BIR Ruling [DA-173-02]

September 20, 2002 BIR RULING [DA-173-02] Section 195; BIR Ruling No. 091-99 Bank of Commerce Banker's Center 6764 Ayala Avenue Makati City Attention: Atty. Marissa B. Espino Director-Legal Services Gentlemen : This refers to your letter dated May 22, 2000 which was forwarded by the Assistant Commissioner, Large Taxpayer Service, requesting this Office to issue a definitive ruling on the following concern: 1. Exemption of the Dacion En Pago with Mandatory Buy Back Agreements from payment of Capital Gains tax; and 2. Payment of Documentary Stamp Tax according to the pertinent provisions of the Internal Revenue Code on "Mortgages, Pledges and Deeds of Trust". It is represented that on November 9, 2001, the Traders Royal Bank (TRB) and Bank of Commerce (BOC) executed a Purchase and Sale Agreement whereby it stipulated the TRB's desire to sell and the BOC's desire to purchase identified recorded assets of TRB in consideration of BOC assuming identified recorded liabilities including its (TRB) booked contingent accounts per Consolidated Statement of Condition as of August 31, 2001. In the same instrument, the parties provided the "Conditions Precedent" upon which the effectivity and implementation of the agreement was conditioned upon the submission, fulfillment and/or concurrence of all the enumerated conditions. Among the conditions set forth is that the "BSP shall have given approval for the repayment of the emergency advances in the manner and under the conditions provided in Article IV of the Agreement". These "emergency advances" are part of the liabilities of TRB with the Bangko Sentral ng Pilipinas (BSP) which BOC assumed by virtue of the Purchase and Sale Agreement. Considering the necessity of the repayment of the emergency advances, BSP, TRB and BOC executed on May 3, 2002, an instrument called Dacion en Pago with Mandatory Buy-Back Agreement . The properties subject of the Dacion consisted of the TRB's recorded assets plus the selected assets of BOC. It is inscripted in the foregoing instrument (Dacion) that TRB and BOC will cede, transfer and convey the (listed) assets to BSP, which the latter accepts, with the condition that BOC shall Buy-Back all the property, subject of the Dacion , within ten (10) years from the execution of the Agreement. In consonance with the Agreement, BOC now wants to exercise its right to Buy-Back the properties including those properties in the name of TRB. As a result thereof, BOC paid the documentary stamp tax of 1.5% based on the dacion price of P2,360,213,675.00 or in the total amount of P35,403,475.00. BOC however, believes that since there was no actual transfer that took place with the execution of Dacion en Pago with Mandatory Buy-Back Agreement , the said transaction is not subject to capital gains tax. Hence, this request. In reply thereto, please be informed that Article 1602 of the Civil Code provides: Article 1602. The contract shall be presumed to be an equitable mortgage in any of the following cases: (1) When the price of a sale with right to repurchase is unusually inadequate; (2) When the vendor remains in possession as lessee or otherwise; (3) When upon or after the expiration of the right to repurchase another instrument extending the period of redemption or granting a new period is executed; (4) When the purchaser retains for himself a part of the purchase price; (5) When the vendor binds himself to pay the taxes on the thing sold; (6) In any other case where it may be fairly inferred that the real intention of the parties is that the transaction shall secure the payment of a debt or the performance of any other obligation. In any of the foregoing cases, any money, fruits or other benefit to be received by the vendee as rent or otherwise shall be considered as interest which shall be subject to the usury laws. It can be gleaned from the wordings of the instrument ( Dacion ) that the intention of the parties in ceding, transferring and conveying the properties is not absolute but intended merely to secure the payment of the balance of the loan obligation (of TRB with BSP). In fine, vital circumstances in the instant case lead us to conclude that the assignment denominated as Dacion en Pago with Mandatory Buy-Back Agreement is in reality a Mortgage Agreement which falls under the category of an equitable mortgage as provided for in Article 1602 of the New Civil Code. The determination of classifying on whether the transaction is a sale or an equitable mortgage is necessary for this Office to properly resolve the tax consequence of the same. TAHcCI Now, with respect to corporations, the pertinent provision of the Tax Code which is considered as the basis for the imposition of capital gains on sale, exchange or disposition of lands and/or buildings is Section 27(D)(5) thereof, which provides: Section 27. Rates of Income Tax on Domestic Corporations. xxx xxx xxx (D) Rates of Tax on Certain Passive Income. xxx xxx xxx (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 gain 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 the 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. In interpreting the aforesaid provision, the Bureau, in BIR Ruling No. 091-99, dated July 8, 1999, ruled that for a corporation to be liable to the tax, a true sale, exchange or disposition of capital assets must have transpired. Unlike in transactions made by individuals under Section 24(D)(1) of the Code, where all sales of real property classified as capital assets, including pacto de retro or other forms of conditional sales are subject to the capital gains tax, no similar qualifications exist for capital asset transaction of a corporation. Hence, the latter is subject to such tax only upon a close and completed transaction. "A closed transaction for tax purposes results from a contract of sale which is absolute and unconditional on the part of the seller to deliver to the buyer a deed upon payment of a consideration and by which the purchaser secures immediate possession and exercises all the rights of ownership" ( Comm. vs. Union Pacific R. Co., 86F (2d) 637 CCA 2nd, 1936 Mertens, Chap. 12.118 Vol. 2, p. 236 ). Corollarily, "income consists of realized appreciation of capital or investment and realized returns, either in the form of receipts or benefits, flowing from the use of capital, services, activities or acts of the taxpayer, or which come to the taxpayer other than as a return of capital or investment, or as a substitution of money value for something permanently lost." ( U.S. vs. Supplee-Biddle Hardware Co., 265 U.S. 189, L. Ed. 970, 44 S. Ct. 546 (1924) Mertens Chap. 5.04, Vol, 1, p. 165 ). Hence, realization of income includes the requirement that the transaction be closed or consummated before any taxable income may result. "Any substantial conditional element in a transaction will postpone taxability" ( Michigan Steel Corporation of New Jersey, 38 BTA 435, Mertens, Chap. 12.120, Vol. 2, p. 330 ). Considering that there was no closed and completed transaction that took place, this Office is of the opinion that the Dacion en Pago with Buy-Back Agreement is not subject to the capital gains tax imposed in Section 27(D)(5) of the Tax Code of 1997, but the same is subject to documentary stamp tax imposed on mortgages, pledges and deeds of trust under Section 195 of the same Code, which provides, viz : Section 195. Stamp Tax on Mortgages, Pledges and Deeds of Trust. On every mortgage or pledge of lands, estate, or property, real or personal, heritable or movable, whatsoever, where the same shall be made as a security for the payment of a definite and certain sum of money lent at the time or previously due and owing or forborne to be paid, being payable, and on any conveyance of land, estate, or property whatsoever, in trust or to be sold, or otherwise converted into money which shall be and intended only as security, either by express stipulation or otherwise, there shall be collected a documentary stamp tax at the following rates: (a) When the amount secured does not exceed Five thousand pesos (P5,000), Twenty pesos (20.00). (b) On each Five thousand pesos (P5,000), or fractional part thereof in excess of Five thousand pesos (P5,000), an additional tax of Ten pesos (P10.00). xxx xxx xxx The documentary stamp tax imposed under Section 196 of the Tax Code shall not apply considering that no actual sale or similar conveyance took place by the execution of the Dacion en Pago . 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.) EDMUNDO P. GUEVARA Deputy Commissioner Legal & Inspection Group