BIR Ruling [DA-163-05]

April 14, 2005 BIR RULING [DA-163-05] 39 (A) (1); 014-2003 Pryce Gases, Inc. 17th Floor, Pryce Center 1179 Chino Roces Avenue Makati City Attention: Mr. Simeon S. Umandal First Vice-President and Corporate Secretary Gentlemen : This refers to your letter dated March 4, 2005 requesting confirmation of your opinion that the real estate assets by Pryce Corporation (PC) which when transferred to Pryce Gases, Inc. (PGI) takes the form of a capital asset pursuant to Section 39(A)(1) of the Tax Code of 1997. It is represented that PGI is a gas company involved in the importation and distribution of liquefied petroleum gas (LPG) and the manufacture and marketing of industrial gases, such as oxygen and acetylene. PC, on the other hand is PGI's mother company and is involved mainly in the real estate business, i.e.,buying raw land, developing them into memorial parks, subdivisions, business parks and the like, and selling/operating the developed properties. PGI is undergoing corporate rehabilitation following a creditor-initiated rehabilitation petition filed with the Regional Trial Court (RTC) of Makati City. The court in its Order dated October 10, 2003 approved the final rehabilitation plan, whereby PC will invest up to P2.0 billion worth of real estate assets in, PGI as equity. The assets to be invested by PC will consist mainly of memorial park lots. When the investment is completed, PC shall hold about 98% of the outstanding capital stock of PGI. A series of four (4) properties-for-shares exchange transaction occurred between PC and PGI based on the following Subscription Agreements: 1. Subscription Agreement executed on April 29, 2004 for P525.04 Million; 2. Subscription Agreement executed on June 3, 2004 for P640.00 Million; 3. Subscription Agreement executed on June 25, 2004 for P78.992 Million; 4. Subscription Agreement executed on July 9, 2004 for P160.00 Million; Each of the exchanges have been certified as exempted from capital gains tax/creditable withholding tax, donor's tax and value-added tax pursuant to Section 40(C)(2) and (6)(c) of the Tax Code of 1997. You are of the opinion that the aforestated real estate properties when transferred to PGI shall now be classified as capital assets and not as ordinary assets. In reply; please be informed that Section 39(A)(1) of the Tax Code if 1997 defines a capital asset as: "...property held by the taxpayer (whether or not connected with his trade of business),but does not include stock in trade of the taxpayer or other 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, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property used in the trade or business, of a character which is subject to the allowance for depreciation provided in Subsection (F) of Section 34; or real property used in trade or business of the taxpayer." ITDHcA For a property to be considered as a capital asset, it must not be used, or is not being used in the business of the corporation. The real estate properties transferred by PC to PGI should be classified as capital assets considering that the latter is not engaged in the business of selling real estate. The provisions of Revenue Regulations No. 7-2003, particularly Sec. 3, par. a, enumerates the persons engaged in the real estate business as follows: "1. Real Estate Dealer All real properties acquired by the real estate dealer shall be considered as ordinary assets; 2. Real Estate Developer All real properties acquired by the real estate developer whether developed or undeveloped as of the time of acquisition, and all real properties which are held by the real estate developer primarily for sale or for lease to customers in the ordinary course of his trade or business or which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year and all real properties used in the trade or business, whether in the form of land, building, or other improvements, shall be considered as ordinary assets. 3. Real Estate Lessor All real properties of the real estate lessor, whether land and/or improvements, which are for lease/rent or being offered for lease/rent, otherwise for use or being used in the trade or business shall likewise be considered as ordinary assets." PGI under its Articles of Incorporation is primarily engaged in the manufacture, production, purchase, sale and trade of all kinds of liquids and gases and other chemicals and allied products. For the reason that PGI is neither a real estate dealer, real estate developer nor a real estate lessor, PGI can be regarded as a corporation not engaged in the sale of real estate assets to its customers because its organization and structure is designed and intended only for gas business and as such the aforesaid properties conveyed should not be treated as an ordinary asset. The foregoing case of BIR Ruling 234-92 dated August 27, 1992, would find application in the case at hand, where this Office held that: "...since the land is not used in business by either of the owners but is being held as an investment by all the co-owners, the land is considered a capital asset." It is to be noted that under Sec. 3, par. f, item 3 of Revenue Regulations No. 7-2003 on the determination of whether a particular real property is a capital asset or ordinary asset, the law states that: "f. ... real properties that have been transferred to a buyer/transferee, whether the transfer is through sale, barter or exchange, inheritance, donation or declaration of property dividends . xxx xxx xxx "3. The real property received in an exchange shall be treated as ordinary asset in the hands of the transferee in the case of a tax-free exchange by taxpayer not engaged in real estate business to a taxpayer who is engaged in real estate business, or to a taxpayer, who even if not engaged in real estate business, will use in business the property received in the exchange." The converse of the above-mentioned rule would mean that a real property cannot be an ordinary asset when received in the hands of a transferee who will not use it in the ordinary course of its trade or business and, thus, it could only take the other form of asset which is a capital asset. Similarly, in BIR Ruling No. 014-2003 dated October 28, 2003, this, Office has ruled that: ...Wendell Holdings Co.,Inc. is not habitually engaged in the real estate business as represented, the property under consideration is a capital asset. The property was neither held primarily for sale to customers nor actually used in the, business of Wendell Holdings Co.,Inc." Applying the foregoing, it can be said that PGI being engaged in the gas business cannot possibly be connected in the business of selling real estate, and therefor its real estate assets acquired from PC which considerably will not form part of is trade inventory and which was not subjected to depreciation should not be deemed an ordinary asset. While it is true that the above-mentioned assets acquired by PGI are ordinary assets in the hands of PC, the same already takes the form of a capital asset when it was transferred by PC to PGI which obviously is a corporation not engaged in the real estate business. Furthermore, the Accounting Standard Council (ASC) issued pertinent provisions on the accounting recognition, measurement and classification of non-cash assets, whereby "Inventories",such as: a) assets held for sale in the ordinary course of the business; b) assets in the process of production for such sales; and 3) assets in the form of materials and supplies to be consumed in the production process or in the rendering of services, as well as "Property, Plant and Equipment" which covers tangible assets that are: 1) held by an enterprise for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and b) expected to be used during more than one accounting period are considered ordinary assets. EHSTDA Inasmuch as the real estate properties acquired by PGI from PC are not considered ordinary assets based on the foregoing accounting standards, it is but proper that the above-described properties should be classified as "other assets or "investments" in PGI's financial statement for 2004. 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 null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group