When Payment of Right of Occupancy May Qualify as Rental Deduction

January 26, 1966 BIR RULING NO. 004-66 Dr. Pedro V. Javier Allied Management Consultant 579 Nueva St., Manila S i r : This refers to your letter stating the following: cdta "On February 21, 1964, the establishment of Mr. Gaw Lim, holder of C-4 and C-14, No. 3418056, dated January 13, 1965, located at 812 Salazar Street, Manila, and the entire building in which it was located, were totally destroyed by fire. He was able, however, to save the merchandise. Consequently, he had to look for another location and he was able to occupy No. 837 Salazar Street, Manila, his present business location. To get the place, that is No. 837 Salazar Street, Mr. Gaw Lim had to pay the amount of P5,000.00 for the "right of occupancy". Sometime, this right is called "Goodwill". The amount, at the time, was considered rather exorbitant, but in view of the law supply of locations for stores as a result of the total destruction of that part of China town, he was compelled, against his conscience, to pay the amount of P5,000.00. Now, I understand that some owners of the new buildings in the locality are asking as much as P7,000 for such right. The contract of Mr. Gaw Lim to occupy the place was on the monthly basis that is, his lease is from month to month, not for a certain number of years. In the income tax returns for 1964 of Mr. Gaw Lim, through my advice, he deducted the full amount of P5,000.00 under "Rents", knowing that said disbursement was a necessary business expense in the sense that he could not secure the place without paying the said amount. This payment was acknowledged in an official receipt issued by the owner of the building. May I, therefore, be informed as to whether or not the deduction of P5,000.00 in the income tax returns of Mr. Gaw Lim for 1964 might be considered legal deduction, considering that the amount was actually paid and that the expense was necessary and actual." In reply thereto, I have the honor to inform you that, under the foregoing circumstances, the so-called payments for the "right of occupancy" may not qualify as rental deductions because expenditures of this character although they may occasionally be labeled as rentals are more in the nature of capital advances to secure the lease of the premises. Deduction is not obtained simply because consideration for the payment is to some extent the possession, use or occupancy of property. To take a deduction for rentals, they must be made as a condition of the continued use or possession of the premises or property during that year, so that, if the taxpayer is not required to make the payments, or if he is not in possession, no deduction is allowed. It is quite another thing if the amount paid for the use of property is applied to the contractual monthly rental, in which case, the full amount of the agreed rental would be deductible, subject to limitations based on reasonableness in amount (Par. 25.108 25.109 Mertens, Law of Federal Income Taxation, Vol. 4). It is well to note that expenditures which are incurred to acquire specific assets for use in the taxpayer's business are not generally treated as ordinary and necessary business expenses. In a capital transaction, an amount paid in excess of the value of tangible assets is not a deductible business expense, but constitutes a capital expenditures. This principle has been applied in connection with the purchase of good will (See also Par. 25.40 Mertens, Law of Federal Income Taxation, Vol. 4). In the instant case, it may be assumed that good will also was purchased when your client paid the amount of P5,000.00 allegedly for the right of occupancy. In view thereof, this Office believes that the deduction of P5,000.00 in the 1964 income tax returns of your client Mr. Gaw Lim cannot be considered legal deduction. aisadc Very truly yours, (SGD.) MISAEL P. VERA Acting Commissioner of Internal Revenue