Tax Consequence of a Lease Agreement

July 4, 1990 BIR RULING NO. 129-90 29-00 000-00 129-90 S i r : This refers to your letter dated September 12, 1989 stating that on May 28, 1989, your client, Forte Realty Corporation, JEG Bldg., 150 Legaspi Street, Legaspi Village, Makati, Metro Manila, entered into a lease agreement with Investors Finance Corporation now known as City Trust Finance Corporation for the lease of a 1989 Nissan Maxima 2.0 Sedan Car with Aircon, Stereo and Magwheels; that among other terms, the cost of the leased property is P489,700.00; that the term of lease is 48 months commencing from May 12, 1989 to April 12, 1993 at the monthly rental of P14,376.00, or a total of P690,048.00; and that the lessee is required to pay a guarantee deposit of P73,455.00 to the lessor as security for the prompt and full payment of all rents payable and the due performance of the lessee's other obligations. As orally represented, after the termination of the lease and complete payment of 48 monthly rental, the lessee becomes the owner of the car. Based on the foregoing facts, you pose the following questions in behalf of your client: 1. Is the monthly rental of P14,736.00 deductible from gross income for income tax purposes? 2. Is the cost of maintenance and repair on the property considered deductible from gross income? 3. Is the guaranty deposit of P73,455.00 likewise deductible from gross income if not returned by the lessor at the end of the term of the lease or any extension thereof? 4. Is the monthly rental subject to the expanded withholding tax? In reply, I have the honor to inform you that pursuant to Revenue Regulations No. 19-86, a contract or agreement purported to be a lease shall be treated as conditional sales contract if one or more of the following compelling persuasive factors are present: 1. The lessee is given the option to purchase the asset at any time during the obligatory period of the lease, notwithstanding that the option price is equivalent to or higher than the current fair market value of the asset. 2. The lessee acquires automatic ownership of the asset upon payment of the stated amount of "rentals" which under the contract, he is required to make. 3. Portions of the periodic rental payment are credited to the purchase price of the asset. 4. The receipts of payment indicate that the payment made were partial or full payment of the asset. (par. 4.03/2, Rev. Reg. #19-86) In the absence of the above compelling persuasive factors or contrary implication, an intent warranting treatment of a transaction for tax purposes is a purchase and sale rather than as a lease or rental agreement, if one or more of the following conditions are present: (a) portions of the periodic payments are made specifically applicable to an equity to be acquired by the lessee. (b) the property may be acquired under a purchase option, at a price which is nominal in relation to the value of the property at the time when the option may be exercised, as determined at the time of entering into the original agreement, or which is a relatively small amount when compared with the total payments which are required to be made. (par. 4.03/3, Rev. Reg. No. 19-86) A perusal of the lease agreement shows that the invoice cost of the car being leased by your client (1989 Nissan Maxima) is P489,700.00 while the total lease rental thereof over a period of 4 years is P690,048.00, a difference of P200,348.00 which is approximately 40% higher than the original/invoice cost of the car and adequate to cover the cost of money on the part of the buyer. In other words, the car could be acquired at a relatively small amount by purchase compared with the total payments which are required to be made under a lease agreement. Such being the case, the agreement entered into between your client Forte Realty Corporation and Investors Finance Corporation is a conditional sale. In fact, as verbally disclosed, the lessee becomes the owner of the car after the lessee shall have completed the payment of monthly rentals over a period of 48 months. Accordingly, Questions Nos. 1 and 3 are answered in the negative. The amounts paid by your client Forte Realty Corporation to Investors Finance Corporation as vendor shall be considered as payments which are part of the purchase price to the extent that such amounts do not represent interest or other charges. In the instant case, it can be inferred that 40% of the invoice amount over a 4-year period, or 10% annually, represents the cost of money. Your Question No. 4 is also answered in the negative. Since the lease agreement is in fact a conditional sale; the amount paid as "Monthly Lease" forms part of the purchase price which is not subject to the expanded withholding tax as contemplated under Revenue Regulations No. 6-85. Very truly yours, (SGD.) JOSE U. ONG Commissioner