BIR Ruling [DA-270-04]

May 17, 2004 BIR RULING [DA-270-04] 39 (A) (1); RR 7-2003 DA-152-2004 SGV & Co. 6760 Ayala Avenue 1226 Makati City Attention: Atty. W. U. Villanueva Tax Division Gentlemen : This refers to your letter dated March 25, 2004 requesting for confirmation that the sale of Isleworth Property Inc.'s ("IPI") registered lots which are classified as `investment properties' in its books and considered as capital assets is (i) subject to the 6% capital gains tax (CGT), (ii) subject to documentary stamp tax (DST) of 1.5%, but (iii) is exempt from 10% Value Added Tax (VAT) pursuant to the Tax Code of 1997, as amended. It is represented that your client, IPI is a domestic corporation duly organized and existing under and by virtue of the laws of the Philippines and was duly registered with the Securities and Exchange Commission as a real estate developer on March 8, 1989; that it is mandated to acquire by purchase or lease, hold, construct, improve, develop, repair, manage, maintain, operate, sell, exchange, lease or mortgage properties, personal or real, of whatever kind or nature or any right or interest therein or pertaining thereto; to erect, construct, improve, repair, or develop factory buildings, dwellings, apartments, houses, buildings, structures and/or works of all kinds by its Articles of Incorporation; that IPI acquired eleven (11) parcels of land situated in Baryo Bugtong na Pulo, Lipa City, Batangas as an investment for future development; that the said assets had been classified as "Investments in Real Estate" in the corporation's books; that said properties have been raw, idle and have remained undeveloped since the time of their acquisition and that based on the same audited financial statements, the said properties were not included as part of IPI's inventory; that IPI did not derive income from the said properties; and that the accompanying notes to financial statements in its audited financial statements for the year 2002 state that "the company is a dormant entity." In reply, please be informed that whenever a real estate developer sells real properties forming part of its inventory for sale or lease to customers, it is considered as a sale of ordinary assets subject to the 32% income tax pursuant to Section 27(A) of the Tax Code of 1997. However, when the real estate involved has never formed part of its inventory for sale to customers and has not been used in its trade or business as evidenced by the fact that it has remained idle, raw and undeveloped, such real properties are properly classified as capital assets subject to a final tax of 6% on the gain presumed to have been realized from the sale or transfer thereof pursuant to Section 27(D)(5) of the Tax Code of 1997. The character of the real property involved in a transaction must primarily be determined, i.e. whether or not it is capital or ordinary asset, prior to the application of the appropriate tax rates. Under Section 39(A)(1) of the Tax Code of 1997, the term "capital assets" is negatively defined as property held by the taxpayer (whether or not connected with his trade or business) but does not include (i) stock in trade of the taxpayer or other 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 (ii) property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business; or (iii) 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 (iv) real property used in trade or business of the taxpayer. ( BIR Ruling No. 27-02 dated July 3, 2002 ) Thus, if the real property is a land or building which is not actually used in the business of the seller-corporation and is treated as a capital asset, as that term is defined in Section 39(A) of the 1997 Tax Code, then a final tax of six percent (6%) shall be imposed on the gain presumed to have been realized on its sale, exchange or disposition of such land or building based on the gross selling price of or fair market value as determined in accordance with Section 6(E) of the Tax Code of 1997, whichever is higher, of such land and/or building. (Sec. 27(D)(5);1997 Tax Code of 1997). This rule applies, whether or not the seller corporation is engaged in real estate business. On the other hand, it is only when the real property being sold is an ordinary asset that the withholding tax rates imposed under Section 2.57.2 of Revenue Regulations No. 2-98, as amended, shall apply. The rate of withholding tax will depend on whether, first, the seller is exempt or taxable, second, whether the seller is habitually engaged in real estate business or not; and third, if the seller is habitually engaged in real estate business, the gross selling price, as that term is defined in the above-mentioned Revenue Regulations. ( BIR Ruling DA-152-2004 dated March 31, 2004 citing BIR Ruling No. 27-02 dated July 3, 2002 ) Real property, which is idle and vacant and had not been used in the ordinary course of trade or business nor had it ever been classified as property of a kind which would properly be included in the inventory if on hand at the close of the taxable year, nor had it ever been held by the taxpayer primarily for sale to customers in the ordinary course of trade or business, the income derived from the sale thereof is not subject to the expanded withholding tax under Section 2.57.2 (J) of Revenue Regulations No. 2-98, but only to the 6% capital gains tax imposed under Section 27(D)(5) of the Tax Code of 1997 and to the documentary stamp tax under Section 196 of the same Code, based on the gross selling price or fair market value (FMV) as determined in accordance with Section 6(E) of the Code, whichever is higher. Lots, classified as "investment properties", which are idle, unproductive and unimproved since the time of acquisition, and do not fall under any of the assets enumerated under Section 39(A)(1) of the Tax Code of 1997 and 2(b) of Revenue Regulations No. 7-2003 are classified as capital assets, the sale of which is subject to 6% capital gains tax, DST of 1.5% but exempt from 10% VAT ( BIR Ruling DA-152-2004 dated March 31, 2004 ). Based on your representation, the property of IPI which is idle and vacant and had not been used in the ordinary course of trade or business nor had it ever been classified as property of a kind which would properly be included in the inventory if on hand at the close of the taxable year nor had it ever been held by the taxpayer primarily for sale to customers in the ordinary course of trade or business, the income derived from the sale thereof is not subject to the expanded withholding tax under Section 2.57.2 (J) of Revenue Regulations No. 2-98, but only to the 6% capital gains tax imposed under Section 27(D)(5) of the Tax Code of 1997 and to the documentary stamp tax under Section 196 of the same Code, based on the gross selling price or FMV as determined in accordance with Section 6(E) of the Code, whichever is higher. ( BIR Ruling Nos. DA-217-99 dated April 12, 1999; DA-010-02 dated January 29, 2002 and DA-152-2004 dated March 31, 2004 ). Corollarily, only such real properties held by a real estate developer primarily for sale or lease to customers in the ordinary course of its real estate development business, or which would be properly included in the inventory of such taxpayer if on hand at the close of the taxable year, or used in his trade or business are appropriately classified as ordinary assets. Otherwise stated, real properties of a real estate developer other than those enumerated under Section 39(A)(1) of the Tax Code of 1997 and Section 2(b) of RR 7-2003 are properly deemed as capital assets. Considering that the registered lots classified in IPI's books as investment in real estate are idle, unproductive and unimproved real properties since the time of acquisition, and do not fall under any of the assets enumerated under Sections 39(A)(1) of the Tax Code of 1997 and 2(b) of Revenue Regulations No. 7-2003, the same should be properly classified as capital assets for tax purposes. Accordingly, we hereby confirm your opinion that the sale of IPI's registered lots which are classified as 'investment properties' in its books and considered as capital assets is: (i) subject to capital gains tax (CGT) of 6% pursuant to Section 27(D)(5) of the Tax code of 1997; (ii) subject to DST at the rate of P15,00 for each P1,000.00 or fractional part thereof in excess of P1,000.00, or 1.5% of the consideration or fair market value of the properties, whichever is higher, pursuant to Section 196 of the Tax Code; and (iii) exempt from 10% VAT, the properties not being primarily held and offered for sale or lease to customers in the ordinary course of IPI's trade or business, as provided under Section 109(w) of the Tax Code of 1997. 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.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group