ITAD Ruling No. 148-04

December 17, 2004 ITAD RULING NO. 148-04 Article 34, Vienna Convention on Diplomatic Relations Sec. 233 & 271, Local Gov't. Code of 1991 Revenue Regulations No. 12-2001 VAT Ruling No. 008-00 BIR Ruling No. 030-96 Department of Foreign Affairs 2330 Roxas Boulevard, Pasay City Philippines Attention: Mr. Wilfredo R. Cuyugan Director, Immunities and Privileges Office of Protocol Gentlemen : This refers to your letter dated October 6, 2003 with the information that the Government of Brunei Darussalam, through its Embassy in Manila, plans to purchase real estates in the Philippines for its Chancery and official residence, and seeks, assistance concerning the applicable rate of annual taxes imposed on real properties of foreign missions. In reply, please be informed that under Sections 233 and 271 of the Local Government Code of 1991, local government units are mandated to fix a uniform rate of basic real property tax applicable to their respective localities, the proceeds of which exclusively accrue to them, stated as follows: (1) Provinces not exceeding one percent (1%) of the assessed value of real property, and (2) Cities and Municipalities in the Metropolitan Manila Area not more than two percent (2%) of such assessed value. The proceeds of the tax are shared with the municipalities and barangays. In relation thereto, Article 34 of the Vienna Convention on Diplomatic Relations, pertinent portion of which reads: "Article 34 "A diplomatic agent shall be exempt from all dues and taxes, personal or real, national, regional or municipal, except: a) indirect taxes of a kind which are normally incorporated in the price of the goods and services; xxx xxx xxx" Based on the afore-quoted provision, it is clear that the tax exemption privilege of an Embassy and its diplomatic agents does not include exemption from indirect taxes such as value-added Tax (VAT). However, applying the principle of reciprocity, this, Office may grant VAT exemption to the Embassy of Brunei Darussalam on its local purchases of goods and/or services, it appearing from the list submitted by the Department of Foreign Affairs that Government of Brunei Darussalam allows similar exemption to Philippine Embassy and/or its diplomatic personnel on their purchases of goods and services in your country. TaDSHC As regards the seller of goods or services, it is noteworthy that sales by a VAT-registered entity under the above circumstances shall be treated as effectively zero-rated transactions. [Sec. 4.100-3, Revenue Regulations No. 7-95] In this jurisdiction, the grant of VAT exemption alone would mean that the sellers shall bear the burden of the tax if they will not be allowed to pass-on the VAT to an exempt embassy. To enable local sellers to refund the amount of the tax inputted into the cost of services supplied to an exempt entity, VAT zero-rating is resorted to. In other words, from the point of view of the VAT-registered seller, although the sale of services to an exempt embassy is a taxable transaction for VAT purposes, the process of zero-rating operates to nullify the output tax on the part of the local supplier and the input tax on his own purchase of services related to such effectively zero-rated sale becomes available as tax credit or refund. ( VAT Ruling No. 008-00 dated February 7, 2000 ) Treated as effectively zero-rated transactions, the VAT-registered seller of services town exempt embassy is required to file an application and secure prior approval for zero-rating to be able to claim tax credit/refund on VAT (input tax) previously paid. The said application shall be filed, before an initial sale, with the Audit Information, Tax Exemptions and Incentives Division (AITEID) of this Bureau, which, when approved, shall be effective for 12 months from the date of issuance of the approval. (Revenue Memorandum Circular No. 17-96). Without an approved application for effective zero-rating, the transaction otherwise treated to as zero-rated shall be considered exempt. Consequently, failure on the part of a VAT-registered seller to secure an approval for effective zero-rating of said transaction will result in the forfeiture of his entitlement to claim tax credit/refund on the (VAT) input tax passed on to him. [Secs. 4.107-1(d), 4.102-2 and 4.103-1, Revenue Regulations No. 7-95] In other words, sale of services to an exempt embassy requires a prior approved application for zero-rating in order to consider such sale to be effectively zero-rated. ( BIR Ruling No. 030-96 dated February 27, 1996 ) Furthermore, the seller of the real property classified as capital asset shall be the one responsible for the payment of the capital gains tax involved in said purchase, which is, a final tax of six percent (6%) based on the gross selling price or current fair market value as determined in accordance with Section 6(E) of the Tax Code of 1997, regardless of whether the seller is an individual or corporation, as provided for in Sections 24(D)(1) and 27(E) of the same Code. However, in case of sale of real property classified as ordinary asset held by the seller in the pursuit of his profession, trade or business, the ordinary rules of income tax would apply, hence, any gain shall be reported as ordinary business income, and any loss, if such be the case, can have an offsetting effect. Nonetheless, in case where the seller is not habitually engaged in real estate business, he shall be liable to pay the six percent (6%) creditable withholding tax on any gain derived thereon. ( RR No. 12-2001 dated September 7, 2001 ) Lastly, the seller shall likewise be directly liable for the payment of the documentary stamp tax as provided for under Section 173, in relation to Section 196 of the Tax Code of 1997 which is Fifteen Pesos (P15.00) for each One Thousand Pesos (P1,000.00) or fractional part thereof in excess of One Thousand Pesos (P1,000.00) of such consideration or value. We trust that we have satisfied your query. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service