BIR Ruling No. 076-62

May 21, 1962 BIR RULING NO. 076-62 3rd Indorsement May 11, 1962 Returned to the Regional Director, B.I.R. Regional District No. 3, Manila, the within papers relative to the proposed deficiency income tax sought to be assessed against the PARADISE FARMS, INC., for the fiscal year 1957, involving the amount of P9,605.00. It appears that the Paradise Farms, Inc., is a domestic corporation which owns a vast tract of land which is subdivides and sells into small agricultural lots on the installment basis, payable in from 10 to 12 years time. Upon investigation of the income tax return it filed for 1957, a deficiency income tax was sought to be assessed in the of P9,605.00, which was arrived at as a result of the following disallowances: 1. Balance per Exh. III of financial Statement P43,805.11 2. Amount credited to Trustee's account 80,842.80 3 Amount transferred to a liability account 144,191.23 P268,839.14 Incidentally, the first two figures refer to transfers to reserve accounts to be used purportedly for future development of the sub-division. The amount transferred to a liability account was not explained. These disallowed sums were transferred to unrealized profits which increased the amount recorded in the books of the corporation from P659,368.39 to P928,207.53. This amount was used as a basis for determining the realized taxable profit during the year, in accordance with the formula outlined in section 176 of Revenue Regulations No. 2, as follows: Unrealized Gross Profit X Collections During Realized profits Installment Contract Re- year on Installments taxable for Year ceivable at end of Year Substituting the figures gathered per investigations, the following emerges: P928,207.53 X P185,330.89 P112,461.95 1,529,633.15 Since the corporation reported only the amount of P78,159.92 as gross taxable profits from the sale of the agricultural lots, a discrepancy of P34,302.03, representing the difference between the sum of P112,461.95 and the amount of P78,159.92 was found and sought to be taxed in the sum of P9,605.00. The corporation, thru counsel, questions the disallowance of the sums in question, on the ground that unexpended provisions for the development and improvement of the subdivided farm lots are allowable under accepted accounting methods. Our investigating examiner on the other hand, contends, that in the determination of "gross profits" (that is, sales less cost of real estate sold), "the same should be based on actual expenditures and not on more estimates." (See report of Examiner, pp. 23-24, rec.) The issue for resolution is whether or not provisions set aside for future development of subdivided lots sold on the installment basis should be allowed as deductions in computing income subject to the income tax. Sales on installments of subdivision properties are covered by section 43 of the Tax Code. For purposes of determining taxable income in the sale on installment of subdivision lots, the unexpended provision for future development of the lots sold may be allowed as a deduction, provided the following circumstances concur: 1. There must be a specific provision in the contract of sale that the seller agrees to provide for certain specific improvements on the lots sold at his or its own expense, and 2. The obligation of the seller to provide for said improvements must be enforceable at law. In other words, should the owner or seller fail to comply with his obligation, the purchaser can compel him to put up the said improvements. (Milton A Mackay, 11 B.T.A. 569; Cambria Development Co, 34 B.T.A. 1155). In the instant case, it appears that the sums of P43,805.11 and P80,842.80, respectively, represent unexpended reserve for future development of the subdivided lots sold. Their allowance or disallowance involve a question of fact which require further investigation to determine the provisions of the contract of sale entered into between the corporation and the purchasers. The amount of P144,191.23 transferred to a liability account should be properly explained. Unless properly explained and determined to be allowable, it should be disallowed. LLjur Please be guided accordingly. (SGD.) BENEDICTO PADILLA Acting Commissioner of Internal Revenue This to certify that the above ruling was signed by the Commissioner of Internal Revenue on May 21, 1962. (SGD.) P. F. LANDAS Revenue Operations Head (Legal)