Tax Exemption of Gain from the Involuntary Conversion of a Portion of Real Property Expropriated by the DPWH

November 18, 1992 BIR RULING NO. 329-92 28 373-87 429-88 329-92 Manila Jockey Club, Inc. (MJC) 2000 Felix Huertas, Manila Gentlemen : This refers to your letter dated October 29, 1992, requesting for a confirmation of your convention that the gain from the involuntary conversion of a portion of your real property (i.e., a portion of your horse racetrack premises), which was expropriated by the Department of Public Works and Highways (DPWH), is not recognized as realized income, hence, may not be legally subjected to income tax. cdll It is represented that a portion of MJC's real property (horse racetrack premises) was expropriated by the DPWH for public purposes (i.e., road improvement premises). At the time of expropriation, its net book value is P250,000. Its compensation for the said expropriation is P29,462.440. However, the said compensation is not even enough to repair, restore, and rehabilitate its racetrack premises and facilities. On the contrary, MJC's contract for the partial repair, restoration and rehabilitation of the said premises and facilities is P53,530,000. Your query is whether or not the compensation received by MJC in excess of the net book value of the said expropriated property may legally be recognized as realized taxable income notwithstanding that, simply because of the said expropriation MJC's normal business operations was not only disrupted but, in addition, it would incur a total obligation of more than P53 million just to repair, restore and rehabilitate its horse racetrack premises and facilities. In reply, please be informed that the aforementioned expropriation of MJC's real property is embraced under the involuntary conversion of property doctrine which this Office relied upon in BIR RULING NO. 373-87, dated November 23, 1987, in the case of the MERCURY GROUP OF COMPANIES. This ruling was reiterated in BIR RULING NO. 429-88, dated September 2, 1988: "The excess of the amount of the insurance proceeds over the net book value of the insured assets is not taxable income to the corporation, its having been used in restoring the burned assets. The rule is, where insurance proceeds are actually reinvested in similar property, no gain is recognized. (Herder V. Helvering, 23 AFTR. p. 322)" The aforesaid Herder V. Helvering case is a discussion of the Involuntary Conversion of Property Doctrine in determining whether or not a gain from the involuntary conversion of a property may be recognized as realized income subject to income tax to the recipient, theft or seizure its expropriation or condemnation, or the treat or imminence thereof. " Involuntary Conversion if property (as a result of its destruction, in whole or in part, theft or seizure, or an exercise of the power of requisition or condemnation or the treat or imminence thereof) is compulsorily or involuntary converted into property similar to related in service or use to the property so converted, or into money which is forthwith in good faith . . . expended in the acquisition of other property, or in the acquisition of a control of a corporation owning such other property, or in the establishment of a replacement fund, no gain or loss shall be recognized. If any part of the money is not so expended the gain, if any, shall be recognized, but in an amount not in excess of the money so expended." (MERTENS, Chap. 20, 121, Vol. 3, pp. 337-338) llcd The facts in the Herder V. Helvering case were: On January 15, 1934 fire destroyed the milling property owned by the partnership of George Herder and R. L. Williams. For this loss, the partnership received $50.000 as fire insurance proceeds. This amount was immediately distributed to the partners, being pro-rated in accordance with their respective interest in the partnership, namely, two-thirds to George Herder, and one-third to R. L. Williams. George Herder received $33,333.67 under such distribution and that $19,199.50 thereof represented his portion of the total amount received by the partnership in excess of the adjusted cost basis of the property at the time of its destruction. The Court held the said gain ($19,199.50) is not a realized income, hence, not subject to income tax, ( supra ) pursuant to the rule that no realized income may be recognized from a compulsory or involuntary conversion of a property. This doctrine is one of the several doctrines enunciated by the Courts in the U.S.A. that explain the meaning of the term "income" and "realization of income". It is settled that the 16th Amendment to the Constitution of the United States of America in the year 1913 is the basis of its present income tax laws; that, the said income tax laws of 1913 have been implanted, verbatim, in the Philippines; that, the said income tax laws do not define the meaning of the term "income"; that, there is no such statutory definition of this term until the present; that, the same is true in our jurisdiction since our concepts of the term "income" wholly rely upon the said U.S. doctrines; that, in both jurisdictions, the concepts of the term "income" are enunciated not thru statutes (in order that its meaning may not legally be strapped and restricted) but rather thru regulations and court-enunciated doctrines (in order that its meaning may remain and continue to be dynamic and expensive and hence, remain relevant to meet our constantly changing economic and political life). [See MERTENS, Law of Federal Income Taxation, on the Generic Concepts of Taxable Income, Chap. 5, Vol. 1. See also discussions on Involuntary Conversion of Property Doctrine, MERTENS, Chap. 20.120 to 20.130, Vol. 3] In view of the foregoing, and in the light of your comprehensive dissertation on the doctrines re the meaning of the term "income" and "realization of taxable income", this Office hereby confirms your position that MJC's aforementioned gain from the involuntary conversion of its property is not recognized as realized income, hence, MJC is not subject to income tax thereon, pursuant to BIR RULING NO. 373-87 and as reiterated by BIR RULING NO. 429-88. prcd Very truly yours, VICTOR A. DEOFERIO, JR. Deputy Commissioner (Officer-In-Charge)