BIR Ruling [DA-505-05]

December 16, 2005 BIR RULING [DA-505-05] Sec. 22 (B); DA-470-04 Filinvest Alabang, Inc . Administration Building, FILINVEST Corporate City Alabang-Zapote Road, Alabang, Muntinlupa City Attention: Atty. Andrew James Gerard Dulay Ruiz Tax Counsel Gentlemen : This refers to your letter dated April 20, 2005 requesting confirmation of the various tax consequences arising from the development and construction of the 2301 Civic Place Condominium Project. The facts as represented are as follows: Filinvest Alabang, Inc. ("FAI" for brevity) is a corporation duly organized and existing under the laws of the Republic of the Philippines, and is engaged in the business of acquiring, developing and selling real estate, including commercial lots, residential condominiums and subdivisions. FAI is currently assisting in the development and construction of a twelve (12) floor commercial retail/Small Office Home Office condominium known as "2301 Civic Place" ("Project" for brevity).The project is located on a parcel of land owned by FAI at the Filinvest Corporate City, Alabang, Muntinlupa City. The development is covered by a Project Investment Agreement ("Agreement" for brevity),with the following salient provisions: 1. Investors of the project commit to invest by way of a capital contribution for the financing and/or funding of the Project. Such investment is in an amount equivalent to a percentage share in the total cost of development of the Project. The share of each investor will be computed based on the estimate of the actual cost of the floor area of a particular condominium unit, subject to any cost adjustment arising from changes in the actual cost and/or the floor area. In return for their respective capital contribution, each investor will receive the corresponding Condominium Certificate of Title (CCT) for the condominium unit and its appurtenant parking space; 2. The investor will open a Trust Account with a Trustee-Bank where his capital contribution and any additional contributions will be held, managed and disbursed. The Trustee-Bank shall hold in trust the capital contribution and title to the Project. If the investor is a corporation, it may execute in lieu of the Trust Agreement, an Investment Management Agreement. Prior to the construction of the Project, the investor shall deposit a certain percent his required capital contribution to the Trust Account. He will then deposit the remaining balance through internally generated funds and/or by availing of a construction credit line during the construction period. Upon completion of the Project, any excess funds or properties of the Trust Account, including ownership over the condominium units and its appurtenant parking spaces, as applicable, shall be released to the investors; DIcSHE 3. The Trustee-Bank shall review and approve all disbursements for the Project and for the account of the investor, and shall hold custody of any and all documents relating thereto. Upon approval of each disbursement, the Trustee-Bank shall debit from the Trust Account of the investor the pro-rate share of the investor in such disbursement and issue a check payable directly to the approved payee thereof; 4. The parcel of land where the Project will be constructed on, will be transferred by FAI to the Trustee-Bank, either by way of a sale in case the investors collectively exercise the option to purchase such parcel of land, or by way of assignment in case FAI exercises the option to exchange it for an equivalent number of condominium units and parking spaces. Subsequently, the Trustee-Bank will convey the ownership of the parcel of land to a condominium corporation; 5. FAI will be the Project Manager of the Project. It will be authorized to negotiate and execute contracts as may be required for the development of the Project with architects, construction management engineers, general building contractors and other parties deemed fit and necessary by FAI for the construction of the Project, to do the marketing and advertising of the Project concept to secure sufficient number of investors, to secure the necessary permits and licenses that may be required and to do other acts necessary in the expeditious development of the Project. In return, FAI will receive a management fee; 6. Prior to the completion of the Project, an investor can assign his participation, rights and proportionate interest in the Project, provided it secures the written consent of FAI; and 7. Upon completion of the Project, the investors, including FAI, will form a condominium corporation for the purpose of holding title to, manage and maintain the land and the common areas of the Project, pursuant to the provisions of the Condominium Act. Subsequently, the parcel of land and the common areas will be conveyed by the Trustee-Bank in behalf of the investors to the condominium corporation. Based on the above representations, you are requesting confirmation of your opinions as follows: a) The Agreement will not give rise to a separate 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; b) The assignment of right of an investor with respect to the Agreement is not subject to the Capital Gains Tax (CGT) under Sections 24(D)(1) or 27(D)(5) of the NIRC as amended, or income tax (and subsequently) creditable withholding tax under Sections 24(A)(1) and 27(A) of the NIRC, as amended, Value-Added Tax (VAT) under Section 106 of the NIRC, as amended, and Documentary Stamp Tax (DST) under Section 196 of the NIRC, as amended; c) In the event that FAI exercises its option to transfer the parcel of land subject to the Project to the Trustee-Bank as its capital contribution to the joint venture, said transfer is not subject to income tax and subsequently creditable withholding tax under Section 27(A) of the NIRC, as amended, and/or CGT under Section 27(D)(5) of the NIRC, as amended, and the VAT under Section 106 of the NIRC, as amended, and DST under Section 196 of the NIRC, as amended; d) The transfer of the ownership of the condominium unit and parking slot by the Trustee-Bank to an investor, as a return of his capital contribution; is not subject to income tax and subsequently creditable withholding tax under Sections 24(A)(1) and 27(A) of the NIRC, as amended, VAT under Section 106 of the NIRC, as amended, and DST under Section 196 of the NIRC, as amended; e) Upon completion of the project, the conveyance of the land and common areas in the condominium without any monetary consideration to a condominium corporation shall not be subject to income tax and subsequently creditable withholding tax under Section 27(A) of the NIRC, as amended, the VAT under Section 106 of the NIRC, as amended, and DST under Section 196 of the NIRC, as amended. CSIcTa In reply, please be informed that your above opinions are confirmed as follows: 1) Non-taxable Joint Venture 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) 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. Based on the abovementioned provision of the 1997 Tax Code, as amended, the Agreement entered into by and between FAI and the investors, therefore, shall not give rise to a taxable joint venture. Consequently, it 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 ). 2) Assignment of Rights by Investor The assignment of rights by an investor does not equate to a sale. This is due to the fact that in assignment of rights, the assignee merely steps into the shoes of the assignor without acquiring a better right than what the assignor had in the property to which the rights assigned pertains. A deed of assignment of rights in real property is not a deed of sale of real property itself but the rights pertaining to such property ( BIR Ruling No. DA-252-96 dated July 18, 1996 ). Since no sale is involved, there is no basis for the imposition of withholding tax under Revenue Regulations (RR) No. 2-98, as amended ( BIR Ruling No. 031-01, dated March 15, 2001 ).In the same vein, there is no basis for the imposition of the CGT or the VAT. Further, the assignment of rights, not being a sale of real property, is not subject to DST under Section 196 of the 1997 Tax Code, as amended. Said section refers to the sale of real property, which is obviously not the case in this instance. In this regard, no DST can be imposed on said assignment ( BIR Ruling No. DA-240-01, dated November 16, 2001 ). 3) Option to Transfer Land to Trustee-Bank In case FAI exercises its option to transfer the ownership of the parcel of land to the Trustee-Bank as its capital contribution, such conveyance is not a taxable event that will give rise to the imposition of income tax, and consequently, the withholding tax. Likewise, the said conveyance is not subject to VAT and DST. What is contemplated as subject to withholding tax under RR No. 2-98, as amended, is the sale of real property, and not a capital contribution in the form of said real property. Without a sale having been effected, no taxable event has taken place ( BIR Ruling No. DA-664-04, dated December 23, 2004 ). Moreover, FAI, should it transfer said property to the Trustee-Bank, will neither sell, barter, or exchange goods or property, or render service thereby. In effect, the activity is not within the purview of Sections 106 to 108 of the 1997 Tax Code, as amended, which would otherwise subject said transaction to the VAT. The transfer being in the nature of a capital contribution, the same cannot be subject to VAT ( BIR Ruling No. DA-471-04, dated September 7, 2004 ). TADcCS Relative thereto, the above transfer of real property, not being a sale, is not subject to DST under Section 196 of the 1997 Tax Code, as amended. Said section refers to DST due on all conveyances, deeds, instruments or writings whereby any land, tenement, or realty is sold, granted, assigned, transferred or conveyed. This provision, however, is qualified by Section 185 of RR No. 26, otherwise known as the Revised Documentary Stamp Tax Regulations, as amended. In particular, Section 185 of said regulations provides as follows: "Section 185. Conveyances without consideration. Conveyances of realty, not in connection with a sale, to trustees or other persons without consideration are not taxable ." (emphasis ours) The option of FAI to transfer the land to the Trustee-Bank shall be as a capital contribution to the project, and shall be effected without consideration. There being no consideration involved in said transfer, no DST can be imposed thereon ( BIR Ruling No. DA-240-01, dated November 16, 2001 ). 4) Transfer of Condominium Unit The transfer of the ownership of the condominium units and parking slots (as applicable) by the Trustee-Bank to an investor, as a return of his capital contribution, is not subject to income tax under Sections 24(A)(1) and 27(A) of the 1997 Tax Code, as amended, and consequently, to the creditable withholding tax imposed under RR No. 2-98, as amended. Likewise, it is not subject to VAT under Section 106 of the same Code, and DST under Section 196 thereof. The transfer of ownership of condominium units to the investors is done effectively in consideration of their respective contributions, and is without consideration. As has been ruled by this Office 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 ).The investors, having contributed to the development of the aforementioned Project, did not realize any income upon the allocation of the saleable lots. Hence, the said transfer is not subject to income tax, and consequently, to withholding tax ( BIR Ruling No. DA-240-01 dated November 16, 2001 ). Further, as a return of capital, the transfer of ownership is not a sale, barter or exchange of real property done in the ordinary course of business. As such, said transfer does not fall within the purview of Sections 106 to 108 of the 1997 Tax Code, as amended, which would otherwise subject said transfer to the VAT. The transfer being in the nature of a return of capital, the same cannot be subject to the VAT. Should, however, the investor effect a sale of his condominium unit after the ownership has been transferred to him, the said sale shall be subject to the CGT under Section 24(D) of the 1997 Tax Code, as amended (for individuals), CGT under Section 27(D)(5) or income tax, and consequently, withholding tax under Section 27(A) of the 1997 Tax Code, as amended, in relation to RR No. 2-98, as amended, for corporations. Further, the sale by the investors engaged in realty business of said condominium units would likewise be subject to VAT, depending on the selling price of said condominium unit in relation to RR No. 7-95, as amended. 1 With regard the DST and as previously discussed, 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." As such, the transfers are not subject to the DST imposed under Section 196 of the 1997 Tax Code, as amended, considering that the transfer is made without monetary consideration and is not in connection with a sale. However, the notarial acknowledgments to the transfers shall be subject to the DST pursuant to Section 188 of the 1997 Tax Code, as amended, in the amount of P15.00. However, should the investor effect a sale of his condominium unit after the ownership has been transferred to him, the said sale shall be subject to DST imposed under Section 196 of the 1997 Tax Code, as amended, based on the gross selling price or fair market value of the properties whichever is higher. 5) Transfer of Land and Common Areas to the Condominium Corporation As a general rule, a domestic corporation is subject to income tax at a rate of thirty-two percent (32%) on its taxable income derived during the taxable year from all sources within and without the Philippines ( Section 27[A], 1997 Tax Code, as amended ). Various Revenue Regulations (RR), as issued by this Office, likewise provide for the payments to domestic corporations which are subject to either creditable withholding tax or final withholding tax. The type of withholding tax (whether creditable or final) and the withholding tax rate depends on the type of transaction and the nature of the buyer and seller. cDAEIH The condominium corporation shall be a non-stock, non-profit corporation organized under the provisions of Republic Act (RA) No. 4726, as amended, otherwise known as the Condominium Act. The said condominium corporation shall hold title to the common areas in the Project and to the lot on which the project is located. The transfer shall be without consideration. In this regard, the transfer of land and common areas to the condominium corporation from the Trustee-Bank upon completion of the Project shall not be subject to income tax under Section 27(A) of the 1997 Tax Code, as amended, and consequently, to the creditable withholding tax imposed under RR No. 2-98, as amended. 2 Likewise, the said transfer is not subject to VAT under Section 106 of the 1997 Tax Code, as amended, and the DST under Section 196 of the same Code.This is because no consideration is made for the transfer, and hence no income will be generated by the transfer. There is no gross selling price, or total amount of consideration paid to the Trustee-Bank for the transfer. The transfer of the land and common areas to the condominium corporation is pursuant to RA No. 4726, as amended. The transfer having been made pursuant to the provisions of RA No. 4726, as amended, there is no gain, presumed or actual, which the Trustee-Bank will realize from said transfer. However, the notarial acknowledgment to the transfer is subject to the DST of P15.00 pursuant to Section 188 of the 1997 Tax Code, as amended. 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, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. RR No. 16-2005. 2. RR No. 6-2001.