Whether a Certain transaction constitutes a lease for tax purposes; that the lessor shall report the rentals as rental income and accordingly claim depreciation as deduction on the Leased Project in accordance with such methods as may be allowed by law

March 16, 1995 BIR RULING NO. 054-95 28,24 000-00 054-95 Sycip Gorres Velayo & Co. 6760 Ayala Avenue, Makati Metro Manila Attention: Attys . C . C . Gison & R . L . Tan Tax Division Gentlemen : This refers to your letter dated August 26, 1994 stating that a company (Lessor) not yet in existence, will be incorporated under Philippine Law which will be authorized to engage only in lease transaction; that it will not be organized as a finance company under the "Financing Company Act" (R. A) 5980); that it will have two kinds of shares: (a) common voting; and (b) redeemable non-voting preferred shares; that the, Lessor will be owned by residents and non-residents of the Philippines; that Citibank, N. A. Philippine Branch will be a stockholder of the Lessor; that the lessor shall enter into a lease transaction with a high tech company which is either a BOI-registered export producer or an enterprise located in the Export Processing Zone (the Lessee); that the Lessee, acting as agent of the Lessor, will cause the construction of a building or plant and, acquire the cause the equipment to be installed in the Plant which are needed for the registered export activity of the Lessee (the Project); that the land on which the plant will be built will be leased by another party (unrelated to the Lessor) to the Lessee; that the Lessee will make payments to contractors, sub-contractors and/or suppliers, as the case may be, in relation to the Project, when due; that upon commissioning of the Project, or shortly thereafter, the Lessor will reimburse the Lessee for such payments together with interest thereon, determined at a commercial rate of interest and, if applicable, a fee for supervisory services rendered; that upon commissioning of the Project, the Lessor will enter an agreement with the Lessee whereby it will lease to the former the entire Project under the following terms and conditions: (a) The lease will be for a minimum period of 5 years and a maximum of seven years; (b) The lessee will not be granted an option to purchase. Upon expiration of the lease, it may be renewed or the Lessor may sell the plant to another party under such terms and conditions as may be agreed upon at that time; (c) The lessee will not acquire title to the Project automatically or upon payment of a price. The contract will not provide for a purchase price which the lessee will pay to the lessor to acquire title to the Project; (d) Normal provisions in case of default or loss (such as destruction or expropriation by the Government) or damage to the plant will be incorporated in the lease; (e) All real estate taxes on the leased property and all value-added tax and similar excise or business taxes, and any creditable withholding tax, whether imposed by the National Government or any local government unit, on any payments required to be made by the Lessee to the Lessor existing at the time of the execution of the lease contract shall be for the account of the Lessor, However, in the event of any increase in the tax rates or change in the tax base which will result in higher taxes, the rentals shall be accordingly adjusted. In connection therewith, you are requesting opinion as to whether or not the aforementioned transaction constitutes a lease for tax purposes; that the lessor shall report the rentals as rental income and accordingly claim depreciation as deduction on the Leased Project in accordance with such methods as may be allowed by law. In reply thereto, please be informed that a lease is a contract whereby one of the parties (lessor) binds himself to give to another (lessee) the enjoyment or use of thing for a price certain, and for a period which may be definite or indefinite. (Article 1643, Civil Code). In other words, a lease is an agreement between a lessor and lessee giving the lessee possession and use of a specific property upon payment of rentals over a period of time. The lessor retains ownership of the asset so that it shall not become the property of the lessee or any related third party during the term of the lease. One the other hand, a sale is a contract whereby one of the contracting parties (seller or vendor) obligations himself to transfer ownerships of and to deliver a determinate thing while the other party (buyer or vendee) obligates himself to pay for said thing a price certain in money or its equivalent. (Article 1458, Civil Code). [Section 4 (4.01), Revenue Regulations No. 19-86 dated October 1, 1988]. Under the foregoing facts, the proposed agreement that will be entered into by and between the lessor and the lessee is a contract of lease. Accordingly, the lessor should report the rentals as rental income and claims depreciation deduction during the period that the property is under lease pursuant to Section 29(f) of the Tax Code, as amended. 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 avoid. llcd Very truly yours, LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue