BIR Ruling No. 504-11

December 19, 2011 BIR RULING NO. 504-11 RR 14-2002 City of Cebu Office of the City Treasurer City Hall, M.C. Briones Street Cebu City Attention: Ms. Ofelia M. Oliva OIC, City Treasurer Gentlemen : This refers to your letter dated 19 April 2010 requesting reconsideration of the decision of BIR Revenue Region No. XXIII dated 8 April 2010 issued to the Cebu City Government (CCG) in response to its request for a legal opinion on the tax consequences of the disposition of portions of the South Road Properties (SRP). It is represented that the CCG is registered with the Philippine Economic Zone Authority (PEZA) as an Ecozone Developer/Operator for the establishment, development, construction, administration, management and operation of a 330-hectare area which was declared as a Special Economic Zone by virtue of Presidential Proclamation No. 763 dated 20 January 2005, to be known as Cebu SRP; that pursuant thereto, on 6 January 2006, PEZA issued the Certificate of Registration No. EZ 06-01 which, among others, provided that the CCG is entitled to exemption from national and local taxes, except real property taxes on land owned by the developer, after the income tax holiday (ITH) has expired and in lieu thereof, the CCG shall pay a five percent (5%) tax on gross income (GIT); that as a confirmation of the tax incentive granted under its PEZA registration, on 24 March 2010, through PEZA-ERD Form No. 03-01, Certification No. 2010-0785, the PEZA reiterated the aforesaid incentive and further certified that pursuant to BIR Revenue Regulations (RR) No. 14-2002 and Revenue Memorandum Circular (RMC) No. 72-2004, income payments to PEZA enterprises under the ITH and five percent (5%) incentives are exempt from expanded withholding tax. It is further represented that SM Prime Holdings, Inc., (SM Prime) a domestic corporation and as buyer, and CCG, as seller, executed a Contract to Sell for the purchase of 304,100 square meters of land (subject lot) with a selling price amounting to P2,709,712,000 of which an initial payment of P677,428,000 representing twenty five percent (25%) of the total consideration was paid; that in view of the foregoing, a request was filed with the Revenue Region No. XXIII, Cebu City requesting for a legal opinion on the taxability of the disposition of some portions of the SRP to any interested buyers; that in reply to the request of CCG, a Memorandum was issued by the Regional Director of Cebu City to the Revenue District Officer of RDO No. 82, affirming that no taxes local and national, shall be imposed on business establishments operating within the Ecozone and that in lieu thereof, the Ecozone registered enterprise will be subject to five percent (5%) tax on GIT; that the PEZA registered enterprise is not subject to expanded withholding tax; that in view, however, of the representation made that the area sold to SM Prime is classified as Commercial and will be utilized for such purpose, the Regional Director ruled that if this is confirmed upon verification and due investigation, and pursuant to the rules and regulations implementing RA 7916, then said area deemed commercial and utilized as such is neither included nor granted fiscal incentives as areas in the Ecozone development intended for industrial purposes; and that the Regional Director ruled that the sale of the parcel of land located within the area developed by CCG but not granted fiscal incentives within the Ecozone between CCG and SM Prime, is subject to the regular capital gains tax/creditable withholding tax on sale of real property and the corresponding documentary stamp tax, as well as VAT, based on the gross income earned. ITAaHc In reply, please be informed that Ecozone developers are, except for real property taxes on land owned by them, exempt from local and national taxes and in lieu thereof subject to tax of five percent (5%) of the gross income earned. Section 24 of Republic Act (RA) No. 7916, as amended by RA 8748, provides thus: "Section 24. Exemption from National and Local Taxes. Except for real property taxes on land owned by developers, no taxes, local and national, shall be imposed on business establishments operating within the ECOZONE. In lieu thereof, five percent (5%) of the gross income earned by all business enterprises within the ECOZONE shall be paid and remitted as follows: (a) Three percent (3%) to the National Government; (b) Two percent (2%) which shall be directly remitted by the business establishments to the treasurer's office of the municipality or city where the enterprise is located." However, the above-quoted exemption must be read in conjunction with the Rules and Regulations to Implement Republic Act No. 7916, particularly Section 6, Rule XXI Conditions for Availment of Incentives and Other Privileges, which states, viz. : "Section 6. Duration. All incentives in favor of ECOZONE Enterprise shall continue, as long as they remain in good standing and commit no violation of the Act, these Rules and Regulations, pertinent circulars and directives promulgated thereunder, or the terms and conditions of their registration agreement, permit or franchise unless otherwise provided for in the Act, these Rules and Regulations and registration agreement." In addition, CCG's Certificate of Registration with PEZA as developer/operator of SRP expressly stipulates that CCG's registration shall be subject to the following: ICacDE "representations and commitments set forth in its application or registration, provisions of the above law, and rules and regulations promulgated thereunder and the terms and conditions of the Registration Agreement." Thus, it should be understood that Ecozone enterprises such as CCG must not only observe and abide the provisions set forth under RA 7916, as amended by RA 8748, and its implementing rules and regulations but also by the terms and conditions provided in their Registration Agreement with PEZA. Article II of CCG's Registration Agreement states, viz. : "ARTICLE II Assignment and Transfer 2. The REGISTRANT shall be allowed to lease, sell, assign, mortgage, transfer, or otherwise encumber the area designated as a Special Economic Zone or any interest therein or this Registration Agreement arising therefrom: Provided, however, That with respect to the sale, transfer, assignment or lease of area within the Ecozone as so declared, the same may be made only in favor of entities who are registered or entitled to be registered with PEZA and who in fact subsequently register pursuant to the provisions of Republic Act 7916, as amended, or to entities that are issued permits to locate by PEZA and thus not entitled to avail of the incentives granted by the latter; Provided, further, That any encumbrance or transfer of any right by the REGISTRANT under this Registration Agreement shall be with the prior consent of PEZA, subject to such terms and conditions and/or requirements as it may impose for the sound management, operation and maintenance of the said Ecozone. Any and all rights or interests accruing to third parties in violation of this provision shall not be binding against PEZA." It is evident from the above-quoted provision that CCG shall be allowed to lease, sell, assign, mortgage, transfer or otherwise encumber the area designated as Special Economic Zone provided that such lease, sale , assignment, mortgage, transfer or encumbrance shall be made only in favor of the following: (1) PEZA-registered entities or entitled to be registered with PEZA and who in fact subsequently register pursuant to the provisions of RA 7916 as amended by RA 8748; or (2) entities that are issued permits to locate by PEZA. Accordingly, it is noteworthy that at the time of CCG's sale of an area within the Special Economic Zone to SM Prime, the latter was neither PEZA-registered or entitled to be registered with PEZA nor was issued a permit to locate by PEZA, a clear violation of the Registration Agreement between SRP and PEZA particularly Article II (Assignment and Transfer) thereof. The Supreme Court has held in numerous cases that, "taxation is the rule and exemption is the exception. The burden of proof rests upon the party claiming exemption to prove that it is, in fact, covered by the exemption so claimed. As a rule, tax exemptions are construed strongly against the claimant. Exemptions must be shown to exist clearly and categorically, and supported by clear legal provision." 1 cECaHA Consequently, in absence of clear and convincing proof that SM Prime is an entity allowed to enter into contracts of lease, sale , assignment, mortgage or transfer of area/s designated as Special Economic Zone, CCG shall not be allowed to claim the exemption provided under Section 24 of Republic Act (RA) No. 7916, as amended by RA 8748. Rather than just the location of the property acquired, more importantly are the transactions and parties involved, which must be considered as the significant factors in determining taxation. The taxability of the transaction is determined taken into account the registration of CCG with PEZA as an Ecozone Developer/Operator, which is bound to observe and comply with the terms and conditions provided for in its Registration Agreement with PEZA, including the fact that the area subject of the transaction is part and parcel of the SRP, which was declared as Special Economic Zone by virtue of Presidential Proclamation No. 763 dated 20 January 2005. The factual finding of the Regional Director is also noted that the area sold to SM Prime is classified and would be utilized for commercial purpose. As such, it is outside and not part of, the granted fiscal incentives since areas in the Ecozone are intended for industrial purposes. Thus, the transaction between CCG and SM Prime falls short of being entitled to avail of the 5% tax on gross income earned in lieu of taxes, because it deviates from the conditions for registration of CCG, in order to avail of the incentive. In view thereof, the sale of a portion of SRP by CCG to SM Prime is subject to withholding tax and DST on the sale transaction between CCG and SM Prime. HCISED Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Philippine Amusement and Gaming Corporation (PAGCOR) v. The Bureau of Internal Revenue, G.R. No. 172087, March 15, 2011. Province of Isabela, G.R. No. 165827, June 16, 2006.