Salvador Guevara & Associates

September 19, 2008 BIR RULING [DA-(C-073) 238-08] RR 2-98; 6-2001 & 17-2003; DA-335-06 Salvador Guevara & Associates 815-816, Tower One & Exchange Plaza Ayala Triangle, Ayala Avenue Makati City Attention: Atty. Euney Marie J. Mata-Perez Gentlemen : This refers to your two letters both dated October 11, 2006 requesting on behalf of your client, United Coconut Planters Bank (hereinafter, the "Bank"), for confirmation of your opinion on the following: 1. That the term "consideration" for purposes of determining the gross selling price which shall be the tax base for any creditable withholding tax (CWT) excludes any interest component of the purchase price; 2. That in determining whether the sale by the Bank of real properties to various buyers, whether or not such buyers are engaged in trade or business, qualifies as a sale on the installment basis or a sale on a "cash basis" or a "deferred-payment sale not on the installment basis", the term "initial payments" shall exclude any interest paid on amortizations or installment payments made on the initial year. 3. That no CWT obligation arises upon the Bank's receipt of refundable reservation fees. The withholding of the CWT should be reckoned from the time the first installment is received on or after the sale is closed, and a Contract to Sell is executed; and 4. That no surcharges, interest, and penalties should be due when a sale's "initial payments" exceed 25% of the selling price because of an unanticipated prepayment, provided the Bank immediately causes the remittance of the CWT reckoned from the time the prepayment is made. CEHcSI The facts as represented are as follows: The Bank enters into sales transactions involving its real properties forming part of its inventory of ROPOA (real and other properties owned or acquired). ROPOA represents real and other properties, other than used for banking purposes or held in the investment portfolio, acquired by the Bank in settlement of loans and/or other reasons. Most of such properties of the Bank were acquired through foreclosure of collaterals of clients/borrowers who were unable to pay their accounts with the Bank. They are included in the Bank's inventory of properties for sale to the public in the ordinary course of banking operations in order to recover the amounts receivable from the Bank's defaulting client/borrower. These ROPOA sales transactions are covered by Contracts to Sell, wherein the buyers make an initial downpayment and pay the balance, plus interest, in equal monthly amortizations. In some instances, before a Contract to Sell is executed, the buyers would pay a reservation fee, to reserve the property for a certain period. These fees are initially booked by the Bank as liabilities since such fees would be refundable to the buyers, if the purchase would not materialize within the period agreed. In these sales transactions, the amount of consideration stated in the Contract to Sell is exclusive of interest. However, the buyers are liable to interest on each installment payment. For proper tax administration and to ensure that the appropriate CWT on the sales transactions are deducted, withheld, and remitted to the government at the times prescribed by existing regulations, the Bank has made it a policy to directly cause the remittance to the BIR of the CWT on these sales transactions. The Bank then has the following practice in remitting the CWT on its ROPOA sales: If the buyers are individuals not engaged in trade or business, and the sale qualifies as a "cash basis" sale, the Bank causes the withholding and remittance of the CWT based on the gross selling price or fair market value of the property, reckoned from the payment of the first installment; If the buyers are individuals not engaged in trade or business, and the sale qualifies as an "installment sale", the Bank causes the withholding of the CWT from the last installment; If the buyers are engaged in trade or business (whether corporations or individuals), and the transaction qualifies as a "cash basis" sale, the Bank causes the withholding of the CWT based on the gross selling price or fair market value of the property, reckoned from the payment of the first installment; If the buyers are engaged in trade or business (whether corporations or individuals), and the sale qualifies as an "installment sale", the Bank causes the withholding of the CWT based on the gross selling price or fair market value of the property, reckoned from the payment of the first installment [or execution of Contract to Sell]. The Bank does not defer the collection of the CWT based on each installment, as allowed under Section 2.57.2 (J) of Revenue Regulations No. 2-98 (RR 2-98), as amended. The Bank has always encountered problems or differences in opinion with various BIR officials in determining when a sale is an "installment sale" or on "cash basis" or "deferred payment sale not on the installment plan", under existing rules and regulations. Under Section 2.57.2 (J) of RR 2-98, as amended, where the initial payments do not exceed 25% of the selling price, the sale will be treated as a sale of property on the installment plan. On the other hand, where the initial payments exceed 25% of the selling price, the sale is on a "cash basis" or is a "deferred-payment sale not on the installment plan". There are also instances when based on the Contract to Sell entered into by the Bank with individuals not engaged in trade or business, the "initial payments" for the first year would be calculated not to exceed 25% of the selling price, and as such, no CWT is withheld on the first installment. However, subsequently, the buyers would make a prepayment during the initial year, and as a result of such prepayment, the "initial payments" would in fact exceed 25% of the selling price. The Bank would then immediately cause the withholding and remittance of the CWT, but in many instances, the BIR would slap penalties and surcharges for alleged "late" remittance of CWT. It is the Bank's position that in the "initial payments" for the purpose of the calculation referred to above, any interest component of any amortization or installment of the selling price also made on the first year of sale shall be excluded. In reply, please be informed as follows: (1) "Consideration" as Tax Base for Purposes of Creditable Withholding Tax Excludes Any Interest Component of the Purchase Price Section 2.57.2 (J) of RR No. 2-98, as amended by RR Nos. 6-2001 and 17-2003, provides the rules on the tax treatment of the sale, exchange or transfer of real property classified as ordinary assets, viz. : TaCDIc "(J) Gross selling price or total amount of consideration or its equivalent paid to the seller/owner for the sale, exchange, or transfer of real property classified as ordinary asset. A creditable withholding tax based on the gross selling price/total amount of consideration or the fair market value determined in accordance with Sec. 6(E) of the Code, whichever is higher, paid to the seller/owner for the sale, transfer or exchange of real property, other than capital asset, shall be imposed upon the withholding agent/buyer, in accordance with the following schedule A. Where the seller/transferor is exempt from creditable withholding tax in accordance with Sec. 2.57.5 of these regulations Exempt B. Upon the following values of real property, where the seller/transferor is habitually engaged in the real estate business: xxx xxx xxx C. Where the seller/transferor is not habitually engaged in the real estate business 6.0% Registration with the HLURB or HUDCC shall be sufficient for a seller/transferor to be considered as habitually engaged in the real estate business. If the seller/transferor is not registered with HLURB or HUDCC, he/it may prove that he/it is engaged in the real estate business by offering other satisfactory evidence (for example, he/it consummated during the preceding year at least six taxable real estate transactions, regardless of amount). Notwithstanding the foregoing, for purposes of these Regulations, banks shall NOT be considered as habitually engaged in the real estate business. Gross selling price shall mean the consideration stated in the sales document or the fair market value determined in accordance with Section 6 (E) of the Code, as amended, whichever is higher. In an exchange, the fair market value of the property received in exchange, shall be considered as the consideration. If the buyer is an individual not engaged in trade or business, the following rules shall apply: (i) If the sale is a sale of property on the installment plan (that is, payments in the year of sale do not exceed 25% of the selling price), no withholding of tax is required to be made on the periodic installment payments. In such a case, the applicable rate of tax based on the gross selling price or fair market value of the property at the time of the execution of the contract to sell, whichever is higher, shall be withheld on the last installment or installments immediately prior to such last installment, if the last installment is not sufficient to cover the tax due, to be paid to the seller until the tax is fully paid. CSHDTE (ii) If, on the other hand, the sale is on a "cash basis" or is a "deferred-payment sale not on the installment plan" (that is, payments in the year of sale exceed 25% of the selling price), the buyer shall withhold the tax based on the gross selling price or fair market value of the property, whichever is higher, on the first installment. However, if the buyer is engaged in trade or business, whether a corporation or otherwise, these rules shall apply: (i) If the sale is a sale of property on the installment plan (that is, payments in the year of sale do not exceed 25% of the selling price), the tax shall be deducted and withheld by the buyer on every installment which tax shall be based on the ratio of actual collection of the consideration against the agreed consideration appearing in the Contract to Sell applied to the gross selling price or fair market value of the property at the time of the execution of the Contract to Sell, whichever is higher. The term 'consideration' refers to the selling price exclusive of interest. Interest earned as an incident of installment payment, if any, shall be subject to the ordinary income tax rate. (ii) If, on the other hand, the sale is on a "cash basis" or is a "deferred-payment sale not on the installment plan" (that is, payments in the year of sale exceed 25% of the selling price), the buyer shall withhold the tax based on the gross selling price or fair market value of the property, whichever is higher, on the first installment. xxx xxx xxx (Emphasis supplied) The Regulations provide that the basis for computing the CWT due on sale, exchange, or transfer of real property classified as ordinary asset is the gross selling price or total amount of consideration or its equivalent paid to the seller/owner. The term "gross selling price" is defined in the Regulations as "the consideration stated in the sales document or the fair market value determined in accordance with Section 6 (E) 1 of the Code, as amended, whichever is higher". The term "consideration" is in turn defined, also in the same Regulations, as "selling price exclusive of interest". It is clear from the foregoing that in computing the tax base of the CWT on the sale, exchange, or transfer of real property classified as ordinary asset, the consideration as stated in the sales document shall be exclusive of interest. IaEScC Thus, in computing the CWT, the tax base shall in all instances, as far as the sales transactions of the Bank are concerned, be exclusive of interest considering that the tax is based on the gross selling price, which as defined is the highest between (1) the consideration, which by definition is exclusive of interest; and (2) the fair market value as determined under Section 6 (E) of the Tax Code, which, in all likelihood, is also exclusive of interest. The foregoing interpretation has been previously adopted by this office in BIR Ruling No. DA-335-2006 dated May 22, 2006, that for purposes of determining whether a sale transaction is on a "cash basis" or on an "installment basis" the actual selling price of the property subject of the sale comprises the aggregate of the amount of the purchase price as stated in the document of sale excluding the interest charged in the remaining balance of the purchase price that is amortized on a monthly basis xxx xxx xxx The term "selling price" as used in the regulations is not construed to be limited only to the amount so stated as consideration in the document of sale. Thus, if in the Contract to Sell it is agreed that the buyer will assume some liabilities, i.e., taxes and other charges, the foregoing shall be considered in the computation of the actual consideration in the sale transaction. xxx xxx xxx From the foregoing, it is understood that the actual selling price of the subject property comprises the aggregate of the amount of the purchase price as stated in the document of sale and the balance of the CWT to be assumed by you, as the buyer, with the exclusion of the 11% interest per annum charged in the remaining balance of the purchase price that is amortized on a monthly basis for 120 months. Thus, for purposes of determining whether the subject sale transaction is on a "cash basis" or on an "installment basis" the following computations are hereby made: xxx xxx xxx. 2. The Term "Initial Payments" Shall Exclude Any Interest Paid on Amortizations or Installment Payments Made in the Initial Year aDcEIH RR 2-98, as amended, sets out the rule in classifying sales transaction as either (1) a sale on cash basis or "deferred-payment sale not on the installment plan"; or (2) a sale on installment basis. The criterion used in determining the classification of the sale transaction is whether the initial payments made in the year of sale exceeds twenty five percent (25%) of the selling price. Thus, where the initial payments in the year of sale do not exceed 25% of the selling price, the sale will be treated as a sale of property on the installment plan. On the other hand, where the initial payments in the year of sale exceed 25% of the selling price, the sale is on a "cash basis" or is a "deferred-payment sale not on the installment plan". The term "initial payments" as defined under Section 49 (B) of the Tax Code of 1997, as amended, means the "payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable period in which the sale or other disposition is made". Hence, initial payments refer to the payments which the seller receives before or upon execution of the instrument of sale, such as the downpayment, and those scheduled to be received in cash or property (other than evidences of indebtedness of the purchaser) during the year when the sale or disposition of the real property was made, such as the monthly amortization payments, but excluding the interest. For purposes of the CWT and in determining whether the sale is on "cash basis" or on "installment basis", any interest to be incurred by the buyer on the financing of the consideration/gross selling price should be excluded in the amount of "initial payments", therefore not subject to creditable withholding tax. ECHSDc However, it should be stressed that the said interest earned by the Bank/seller as an incident of installment payment, although not subject to the creditable (expanded) withholding tax, shall be subject to the ordinary income tax. 3. No CWT obligation arises upon the Bank's receipt of refundable reservation fees. Withholding of the CWT should be reckoned from the time the first installment is received on or after the sale is closed and a Contract to Sell is executed; The Bank submits that the CWT should not yet be required to be withheld when the Bank receives reservation fees in the course of a potential sale transaction. It is a practice in sales of real property that the buyer indicates its serious intention by making a reservation fee to reserve the property for a certain period. Upon its receipt of the reservation fee, the Bank would recognize a liability, since at that point, it is still uncertain if the sale will close or materialize. In the event that the potential buyer decides not to pursue the sale, the Bank is obligated to return the reservation fee. On the other hand, if the buyer decides to push through with the sale, a Contract to Sell is executed, and the buyer shall make a downpayment. The reservation fee earlier made shall then be applied against the agreed downpayment. It is only at this point that a "sale" is consummated, and the reservation fee is recorded by the Bank as part of its revenues on the sale of the ROPOA. Based on the above, it is clear that prior to the consummation of the sale, the reservation fee is not yet part of the purchase price or gross consideration for the sale of the ROPOA. At that time, such amount is merely a consideration for the privilege of having the property "reserved" during the agreed period; it cannot yet be deemed to be part of the consideration or price for the sale of the property since there is no sale of real property to speak of yet which should give rise to any CWT liability. The obligation to withhold CWT under RR No. 2-98, as amended, is on sales of real property only. Settled is the rule that RR No. 2-98, as amended, enumerates the income payments subject to CWT and only the particular payments made to persons enumerated therein are subject to the CWT. 2 Since the reservation fee on sales of real property is not among those income payments enumerated under RR No. 2-98, as amended, as subject to CWT, no CWT should be imposed thereon. Also, it should be emphasized that the Bank would be obliged to refund or return the reservation fee received if the sale is not consummated. On this basis, there should be no obligation to withhold and remit any CWT on the sale of real properties upon the Bank's receipt of any reservation fee for a potential sale. The CWT withholding should be reckoned from the time the sale is closed and consummated and the reservation fee forms part of or applied against the purchase price. cSTCDA 4. Whether surcharges, interest, and penalties should still be due in case "initial payments" would exceed 25% of the selling price due to unanticipated prepayment in the year of sale The basis of whether or not the initial payment would exceed 25% of the selling price to classify such sale as a "cash sale" or a "deferred payment sale not on the installment plan" or "installment sale" is the terms and conditions provided in the "Contract to Sell". Thus, if based on the Contract to Sell the sale is considered as a "cash sale", it is understood that no surcharges, interest, and penalties is imposed on a sale's "initial payments". However, in case of "unanticipated prepayments", that is, the buyer initially intended to pay on "installment basis" but later on decided to pay on "cash basis" or "deferred payment sale not on the installment plan" during the year of sale, the Bank should not be liable for late payment of penalties or interest because of unanticipated prepayments made by its buyers during the initial year, when the initial calculation or the Contract to Sell definitely shows that the sale qualifies as an installment sale. This is of course subject to the condition that the Bank immediately causes the withholding and remittance of the CWT upon its receipt of the prepayment. 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 Footnotes 1. Section 6 (E), Tax Code provides: (E) Authority of the Commissioner to Prescribe Real Property Values. The Commissioner is hereby authorized to divide the Philippines into different zones or areas and shall, upon consultation with competent appraisers both from the private and public sectors, determine the fair market value of real properties located in each zone or area. For purposes of computing any internal revenue tax, the value of the property shall be, whichever is the higher of: AHaDSI (1) the fair market value as determined by the Commissioner; or (2) the fair market value as shown in the schedule of values of the Provincial and City Assessors. 2. BIR Ruling No. DA-226-02 dated November 29, 2002.