Taxability of Rental Allowance

December 23, 2005 BIR RULING NO. 023-05 RR 2-98 KPPI Realty Corporation Level 5, Shangri-La Plaza Mall EDSA corner Shaw Boulevard Mandaluyong City Attention: Kin Sun Ng Group Financial Controller Federico G. Noel, Jr. Corporate Legal Counsel Gentlemen : This refers to your letter dated September 8, 2005 requesting confirmation of the following, to wit: 1. That the rental allowance paid by KPPI Realty Corp. (KRC) to Centrum I Condominium Corporation (Centrum) and the unit Owners is not subject to the 5% EWT imposed on rental fees; and 2. That payments of rental allowance for relocation and displacement costs, to compensate for the loss of anticipated profits by Centrum and the unit Owners during the construction period, and as penalty (for losses that may be suffered by Centrum and its unit Owners) in case of delay by KRC to deliver to Centrum and unit Owners, the allocable units on the time, are not among the items subject to EWT, under RR No. 2-98, as amended. It is represented that KRC entered into a Memorandum of Agreement (MOA) with the condominium owners of Centrum, as represented by their lawyer, Ms. Milagros T. Garcia (the "Owners"),and Centrum, wherein KRC offered to re-develop the existing Centrum I Condominium by providing the funds, facilities and technical know-how for the demolition of said condominium and constructing on it a high rise residential condominium (the "Project").The Owners and Centrum shall contribute to the Project their respective units and the land (the "Property") on which the existing condominium is located, and to receive in return for said contribution, units in the resulting development; the remaining units therein shall be allocated to KRC, subject to the terms and conditions of the MOA. Moreover, in consideration and by way of a return on their contributions to the Project, each Owner who contributes his condominium unit and his appurtenant interest in the common areas of Centrum I Condominium and in the land shall be allocated a condominium unit in the Project with a net area which is five percent (5%) more than that of his present condominium unit together with the replacement, of his existing parking slot. Furthermore, coincidental with the signing of the Escrow Agreement and for the duration of the construction of the Project until the delivery for occupancy of the condominium units in the Project, each Owner shall be entitled to receive a rental allowance to cover the relocation and displacement costs as provided for in Article IV Section 4 of the MOA, to wit: EADSIa "Article IV 4. Coincidental with the signing of the Escrow Agreement and for the duration of the construction of the Project until the delivery for occupancy of the condominium units in the Project, each Owner shall be entitled to receive a Rental Allowance to cover the relocation and displacement costs ..." This provision was intended to compensate displaced unit owners for the cost of lease of another residential unit during the construction period. In respect to Centrum, the amount was intended to defray the unrecovered portion of its capital investment as well as the loss of anticipated profits pertaining thereto, which were not fully recovered by way of lease and deemed unrecoverable/unearned from the time the construction began. On the part of KRC, rental allowance was considered as part of the development cost of the Project. Nevertheless, as represented, KRC did not rent or lease the said property but was required to take possession of the property in order to implement the Project. Moreover, the relocation and displacement costs include the penalty which was intended to cover the damages to be suffered by Centrum and the Owners in case KRC is in delay in delivering the new units at the time agreed upon under the MOA. In reply, please be informed that Section 2.57.2 (C) of RR No. 2-98, as amended, provides as follows: "Rentals on gross rental for the continued use or possession of real property used in business which the payor or obligor has not taken or is not taking title, or in which he has no equity Five Percent (5%)" KRC's continuous possession of the Property is a prerequisite for KRC to fulfill its obligation under the MOA. Objectively, KRC does not rent or lease the said real property but takes possession of the property in order to construct a high-rise residential condominium in pursuance of the MOA. Consequently, the payment of rental allowance paid by KRC to Centrum is not the rental fees contemplated under Section 2.57.2(c) of Revenue Regulations (RR) No. 2-98, as amended, but should be taken as part of development cost to KRC, which is but a contribution of KRC to the Project. Hence, we confirm that the same is not subject to 5% EWT. IHEAcC However, a distinction should be made with respect to the unit owners of Centrum who receive rental allowance as a consequence of the Project. If the unit owners have been using their respective units for their own/direct use, the rental allowance that they receive from KPPI should be treated as allowance for relocation/displacement not subject to EWT for rentals. It is in the concept of actual or compensatory damages not subject to tax. On the other hand, if the unit owners have been leasing their respective units and earning rental income therefrom, the rental allowance from KPPI can be treated as "rent" which could be subject to withholding tax. The rental allowance should be treated as a continuous rental income to the unit owners. With respect to Centrum itself, to the extent that the rental allowance is intended to cover anticipated profits, and not return of investment, the same shall also be treated as income subject to tax. Finally, since the rental allowance is not a payment for the purchase of service, there being no service rendered or to be rendered by Centrum to KRC, the said rental allowance is not subject to the 2% EWT imposed under RR No. 30-03 notwithstanding the fact that KRC is a top ten thousand corporation. 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, (SGD.) JOSE MARIO C. BUAG Commissioner of Internal Revenue