BIR Ruling [DA-203-03]

June 30, 2003 BIR RULING [DA-203-03] 27 (D) (5), 32 329-92, 8-95, DA-158-2002 Shoemart, Inc. 400 C. Palanca Sr. St. Quiapo, Manila Attention: Ms. Cecilia R. Patricio Senior Assistant Vice President Gentlemen : This refers to your letter dated April 25, 2003 requesting for a confirmation of your opinion that the Deed of Exchange executed by and between Shoemart, Inc. (Shoemart) and Public Estates Authority (PEA) involving two (2) parcels of land, both located within the Central Business Park I-Island A, Pasay City (CBP-I, Island A) is exempt from the payment of the capital gains tax and documentary stamp tax. We quote the pertinent portion of your request as follows: "Pursuant to Presidential Decree 1084, PEA was authorized to and empowered to reclaim lands and to develop, improve, acquire, administer, deal in, subdivide, dispose, lease and sell the same to individuals or entities. PEA (then) became the registered owner of huge parcels of 'reclaimed' land in Pasay City now known as CBP-1, Island A. Following a series of events, on 9 August 1994, a "Joint Venture Agreement" later on amended by a "Supplemental Agreement (to the Joint Venture Agreement)" dated 27 May 1999 (hereinafter jointly referred to as "JVA"), were executed between PEA as Owner and Shoemart as Developer wherein the Developer undertook "to develop substantially in accordance with the Manila-Cavite Coastal Road Reclamation Project Master Development Plan . . . the whole projects/subdivision into a mixed use first class residential, commercial, recreational, institutional, office and financial district area and provide therein the works, improvements and facilities as described in said Master Development Plan such as reclamation works and works containment structures, roadway system which includes some bridges, drainage/storm sewer system, sewerage collection system, park and street lighting system, power distribution system and provision for telephone distribution system and all landscaping and exterior design works." . . . "As stipulated by the parties in the said JVA, "the Developer shall bear all the development expenses and related costs and shall assume all the risks related thereto. It shall also reimburse the Owner for the costs incurred in the preparation of technical engineering plan for the project and shall solely bear the costs necessary to procure all the necessary heavy equipment and engineering staff to carry out the development work of the project, purchase materials and supplies, including professional services required and implement all development works needed for the project. In addition, all expenses for the maintenance and upkeep of the roads and open spaces, curbs and gutters, lighting and all other project/subdivision facilities, including water channels surrounding the project, prior to the turn-over to the project/subdivision Association shall be for the account of the Developer. "One of the significant highlights of the JVA dealt on the "sharing/development options." In consideration of the above-mentioned premises, the agreement of the parties was that "of the total reclaimed land of approximately One Million Seven Hundred Twenty Six Thousand Eight Hundred Thirty Nine (1,726,839) Square Meters, the Owner shall receive sixty-five percent (65%) of the gross area of all lots inclusive of the area mandated to be devoted to roads and open spaces in the entire projects/subdivision, or an aggregate area of approximately One Million One Hundred Twenty Two Thousand Four Hundred Ninety One (1,122,491) Square Meters. On the other hand, the Developer shall receive as its share, thirty-five percent (35%) of the gross area, or approximately Six Hundred Four Thousand Three Hundred Forty Eight (604,348) Square Meters." In line with its commitment to copy with the schedule of work in relation to the development plan, Shoemart (the Developer) timely commenced and successfully implemented the development works on CBP-1, Island A under the JVA. In return and in accordance with the terms and conditions of the JVA, PEA (the Owner) has caused the transfer of the agreed portion of the developed area equivalent to Six Hundred Four Thousand Three Hundred Forty Eight (604,348) Square Meters to Shoemart (the Developer) by way of a Deed of Conveyance in favor of Shoemart. . . . cHDaEI "Notably, under Section 7.2.1 (Estimated Power Requirement) of the Boulevard 2000 Integrated Framework Plan which was prepared in pursuit of the objectives to implement the development objectives of CBP-1, Island A Project, two (2) Power Substations were allocated to meet the power requirement of CBP-1, Island A. Nonetheless however, the Manila Electric Company (hereinafter "MERALCO"), based on their study on the power requirement of CBP-1, Island A, recommended the establishment of an additional two (2) Power Substations in the area. Purportedly in consonance thereto, under the SM (Shoemart) Master Development plan duly approved by the PEA Board of Directors on 9 November 1998, the said four (4) MERALCO Power Substations were proposed to be built in the following areas, to wit: a) Open space adjacent to Manila Bay (50 meter green strip) Two (2) Substations, b) Open space beside the Libertad Channel One (1) Substation; and c) Pasay Hongkong Realty Dev't. Corp. (PHRDC) property One (1) Substation xxx xxx xxx "With particular reference to MERALCO Power Substation No. 2, the same is proposed to be built on PEA's Lot No. 13-A (a common area) in CBP-1, Island A, (which is covered by Transfer Certificate of Title No. 141665 under the name of PEA) and is located at the intersection of Bay and Seaside Boulevards, specifically on the west side of Bay Boulevard . . . After several detailed discussions on the viability of placing the MERALCO Power Substation No. 2 on the said proposed site however, it became apparent that normal seawave actions not to mention the seawave conditions during a stormy weather, will bring about certain technical difficulties or problems to said MERALCO Power Substation No. 2, due to the proximity of its proposed location to the seawall along Seaside Boulevard. In simple terms, the presence of this MERALCO Power Substation No. 2 in the proposed site (PEA's Lot No. 13-A) carries great technical risks since the said proposed location is extremely open and exposed to elements coming from actions of the sea. . . . "To address this concern, PEA interposed the remedy of "land swapping", which was accepted by Shoemart. In doing so, the parties agreed that PEA's Lot No. 13-A (the original proposed site) having an area of Three Thousand Four Hundred One (3,401) Square Meters, be exchanged with Shoemart's Lot No. 19 (covered by Transfer Certificate of Title No. 142610 under the name of Shoemart, Inc.). Through this exchange or swap, Shoemart's Lot 19 (taken from the usable or disposable portion of Shoemart's land will then be converted as to form part of the common area within PEA's land and vice versa. Much to the desire of Shoemart to hold on to this (usable and, disposable) parcel of land, it nevertheless, for the good interest of all locators in the estate consented to forego of such parcel of land as the (new) location where the proposed MERALCO Power Substation No. 2 will be placed. It is believed that the transfer or relocation of the proposed site of MERALCO Substation No. 2 from PEA's Lot No. 13-A to the aforesaid Shoemart's Lot No. 19 (which is found across the eastern side of Bay Boulevard) is the most prudent thing that can be done since the new proposed location at Shoemart's Lot No. 19 stands protected from the actions of the sea coming near the Bay Boulevard Bridge as well as the seawall not to mention that the inland location of Shoemart's Lot 19 as the site for said MERALCO Power Substation No. 2 will provide easier transmission line accesses as well as a sheltered location for the power equipments. . . . "By way of a Deed of Exchange, Shoemart thereby cedes, transfers and conveys to PEA its land with an area of Three Thousand Four Hundred One (3,401) Square Meters, identified as Lot 19 and on the other hand, PEA cedes, transfer and conveys to Shoemart its land with an equal area of Three Thousand Four Hundred One (3,401) Square Meters, identified as Lot 13-A, both lands being situated in CBP-1, Island A, Pasay City. . . ." and that in support of your request, you submitted to this Office the following documents, viz.: a) Joint Venture Agreement dated 9 August 1994; b) Supplemental Agreement (to the Joint Venture Agreement) dated 27 May 1999; c) Conceptual Site Development Plan of the entire reclaimed land with the areas allotted or awarded each to PEA and Shoemart duly indicated and marked; d) Copies of the said Boulevard 2000 Integrated Framework Plan; e) Site Plan of the proposed locations of the four (4) MERALCO Power Substations; f) Technical Report dated 8 August 2000; g) Copies of the drawing/sketch of the location of the said two (2) lots and Resolution dated 21 September 2000 of the PEA Board of Directors; and h) Deed of Exchange of Real Property between PEA and Shoemart. In reply, please be informed that the execution of the Deed of Exchange between PEA and Shoemart, conveying real property in favor of Shoemart, in substitution for the parcels of land involuntarily ceded by Shoemart to PEA to give way to the construction of MERALCO Power Station No. 2 partakes the nature of an involuntary conversion. The doctrine of involuntary conversion of property was relied upon by this Office in BIR Ruling No. 373-87 dated November 23, 1987 and BIR Ruling No. 429-88 dated September 2, 1988 and reiterated in BIR Ruling No. 329-92 dated November 18, 1992. The Involuntary Conversion of Property Doctrine, as explained in BIR Ruling No. 329-92, is quoted thus: "xxx xxx xxx "In reply, please be informed that the aforementioned expropriation of MJC's real property is embraced under the involuntary conversion of property doctrine which this Office relied upon in BIR RULING NO. 373-87, dated November 23, 1987, in the case of the MERCURY GROUP OF COMPANIES. This ruling was reiterated in BIR RULING NO. 429-88, dated September 2, 1988: "The excess of the amount of the insurance proceeds over the net book value of the insured assets is not taxable income to the corporation, it having been used in restoring the burned assets. The rule is, where insurance proceeds are actually reinvested in similar property, no gain is recognized. ( Herder V. Helvering, 23 AFTR, p. 322 )" "The aforesaid Herder V. Helvering case is a discussion of the Involuntary Conversion of Property Doctrine in determining whether or not a gain from the involuntary conversion of a property may be recognized as realized income subject to income tax to the recipient, theft or seizure, its expropriation or condemnation, or the threat or imminence thereof. "Involuntary Conversion if property (as a result of its destruction, in whole or in part, theft or seizure, or an exercise of the power of requisition or condemnation or the threat or imminence thereof) is compulsorily or involuntarily converted into property similar or related in service or use to the property so converted, or into money which is forthwith in good faith . . . expended in the acquisition of other property, or in the acquisition of a control of a corporation owning such other property, or in the establishment of a replacement fund, no gain or loss shall be recognized. If any part of the money is not so expended the gain, if any, shall be recognized, but in an amount not in excess of the money so expended. ( MERTENS, Chap. 20, 121, Vol. 3, pp. 337-338 ) "The facts in the Herder V. Helvering case were: On January 15, 1934 fire destroyed the milling property owned by the partnership of George Herder and R.L. Williams. For this loss, the partnership received $50,000 as fire insurance proceeds. This amount was immediately distributed to the partners, being pro-rated in accordance with their respective interest in the partnership, namely, two-thirds to George Herder, and one-third to R.L. Williams. George Herder received $33,333.67 under such distribution and that $19,199.50 thereof represented his portion of the total amount received by the partnership in excess of the adjusted cost basis of the property at the time of its destruction. "The court held the said gain ($19,199.50) is not a realized income, hence, not subject to income tax, (supra) pursuant to the rule that no realized income may be recognized from a compulsory or involuntary conversion of a property. This doctrine is one of the several doctrines enunciated by the Courts in the U.S.A. that explain the meaning of the term "income" and "realization of income". xxx xxx xxx" In BIR Ruling No. DA-158-2002 dated September 12, 2002 involving adjacent property of the instant case, wherein a Deed of Exchange was executed by and between Manila Bay Development Corporation (MBDC) and PEA, whereby the latter conveyed real property in favor of MBDC, in substitution for the parcels of land involuntarily ceded by MBDC to PEA pursuant to the Boulevard 2000 Integrated Framework Plan, this Office ruled that the conveyance in favor of MBDC partakes the nature of involuntary conversion. The said ruling continues by stating that: "xxx xxx xxx ". . . the applicability of the involuntary conversion of property doctrine is apparent when MBDC was required to cede certain portions of its parcel of land located in the Boulevard Reclamation Area to PEA pursuant to the Boulevard 2000 Integrated Framework Plan which was approved by no less than then President of the Philippines, Fidel V. Ramos. As payment for the lands required to be ceded by MBDC to PEA, PEA's lands also in the same area were transferred to MBDC. "In view of the foregoing, this Office is of the opinion as it hereby holds that the gain, if any, on the involuntary conversion of MBDC's property is not recognized as realized income, hence, not subject to income tax. . . . xxx xxx xxx" Applying the aforecited rulings to the case at bar, this Office is of the opinion as it hereby holds that the exchange of properties between PEA and Shoemart is not subject to the corporate income tax under Section 27(A) of the Tax Code of 1997 or to the capital gains tax imposed under Section 27(D)(5) of the same Code nor to the creditable withholding tax imposed under Revenue Regulations No. 2-98, as amended. However, it is subject to the documentary stamp tax imposed under Section 196 of the Tax Code of 1997. Furthermore, the notarial acknowledgment to the said deed is subject to the documentary stamp tax of P15.00 pursuant to Section 188 of the same Code. This ruling is being issued on the basis of the foregoing facts as represented. This ruling is limited only to the tax consequences of the transaction that you described on the presumption that such transaction is legal and binding on the parties. However, if upon investigation, it will be disclosed that the facts are different, and/or any of the requirements imposed in this letter are not complied with, then this ruling shall be considered null and void. CAHTIS Very truly yours, Commissioner of Internal Revenue By: (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group