BIR Ruling [DA-740-06]

December 28, 2006 BIR RULING [DA-740-06] Sec. 22 (B); Sec. 27 (A); DA-470-04 Enjoy Realty & Development Corporation #21 Zone-5, San Felipe 4400 Naga City Attention: Engr. Emeterio L. Aman, CE President and Chairman of the Board Gentlemen : This refers to your letter dated November 20, 2006 requesting confirmation of the various tax consequences arising from a Joint Venture Agreement for construction purposes, between Enjoy Realty & Development Corporation ("ERDC") and the owner of several parcels of land located at San Felipe, Naga City. The facts as represented are as follows: On November 6, 2006 Enjoy Realty and Development Corporation ("Developer"), a corporation duly organized and existing under Philippine laws entered into a Joint Venture Agreement ("JVA") with Mr. Mariano McArnold S. Lim, Sr. ("Landowner") for the development of his 42,513 square meters property located in San Felipe, Naga City, into a residential subdivision ("Project") with a lot sharing of 62% for the Developer and 38% for the Landowner. The above 42,513 square meters property consists of several parcels of land covered by Transfer Certificates of Title (TCT) Nos. 29901, 29902, 29903, 29904, 29905, 32452, 32453, 32454, 32455, 32456, 32457, 32458 and 29928, all issued by the Register of Deeds of Naga City. The salient terms of the JVA are summarized below as follows: 1) In consideration of the receipt by the Landowner of his share of the saleable lots in the project, the Landowner authorizes the Developer to develop the subject property into an exclusive residential subdivision, and for this purpose, authorizes the Developer to enter into and have access to the subject property, and to start the Project and to perform such other works as may be necessary for the completion of its development. 2) In consideration of the receipt by the Developer of its share of the saleable lots in the project, the Developer shall: (1) provide the necessary financing to construct and develop the Project, and (2) provide the necessary expertise and be responsible for the over-all development of the Project. TAIcaD 3) In return for their respective contributions to the Project, the Developer and the Landowner shall partition their respective interests in the Project and receive their respective allocations of the saleable portion as follows: i. LANDOWNER 38% x Saleable Area ii. LAND DEVELOPER 62% x Saleable Area 4) The Landowner and Developer shall select the saleable lots to represent their respective allocation in an alternating manner by block, from the developed subdivision lots in each block. The actual distribution to the Landowner and Developer of the saleable lots received pursuant to their respective allocations shall be effected through the execution of a Memorandum of Sharing which the parties will execute without monetary consideration for the Project. 5) The road lots, electrical facilities, and water systems shall be donated to either the concerned agency/ies or the City of Naga. 6) The open spaces shall be in the name of the Developer and shall be donated in the future to the Homeowners Association and/or the City of Naga as the case may be. 7) After distribution of the saleable lots, the Landowner and Developer shall maintain separate ownership of their allocated saleable lots and may sell, lease, or transfer their respective saleable lots to third parties. From the foregoing, you are requesting confirmation that: 1) The joint venture whereby the Landowner will contribute his parcels of land and the Developer will provide the necessary financing to construct and develop the Project and provide the necessary expertise and be responsible for the over-all development of the Project does not give rise to a taxable joint venture, hence, is not subject to corporate income tax pursuant to Section 22 (B) in relation to Section 27 (A) of the Tax Code, as amended. 2) The allocation and distribution of their respective shares in the Project through a Memorandum of Sharing consisting of saleable lots, in consideration for their respective contributions to the joint venture is not a taxable event, hence, is not subject to the regular corporate income tax under Section 27 (A) of the Tax Code, as amended, nor to the creditable withholding tax under Revenue Regulations 2-98, as amended, nor the value-added tax under Section 106 and the Documentary Stamp Tax ("DST") imposed under Section 196 of the Tax Code, as amended, because the allocation is a mere return of capital that each of the parties has contributed to the Project. 3) In the event, however, that the joint venture partners subsequently sell their respective allocations of the saleable lots, such sale shall be subject to capital gains tax for the Landowner and the regular corporate income tax under Section 27 (A) of the Tax Code for the Developer, and consequently to expanded withholding tax under Revenue Regulations No. 2-98, as amended; to value-added tax, if applicable and to the documentary stamp tax under Section 196, both of the Tax Code of 1997, as amended. CTDacA 4) Consequently, the confirmation of this request will authorize the Revenue District Officer ("RDO") of the revenue district where the parcels of land are located to issue the corresponding Tax Clearance Certificate/Certificate Authorizing Registration with regard to the transfer of the saleable lots to the Landowner and the Developer based on their respective allocations without need of presentation of proof of payment of the creditable withholding tax, documentary stamp tax and value-added tax. 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." (Underscoring 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. From the foregoing, the Joint Venture Agreement entered into by and between the Landowner and the Developer, 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 the Landowner and the Developer, 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 the Developer and/or the Landowner. 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 ). The Developer and the Landowner, 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. The Developer and/or the Landowner 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 the Developer, 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 the Landowner, his subsequent sales of the lots allocated to him will be subject only to capital gains tax (CGT) at 6%, pursuant to Section 24 (D) (1) of the 1997 Tax Code, as amended. EcSaHA Further, when the Developer and the Landowner 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 the Developer and the Landowner, 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 Tax Code, as amended, in the amount of P15.00. This will authorize the Revenue District Officer (RDO) of the revenue district where the properties are located to issue the corresponding Tax Clearance Certificate (TCL) with regard to the transfer of the saleable lots to the Developer and the Landowner based on their respective allocations without need of presentation of proof of payment of the creditable withholding tax, documentary stamp tax and value-added tax. 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