BIR Ruling [DA-560-06]

September 19, 2006 BIR RULING [DA-560-06] 27 (D) (5); DA 270-04 Atty. Rommel M. Santiago & Associates Unit 1802 18/F The Peak Condominium L.P. Leviste Street, Salcedo Village Makati City Gentlemen : This refers to your letter dated July 10, 2006 stating that LABAL REALTY DEVELOPMENT, INC. (Labal) is a corporation duly organized and existing under the laws of the Philippines and was incorporated on January 3, 1990; that since Labal's incorporation it has managed several properties not part of its inventory and leased properties that are part of its inventory; that Labal did not undertake any development on its real properties that are part of its inventory; that sometime in October 1990, Labal purchased a vacant property located in Pasig City covered by TCT No. PT-80475; that said property is a vacant and/or idle land which was never used by Labal in its trade or business and is classified as a capital asset in its financial statement; and that said property was never subjected to depreciation, nor included in the stock in trade or inventory, nor held primarily for sale or lease to customers in the ordinary course of its trade or business, and was never leased out since its acquisition. In connection therewith, you now request confirmation of your opinion that the sale of the above-mentioned real property, being a capital asset, is subject to capital gains tax and is not subject to value-added tax (VAT). In reply thereto, 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 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 (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. 027-02 dated July 3, 2002 ) EIcTAD 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 the term is defined in Section 39(A) of the Tax Code of 1997, 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. 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 DA152-04 dated March 31, 2004 citing BIR Ruling No. 27-02 dated July 3, 2002 ) When real property, which is idle and vacant, 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 or improvements, 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 No. DA152-04 dated March 31, 2004 ) Based on your representation, since the property of Labal is 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 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 No. DA217-99 dated April 12, 1999; DAO10-02 dated January 29, 2002 and DA152-04 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 Revenue Regulations No. 7-2003 are properly deemed as capital assets. Considering that the registered property classified in Labal's books as investment in real estate remains vacant and unproductive since the time of acquisition, and does not fall under any of the assets enumerated under Sections 39(A)(1) of the Tax Code of 1997 and Section 2(b) of Revenue Regulations No. 7-2003, the same should be properly classified as capital asset for tax purposes. STcDIE Accordingly, we hereby confirm your opinion that the sale of Labal's real property which is classified as "investment properties" in its books and considered as capital assets is: (1) subject to the capital gains tax of 6% pursuant to Section 27(D)(5) of the Tax Code of 1997; (2) 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 of 1997; and (3) exempt from 10% VAT, pursuant to Section 109(w), supra , as amended by R.A. No. 9337, as implemented by Revenue Regulations No. 16-2005. ( BIR Ruling No. DA270-04 dated May 17, 2004 ) 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.) JAMES H. ROLDAN Assistant Commissioner Legal Service