Bank's Inventory of Foreclosed Properties Are Deemed Ordinary Assets

September 14, 1999 BIR RULING NO. 143-99 Sec. 25, GBA; RR 2-98-000-00-143-99 Solidbank 777 Paseo de Roxas Makati City Attention: Mr . Ricardo V . Martin First Vice President & Financial Controller Gentlemen : This refers to your letter dated May 11, 1999 requesting for a ruling on the following matters, viz: 1. That the Bank's inventory of real estate properties which were acquired in satisfaction of loans are considered ordinary assets rather than capital assets; and 2. That although Solidbank has not opted to join the indicated real estate organizations, it is nevertheless considered to be habitually engaged in the real estate business the sales of said real estate properties is subject to creditable withholding tax at the rates of 1%, 3%, or 5%, depending on the amount of the selling price. LexLib It is represented that Solidbank, as a financial institution, extends loans to its clients and such loans are invariably secured by mortgages on real estate properties; that if the borrower is unable to pay the loan on due date, or after the extension of the maturity date, if allowed, the Bank, in order to protect its interest, resorts to foreclosure of the mortgage; that after the expiration of the redemption period allowed by law for the borrower to redeem the property, the Bank takes steps to consolidate the title to the property in its name, and these steps include the payment of relevant internal revenue taxes associated with the transfer; that such real estate may be in the form of single lots, raw lands, subdivision lots, condominium projects, town house projects, etc. which have been offered by the clients, including those engage in the real estate business, as collaterals to loan; that the foregoing is in accordance with Section 25(C) of the General Banking Acts, which provides in part "Any commercial bank may purchase, hold and convey real estate for the following purposes: "xxx xxx xxx "c) Such as shall be conveyed to it in satisfaction of debts previously contracted in the course of its dealing; "d) Such as it shall purchase at sales under judgment, decrees, mortgages, or trust deeds held by it and such as it shall purchase to secure debts due it. "But no such bank shall hold the possession of any real estate under mortgage or trust deed, or the title and possession of any real estate purchased to secure any debt due to it, for a longer than five years. (as amended by P.D. No. 71)." that by the nature of the Bank's business, the Bank and its branches through its head office holds numerous real properties which were foreclosed as a result of its clients failure to settle their loan obligation; that the number of accounts continues to increase particularly during periods of national economic difficulties, thereby an inventory of these properties; and that it is the Bank's policy to comply with the requirements of the banking law to dispose of these properties, primarily by sale to interested parties and over the years, the number of such sales has been substantial. prcd In reply, please be informed that pursuant to Sec. 2.57.2(J) of Revenue Regulations No. 2-98 (then Rev. Regs. 6-85, as amended by Rev. Regs. 1-90 and further amended by Rev. Regs. 6-94 and 12-94), implementing R.A. No. 8424, "An Act Amending the National Internal Revenue Code, as amended" relative to the withholding on income subject to the Expanded Withholding Tax, except as otherwise provided, there shall be withheld a creditable income tax rates from the following items of income payments to persons residing in the Philippines; "(J) Gross selling price or total amount of consideration or its equivalent paid to the seller/owner for the sale, exchange or transfer of Real property, other than capital assets, sold by an individual, corporation, estate, trust, trust fund or pension fund and the seller/transferor is habitually engaged in the real estate business in accordance with the following schedule Those which are exempt from a withholding tax at Exempt source as prescribed in Sec. 2.57.5 of these regulations With a selling price of five hundred thousand pesos (P500,000.00) or less 1.5% With a selling price of more than five hundred thousand pesos (P500,000.00) but not more than two million pesos (P2,000,000.00) 3.0% With selling price of more than two million pesos (P2,000,000.00) 5.0% "A seller/transferor must show proof of registration with HLURB or HUDCC to be considered as habitually engaged in the real estate business. . . ." The foregoing creditable withholding tax rates apply to sale or disposition of real properties by a taxpayer who is habitually engaged in the real estate business. Categorically, under Section 39 of the 1997 Tax Code, these properties held by a taxpayer primarily for sale in the ordinary course of business are considered as ordinary assets the same being excluded in the definition of "capital asset". While the regulations requires membership in the Housing and Land Use Regulatory Board (HLURB) or Housing Urban Development Coordinating Council (HUDCC) to be considered as habitually engaged in the real estate business, the same should not be the sole criterion considering that the taxpayer Bank is able to acquire numerous real estates which, by law, are being required to be disposed in the course of its business. In Section 25 of the General Banking Act, banks are required to dispose of the foreclosed properties within a period not longer than five (5) years, rather than hold them for investment or speculation. Thus, by operation of law, these properties should be included by banks in their inventory of assets to be sold in the course of their business. In this light, this Office believes that this kind of activity is a valid consideration in treating the taxpayer Bank to be habitually engaged in the real estate business. For purposes of the above regulations, the term habitually engaged in the real estate business is not limited or restricted only to persons duly registered with the HLURB or HUDCC. The proviso simply means that any person duly accredited by the said government agencies shall be deemed habitually engaged in the real estate business. However, even in the absence of registration therewith, a person may also be treated habitually engaged in the real estate business upon showing that he is in fact actually engaged in the said business. (BIR Ruling No. 059-99 dated April 30, 1999) Furthermore, then Rev. Regs. 12-94 merely requires submission of evidence showing that the taxpayer is in fact habitually engaged in the real estate business. This fact is duly disclosed in the Bank's financial statements, such as the inventory of the foreclosed real properties, as well as income earned from disposition or sale of the same. In the light of the foregoing, this Office hereby holds that the Bank's inventory of foreclosed properties which are mandated by law to be disposed of within a period not longer than five (5) years are ordinary assets the gain or loss from the sale of which to be included in computing the Bank's net taxable income during the year pursuant to Section 28(A) of the 1997 Tax Code. Moreover, and considering that the disposition of said foreclosed properties qualifies the Bank to be habitually engaged in the real estate business, income from sale or disposition of the same is subject to a creditable withholding income tax at the rate provided for in Section 2.57.2(J) of Rev. Regs. No. 2-98. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation it shall be disclosed that the facts are different, then this ruling shall be considered null and void. cdll Very truly yours, (SGD.) BEETHOVEN L. RUALO Commissioner of Internal Revenue