BIR Ruling [DA-572-06]

September 22, 2006 BIR RULING [DA-572-06] Sec. 22 (B); DA-470-04 Angara Abello Concepcion Regala & Cruz ACCRA Building, 122 Gamboa Street Legaspi Village, Makati City Attention: Attys. Victor P. Lazatin, Ruby Rose J. Yusi & Rochelle Magnolia F. Tamin Gentlemen : This refers to your letters dated September 14, 2005 and January 20, 2006 requesting confirmation of the various tax consequences arising from the development and construction agreement by and between Araneta Center, Inc. ("ACI") and Megaworld Corporation ("Megaworld"). The facts as represented are as follows: ACI is the registered owner of several parcels of land with a total area of 42,136.15 square meters, more or less, located within Araneta Commercial Complex, Cubao, Quezon City, and presently included and/or covered by Transfer Certificate of Title Nos. RT 1698 (134243), RT 1699, RT 1696 (288360), RT 1700 (134242), RT 108866 (134244), RT 46720 (87012), RT 41435 (29904), and N 265070 issued by the Registry of Deeds for Quezon City (collectively, the "Properties"), which are composed of the following: (a) The vacant lot originally slated for the Manhattan Mall Project located along Gen. Malvar Avenue with an area of 11,257.00 square meters, more or less; (b) That presently occupied by the Aurora Apartment Row located along Gen. Malvar Avenue with an area of 4,920.30 square meters, more or less; (c) A portion of the area presently leased by Rustan Commercial Corporation, and located along Gen. Romulo Avenue with an area of 13,558.456 square meters, more or less; and (d) That presently occupied by the Auto Centro and Bus Terminal located along Gen Romulo Avenue with an area of 12,400.40 square meters, more or less. SEHTAC Megaworld, on the other hand, a developer of medium and high-rise condominium projects, will re-develop the Properties and convert the same into mixed residential and commercial/retail condominium projects. On August 3, 2005, ACI and Megaworld executed a Memorandum of Agreement ("MOA") whereby they agree to form an incorporated joint venture for the purpose of developing the Properties. The capital contributions of the parties are as follows: (a) Megaworld will provide financing, planning, designing, marketing, construction, monitoring and supervision of all the facets of the work, which shall consist of four (4) independent projects to be covered by separate development agreements; and (b) ACI will contribute the Properties for each project. After the re-development of the Properties and in return for their investment, the parties will receive the following: A. ACI 1. One Hundred Percent (100%) of all the commercial/retail condominium units in each of the projects, consisting of undivided and bare finished commercial/retail spaces located in the ground floors of each condominium tower with a minimum total area of 20,080 square meters; 2. Fifteen Percent (15%) of the residential condominium units and the corresponding allocated parking slots in Projects 1, 2, and 4; and 3. Seventeen Percent (17%) of the residential condominium units and the corresponding allocated parking slots in Project 3. B. Megaworld 1. Eighty-Five Percent. (85%) of the residential condominium units and the corresponding allocated parking slots in Projects 1, 2, and 4; and 2. Eighty-Three Percent (83%) of the residential condominium units and the corresponding allocated parking slots in Project 3. Based on the above representations, you are requesting confirmation of your opinions as follows: a) The terms of the MOA between ACI and Megaworld do 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; AICEDc b) The allocations of condominium units to ACI and Megaworld in the various projects pursuant to the MOA, and the execution of the respective deeds of partition to implement such allocations, are not taxable events and therefore are not subject to income tax, expanded withholding tax, value-added tax and documentary stamp tax. 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 terms of the Memorandum of Agreement entered into by and between ACI and Megaworld, therefore, do 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) Allocations of Condominium Units The distribution of the condominium units and parking slots to the joint venture partners, as a return of their capital contributions, is not 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. The distribution of the condominium units and parking slots to the co-venturers 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 co-venturers, having contributed to the development of the aforementioned Projects, did not realize any income upon the allocation of the saleable units and parking slots. 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 distribution of the condominium units and parking slots 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. HCaDIS Should, however, the co-venturers effect a sale of their respective shares in the above-mentioned Projects after the ownership of the condominium units and parking slots allocated to them has been transferred in their respective names, the said sale shall be subject to the income tax imposed under Section 27(A) of the 1997 Tax Code, as amended, and consequently, to the withholding tax in relation to RR No. 2-98, as amended. Likewise, the sale of the condominium units and parking slots by the co-venturers to third party is subject to the 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. Further, the sale by the co-venturers engaged in realty business of said condominium units and parking slots would likewise be subject to VAT, depending on the selling price of said realties in relation to RR No. 16-2005, implementing Republic Act No. 9337. With regard the DST, 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 distribution or transfer of the condominium units and parking slots to the co-venturers is not subject to the DST imposed under Section 196 of the 1997 Tax Code, as amended, considering that the said distribution or transfer is made without any monetary consideration and is not in connection with a sale. However, the notarial acknowledgment to the transfer shall be subject to the DST pursuant to Section 188 of the 1997 Tax Code, as amended, in the amount of P15.00. 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