Tax Consequences of Certain Agreements

December 6, 2001 BIR RULING NO. 056-01 Villareal Rosacia Dio & Patag Penthouse, Northeast Tower The Goldloop Towers One Goldloop Plaza, Ortigas Center Pasig City Attention: Atty. Tarcisio A. Dio Gentlemen : This refers to your letter dated September 15, 2000 stating that your client, Northern Cement Corporation (NCC) obtained various loans from the Development Bank of the Philippines (DBP) to finance the acquisition of equipment for NCC's cement manufacturing plant in Labayug, Sison, Pangasinan; that the series of devaluation of the Philippine currency in the 1970s, the adoption of the floating exchange rate system for the Philippine Peso and subsequent depreciation of the Peso against the US Dollar and the German Deutsche Mark as well as the depressed market for the cement industry then, resulted in financial difficulties to NCC and its inability to pay its loan obligations to the DBP in the early 1980s; that NCC offered to cede, transfer and convey its property to DBP via a " dacion en pago ", that DBP acceded to the offer of NCC and, on November 10, 1981, NCC and DBP entered into an agreement captioned "Deed of Cession of Properties in Payments of Debts ( Dacion en Pago )", whereby, in full settlement of its outstanding obligations to the DBP, NCC alienated in favor of DBP, parcels of land, buildings and equipment; that on the same day of November 10, 1981, NCC and DBP entered. into another agreement captioned "Deed of Conditional Sale", where, in consideration of, and subject to, the payment of P575,000,000.00 by NCC to DBP over a period of 20 years starting January 1, 1981, DBP sold back the property to NCC; that the Deed of Cession of Properties in Payment of Debts ( Dacion en Pago ) and the rights, interest and claims of DBP over the property were annotated as Entry Nos. 290280, 317320, 576225 and 576226 in the Memorandum of Encumbrances of the relevant land titles, particularly, TCT Nos. 71010, 71497 and 83271, all of the Registry of Deeds for Pangasinan; that NCC recorded the above transactions as a restructuring of a continuing debt and the property subject of the above-mentioned agreements were carried in the accounts on the same basis as they were prior to entering into the said agreements in accordance with a Special Bulletin issued by PICPA in July 1981; that pursuant to Administrative Order No. 14 issued on February 3, 1987 (approving the Identification of and Transfer to the National Government of Certain Assets and Liabilities of the Development Bank of the Philippines and the Philippine National Bank), as implemented (in regard to DBP) by a Deed of Transfer dated February 27, 1987, DBP for consideration, assigned certain loans/receivables to the National Government, together with DBP's rights, titles and interests under the "Credit Documents" and "Security Documents", including DBP's assets acquired from NCC; that by virtue of Proclamation No. 50 dated December 8, 1986, as amended, the National Government constituted the APT as its Trustee over the Trust Properties defined in said Proclamation; that the execution of the Deed was made upon approval by the Committee on Privatization, the transactions subject thereof being in line with the privatization program contemplated under Proclamation No. 50 dated December 8, 1986, that on February 22, 2000, the Republic of the Philippines through its Trustee, APT, as Vendor, and NCC, as Vendee, entered into an agreement captioned "Deed of Absolute Sale and Release From Liens and Encumbrances" whereby for and in consideration of the above premises and the full payment by the NCC to the APT of the purchase price of P575,000,000.00 inclusive of interest, the latter sold, transferred and conveyed to the former, its successors and assigns the properties described in the Deed of Cession of Properties in Payment of Debt ( Dacion en Pago ) and the Deed of Conditional Sale, subject to the condition that "all applicable/relevant transfer costs, notarial fees, registration fees, documentary stamp tax, and all other expenses/taxes existing prior to and/or incidental to the execution and delivery of the said Deed of Absolute Sale shall be for the account of, and shall be paid for by, the Vendee"; and that subsequently, NCC presented the Deed for registration with the Registry of Deeds of Pangasinan for the cancellation of the liens and encumbrances on the Titles, the said Registry of Deeds has required NCC to submit a Certificate Authorizing Registration (CAR) from the Bureau of Internal Revenue and payment of the supposedly appropriate capital gains tax and documentary stamp tax on deeds of sale and conveyances of real property. Based on the foregoing representations, you now request for a ruling that under the above-mentioned agreements entered into by NCC with DBP and APT, NCC is not liable for (i) income tax nor as a withholding tax agent for creditable withholding tax; (ii) capital gains tax; and (iii) documentary stamp tax on the deeds of sale and conveyances of real property. In reply thereto, please be informed that Article 1602 of the Civil Code of the Philippines provides "Art. 1602. The contract shall be presumed to be an equitable mortgage, in any of the following cases: (1) When the price of sale with right to repurchase is unusually inadequate; (2.) When the vendor remains in possession as lessee or otherwise; (3) When upon or after the expiration of the right to repurchase another instrument extending the period of redemption or granting a new period is executed; (4) When the purchaser retains for himself a part of the purchase price, (5) When the vendor binds himself to pay the taxes on the thing sold; (6) In any other case where it may be fairly inferred that the real intention of the parties is that the transaction shall secure the payment of a debt or the performance of any other obligation." The above-cited article enumerates six (6) distinct and separate circumstances, the presence of any of which immediately gives rise to the presumption that a contract with the right to repurchase is an equitable mortgage (Estrada vs. Millet , (CA) 55 OG 6028). In the instant case, although the relevant documents are denominated as "Deed of Cession of Properties in Payment of Debts ( Dacion en Pago )", "Deed of Conditional Sale" and "Deed of Absolute Sale and Release from Liens and Encumbrances", in reality the parties intended an equitable mortgage. It is well settled in this jurisprudence that the name given to contracts does not bar a determination of the true intent of the parties. ( Aguirre vs. The Hon. Court of Appeals , G.R. No. 131520, January 20, 2000) The contractual intent of NCC and DBP/APT under the above stated agreements was really to restructure as they in fact restructured the loan obligations of NCC, with the Properties serving as collaterals to secure the payment of the restructured loans. The contemporaneous and subsequent acts of NCC, DBP and APT manifest that, despite the execution of the Deed of Cession of Properties in Payment of Debts ( Dacion en Pago ), the Properties were not really conveyed to DBP/APT, considering that titles were not cancelled and no new certificates of title in the name of DBP or APT were issued. Even after November 10, 1981; NCC remained in continuous possession of the Properties and exercised all the rights and discharged all the obligations of an owner thereof, viz: paying the real property taxes thereon, securing the necessary insurance policies from time to time, using and dealing with the Properties for the operations of its cement manufacturing plant, and not paying or being required to pay any rental either to DBP or APT. In other words, there was really no absolute and unconditional sale, transfer and conveyance of the properties from NCC to DBP and later to the APT. Thus, there was no actual sale of the properties from APT to NCC under the Deeds of Conditional Sale and of Absolute Sale. Clearly, the circumstances contemplated in paragraphs (2) and (6) of the above-cited Article are present in the transactions between NCC and DBP, as later substituted by the APT. Accordingly, the Deed of Cession of Properties in Payment of Debts ( Dacion en Pago ), Deed of Conditional Sale and the Deed of Absolute Sale and Release From Liens and Encumbrances merely established an equitable mortgage and consequently not subject to income tax, capital gains tax and documentary stamp tax, under Section 196 of the Tax Code of 1997. ( BIR Ruling No. 091-99 dated July 8, 1999 ) SUCH BEING THE CASE, this Office is of the opinion as it hereby holds that NCC is not liable for income tax, creditable withholding tax, or capital gains tax relative to the Deed of Absolute Sale and Release From Liens and Encumbrances executed on February 22, 2000 by the Republic of the Philippines through its Trustee, APT. Considering further that the said Deed is actually in the nature of a release of the mortgage initially made by NCC to DBP, the mortgage itself should have been subjected to the documentary stamp tax at the rate of P3.50 if the amount exceeds P1,000 or an additional tax of P3.50 on each P3,000 or fractional thereof in excess of P3,000 imposed under then Section 244 of the Tax Code, as amended, together with the corresponding 25% surcharge from the date of the execution of Deed of Cession of Properties in Payments of Debts ( Dacion en Pago ) on November 10, 1981 until full payment thereof. 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.) REN G. BAEZ Commissioner of Internal Revenue