BIR Ruling [DA-690-06]

December 7, 2006 BIR RULING [DA-690-06] Sec. 22 (B); DA-470-04 Filinvest Land, Inc . 173 P. Gomez Street San Juan, Metro Manila Attention: Atty. Andrew James Gerard Dulay Ruiz Tax Counsel Gentlemen : This refers to your letter dated September 14, 2006 requesting confirmation of the various tax consequences arising from a Joint Venture Agreement for construction purposes, between Filinvest Land, Inc. and the owner of several parcels of land located at Barrio Dumoy, Bago Aplaya, Talomo District, Davao City. The facts as represented are as follows: Filinvest Land, Inc. ("FLI" for brevity) is a corporation duly organized and existing under the laws of the Republic of the Philippines, engaged in the business of acquiring, developing and selling real estate, including residential subdivisions. On the other hand, Ocean Five Beach Club, Inc. ("Ocean Five" for brevity) is the absolute and registered owner of several parcels of land, covered by Transfer Certificates of Titles (TCT) Nos. 356281 and 356283. Said real property, with an aggregate area of 63,981 square meters (m 2 ), is located in Barrio Dumoy, Bago Aplaya, Talomo District, Davao City. On January 7, 2005, FLI, as the developer, entered into a Development Agreement with Ocean Five for the subdivision and horizontal development of the real property abovementioned, to be known as Villa Mercedita residential subdivision project. The salient portions of the Development Agreement are as follows: 1. FLI shall undertake the subdivision and horizontal development of the subject real property, which development shall include improvements and facilities as agreed upon; 2. FLI shall shoulder all the equipment, engineering, materials, supplies and labor expenses incurred relative to the subdivision and horizontal development of the said real property; 3. For and in consideration of the development obligations and undertakings it will assume, FLI will receive Sixty percent (60%) of the saleable lots which shall result from said subdivision and horizontal development. The remaining Forty percent (40%) shall be retained in ownership by the Owners; 4. Upon approval of the subdivision plan by the proper government agencies, the parties shall allocate the saleable subdivision lots in accordance with their aforesaid sharing, in the most equitable and practical way possible, with due consideration and regard to the terrain, location, and projected values of such subdivision lots. IcEaST On September 15, 2006, both FLI and Ocean Five entered into a Partition Agreement, and a Deed of Lot Allocation, both documents essentially adjudicating amongst themselves certain portions of the abovementioned properties so developed, as part of their respective shares under the Development Agreement. From the foregoing, you are requesting confirmation that: 1. The Development Agreement between FLI and Ocean Five, for the subdivision and horizontal development of the abovementioned real property located in Barrio Dumoy, Bago Aplaya, Talomo District, Davao City, into a residential subdivision, will not give rise to a 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; 2. The allocation of saleable lots between FLI and Ocean Five 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 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 the Deed of Lot Allocation whereby FLI and Ocean Five have 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 NIRC, as amended, nor to any income tax, and consequently 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 contributed. However, it is understood that should FLI and/or Ocean Five 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 35%, in accordance with Section 27(A) of the NIRC, as amended, and consequently to withholding tax as implemented under Revenue Regulations (RR) No. 2-98, as amended. In reply, please be informed as follows: 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 Tax Code, 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. DCATHS From the foregoing, the Development Agreement entered into by and between FLI and Ocean Five, therefore, is not subject to the income tax imposed under Section 27(A) of the Tax Code of 1997, as amended. ( BIR Ruling No. DA-470-04, dated September 7, 2004 ) On the issue of the allocation of the saleable lots between FLI and Ocean Five, it is the opinion of this Office that said allocation, which is done effectively in consideration of their respective contributions, does not constitute a taxable event, as no income is actually realized by either FLI and/or Ocean Five. The Partition Agreement will be executed without consideration, and is not in connection with any sale between the said parties. As has been ruled by the BIR 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 ). FLI and Ocean Five, both having contributed to the development of the aforementioned real property, did not realize any income upon the allocation of the saleable lots. Hence, the allocation of lots which will arise from the execution of a Partition Agreement is not subject to income tax, and consequently, to withholding tax. The said allocation, likewise, is not subject to VAT. FLI and/or Ocean Five will only realize income upon their respective sales of the saleable lots allocated to each of them. In this regard, said sales, on the part of FLI, would be subject to regular (corporate) income tax at 35%, in accordance with Section 27(A) of the Tax Code, as amended, and consequently to withholding tax as implemented under Revenue Regulations (RR) No. 2-98, as amended. Said sales, likewise, are subject to VAT. On the part of Ocean Five, the tax consequence on the subsequent sales of the lots allocated to it would depend on its classification of the lots it received. Thus, if the allocated lots are treated or booked as ordinary assets, the subsequent disposition thereof is subject to the regular corporate income tax at 35% imposed under Section 27(A) of the Code, and consequently, to the withholding tax imposed under RR No. 2-98, as amended by RR 6-2001. However, if said allocated lots are recorded as capital assets, the sale thereof is subject to the capital gains tax (CGT) at 6%, pursuant to Section 27(D)(5) of the 1997 Tax Code, as amended. Further, when FLI and Ocean Five will allocate unto each other their share in the saleable lots in consideration of their respective contributions, the document for said allocation shall not be subject to the DST imposed under Section 196 of the 1997 Tax Code, as amended, considering that the allocation is made without monetary consideration and is not in connection with a sale. In this regard, 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." Accordingly, since the planned Partition Agreement to be executed shall be entered into without consideration, and shall not be in connection with a sale between FLI and Ocean Five, no DST is due and collectible on said future Partition Agreement. However, the notarial acknowledgment to said Partition Agreement shall be subject to the DST pursuant to Section 188 of the NIRC, as amended, in the amount of P15.00. DcCHTa 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