BIR Ruling [DA-431-04]

August 11, 2004 BIR RULING [DA-431-04] 22 (B) DA-240-2001 Filinvest Land, Inc . 173 P. Gomez St. San Juan, Metro Manila Attention: Atty . Andrew James Gerard Dulay Ruiz Tax Counsel Gentlemen : This refers to your letter dated July 27, 2004 requesting for a ruling on the tax consequences of a joint venture executed by and between Filinvest Land, Inc. (FLI for brevity) and Mr. Cecilio T. Gempesaw for the development of "Orange Groove III Project". It appears that FLI is a corporation duly organized and existing under the laws of the Philippines and is engaged in the business of acquiring, developing and selling real estate, including residential subdivisions. On the other hand, Cecilio T. Gempesaw is the absolute and registered owner of a parcel of land covered by Transfer Certificate of Title (TCT) No. T-352857, identified as Lot 1054-A-1 with an area of 36,806 sq.m. and is located at Matina Pangi, Davao City. On July 16, 2003, FLI, as the developer, entered into a Development Agreement with Cecilio T. Gempesaw for the subdivision and horizontal development of the real property aforementioned. The salient portions of the said Development Agreement are as follows: 1. FLI shall undertake the subdivision and horizontal development of the subject real property, to be identified as the "Orange Groove III Project", a residential project, which development shall include improvements and facilities as agreed upon in the Master Plan for Development; 2. FLI shall shoulder all the equipment, engineering, and labor expenses incurred relative to the subdivision and horizontal development of the Orange Groove III Project; 3. For and in consideration of the development obligations and undertakings it will assume, FLI will receive sixty-five percent (65%) of the saleable lots which shall result from said subdivision and horizontal development. The remaining thirty-five percent (35%) shall be retained in ownership by Cecilio T. Gempesaw; 4. Upon determination of the saleable lots which would be assigned respectively to FLI and Cecilio T. Gempesaw, the aforesaid co-venturers will execute a Deed of Allocation to allow the lots pertaining to them to be registered in their respective names. FLI and Cecilio T. Gempesaw entered into a Partition Agreement on July 19, 2004 and a Deed of Allocation was likewise executed on July 22, 2004, whereby the developed saleable lots were allocated between themselves, based on the terms of the Development Agreement previously executed. The said documents adjudicated the saleable lots between the parties, as part of their respective shares in the Orange Groove III Project and to allow the registration of said allocated saleable lots in their respective names. Based on the foregoing, you now request for confirmation that: 1. The Development Agreement between FLI and Cecilio T. Gempesaw, for the subdivision and horizontal development of the Orange Groove III Project, will not give rise to a taxable joint venture as provided under Section 22(B), in relation to Section 27(A), both of the Tax Code of 1997; aSIETH 2. The allocation of saleable lots between FLI and Cecilio T. Gempesaw, 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 to 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 and Deed of Allocation whereby FLI and Cecilio T. Gempesaw 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 1997 Tax Code, nor to any income tax and 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 has contributed. However, it is understood that should FLI and/or the Owner 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 32%, in accordance with Section 24 of the Tax Code of 1997, and consequently to withholding tax as implemented under Revenue Regulations (RR) No. 2-98, as amended. In reply, please be informed as follows: 1. Pursuant to Section 22(B) of the Tax Code of 1997, the term corporation includes partnership, 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. P.D. No. 929 amended the definition of the taxable corporation as not to include joint venture formed for the purpose of undertaking construction projects. The reasons for such amendment are: (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 them to enter into joint ventures to pool their limited resources in undertaking big construction projects; (4) To assist them in achieving competitiveness with foreign contractors, the joint ventures formed by them should not be considered an additional income tax lien. Considering that it is the intention of the legislature to exclude joint venture or consortium formed for the purpose of undertaking construction projects from the definition of taxable corporation, this Office is of the opinion as it hereby holds that the joint venture entered into by and between FLI and Cecilio T. Gempesaw is not subject to the regular corporate income tax under Section 27(A) of the Tax Code of 1997. 2. The allocation of saleable lots of the project between Cecilio T. Gempesaw and FLI, in consideration of their respective contributions, as stipulated in the Development Agreement is not a taxable event and is not subject to income tax or any withholding tax because the allocation is a mere return of capital that each has contributed. ( BIR Ruling No. DA-192-2001 dated October 17, 2001 ) The transfer is also not subject to VAT since under Section 105 of the Tax Code of 1997, any person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, renders services and any person who imports goods shall be subject to VAT imposed in Sections 106 to 108 of the same Tax Code. Hence, by contributing its parcel of land, the Owner, neither sells, barters, exchanges goods, property nor renders services to be subject to VAT. ( BIR Ruling No. DA-240-2001 dated November 16, 2001; BIR Ruling No. DA-115-2001 dated September 5, 2001 ) The Partition Agreement and Deed of Allocation whereby Cecilio T. Gempesaw and FLI will allocate unto each other their share in the saleable area in consideration of their respective contributions is not subject to the documentary stamp tax imposed under Section 196 of the Tax Code of 1997, income tax and any withholding tax because the allocation is made without monetary consideration and is not in connection with a sale. The partition is made merely to segregate the saleable area between the parties, as the return of the capital which each has contributed. However, the acknowledgment to said Partition Agreement and Deed of Allocation is subject to the documentary stamp tax pursuant to Section 188 of the Tax Code of 1997. It is understood however, that upon subsequent disposition by the co-venturers of the areas allocated to them, the gain that may be realized by them from such sale will be subject to the creditable withholding tax under Revenue Regulations (RR) No. 2-98, as amended by RR No. 6-2001 or capital gains tax under Section 24(D)(1), as the case may be. Moreover, such sale shall be subject to the documentary stamp tax imposed under Section 196 of the Tax Code of 1997, based on the gross selling price or fair market value of the properties, whichever is higher. Furthermore, the said sale shall likewise be subject to VAT. 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 will be considered null and void. THaDAE Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service