BIR Ruling [DA-305-05]

July 5, 2005 BIR RULING [DA-305-05] KPMG Laya Mananghaya & Co . 22F Philamlife Tower 8767 Paseo de Roxas Makati City Attention: Atty. Francisco G. Tagao Head, Tax & Corporate Services Gentlemen : This refers to your letter dated June 28, 2005 stating that your client, Asia Recovery Corporation (ARC),is a domestic corporation, acquired from Metro Bank and Trust Company (Metrobank) the loan portfolio of Pathfinder Holdings Philippines, Inc. (PHPI);that the loan was secured by real estate mortgage consisting of Cebu Plaza Hotel owned by PHPI and the land on which it stands is owned by Trellis Properties Corporation (TPC),aggregately called "real properties";that ARC merely acquired the above loan portfolio for investment purposes; that unfortunately, however, subsequent events showed that the loan investment turned out to be a bad investment for ARC; that PHPI experienced extreme financial difficulties, defaulted on its loan obligation and ceased its hotel operations on March 15, 2003; that ARC was left with no option but to go against the security to be able to recoup its loan investment; that on December 3, 2004, a dacion en pago agreement was entered into between and among ARC, PHPI and TPC which was consummated in March 2005 whereby ARC shall acquire the real properties in payment for PHPI's loan obligation; that ARC treated the real properties as a capital investment consistent with its treatment of the loan portfolio as a capital investment; that ARC neither used the properties in its business nor it held them primarily for sale or for lease to its customers; that it never claimed depreciation on these properties; that thereafter, Cathay Int'l Resources Corp. (CIRC) offered to buy the real properties; and that on May 18, 2005, ARC sold the said properties by way of Deed of Conditional Sale. Based on the foregoing representations, you now request confirmation of your opinion that: (1) The sale of Cebu Plaza Hotel and the land on which it stands is subject to the capital gains tax of 6% under Section 27(D)(5) of the Tax Code; and (2) The sale of the above properties is exempt from value added tax of 10% under Section 109(w) of the Tax Code which is renumbered as Section 109(1)(P) of the Tax Code, as amended by Republic Act (R.A.) No. 9337 effective July 1, 2005. In reply thereto, please be informed that Section 27(D)(5) of the Tax Code provides that 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 a corporation and are treated as a capital asset, based on the gross selling price or fair market value as determined in accordance with Section 6 (E) of the Tax Code, whichever is higher, of such lands and/or buildings. In relation thereto, Section 39(A)(1) of the said Code defines the term "capital assets" to mean property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property 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 property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or 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 real property used in trade or business of the taxpayer. From the foregoing provisions of the Tax Code, there can be no uncertainty that the properties held by ARC are indeed capital assets, since the same are neither part of its stock in trade nor included in its inventory at the close of the taxable year. They are neither primarily held for sale or lease to its customers in the ordinary course of its business nor were they ever subjected to depreciation. They were neither used in the trade or business of ARC. The dacion en pago , from which the property investment arose, did not result to an acquisition of an ordinary asset. The real properties were merely acquired by ARC in payment of PHPI's loan obligation. They were not acquired with the intention of selling or leasing them to its customers in the course of trade or business. Although there was a reclassification from loan investment to property investment, the same was constantly treated by ARC as a capital asset. As such, the subsequent sale of the real properties by ARC to CIRC is subject to the capital gains tax of 6% in accordance with Section 27(D)(5) of the Tax Code. ( BIR Ruling [DA-152-04] dated March 31, 2004 and BIR Ruling [DA-111-03] dated April 8, 2003) However, Section 109(w) of the same Tax Code [which is now renumbered as Section 109(1)(P) under R.A. No. 9337 effective July 1, 2005] provides that the sale of real properties not primarily held for sale to customers or held for lease in the ordinary course of trade or business shall be exempt from the 10% value-added tax. Moreover, as held in BIR Ruling [DA-32-05] dated January 27, 2005 ,the term "primary" is defined as "first, principal, chief, leading, or first in order of time, or development, or intention" (Black's Law Dictionary, Sixth Edition).Thus, to be "held primarily for sale or lease," the property must be held with the chief intention of being sold or leased. Also, in VAT Ruling No. 034-2001, dated June 13, 2001 ,it was held that the sale of real property may only be imposed with the 10% value added tax provided that the same is primarily held for sale to customers or held for lease in the ordinary course of trade or business. Inasmuch as the real properties are classified as capital assets in the hands of ARC which acquired thereby in payment for PHPI's loan obligation, the same were not primarily held for sale to customers or held for lease in ordinary course of trade or business thereof. As such, their subsequent sale to CIRC is exempt from the value added tax of 10% under Section 109(w) of the Tax Code [which is now renumbered as Section 109(1)(P) of the Tax Code, as amended by R.A. No. 9337 effective July 1, 2005]. Considering that the sales transaction took place prior to the effectivity of R.A. No. 9337 on 1 July 2005, Section 109(w) of the Tax Code and the rulings issued thereto would still apply to this transaction. ( BIR Ruling No. DA277-05 dated June 23, 2005 ) Moreover, Section 109(w) which is renumbered as Section 109(1)(P) of the Tax Code pursuant to R.A. No. 9337 and, there is no inconsistency between the two laws as the sale of real properties not primarily held for sale to customers or held for lease in the ordinary course of trade or business remains exempt from VAT. HEaCcD 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 & Inspection Group