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What 6% tax are you talking about?

Broad sheets and news channels last Thursday reported Finance Secretary Jose Isidro N. Camacho as having told the Senate Finance Committee that the administration is thinking of proposing legislation to eliminate "the 6 percent capital gains tax on the sale of real estate assets". The rationale for the proposal was purportedly to help in the promotion of the use of banks of asset management companies (AMCs) and the restructuring of bank’s non-performing loans. I am 100 percent sure that media did not get the good secretary right.

In its bare essential, the AMC idea was for a bank to organize, with funders as its partners, a corporation whose primary purpose is to acquire the nonperforming assets of the bank at a discount and to eventually collect on the loans and/or liquefy the real estate holdings. The win-win situation consists in the bank getting some cash for its non-cash assets; the AMC, on the other hand, earns from the loan repayments and conversion of the real estate.

The unanimous sense from the media reports is that the specific transaction the good secretary was talking about was the transfer by the banks of what the banking regulations call the ROPOA, acronym for "real and other properties owned or acquired". If that is so, then my colleagues in the reporting media need some basic information which I gladly now proffer.

The first item to correct is that pieces of real estate owned by the banks as a result of loan foreclosures are not capital assets and therefore their disposition does not attract the capital gains tax of 6 percent imposed by Section 27(D)(5) of the Tax Code.

As early as 1998, the then Commissioner of Internal Revenue Liwayway Vinzons-Chato in a ruling addressed to the Philippine National Bank stated that since the ROPOA are not part of the stock in trade of the banks, nor held by them primarily for sale to customers in the ordinary course of its business nor business property subject to depreciation nor, finally, used in the business of the banks, then they are ordinary assets and "therefore, the sale, exchange or disposition of such properties will not be subject to the capital gains tax imposed under Section 27(D)(5) of the Tax Code of 1997" (BIR Ruling No. 103-98, June 29, 1998).

This was followed by Ms. Chato’s successor, Bethhoven L. Rualo a year later. He held that real estate acquired by a company, whose main business was contracting for aluminum fabrication and installation in condominium projects, by way of dacion en pago or exchange or offset arrangement constitute ordinary and not capital assets on the part of the acquiring company. Their subsequent sale is not subject to the capital gains tax but instead "to the normal corporate income tax imposed under Section 27(A)" of the Tax Code (BIR Ruling No. 071-99).

What may have caused the confusion the minds of those who heard the good secretary was the 6 percent. As stated, the Tax Code imposes 6 percent capital gains tax on the sale, exchange, or disposition of lands and/or buildings which are not actually used in the business of a corporation. This 6 percent is a final tax.

Recently, however, the sale of real property classified as an ordinary asset, where the seller is not habitually engaged in the real estate business, was made subject to a 6 percent withholding tax. It used to be 7.5 percent, but was reduced to 6 percent by Revenue Regulations No. 6-2001 issued last July 31, 2001. This 6 percent (which used to be 7.5 percent) is, and had always been, not a final tax, but a creditable withholding tax. This means that this 6 percent is a mere advance payment of the tax due (just like the 20 percent withholding on talent fees) and will eventually be taken into account when the seller files its final corporate income tax, usually on April 15 of the succeeding year.

But what clinches the argument that the secretary was not correctly heard is the fact that 6 percent, whether by way of final tax or simply creditable withholding tax, is too expensive for the banks to bear. Thus, it is almost a certainty that they will try to avoid the payment of the 6 percent by transferring their ROPOA under the conditions covered by Section 40(C)(2) of the Tax Code. This part of the Tax Code provides for the recognition of neither gain nor the loss when property is transferred to a corporation by a person in exchange for stock or unit of participation in such corporation of which as a result of such exchange, said person, alone or together with others not exceeding four persons, gains control of the corporation. Since the funding partners of the banks in the AMCs are foreigners, control of the AMC on the part of the transferring banks is an inevitability because corporations owning land in the Philippines must be owned at least 60 percent by Filipinos.

The long and short of all these is that banks do not need to have any tax abolished prior to their taking the AMC route of ridding their balance sheets of their ROPOAs. What they direly need are funders who are willing to put in their funds in the AMC as well as, perhaps more important, a realization on the part of the banks that funders will come in only if there is money to be made. That money should come, at least partly by way of a hair cut on the banks themselves who should be willing to transfer their ROPOA at realistic, meaning rock bottom prices, and not from the government by way of the abolition of standing tax rules. After all, their ROPOAs grew to their current level due, in no small measure to the way they do business.