"Down Payment" and "Deferred Payment" Distinguished

April 4, 1974 BIR RULING NO. 007-74 "Down payment" and deferred payment, distinction between; when selling price is in excess of 25% . This refers to your letter dated February 11, 1974 requesting a ruling on the following queries: cdt "In January, 1973, I entered into a contract to sell a tract of land for an agreed price of P240,000 payable in installments for a period of three years. Upon signing the agreement, the buyer paid to me as an advance the sum of P40,000 on the understanding that in July 1973 I shall be paid a quarterly installment of P20,000 upon the signing of the Deed of Sale. The Deed of Sale was duly signed and registered in August, 1973. Actually, the buyer has paid me the sum of P40,000 from January to June, and another P40,000 from July to October 1, 1973. The Deed of Sale specifies the manner of payments to be made to me thereafter in quarterly installments of P20,000 for the years 1974 and 1975 until the full amount of P240,000 is settled. Under the terms of this agreement and considering the amount of payments I have so far received, may I be enlightened on the following: 1. Since the amount of P40,000 was paid to me as a advance payment before the signing and registration of the Deed of Sale, should it be included in the sale price? 2. This property was originally rice land which was bought by the buyer to be converted into a homesite, does not this fall under the provision of Presidential Decree No. 27 as amended regarding land properties sold exempting from taxes all payments received by the owner on or before October 5, 1973? 3. The land sold was an inheritance and I became the sole owner after buying out my co-heirs. How, then, should I compute its acquisition cost in order to figure capital gains? Should I include the cost of improvement as expenses incurred? 4. I have invested certain portions of the amount I have been paid in 1973 in Central Bank Certificates and PNB Banker's Acceptance certificate. Are these investment tax free? 5. Since I have not yet received payments for 1974 and 1975, should I pay taxes on the payments which I have not yet received or only for the amount which I received in 1973? In other words, should not the tax on this particular transaction be levied and spread through the three year period of payments as stipulated in the Deed of Sale? 6. This being the first time that a problem of this nature has occurred to me, may I be enlightened as to what are my tax obligations in connection with this particular transaction?" In reply thereto, I have the honor to inform you as follows: If the advance payment of P40,000 constitutes earnest money given in a contract of sale, it shall be considered as part of the price and as proof of the perfection of the contract. (see Art. 1482, New Civil Code ).It is clear from your representations that the intention of the parties to the contract of sale is to treat such advance payment of P40,000 as part of the contract or selling price. Query No. 2 is answered in the negative. Your sale of riceland in this case is not the sale contemplated by Presidential Decree No. 27 dated October 21, 1972 as amended by Presidential Decree No. 27-A which exempts the landowner from the capital gains tax on the proceeds of the amortizations paid him by the tenant-purchaser and likewise from income tax due on the accruing interest paid as an addition to the total cost of the land. The gain or loss from a sale or other disposition of property is measured by the difference between the amount realized and the "basis" of the property to the taxpayer, adjusted to the date of sale. ( par. 902 & 935, pp. 302 & 320, 1968 US Master Tax Guide ).In computing gain or loss on sale of property, the cost or other basis must be adjusted for any expenditure, receipt, loss, or other item properly chargeable to capital account. This necessitates an addition for improvements and betterments made to the property since its acquisition. Other capital charges are added to the cost, for example, brokers' commissions, lawyers' fees, recording fees, etc.,incurred in buying real estate. ( par. 937, p. 320, supra ). Thus, under Section 35(a) and (b) of the Tax Code, the profit realized from the sale of your riceland should be determined on the basis of the fair market price or value of the land on March 1, 1913, if acquired prior to that date, plus cost of improvements thereon; or if acquired on or after March 1, 1913, on the basis of the cost thereof for that portion of the riceland acquired by purchase from your co-heirs, and on the basis of the fair market price or value as of the date of the acquisition for that portion of the land originally inherited by you, and in either care, plus the cost of improvements thereon. The tax-exemption provided in Presidential Decree No. 16 as amended by Presidential Decree No. 16-A covers only the capital gains realized from the sale, transfer or exchange of capital assets during the one-year period of its effectivity from the date of its promulgation on October 5, 1972. Under Section 34(b) of the Tax Code, as amended by Presidential Decree Nos. 16 and 16-A, the entire net proceeds of the transaction (sale) and not only the gains thereof should be invested in capital stocks of preferred productive enterprises or in the purchase of new issues of government bonds, securities, e.g., Central Bank certificates in your case, debentures and notes other than treasury bills within six (6) months from the date the gains were realized, in order that the gains derived may be exempt from the capital gains tax. (see B.I.R. Rulings dated March 1, 1973 and April 12, 1973). Hence, if only a portion of the proceeds is invested, only the portion of the gain will be exempt from income tax. In other words, only such portion of the gain as the amount representing the investment bears to the amount representing the proceeds of the sale of capital assets is exempt from income tax. ( B.I.R. Ruling dated March 12, 1973 ). The answer to query No. 5 hinges on the determination of whether under the foregoing circumstances, your sale of property is on the installment basis or on the deferred-payment basis, not on the installment plan. cd The basic distinction between a sale of real property on the installment plan and a sale on a deferred-payment basis, not on the installment plan lies on the amount of the "initial payments" received by the seller. (see Section 43(b), National Internal Revenue Code). The sale is on the installment plan if the initial payments in the year of sale do not exceed twenty-five per cent (25%) of the selling price. If the initial payments in the year of sale exceed twenty-five per cent (25%) of the selling price, then the sale is on the deferred-payment basis, not on the installment plan. ( see also B.I.R. Ruling No. 70-034 dated June 29, 1970 ). The term "initial payments" is defined in the statute to mean payments received "in cash or property other than evidences of indebtedness of the purchaser during the taxable year in which the sale or other disposition is made".This term must not be equated with what is commonly called "down payment" because its meaning is much broader than that. (2 Mertens, Federal Income Taxation 447).While it covers any down payment made, it goes further and includes all payments actually or constructively received during the year of sale. ( Gertrude H. Sweet, 8 BTA 404; Corland Specialty Co.,22 BTA 808; Mamie E. Einig, 19 BTA 1105 ).And the aggregate of all such payments determines whether or not the limit which the law has set has been exceeded. (see also B.I.R. Ruling No. 011-69 dated October 3, 1969 & B.I.R. Ruling No. 70-034, supra ). Since the aggregate initial payments in 1973 which is the year of sale, consisting of P40,000 (advance payment, January-June, 1973) plus P40,000 paid from July to October 1, 1973 (covering 2 quarterly installments) or in the total amount of P80,000.00 as of December 31, 1973, is in excess of 25% of P240,000.00, the selling price of the land, your gain realized from the said sale should be reported on a deferred payment method, not on the installment plan. In other words, your taxable gain or income returnable during the year of sale (1973) is the difference between the selling or contract price of P240,000.00 and your acquisition cost of the land, determined in accordance with Section 35(a) and (b) of the Tax Code plus cost of improvements thereon, even though you have not actually received the entire purchase price in the year of sale. This is the necessary result of the rule we have in our law that in a transaction which falls under the category of a sale on a deferred-payment basis, not on the installment plan. "the obligations of the purchaser received by the vendor are to be considered as the equivalent of cash." ( See 177, Rev . Regs . No . 2 ). cdtai