Department of Public Works and Highways (DPWH)

March 10, 2009 BIR RULING [DA-(C-038) 145-09] RA 8974; Sec. 24, 27, 106 & 196; RR 2-98, 6-01, 7-03, 16-05 & 4-07; RMO 41-91; 144-96 Department of Public Works and Highways (DPWH) Infrastructure Right-of-Way and Resettlement Project Management Office (IROW-PMO) Rosario, Pasig City Attention: Mr. Patrick B. Gatan, CESO III Project Director Gentlemen : This refers to your letter dated February 17, 2009 stating that the DPWH-IROW-PMO is tasked to undertake the acquisition of Right-of-Way (ROW) for the Tarlac-Pangasinan-La Union Toll Expressway (TPLEX) Project. As the implementing agency of the TPLEX Project, the DPWH-IROW-PMO, in the exercise of the government's power of eminent domain, will acquire thru expropriation proceedings and/or negotiated sale various affected properties needed as ROW site for public use. As such, there is a forcible taking of affected properties therein. Republic Act 8974, (An Act to Facilitate Acquisition of Right-of-Way, site or location for National Government Infrastructure Projects and for other purposes) and its Implementing Rules and Regulations (IRR) stipulate the following provisions: a) Section 7-h the lot owner shall have sufficient funds to acquire similarly situated lands of approximate areas as those required from them by the government and thereby rehabilitate themselves as early as possible. b) Section 10 the Implementing Agency shall determine the valuation of the improvements and/or structures on the land to be acquired using replacement cost method. From the foregoing, it is your view that the withholding of capital gains tax equivalent to six percent (6%) will deprive the owners of the properties taken of the full gross value of just compensation thereby preventing them to acquire similarly-situated lands and to construct improvements/structures thereon. Thus, in line therewith, you are requesting, in effect, confirmation that the property owners affected by the TPLEX Project, who will eventually transfer the ownership of their respective properties to DPWH, are exempt from the payment of the 6% capital gains tax. In reply, please be informed that this Office on several occasions ruled that involuntary transfers of real properties, including expropriation sale, are subject to applicable taxes, depending on whether the subject properties are classified as capital assets or ordinary assets. Section 24 (D) (1) of the Tax Code of 1997, as amended, provides: "(D) Capital Gains from Sale of Real Property. (1) In General. The provisions of Section 39(B) notwithstanding, a final tax of six percent (6%) based on the gross selling price or current fair market value as determined in accordance with Section 6(E) of this Code, whichever is higher, is hereby imposed upon capital gains presumed to have been realized from the sale, exchange, or other disposition of real property located in the Philippines, classified as capital assets, including pacto de retro sales and other forms of conditional sales, by individuals, including estates and trusts: . . . ." AaITCH Thus, in BIR Ruling No. 144-96 dated December 24, 1996 addressed to Hon. Manuel "Lito" Lapid, which refers to the expropriation by the Provincial Government of Pampanga, with the assistance of the National Government of a number of properties which were adversely affected by the construction of FVR megadike and similar structures to prevent further destruction from lahar and floodwaters especially in the high risk areas in the province, this Office ruled that "expropriation sale is subject to the capital gains tax regardless of whether any gain or profit was derived therefrom since the aforecited law is comprehensive enough to cover not only voluntary sale but also involuntary sale". Both the capital gains and documentary stamp taxes, however, were computed based on the actual consideration or "just compensation" stated in the Deed of Sale, for expropriation done through negotiated sale, or in the document pertaining to the expropriation if taking of property was made through an expropriation proceedings (Revenue Memorandum Order (RMO) No. 41-91). Pursuant to Section 2.57.1 (A) (6) of RR No. 2-98, as amended, capital gains presumed to have been realized from the sale, exchange or other disposition of real property located in the Philippines, classified as capital assets, including pacto de retro sales and other forms of conditional sales, shall be subject to a 6% final withholding tax. As above-mentioned, the foregoing proviso is comprehensive enough to include therewith an expropriation or negotiated sale resulting in the exercise by the government of its power of eminent domain. As such, the DPWH is constituted as a withholding agent to withhold the said 6% final withholding tax. TCEaDI However, if the owner of the affected property of the TPLEX Project is an individual, then he may opt to report the gain realized in the expropriation sale in the manner provided for under Section 24 (A) (1) of the Tax Code, as amended. Under Section 24 (D) (1) of the Tax Code, as amended, an individual taxpayer has the option to report his tax liabilities, if any, on gains realized on dispositions of real property to the government or any of its political subdivisions or agencies either as a transaction subject to capital gains tax of 6% under Section 24 (D) (1) of the Tax Code, as amended, or under Sec. 24 (A) (1) thereof. Accordingly, if said individual taxpayer opt to report the gain realized in the expropriation sale in the manner provided for under Section 24 (A) (1) of the Tax Code, then the 6% tax withheld by the DPWH shall be credited against his tax liabilities determined at the close of the taxable year when the expropriation took place. Moreover, if the property affected by the TPLEX Project is a principal residence of an individual, said individual taxpayer may avail the exemption granted under Section 24 (D) (2) of the Tax Code of 1997, as amended. Pertinent portion of Section 24 (D) (2) of the Tax Code provides as follows: "(2) Exception . The provisions of paragraph (1) of this Subsection to the contrary notwithstanding, capital gains presumed to have been realized from the sale or disposition of their principal residence by natural persons, the proceeds of which is fully utilized in acquiring or constructing a new principal residence within eighteen (18) calendar months from the date of sale or disposition, shall be exempt from the capital gains tax imposed under this Subsection: Provided, That the historical cost or adjusted basis of the real property sold or disposed shall be carried over to the new principal residence built or acquired: Provided, further, That the Commissioner shall have been duly notified by the taxpayer within thirty (30) days from the date of sale or disposition through a prescribed return of his intention to avail of the tax exemption herein mentioned: . . . ." However, considering that the DPWH will have to withhold the 6% tax on the presumed gain realized by the owner of the affected property, then the said owner, upon compliance of all the conditions on the availment of the exemption granted under Section 24 (D) (2) of the Tax Code, as implemented by RR No. 14-2000, as amended, shall have no other recourse but to file a claim for refund of the amount so withheld. On the other hand, if the property affected by the TPLEX Project is owned by a corporation, and the said property is considered as its capital asset, then the capital gains presumed to have been realized by the said corporation from the expropriation or sale via negotiation of its capital asset, shall be subject to the 6% final withholding tax imposed under Section 2.57.1 (G) of RR No. 2-98, as amended. 1 The tax herein imposed shall be based on the amount that will be received by the corporate owner of the affected property as "just compensation", the same being considered as the actual consideration or consideration contracted to be paid in accordance with RMO No. 41-91. If the property affected, however, is considered as an ordinary asset, whether owned by an individual or a corporation, its transfer to DPWH shall be subject to the creditable withholding tax imposed under Section 2.57.2 (J) of RR No. 2-98, as amended by RR No. 6-01. The rate to be imposed therewith shall depend on the value of the property to be expropriated or subjected to a negotiated sale, 2 and to be consistent, the basis of the withholding tax herein imposed shall be the just compensation or the consideration contracted to be paid, in accordance with RMO No. 41-91. Furthermore, the gross value in money derived by an owner of a property, classified as an ordinary asset, and forming part of the assets primarily held for sale to customers or held for lease in the ordinary course of business, subjected to a negotiated sale or expropriation sale with the DPWH, is subject to the 12% VAT imposed under Section 106 (A) of the Tax Code, as amended. Likewise, the transfer of the affected property, classified as an ordinary asset, but not primarily held for sale to customers or held for lease in the ordinary course of trade or business but the same is used in the trade or business of the owner, although involuntary and forced upon only on the owner by virtue of the exercise of the government's power of eminent domain, and therefore it cannot be said to have been conducted in the course of the taxpayer's trade or business, nevertheless, is subject to the value-added tax (VAT) imposed under Section 106 (A) of the Tax Code of 1997, as amended. Section 4.109.1 (p) of RR No. 16-05, as amended by RR No. 4-07, provides, viz. : "(p) The following sales of real properties are exempt from VAT, namely: (1) Sale of real properties not primarily held for sale to customers or held for lease in the ordinary course of trade or business. However, even if the real property is not primarily held for sale to customers or held for lease in the ordinary course of trade or business but the same is used in the trade or business of the seller, the sale thereof shall be subject to VAT being a transaction incidental to the taxpayer's main business." Finally, this ruling shall serve as sufficient basis for the BIR to issue the Certificates Authorizing Registration and Tax Clearance Certificates, for all the property transfers effected in connection with the implementation of the TPLEX Project, provided that the concerned parties submit the respective documents of acquisitions effecting the said transfers to the concerned RDO for evaluation and for the proper assessment of taxes pursuant to the foregoing. Please be guided accordingly. Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. RR No. 7-2003 provides for the guidelines in the classification of assets, whether capital or ordinary. 2. Sec. 3 of RR 6-01, amending Sec. 2.57.2 (J) of RR 2-98, provides the applicable rate on sales of ordinary assets.