BIR Ruling [DA-197-06]

March 28, 2006 BIR RULING [DA-197-06] Sec. 22 (B); DA-470-04 Filinvest Land, Inc . 173 P. Gomez Street San Juan, Metro Manila Attention: Atty. Andrew James Gerard Dulay Ruiz Tax Counsel Gentlemen : This refers to your letter dated November 18, 2005 requesting confirmation of the various tax consequences arising from a Joint Venture Agreement for construction purposes, between Filinvest Land, Inc. and First Optima Corporation. It is represented that Filinvest Land, Inc. ("FLI" for brevity) is a corporation duly organized and existing under the laws of the Republic of the Philippines, engaged in the business of acquiring, developing and selling real estate, including residential subdivisions. On the other hand, First Optima Corporation ("FOC" for brevity) is the absolute and registered owner in fee simple of a parcel of land, covered by Transfer Certificate of Title (TCT) No. 652714. Said real property, with an area of 24,546 square meters (m 2 ), is located in Taytay, Province of Rizal. On September 21, 1996, FLI, as the developer, entered into a Development Agreement with FOC for the subdivision and horizontal development of the real property abovementioned. The salient portions of the Development Agreement are as follows: 1. FLI shall undertake the subdivision and horizontal development of the subject real property, to be identified as the "Manor Ridge at Highlands Pointe Project", a residential project, which development shall include improvements and facilities as agreed upon; 2. FLI shall shoulder all the equipment, engineering, and labor expenses incurred relative to the subdivision and horizontal development of the Sta. Cecilia Subdivision Project; 3. For and in consideration of the development obligations and undertakings it will assume, FLI will receive Sixty percent (60%) of the saleable lots which shall result from said subdivision and horizontal development. The remaining Forty percent (40%) shall be retained in ownership by FOC; DaECST 4. Upon determination of the saleable lots which would be assigned respectively to FLI and FOC, FLI and said FOC will execute a Deed of Allocation to allow the lots pertaining to both FLI and FOC may be registered in their respective names. On October 19, 2005, FLI and FOC entered into Partition Agreement, whereby the developed saleable lots were allocated between FLI and FOC, based on the terms of the Development Agreement. The said documents adjudicated the said saleable lots between the parties, as part of their respective shares in the Manor Ridge at Highlands Pointe Project, to allow the registration of said allocated saleable lots in their respective names. Based on the foregoing, you are requesting confirmation of your opinions as follows: 1. The Development Agreement between FLI and FOC, for the subdivision and horizontal development of the abovementioned real property located in Taytay, Province of Rizal, into a residential subdivision, will not give rise to a taxable joint venture as provided under Section 22(B), in relation to Section 27(A), both of the National Internal Revenue Code (NIRC), as amended; 2. The allocation of saleable lots between FLI and FOC in consideration of their respective contributions, as stipulated in the Development Agreement, is not a taxable event and is not subject to income tax, and subsequently withholding tax, and the Value-Added Tax (VAT), since the allocation of saleable lots is in fact a mere return of capital that each has contributed; 3. The Partition Agreement whereby FLI and FOC allocated unto each other their share in the saleable lots in consideration of their respective contributions, is not subject to the Documentary Stamp Tax (DST) imposed under Section 196 of the NIRC, as amended, nor to any income tax, and consequently withholding tax, since the allocation is made without monetary consideration and is not in connection with a sale. Rather, the partition is made merely to segregate the saleable lots between the parties, as the return of the capital which each contributed. However, it is understood that should FLI and/or FOC sell any of the saleable lots allocated to them, to third parties, the gain that may be realized from said sale will be subject to regular corporate income tax at 35%, in accordance with Section 24 of the NIRC, as amended, and consequently to withholding tax as implemented under Revenue Regulations (RR) No. 2-98, as amended. In reply, please be informed that your above opinions are hereby confirmed as follows: Section 22(B) of the 1997 Tax Code, as amended, states thus: "Section 22. Definitions . When used in this Title: xxx xxx xxx. (B) The term 'corporation' shall include partnerships, no matter how created or organized, joint-stock companies, joint accounts ( cuentas en participacion ), associations, or insurance companies, but does not include general professional partnerships and a joint venture or consortium formed for the purpose of undertaking construction projects or engaging in petroleum, coal, geothermal and other energy operations pursuant to an operating or consortium agreement under a service contract with the Government. 'General professional partnerships' are partnerships formed by persons for the sole purpose of exercising their common profession, no part of the income of which is derived from engaging in any trade or business." (emphasis supplied) ETDSAc The abovementioned exemption was initiated under Presidential Decree (PD) No. 929, dated May 4, 1976, which amended the definition of a "taxable" corporation in the NIRC, as amended, to specifically exclude joint ventures formed for the purpose of undertaking construction projects. Said PD instituted the amendment of the definition of the term "taxable" corporation in recognition of the following situations: (1) Local contractors contribute substantially to the development program of the country; (2) Local contractors are at a disadvantage in competitive bidding with foreign contractors in view of limited capital and financial resources; (3) In order to be able to compete with big foreign contractors, it may be necessary for local contractors to enter into joint ventures to pool, their limited resources in undertaking big construction projects. Hence, to assist the local contractors in achieving competitiveness with foreign contractors, the joint ventures formed by said local contractors were thus deemed as not falling under the definition of a "taxable" corporation, and thus not subject to income tax. This was, and still is, the intention of the legislature. From the foregoing, the Development Agreement entered into by and between FLI and FOC, therefore, is not subject to the income tax under Section 27(A) of the 1997 Tax Code, as amended. ( BIR Ruling No. DA-470-04, dated September 7, 2004 ) On the issue of the allocation of the saleable lots between FLI and FOC based on the Partition Agreement, this office is of the opinion that said allocation, which is done effectively in consideration of their respective contributions, does not constitute a taxable event, as no income is actually realized by either FLI and/or FOC. The Partition Agreement was executed without consideration, and is not in connection with any sale between the said parties. As has been ruled by the BIR on numerous occasions, income, in a broad sense, means all wealth which flows into the taxpayer other than as a mere return of capital ( Section 36, RR No. 2 ). FLI and FOC, both having contributed to the development of the aforementioned real property, did not realize any income upon the allocation of the saleable lots. Hence, the allocation of lots arising from the Partition Agreement is not subject to income tax, and consequently to withholding tax. ( BIR Ruling No. DA-240-01, dated November 16, 2001 ) FLI and/or FOC will only realize income upon their respective sales of the saleable lots allocated to each of them. In this regard, said sales would be subject to the regular corporate income tax at 35%, in accordance with Section 24 of the 1997 Tax Code, as amended, and consequently to withholding tax as implemented under Revenue Regulations (RR) No. 2-98, as amended. Likewise, as a return of capital, the above allocation/transfer of saleable lots to FLI and FOC is not a sale, barter or exchange of real property done in the ordinary course of business. As such, said allocation/transfer does not fall within the purview of Sections 106 to 108 of the 1997 Tax Code, as amended, which would otherwise subject said allocation/transfer to the VAT. The allocation/transfer being in the nature of a return of capital, the same cannot be subject to the VAT. Further, the Partition Agreement whereby FLI and FOC have allocated unto each other their shares in the saleable lots in consideration of their respective contributions, is not subject to the DST imposed under Section 196 of the NIRC, as amended, considering that, as stated earlier, the allocation is made without monetary consideration and is not in connection with a sale. In this regard, Section 185 of the Revised Documentary Stamp Tax Regulations (Regulations No. 26)provides that "conveyances of realty not in connection with a sale, to trustees or other persons without consideration are not taxable." Accordingly, since the aforementioned Partition Agreement was executed without consideration and was not in connection with a sale between FLI and FOC, said Partition Agreement, therefore, is not subject to DST imposed under Section 196 of the 1997 Tax Code, as amended. However, the notarial acknowledgment to said Partition Agreement is subject to the DST pursuant to Section 188 of the NIRC, as amended, in the amount of P15.00. 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. EcTDCI Very truly yours, Commissioner of Internal Revenue By: (SGD.) PABLO M. BASTES, JR. OIC, Head Revenue Executive Assistant Legal Service