Sales of Real Property or Land are subject to either Value Added Tax or Capital Gains Tax
Navigating the financial landscape of real estate transactions is complex, and is fraught with significant implications. One of the key aspects that property sellers need to understand is the tax implications of their transactions. This article, building upon another a previous discussion on the classification of real property or land as either an ordinary asset or a capital asset, focuses on the crucial decision of when to pay either the twelve percent (12%) Value Added Tax (VAT) or the six percent (6%) Capital Gains Tax.
The choice between these two tax rates is not arbitrary. It is dictated by the nature of the asset being sold, as defined by specific rules and regulations. Misclassification can lead to financial penalties and legal complications. Therefore, it is of utmost importance to make an informed decision.
When to Pay Value Added Tax (VAT) in Sales of Real Property or Land
To determine whether a transaction involving real property is subject to Value Added Tax (VAT), the requisites laid down by law and the pertinent regulations of the Bureau of Internal Revenue must be present. Thus, the following are the requisites to determine whether a transaction involving real property is subject to VAT:
a. The transfer must be in the nature of sale or transaction deemed sale;
b. The transfer must have been in the ordinary course of trade or business or incidental thereto;
c. The real property must be considered as an “ordinary asset” as opposed to a “capital asset”.[1]
When a Transaction is considered as a “Transaction Deemed Sale”
There exists a contract ofsalewhen one of the contracting parties obligates himself to transfer the ownership of and to deliver a determinate thing, and the other to pay therefor a price certain in money or its equivalent.[2]
On this note, Section 106(B) of the NIRC, as amended, in relation to Section 4.106-7 of Revenue Regulation No. 16-2005, as amended explains when a transaction is deemed a sale subject to VAT, to wit:
“SEC. 4.106-7. Transactions Deemed Sale. –
(a) The following transactions shall be “deemed sale” pursuant to Sec. 106 (B) of the Tax Code:
(1) Transfer, use or consumption not in the course of business of goods or properties originally intended for sale or for use in the course of business. Transfer of goods or properties not in the course of business can take place when VAT-registered person withdraws goods from his business for his personal use;
x x x.” [Emphasis and underscoring supplied.]
Hence, if the sale of real property or land is a sale in the course of business, the Bureau of Internal Revenue will consider the transaction as one that is subject to Value Added Tax.
Real Property or Land Sale made in the Ordinary Course of Business
Section 105 of the NIRC, as amended, clearly states that a transaction is subject to VAT if made in the course of business or incidental thereto. For clarity, pertinent provision of the law provides:
“Section 105. Persons Liable. – Any person who, in the course of trade or business, sells barters, exchanges, leases goods or properties, renders services, and any person who imports goods shall be subject to the value-added tax (VAT) imposed in Sections 106 to 108 of this Code.
The value-added tax is an indirect tax and the amount of tax may be shifted or passed on to the buyer, transferee or lessee of the goods, properties or services. This rule shall likewise apply to existing contracts of sale or lease of goods, properties or services at the time of the effectivity of Republic Act No. 7716.
The phrase ‘in the course of trade or business’ means the regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto, by any person regardless of whether or not the person engaged therein is a nonstock, nonprofit private organization (irrespective of the disposition of its net income and whether or not it sells exclusively to members or their guests), or government entity.
The rule of regularity, to the contrary notwithstanding, services as defined in this Code rendered in the Philippines by non-resident foreign persons shall be considered as being course of trade or business. [Emphasis and underscoring supplied]
xxx
Section 106. Value-Added Tax on Sale of Goods or Properties.
(A) Rate and Base of Tax. – There shall be levied, assessed and collected on every sale, barter or exchange of goods or properties, a value-added tax equivalent to twelve percent (12%) of the gross selling price or gross value in money of the goods or properties sold, bartered or exchanged, such tax to be paid by the seller or transferor.
(1) The term ‘goods or properties’ shall mean all tangible and intangible objects which are capable of pecuniary estimation and shall include:
(a) Real properties held primarily for sale to customers or held for lease in the ordinary course of trade or business;
xxx” [Emphasis and underscoring supplied.]
Moreover, the Supreme Court held in the case of Commission of Internal Revenue vs. Magsaysay Line, Inc., et. al.[3] that:
“Yet VAT is not a singular-minded tax on every transactional level. Its assessment bears direct relevance to the taxpayer’s role or link in the production chain. Hence, as affirmed by Section 99 of the Tax Code and its subsequent incarnations, the tax is levied only on the sale, barter or exchange of goods or services by persons who engage in such activities, in the course of trade or business. These transactions outside the course of trade or business may invariably contribute to the production chain, but they do so only as a matter of accident or incident. As the sales of goods or services do not occur within the course of trade or business, the providers of such goods or services would hardly, if at all, have the opportunity to appropriately credit any VAT liability as against their own accumulated VAT collections since the accumulation of output VAT arises in the first place only through the ordinary course of trade or business.
That the sale of the vessels was not in the ordinary course of trade or business of NDC was appreciated by both the CTA and the Court of Appeals, the latter doing so even in its first decision which it eventually reconsidered. We cite with approval the CTA’s explanation on this point:
In Imperial v. Collector of Internal Revenue, G.R. No. L-7924, September 30, 1955 (97 Phil. 992), the term “carrying on business” does not mean the performance of a single disconnected act, but means conducting, prosecuting and continuing business by performing progressively all the acts normally incident thereof; while “doing business” conveys the idea of business being done, not from time to time, but all the time. [J. Aranas, UPDATED NATIONAL INTERNAL REVENUE CODE (WITH ANNOTATIONS), p. 608-9 (1988)]. “Course of business” is what is usually done in the management of trade or business. [Idmi v. Weeks & Russel, 99 So. 761, 764, 135 Miss. 65, cited in Words & Phrases, Vol. 10, (1984)].
What is clear therefore, based on the aforecited jurisprudence, is that “course of business” or “doing business” connotes regularity of activity. In the instant case, the sale was an isolated transaction. The sale which was involuntary and made pursuant to the declared policy of Government for privatization could no longer be repeated or carried on with regularity. It should be emphasized that the normal VAT-registered activity of NDC is leasing personal property.
This finding is confirmed by the Revised Charter of the NDC which bears no indication that the NDC was created for the primary purpose of selling real property.
The conclusion that the sale was not in the course of trade or business, which the CIR does not dispute before this Court, should have definitively settled the matter. Any sale, barter or exchange of goods or services not in the course of trade or business is not subject to VAT.
x x x.” [Emphasis and underscoring supplied.]
The provisions above-quoted clearly indicate that the transaction must have been done in the course of trade or business or incidental thereto in order for the transaction to be subject to VAT. To be considered as a transaction done in the ordinary course of trade or business, there must be regularity of the transaction and it must be in pursuit of an economic or commercial activity.
If the sale of Real Property or land was not regular in the sense that the same was a one-time transaction, and/or the seller/taxpayer is not engaged in real estate business or any business where the property is considered as an ordinary asset, the sale is not subject to Value Added Tax. To reiterate, only the sale of real property or land in the ordinary course of business, or the sale of real property or land which is considered as an ordinary asset, is subject to Value Added Tax.
When Real Property or Land is Classified as an Ordinary Asset
When what is being sold is Real Property or Land that is considered by the Bureau of Internal Revenue as an ordinary asset, the sale will be subject to Value Added Tax. Only sales of capital assets are not subject to Value Added Tax. Instead, sales of Real Property or Land which are considered as capital assets are assessed the lower tax of six percent (6%) capital gains tax as opposed to the Value Added Tax of twelve percent (12%).
The Bureau of Internal Revenue defines ordinary assets as all real properties specifically excluded from the definition of capital assets under Sec. 39(A)(1) of the Code, namely a) stock in trade of a taxpayer or other real property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year; b) real property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business; c) real property used in trade or business (i.e., buildings and/or improvements) of a character which is subject to the allowance for depreciation, or c) real property used in trade or business of the taxpayer. Also, real properties acquired by banks through foreclosure sales are considered as their ordinary assets. There are special rules to follow in determining whether real property or land is classified as either an ordinary asset or a capital asset.
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[1] Section 105, National Internal Revenue Code.
[2] Art. 1458, Civil Code of the Philippines.
[3] G.R. No. 146984, 28 July 2006.
