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The BIR reverses the Supreme Court!

(Article published in the Aug 18,2003 issue of TODAY, Business Section)

          When  Atty. Allan Paguia, whom I taught Taxation and not Remedial Law when he was a student at the Ateneo Law School, recently suggested that the Sandiganbayan, in effect reverse the Supreme Court, the entire nation eagerly watched with bated breath how the legal curiosity would pay itself out.  The Sandiganbayan, it is now history, demurred.

            Something of the kind, however, occurred the few months earlier while nobody was watching, but unfortunately for my admittedly sui generis student, he could not claim the credit for it.  The achievement belongs to BIR Commissioner Guilermo L. Parayno Jr. and Finance Secretary Jose Isidro N. Camacho, neither of whom learned their taxation from me.  In an issuance dated December 27, 2003, but received by the BIR Records Section on February 11, 2003, at 4:52 p.m., the good commissioner recommended and the good secretary approved Revenue Regulations 7-2003.

            Revenue Regulations 7-2003 provides the guidelines to be used by all and sundry in determining whether a particular piece of real property is a capital asset or an ordinary asset.  Those guidelines, for the most part, repudiate the principles behind the case of Tomas Calasanz, et al v. Commissioner of Internal Revenue, G.R. L-26284, promulgated by the Supreme Court on October 9, 1986.

            Calasanz involved a taxpayer who inherited a large parcel of agricultural land.  In order to liquidate her inheritance, the taxpayer had the land   surveyed and subdivided into lots. After putting in roads, gutters, drainage and lighting a system, the lots were sold to the public at a profit. 

            One of the issues before the Supreme Court was whether the gains from the sales were capital gains (because the subdivided lots were considered “capital assets”) or ordinary gains (because the lots were classified as “ordinary assets”).  The tax consequences of the lots being capital assets are, naturally, significantly different from the tax consequences of their being ordinary assets.  In deciding the issue, the Supreme Court thought it useful to state what the law is on how to determine whether a sale is one of a capital asset or of an ordinary asset. 

To start with, Calasanz recognized that there was no rigid rule or fixed formula by which it can be determined with finality whether property sold by a taxpayer was a capital or an ordinary asset.  Said the Supreme Court: “Although several factors or indices have been recognized as helpful guides in making a determination, none of this is decisive; neither is the presence nor the absence of these factors conclusive.  Each case must in the last analysis rest upon its own peculiar facts and circumstances.”

In a footnote, the Supreme Court, to illustrate the number and the variety of the items to be looked into, called on one of its earlier decisions, Tuason, Jr. v. Lingad, 58 SCRA 170, which listed a number of factors to be considered in determining the correct boundary between a capital and an ordinary asset.  These factors were: (a) the purpose for which the property was initially acquired; (b) the purpose for which the property was subsequently held; (c) the extent to which improvements, if any, were made to the property of the taxpayer; (d) the frequency, number and continuity of sales; (e) the extent and number of the transactions involved; (f) the ordinary business of the taxpayer; (g) the extent of advertising, promotion, or other activities used in soliciting buyers for the sale of the property; (h) the listing of property with brokers; and (i) the purpose for which the property was held at the time of sale.

That an asset maybe a capital at one time but be ordinary at time of sale, and vice versa, is clearly acknowledge when the Supreme Court observed that “a property initially classified as a capital asset may thereafter be treated as an ordinary asset if a combination of factors indubitably tend to show that the activity was in furtherance of or in the course of the taxpayer’s trade or business.”  In order words, the characterization of being a “capital” or an “ordinary” asset changes and is not cast in stone.  Undoubtedly that situation requires a process where both the taxpayer and the tax collector must use their brains in order to correctly determine whether an asset is capital or ordinary.  Apparently, however, the use of brains was considered by whoever thought of the regulations to be dangerous to the financial health of the country.  Hence, Revenue Regulations 7-2003.  

Here are some no-brainer guidelines from Revenue Regulations 7-2003. 

Real properties acquired by banks through foreclosure sales are, following a ruling issued on June 29, 1998 (BIR Ruling 103-98), considered as their ordinary assets because, I assume, foreclosing real-estate mortgages is part of a bank’s business and the banks may thereby be classified as being the real-estate business.  But the banks are not considered to be habitually engaged in the real-estate business for the purpose of the withholding tax duty imposed on sellers of real estate.  This fine distinction, appreciated only by astute, results in larger withholding tax on sales made by banks of their ROPOAS.

A property purchased by a taxpayer engaged in the real-estate business for future use in the business, even though this purpose is later thwarted by circumstances beyond the taxpayer’s control, does not lose its character as an ordinary asset.  Nor does a mere discontinuance of the active use of property change its character previously established as a business property.  As the French are said to say, once a whore, always a whore.  

For taxpayers who are not engaged in the real-estate business, real properties which are used or being used or have been previously used in the trade or business of the taxpayer shall be considered ordinary assets.

To leave no doubt, the regulations reiterate, that “so long as the property is or has been used for business purposes, whether for the benefit of the owner or any of its members or stockholders, its shall be considered as an ordinary asset.”

In the case of a taxpayer who changed its real-estate business to a nonreal estate business, or who amended its articles of incorporation from a real-estate business to a nonreal estate business, the change of business or amendment of the primary purpose of the business shall not result in the reclassification of real property held by it from ordinary asset to capital asset.

All real properties originally acquired by a taxpayer engaged in the real-estate business shall not result in its conversion into a capital asset even if the same is subsequently abandoned or becomes idle.

It is bad enough that all these are contrary to the Supreme Court’s pronouncement that the purpose for which the property was initially acquired, the purpose for which it was subsequently held, and the purpose for which the property was held at the time of the sale are to be all considered in making the needed determination.

But this one takes the cake: A taxpayer whose primary purpose of engaging in business, or whose Articles of Incorporation states that its primary purpose is to engage in real-estate business shall be deemed to be engaged in the real-estate business.  This means that if a corporation whose primary purpose, as stated in its Articles of Inc., is to engage in the business of developing subdivisions, buys, as its first and only transaction after incorporation, a parcel of land and then uses it instead to raise chickens for commercial purposes – a secondary purpose stated in the same articles – that corporation will be considered as engaged in the real-estate business.

My heart goes out to Allan Paguia.  He took the wrong train to fame, undoubtedly in good faith, and will now be remembered as one who knows his tax better than he knows his remedial law.  But then again his is a better fate than that of whoever crafted Revenue Regulations 7-2003.  Commissioner Parayno and Secretary Camacho would not want to remember that one at all.