BIR Ruling [DA-529-06]

September 1, 2006 BIR RULING [DA-529-06] Secs. 196 & 198, NIRC; DA-139-97 dtd. Dec. 29, 1997 Allied Banking Corporation Allied Bank Center, 6754 Ayala Avenue corner Legaspi St., Makati City Attention: Helen Y. Ang Asst. Vice President Gentlemen : This refers to your letter dated December 1, 2005, requesting confirmation of your opinion that the return of investment or participation in the form of a real property and/or other types of assets in lieu of cash to a trustor in a common trust fund upon termination of a trust agreement is not subject to capital gains tax, documentary stamp tax and other taxes. It is represented that one of the functions of your Trust Department (trustee) is the administration and management of trust funds, one of which is a common trust fund (CTF); that a common trust fund is a pooled fund representing the collective investments of numerous investors or trustors geared toward the achievement of certain investment objectives; that a trustor becomes a participant by contributing cash to the fund and withdraws the same participation in cash; that the pooled fund is invested in the following investment outlets, to wit: (1) government securities; (2) clean loans; (3) loans secured by real estate mortgage (REM); and (4) bank deposits; that the income earned on these investments is distributed among the CTF participants after being subjected to a 20% withholding tax pursuant to Section 24(B)(1) of the Tax Code of 1997; that in the course of your operation, some loans secured by REMs defaulted resulting in the foreclosure of said REMs; that likewise, several clean loans defaulted and remained uncollected; that attempts to dispose of the real properties acquired through foreclosure, which are now registered in the name of the bank proved futile; that the Bangko Sentral ng Pilipinas (BSP) recently issued BSP Circular No. 447 mandating the phase out of all CTFs effective September 30, 2006; that this would therefore necessitate the liquidation of the CTFs by returning the participation of the trustors; that as part of the exit plan, the bank/trustee has been returning the participation of the trustors in cash; that with regard to the foreclosed real properties and uncollected defaulted loans, the trustee has reached an agreement with the trustors to the effect that instead of receiving their participation in cash, the trustors are amendable to be assigned the real properties of the fund as well as the bad Debts (uncollected loans); that taking into consideration that this is a return of an investment or participation in a trust, you would like to seek a confirmation of your opinion that the return of investment in the form of properties is not taxable in the same manner that the return of the participation of the other trustors in cash are not taxable. In reply, please be informed that inasmuch as the phase-out of the Trust Department was pursuant to a BSP Circular No. 447, as further ordered by the BSP through its Supervision and Examination Department, complying with the Monetary Board's Resolution No. 1279 dated September 9, 2004 which directed the following: (1) The bank shall not launch any new CTF plan; (2) The Trust Department shall stop accepting new investor effective October 1, 2004, likewise shall stop accepting additional placements from existing CTF investors effective April 1, 2005, and (3) the Trust Department shall submit to the BSP not later than January 3, 2005 its action plans to phase out the outstanding CTFs by October 1, 2006 or by October 1, 2009 in the case of tax-exempt CTFs. The trustee has no recourse but to terminate the living trust specifically, the CTF. TEDAHI Since the directive issued by the BSP is mandatory, it will therefore result to total closure or termination of the trustor-trustee relationship between the trustee, Allied Bank Corporation and the participant-investor-trustors. Although this is not the liquidation contemplated under the Corporation Code, in its strict sense, the Trust Department must undergo a kind of liquidation of its assets and liabilities held and assumed by it as Trustee thereof. Since some parts of the Fund were invested in real estate mortgages (REM) and there were no bidders for these REMs, the Fund is tied up in properties. To beat the deadline of September 30, 2006, some participants agreed to accept properties instead of cash as their return of investments. While the act of conveyance is without consideration, this is not however, considered as donation since there is no donative intent on the part of the trustee-transferors, neither it is considered a sale of these assets since the participant-investor-trustors are the beneficial owner of the Trust Fund which own the property/ies. Hence, the conveyance of real properties to each participant-investors, with value equivalent to the participant-investors' participation/interest in the fund is just a mere return of capital or investment. Thus, Section 36 of the Income Tax Regulations provides that income in the broad sense, means all wealth which flows into the taxpayer other than a mere return of capital. Such being the case, any and all amounts which represent a return of contributions to the common trust fund, shall not be subject to income tax, since the same are considered as mere return of capital. However, any and all value of the properties actually distributed to the said participants over and above their contributions/participation in the CTF, shall be taxable to them in the year in which so paid or distributed. Likewise, Section 196 of the Tax Code of 1997 provides, viz: "SEC. 196. Stamp Tax on Deeds of Sale and Conveyance of Real Property . On all conveyances, deeds, instruments, or writings, other than grants, patents or original certificates of adjudication issued by the Government, whereby any land, tenements or other realty sold shall be granted, assigned, transferred or otherwise conveyed to the purchaser, or purchasers, or to any other person or persons designated by such purchaser or purchasers, there shall be collected a documentary stamp tax, at the rates herein below prescribed, based on the consideration contracted to be paid for such realty or on its fair market value determined in accordance with Section 6(E) of this Code, whichever is higher. Provided , That when one of the contracting parties is the Government, the tax herein imposed shall be based on the actual consideration. xxx xxx xxx." Moreover, the conveyance of the assets of the Trustee Bank to the investor-participant-trustors pursuant to the directive issued by the Monetary Board in Resolution No. 1279 dated September 9, 2004 is not subject to documentary stamp tax under the foregoing Section 196 since the Trustee is not selling the assets but is merely returning the investor-trustors' participation in the Trust Fund. The Trustee Bank merely holds the property for and in behalf of the participants-investors who are the beneficial owners of the Trust Fund, such that the conveyance of the properties acquired by the Fund is but a mere return of investment. Accordingly, it is not subject to documentary stamp tax under Section 196 of the same Code. However, the notarial acknowledgment of the said deed is subject to the documentary stamp tax of P15.00 only pursuant to Section 188 of the same Code. (BIR Ruling No. DA-145-2000 dated March 10, 2000) Furthermore, the assignment by the Trustee of uncollected defaulted loans to other investor-participants as return of their participation in the fund is likewise not subject to documentary stamp tax under Section 198, quoted hereunder as follows: "SEC. 198. Stamp Tax on Assignment and Renewals of Certain Instruments . Upon each and every assignment or transfer of any mortgage, lease or policy of insurance, or the renewal or continuance of any agreement, contract, charter, or any evidence of obligation or indebtedness by altering or otherwise, there shall be levied, collected and paid a documentary stamp tax, at the same rate as that imposed on the original instrument. "xxx xxx xxx." The above-quoted Section clearly provides for the imposition of documentary stamp tax on the renewal or continuance of loan agreements and promissory notes. In the instant case, documentary stamp tax shall not be imposed on the assignment by the Trustee Bank of its uncollected defaulted loans to the investors-participants, since the same is not for renewal or continuance. The Trust as a mere agent of the participant-investors in the CTF is not the real creditor of the amount loaned. The participant-investors in the CTF are the real creditors. (BIR Ruling No. 139-97 dated December 29, 1997) The term "assignment or transfer" in Section 198 of the same Code applies only to "mortgage, lease or policy of insurance." 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. HSCATc Very truly yours, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service