in accordance with the accounting method regularly employed in keeping his books of accounts, pursuant to Section 43 of the said Code. This rule 6 is apparent and patent in Section 49 of the Code which used the word "may" vis-a-vis reporting of income from deferred or installment payment sales, regardless of whether or not the buyer's initial payments in the year of sale exceed or do not exceed 25% of the selling price. The "initial payments in an amount exceeding 25% of the selling price " is the criterion in ascertaining whether the transaction is a "cash sale" or "sale on installment." In BIR Ruling No. 078-94 dated March 18, 1994 and as reiterated in BIR Ruling No. 112-99 dated July 29, 1999, (which involve sales consummated from years 1991 to 1997) the Commissioner of Internal Revenue held that, "in case of a sale of real property on installment plan, if the buyer's initial payments in the year of sale exceed 25% of the selling price, the transaction shall be considered as a 'cash sale,' in which case, the seller's income from the sale transaction shall be taxable entirely in the year of sale. Considering that the said income had already been reported by the seller in the year of sale, the buyer was no longer required to withhold any creditable expanded withholding tax on his subsequent payments of amortization." 7 Based on the list of buyers furnished to this Office, almost all of the subject buyers of the condominium units are individuals not engaged in trade or business. Moreover, as represented by Regalia and as indicated in the Notes to the Financial Statements, the sales were on deferred payment cash basis. Thus, we apply Revenue Regulations No. 1-90, as amended (now Section 2.57.2(J) of Rev. Regs. No. 2-98, as amended by Rev. Regs. 8-98), the pertinent portion of which provides as follows, to wit: "Where the consideration or part thereof is payable on installment , no withholding of tax is required to be made on the periodic installment payments where the buyer is an individual not engaged in trade or business. In such a case, the applicable rate of tax based on the entire consideration shall be withheld on the last installment or installments to be paid to the seller. "However, if the buyer is engaged in trade or business, whether a corporation or otherwise the tax shall be deducted and withheld by the buyer on every installment." (Emphasis supplied.) This provision presupposes that the mode of payment is on installment plan , i.e. , when the payments made by the purchaser during the year of sale do not exceed 25% of the selling price . Moreover, the obligation to withhold from installment payments arises only when the buyer is engaged in business. Thus, if the buyer is an individual who is not engaged in trade or business and the sale is a sale of property on the installment plan, i.e., the payments in the year of sale does not exceed 25% of the selling price, no withholding of tax is required to be made on the periodic installment. In such case, the applicable rate of tax based on the gross selling price or fair market value of the property, whichever is higher, shall be withheld in the last installment. On the other hand, if the sale is on "cash basis" or is a "deferred-payment sale not on installment plan," i.e., the initial payments in the year exceed 25% of the selling price, the buyer shall withhold the tax based on the gross selling price or market value of the property, whichever is higher, on the first installment. If the buyer is a corporation, or an individual engaged in trade or business, it is required to withhold the appropriate amount of tax on each installment. However, this rule is to be clarified, depending on whether the sale is a sale of property on the installment plan, on the one hand, or a deferred payment sale not on the installment plan, on the other (such items being defined in the next succeeding discussion). Thus, if the sale is a sale of` property, on the installment plan, the buyer should withhold the appropriate amount of tax on each installment payment. On the other hand, if the sale is a deferred payment sale not on the installment plan, which is in effect treated as a cash sale, the withholding tax shall be withheld from the initial payment, based on whichever is higher, the gross selling price or the fair market value of the property, determined in accordance with Section 6(E) of the Tax Code. Thus, where the initial payment made by the purchaser exceeds 25% of the selling price the sale shall be considered as a "deferred payment sale not on the installment plan" or a "cash sale" so that the withholding of tax is required to be made during the taxable year when the initial payment was made. In the instant case where the initial payments collected in the year of sale exceeded twenty-five percent (25%) and the amount of the entire sale was accrued and reported in the same CY 1997 Audited Financial Statements of Regalia although there was no actual full payment yet, this Office hereby holds that the transaction falls within the purview of "deferred-payment sales not on the installment plan," hence, withholding of the tax should have been made in year of sale, i.e. , 1997, when the initial payment exceeding 25% of the selling price was made. Necessarily, the income tax of the seller in the said year of sale shall be fully paid based on the gross selling price or the total amount of consideration or the FMV, whichever is higher, pursuant to Sec. 6(E) of the 1997 Tax Code. Hence, if the sale is "deferred payment sale," the so-called "last installment payment" beyond the year 1997 shall already be exempt from the creditable withholding tax. In the case of sale of sales of real property where the initial payments do not exceed twenty-five percent (25%), the same shall be treated as sale on installment plan subject to the foregoing Section 2.57.2(J) of Rev. Regs. No. 2-98, as amended by Rev. Regs. 8-98. Consequently, the individual buyer who is not engaged in trade or business shall not withhold tax on his periodic installment payments. He is however, required to withhold the applicable tax rate on the last installment or installments to be paid to the seller. Conversely, "if the buyer is engaged in trade or business, whether a corporation or otherwise, the tax shall be deducted and withheld by the buyer on every installment." 8 II. Considering however, that there was no regulation which constitute an individual taxpayer not engaged in trade or business as duly authorized withholding agent for the government, the seller shall have to accrue and report the full amount of the selling price in the year of sale, and which Regalia did in this case. It is noted further that while Regalia has treated the sales of its units in the year 1997 as cash sales, it reported a loss, hence, it did not pay tax (not being subject to MCIT at that time). At the outset, however, the income from these deferred cash sales not on installment plan was duly reported by Regalia in accordance with the accounting method which they employed. In view of the foregoing, this Office therefore holds, as it hereby confirms your opinion that, where the condominium units are sold by Regalia to individuals not engaged in trade or business the consideration of which is payable on installment, no withholding of tax is required to be made on the periodic installment payments pursuant to then Revenue Regulations No. 1-90 (now Sec. 2.57.2(J) of Rev. Regs. No. 2-98, as amended by Rev. Regs. 8-98). Corollarily, where the income from such sales on "deferred payment basis" have been accrued and already reported by Regalia in the year of sale, as disclosed in their CY 1997 Audited Financial Statements, because the initial payment in the year of sale exceeded 25% of the selling price in which case the sale is considered a "cash sale" prior to the last installment or installments paid thereto, the buyer is no longer required to withhold any creditable expanded withholding tax on the final payment of amortization, because the income on these transactions has already been reported land the tax thereon had been paid, making the withholding tax, a procedure for tax collection, utterly unnecessary. Consequently, the individual buyers on deferred installment plan or "cash sale" shall not be liable to any deficiency expanded withholding tax on their payments of amortization nor to any surcharge or interest for their non-withholding of the tax on any of their subsequent periodic installment payments. III. Finally, with respect to your manifestation that since your client's corporate buyers are aware of their obligation to withhold the creditable expanded withholding tax on their periodic payments, you are interested in securing a ruling only for the individual buyers, this office shall hold you responsible to advise them on the matter in accordance with Sec. 2.57.2(J) of Rev. Regs. No. 2-98, as amended by Rev. Regs. 8-98. However, for purposes of issuing the corresponding CAR on each sale, the RDO having jurisdiction over Regalia should determine that income from each such sales has in fact been recognized in full. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it shall be disclosed that the facts are different, then this ruling shall be considered null and void. cDAITS Very truly yours, (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal & Inspection Group Footnotes 1. BIR Ruling No. 078-94 dated March 18, 1994. 2. Sec. 44(b). The Revenue Act of 1928 (SEVENTIETH CONGRESS, SESS I, CH. 852, 1928.) "SEC. 44. INSTALLMENT BASIS. "(a) Dealer's in personally property. . . . "(b) Sales of realty and casual sales of personalty. In the case (1) of a casual sale or other casual disposition of personal property (other than property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year), for a price exceeding $1,000, or (2) of a sale or other disposition of real property, if in either case the initial payments do not exceed 40 per centum of the selling price, the income may, under regulations prescribed by the Commissioner with the approval of the Secretary, be returned on the basis and the manner above prescribed in this section. As used in this section the term "initial payments" means the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable period in which the sale or other disposition is made." 3. BIR Ruling No. 112-99 dated July 29, 1999 4. 304 U.S. 191, 20 AFTR 1248, 38-1 USTC 9286 (1938) 5. Pacific National Co. v. Welch, 304 U.S. 191, 20 AFTR 1248, 38-1 USTC 9286 (1938), supra . 6. "Doctrine of Election," as enunciated in the case of Pacific National Co. v. Welch, supra . 7. BIR Ruling No. 078-94 dated March 18, 1994 and BIR Ruling No. 112-99 dated July 29, 1999. 8. Par. 2 Section 2.57.2(J) of Rev. Regs. No. 2-98, as amended by Rev. Regs. 8-98).