Nero Realty Corporation

September 11, 2008 BIR RULING [DA-(C-060) 209-08] 27 (D) (5); RR-7-2003; DA(C-020) 100-2008 Nero Realty Corporation No. 3 Anahaw St., Forbes Park Village Makati City Attention: Ma. Carolina G. de Ocampo Director Gentlemen : This refers to your letter dated August 14, 2008 requesting for a ruling on the applicability of the provisions of Section 27 D (5) of the Tax Code of 1997, as amended, on the sale of your company's sole real property. The facts as represented are as follows: NERO REALTY CORPORATION ("NERO", for brevity) is a domestic corporation established under the laws of the Republic of the Philippines on April 20, 1993. Its primary purpose was to acquire by purchase, lease, donation or otherwise, and to own, use, improve, develop, sell, mortgage, exchange, lease, develop and hold for investment or otherwise, real estate of all kinds, whether improve, manage or otherwise dispose of buildings, houses, apartments, and other structures of whatever kind, together with their appurtenances. DcaECT NERO acquired only one real property located in Forbes Park, Makati City covered by Transfer Certificate of Title (TCT) No. 211081 issued by the Registry of Deeds for Makati City as part of its investment supposedly intended for speculation as to the later appreciation of real estate values. NERO, however, had never commenced commercial operation since the time of its incorporation, thereby leaving the above acquired property idle, unproductive and unimproved. The said asset has been classified as "Investment" in the corporation's books and has never been used by NERO in its trade or business, nor subjected to depreciation, nor held primarily for sale or lease to customers in the ordinary course of business, and never been offered for rent or actually leased to anybody since its acquisition. Thus, NERO did not derive any income at all from the said property. SHAcID The Board of Directors of NERO now intend to dissolve the corporation and it has been decided to dispose the said sole idle realty of the corporation converting the same to cash asset for convenience in the distribution of the same in the process of liquidation and also, due to lack of interest of the stockholders in maintaining the same for the reason that it spending a huge amount of money paying real estate tax rather than benefiting from said property. In connection therewith, it is your position that the above property should be classified as a capital asset and the sale thereof is subject to the 6% capital gains tax, based on the following grounds, to wit: AcEIHC 1) NERO, although engaged in the real estate business, has not commenced operation of its business since the time of its incorporation and in the process of dissolving the corporation within the year; 2) It has held the above property primarily for investment; 3) The property had been idle, unproductive and unimproved since the time it was acquired by NERO; and 4) The property never formed part of NERO's inventory of properties for sale as it has never commenced operation. HaTAEc In support of your request, you submitted the following documents: 1. Corresponding Transfer Certificate of Title; 2. Corresponding Tax Declaration; 3. NERO's Articles of Incorporation; cCSHET 4. Comparative Audited Financial Statement for the years 2006 and 2007; and 5. Certification from the Forbes Park Association, Inc. certifying, among others, that the subject realty has never been leased whatsoever. EaHcDS In reply thereto, please be informed that Section 27 (D) (5) of the Tax Code of 1997, as amended, as implemented by Revenue Regulations No. 7-2003, provides "(5) Capital Gains Realized from the Sale, Exchange or Disposition of Lands and/or Buildings. A final tax of six percent (6%) is hereby imposed on the gain presumed to have been realized on the sale, exchange or disposition of lands and/or buildings which are not actually used in the business of a corporation and are treated as capital assets, based on the gross selling price or fair market value as determined in accordance with Section 6(E) of this Code, whichever is higher, of such lands and/or buildings." The character of the real property involved in the 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 1997 Tax Code, the term "capital asset" 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 or lease to customers in the ordinary course of trade or business; or (iii) property used in 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. 27-02 dated July 3, 2002) It is undisputed that the yardstick for determining whether the property is capital asset or ordinary asset is the actual use of the said property. Thus, if the property is not actually used in trade or business of the taxpayer, whether or not connected with his trade or business, or not held for lease or sale to customers, it will be classified as a capital asset. Moreover, if the property is merely held for investment purposes and remains vacant and idle, it is deemed a capital asset. HCIaDT This is fortified in BIR Ruling No. 014-2003 dated October 28, 2003, where this Office ruled that "It is apparent under the foregoing provision that for a property to be considered an ordinary asset it must be actually used in the business of the corporation. Accordingly, on the condition that Wendell Holdings Co., Inc. is not habitually engaged in the real estate business as represented, the property under consideration is a capital asset. The property was neither held primarily for sale to customers nor actually used in the business of Wendell Holdings Co., Inc. . . . The property is not actually used in the business of Wendell Holdings Co., Inc. as it has remained idle and undeveloped. Therefore, the sale of the property under consideration is a sale of a capital asset, not an ordinary asset. As such, the transaction is subject to capital gains tax of 6% under Section 27(D)(5) and not to the creditable withholding tax." DIESHT Considering that NERO had never commenced commercial operations since its incorporation and in fact in the process of dissolving the corporation within the year, and considering further that the subject real property registered under NERO's name, classified as "investment property" in its books, had not been used in business since inception and was never leased out nor held it out for sale in the ordinary course of trade or business, nor included as part of its inventories nor did it derive any income at all, the above subject property is properly treated and classified as a capital asset. The sale by the incorporators of the said property in furtherance of NERO's dissolution and liquidation, therefore, is subject to the 6% capital gains tax imposed under Section 27 (D) (5) of the 1997 Tax Code and to the documentary stamp tax of 1.5% imposed under Section 196 of the same Code, based on the gross selling price or fair market value as determined in accordance with Section 6 (E) of the 1997 Tax Code, whichever is higher. Corollary thereto, Section 14 (B) (p) (1) of Revenue Regulations No. 4-2007, amending Section 4.109-1 (B) (p) (1) of Revenue Regulations No. 16-2005, implementing Republic Act No. 9337 (Reform VAT Law), provides "(p) The following sales of real properties are exempt from VAT, namely: DCATHS (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." cHaCAS The term "primary" is defined as 'first, principal, chief, leading or first in order of time, or development, or intention' (Black's Law Dictionary, Sixth Edition). Thus, to be 'held primarily for sale or lease', the property must be held with the chief intention of being sold or leased. In VAT Ruling No. 012-02, it was held that the sale of properties of MGM Motor Trading, Inc. is not subject to VAT since the properties sold were neither primarily held for sale to customers nor for lease in the ordinary course of its trade or business. Also in BIR Ruling No. DA-665-06, dated November 14, 2006, the BIR has ruled that sale of real properties of Benson Realty & Development Corporation, which are not primarily held for sale to customers in the ordinary course of trade or business nor included as part of its inventory of property for lease, is not subject to the 12% VAT. Likewise, in DA-685-06, dated November 30, 2006, it was reiterated that the sale of real properties of Union Ajinomoto Realty Corporation, not being used in the ordinary course of its trade or business, is not subject to the 12% value-added tax. SCaDAE Accordingly, as the property under consideration was neither primarily held for sale or for lease to customers nor actually used in the ordinary course of trade or business of NERO, the sale of the above-mentioned property is exempt from the 12% value-added tax (VAT) pursuant to Section 109 (P) of the Tax Code of 1997, as amended by Republic Act No. 9337, and implemented by Revenue Regulations No. 16-2005, as amended. This ruling is being issued on the basis of the foregoing facts as represented. If upon investigation, however, it is disclosed that the facts are different, then this ruling shall be considered null and void. HTDcCE Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service