"Dacion" and "Foreclosure" Transactions of Real Estate Firms Subject to 5% Creditable Withholding Tax

September 2, 2003 BIR RULING NO. 007-03 RR 6-2001 000-00 Household Development Corp. Las Pias Business Center Alabang-Zapote Road Las Pias City Attention: Cynthia J. Javares Vice President Gentlemen : This refers to your letter dated January 17, 2003 requesting for a definitive ruling on the implementation of the provisions of Revenue Regulations No. 6-2001 in connection with the various transactions of HOUSEHOLD DEVELOPMENT CORPORATION (HOUSEHOLD for brevity) with some of its creditor banks. The facts, as you represent, are as follows: HOUSEHOLD is a corporation duly organized and existing under and by virtue of the laws of the Philippines. Its primary purpose as provided for in its Articles of Incorporation is: "To engage, in the development of rural and urban real properties and in relation thereto, to engage in general building and contracting business to improve, manage, develop, sell, assign, transfer, lease, mortgage, pledge, or otherwise dispose of, or turn to account or deal with, all or any part of the property of the company and from time to time to vary an investment or employment of the capital of the company; and to the same extent as juridical person might or could do, to purchase or otherwise acquire and to hold on, maintain, work, develop, sell, lease, exchange, hire, convey, mortgage, or otherwise dispose of and deal in lands, leaseholds, and any interest, estate and rights in real property, and any franchises, rights, licenses or privileges necessary, convenient or appropriate for any of the purpose herein expresses." HOUSEHOLD is registered with the Bureau of Internal Revenue (BIR for brevity) as a "Real Estate Developer". Being habitually engaged in the real estate business and in compliance with the BIR Revenue Regulations No. 12-94, HOUSEHOLD is a member of the Chamber of Real Estate & Builders' Associations, Inc. (CREBA for brevity). As per its audited financial statement, HOUSEHOLD'S assets consist primarily of contracts receivables and cash (or cash equivalent) derived from real estate sales. In addition, booked under "Real Estate Held for Sale and Development" are i) LOT INVENTORIES, which refers to developed lots and lots with ongoing development currently being sold in the market; and ii) RAWLAND, which refers to undeveloped properties acquired and intended for future development. Having been affected by the economic conditions brought by the financial crisis that hit the Asian region in 1997, HOUSEHOLD encountered difficulties in generating sufficient cash flows to fully service its interest-bearing obligations. Hence, in settlement of its outstanding loan obligation, HOUSEHOLD entered into dacion arrangement with several of its creditor banks, whereby some of its undeveloped properties were ceded, transferred and conveyed by way of dacion en pago to the creditor banks. Foreclosures of its undeveloped properties used to secure HOUSEHOLDS loan obligation were likewise resorted to. For the said "dacion" and "foreclosure" transactions, the BIR imposed 6% creditable withholding tax (CWT) due mainly to HOUSEHOLDS failure to present proof of registration with the HLURB and/or HUDCC for the undeveloped properties subject thereof. Arguing that it should be subject to 5% CWT, HOUSEHOLD offered to submit other "satisfactory evidence". HOUSEHOLD contended that it could not possibly present registration with the HLURB or HDCC because the properties subject of the said transactions are undeveloped properties. However, the BIR remained adamant on its position invoking the above-quoted provisions of RR No. 6-2001. It is your opinion that despite absence of registration with the HLURB and/or HUDCC for the undeveloped properties subject of the "dacion" and "foreclosure" transactions, HOUSEHOLD, being habitually engaged in the real estate business, should be subject to 5% CWT and not 6%. In reply, please be informed that Sec. 3(J) of Revenue Regulations No. 6-2001(RR 6-2001 for brevity) provides that: "SECTION 3. Revised Rates of Creditable Withholding Tax. Section 2.57.2 of Revenue Regulations No. 2-98, as amended, is hereby further amended as follows: xxx xxx xxx (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 Section 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 value of real property, where the seller/transferor is habitually engaged in the real estate business: With a selling price of Five Hundred Thousand Pesos) P500,000.00) or less 1.5% With a selling price of more than Five Hundred Thousand Pesos (P500,000.00) but not more than Two Million Pesos (P2,000,000.00) 3.0% With a selling price of more than Two Million Pesos (P2,000,000.00) 5.0% 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. xxx xxx xxx." (Emphasis supplied.) RR 6-2001 expressly allows the presentations of other "satisfactory evidence" to prove that the seller/transferor is habitually engaged in real estate business. Evidently, it has taken into consideration and has recognized the fact that, while the seller/transferor is habitually engaged in real estate business, there may be instances that the property subject of a particular transaction is not registered with the HLURB or HUDCC. But what may constitute "satisfactory evidence" is a matter of discretion dictated by absolute prudence on the part of this Office. To this Office's mind, the Articles of Incorporation, CREBA Certificate of Membership, Financial Statements and BIR Certificate of Registration are certainly more than "satisfactory evidence" to prove that HOUSEHOLD is a corporation habitually engaged in real estate business. In view of the foregoing, it is the considered opinion of this Office that HOUSEHOLD is habitually engaged in real estate business. As such its "dacion" and "foreclosure" transactions with its creditor banks affecting its undeveloped properties should be subject to 5% CWT and not 6%. Additionally, the 5% CWT should be based on the gross selling price/total amount of consideration or the fair market value determined in accordance with Section 6(E) of the Code, whichever is higher. Upon perusal of the docket, more particularly the Amended Deed of Absolute Sale by way of Dacion en Pago , it appears that out of the total outstanding obligation of HOUSEHOLD amounting to Nine Hundred Ninety Five Million Seven Hundred Twenty One Thousand Five Hundred Twenty Seven Pesos and Seventy Eight Centavos (P995,721,527.78), only Two Hundred Eighty Nine Million Six Hundred Twelve Thousand Seven Hundred Sixty Five Pesos and Ninety Five Centavos (P289,612,765.95) was extinguished and paid, which is the equivalent amount of the total consideration stated in the said Deed. On the other hand, the zonal value of the subject properties is Four Thousand Pesos (P4,000.00) per square meter multiplied by the total area of Sixty Eight Thousand and Fifty Nine square meters (68,059 sq.m.) or a total amount of Two Hundred Seventy Two Million Two Hundred Thirty Six Thousand Pesos (P272,236,000.00). Thus, pursuant to Sec. 3(J) of RR 6-2001, the 5% CWT should be based on the total consideration of Two Hundred Eighty Nine Million Six Hundred Twelve Thousand Seven Hundred Sixty Hundred Sixty Five Pesos and Ninety Five Centavos (P289,612,765.95), it being the higher value. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be ascertained that the facts are different; then this ruling shall be considered void. Very truly yours, (SGD.) GUILLERMO L. PARAYNO, JR. Commissioner of Internal Revenue