BIR Ruling [DA-186-06]

March 28, 2006 BIR RULING [DA-186-06] Section 24 (B) (2) Cabaero Katigbak Clemente & Co., CPAs 4/F Saville Bldg., 8728 Paseo de Roxas Makati City Attention: Ms. Maria Cecilia C. Katigbak Partner Gentlemen : This refers to your letter dated January 31, 2006 requesting on behalf of your client, Teoville Development Corporation (TDC) for a ruling in relation to the taxability of property dividends as follows: 1. That property dividends to be declared consisting of real property shall be recorded at their respective book value in the books of both TDC and the recipient stockholders of TDC; 2. That the stockholders of TDC shall not be subject to any income tax and capital gains tax upon their receipt of the real properties as property dividends but individual stockholders shall be subject to dividend tax of 10% based on book value of the property; 3. That the property dividend distributed out of the capital assets of the TDC shall not be subject to value-added tax (VAT). However, property dividends distributed from the assets of the company that are used in business shall be subject to VAT; and 4. That the Deed of Conveyance to be executed by TDC and its recipient stockholders covering the properties, not being a sale and being without consideration, shall not be subject to any documentary stamp tax other than the documentary stamp tax of PhP15.00 pursuant to Section 188 of the Tax Code. As represented, TDC is a domestic corporation with business address at 4th Floor, Saville Building, 8728 Paseo de Roxas, Makati City. It was incorporated on April 25, 1967 to engage in the real estate business. Currently, TDC's main source of revenue is leasing of its properties. All of its present stockholders are resident Filipino citizens. IHDCcT As of December 31, 2004 audited financial statements, TDC has retained earnings of PhP5,880,129.10 that could increase by December 31, 2005 if the company would have net profits for the calendar year 2005. Of the total retained earnings, PhP3,000,000.00 was appropriated while the remaining is unappropriated. The Board of Directors (BOD) has the option to reverse the Appropriated Retained Earnings and declare it as property dividend. Presently, TDC has various lots located in the City of Paraaque, Metro Manila. In TDC's books, these real properties were classified into two (2) groups. The First Group consists of properties that are used in business. These were leased to its tenants, wherein TDC derived its revenue, thus, these are considered as ordinary assets. In its books and financial statements, these were recorded and classified as "Land" under the Land, Property and Equipment account and which has a total book value of PhP4,539,057.32. This consists of eight (8) lots with an area ranging from approximately 300 square meters to 600 square meters. The Second Group consists of properties that are held by the corporation merely as an investment and classified in its books and financial statements as "Investment." It has a total book value of PhP6,033,500.00. These are idle lots that have never been leased/rented nor used in the ordinary course of business, thus, these have been considered as capital assets from the very beginning as these were never subdivided into smaller lots. In fact, these were allotted for executive office of the corporation and the others were to be used as the utilities/maintenance yard of the company. It is the desire of the BOD to distribute the Second Group of properties to its stockholders through property dividends. In reply, please be informed as follows: 1) The property dividends shall be recorded at book value in the books of both TDC and the recipient stockholders of TDC (BIR Ruling No. DA-268-98 dated June 25, 1998). The book value should be understood to mean historical cost and should not include any revaluation increment on the property (BIR Ruling No. DA-280-99 dated May 13, 1999). 2) Prior to the amendments introduced into the Tax Code by Republic Act (R.A.) No. 8424 (Tax Code of 1997), corporate dividend distribution was, in general, exempt from income tax. However, beginning on January 1, 1998 or the date of effectivity of R.A. No. 8424, dividend became subject to final withholding tax pursuant to the last paragraph of Section 24(B)(2) of the Tax Code of 1997 which provides, viz : "Provided, however, That the tax on dividends shall apply only on income earned on or after January 1, 1998. Income forming part of retained earnings as of December 31, 1997 shall not, even if declared or distributed on or after January 1, 1998, be subject to this tax." The provision of the Tax Code on source dividend distribution states that ". . . any distribution made to the shareholders or members of a corporation shall be deemed to have been made from the most recently accumulated profits or surplus, and shall constitute a part of the annual income of the distributee for the year in which received ." (Section 73(C), Tax Code of 1997). This proviso originated from the original Tax Code of 1939 (Commonwealth Act No. 466), during which time, dividend was taxable. HASTCa Hence, to reconcile Sections 24(B)(2) and 73(C) both of the Tax Code of 1997, this Office ruled in BIR Ruling No. DA-061-01 dated April 10, 2001 ". . . if a corporation had accumulated profits as of December 31, 1997, its distribution of dividends beginning 1998 and thereafter must come from the most recently accumulated profits unless a board resolution by the Board of Directors has been issued stating that said dividends declared forms part of the Retained Earnings as of December 31, 1997." Accordingly, property dividends declared and distributed by TDC to its stockholders on or after January 1, 1998, if forming part of retained earnings as of December 31, 1997, shall not be subject to income tax pursuant to Section 24(B)(2) of the Tax Code of 1997, and consequently to any withholding tax (BIR Ruling No. DA-061-01 dated April 10, 2001). Moreover, the receiving stockholders shall not be subject to capital gains tax on the difference between the fair market value and the book value of the shares of stock declared and distributed as property dividends under Section 24(C) of the Tax Code of 1997 (BIR Ruling No. DA-280-99 dated May 13, 1999 and DA-583-99 dated October 6, 1999). This is so because there is no realized gain if the value used at the time of distribution is book value. A company realized no taxable income in declaring a dividend since the distribution of dividends among the stockholders is not a sale nor were assets used to discharge an indebtedness ( General Utilities and Operating Co. vs. Helvering , 296 U.S. 200-207 and DA-583-99 dated October 6, 1999). The Tax Clearance Certificate (TCL) for computerized areas or Certificate Authorizing Registration (CAR) for non-computerized areas shall be secured from the Revenue District Officer of the Revenue District Office (RDO) where the taxpayer-transferor is registered or is required to be registered. For this purpose the RDO where the taxpayer-transferor is registered or is required to be registered shall refer to the RDO having jurisdiction over the domicile or legal residence, principal office/place of business of the transferor where he/it is registered or is required to be registered (Revenue Memorandum Order No. 17-97). The parties shall cause the annotation at the back of the Transfer Certificate of Title the date of distribution of property dividend and the book value or historical cost of the same which shall serve as the basis of the computation of the tax upon its subsequent disposition (BIR Ruling No. DA-278-98 dated June 26, 1998). However, the subsequent sale or other disposition of the real properties received as property dividends by the individual stockholders of TDC shall be subject to the 6% capital gains tax based on the gross selling price or fair market value prevailing at the time of the sale pursuant to Section 24(D)(1) of the Tax Code of 1997 if the said property, qualifies as a capital asset as of the time of sale, otherwise, the gain measured pursuant to Section 40 shall be subject to the regular income tax rates on individuals. 3) Inasmuch as the real properties distributed as property dividends do not constitute stocks in trade and are not primarily held for sale or for lease in the ordinary course of business, TDC shall not be subject to VAT on its distribution of property dividends in favor of its stockholders (Section 109(P), Tax Code of 1997, as amended by R.A. No. 9337 and BIR Ruling No. DA-280-99 dated May 13, 1999). AEDHST 4) Under Section 185 of Regulations No. 26, as amended, otherwise known as the Documentary Stamp Tax Regulations, conveyances of realty, not in connection with a sale to trustees or other persons without consideration are not taxable. Considering that the transfer of said real properties to your stockholders is not in connection with a sale but as property dividends and the same is without monetary consideration, the deed of conveyance to effect the transfer of such property dividends to TDC's' recipient stockholders is not subject to the DST imposed under Section 196 of the Tax Code of 1997, as amended. However, the acknowledgment of said deed of conveyance is subject to the DST of PhP15.00 pursuant to 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 disclosed that the facts are different, then this ruling shall be considered as null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) PABLO M. BASTES, JR. OIC, Head Revenue Executive Assistant Legal Service