Tax Articles

Real Property Taxation: Classification of Taxpayers

By Atty. Fulvio D. Dawilan

Fulvio D. Dawilan Managing Partner   +632 8403 2001 loc.310 This email address is being protected from spambots. You need JavaScript enabled to view it. View Profile

The taxation system governing real property transactions in our jurisdiction is among the most complicated. The complication in the rules often leads to disputes between the property owner or taxpayer and the tax authorities. Among the factors causing these confusions are the nature or proper classification of the property, the classification of the taxpayer or seller and the buyer, the type of transaction involved, the tax base for purposes of computing the tax, the determination of the applicable taxes and tax rates, the party responsible for the payment, and the proper timing for the payment of taxes.

We will dissect each of these factors, but for this issue, I will limit the discussion to the imposable taxes in general and the differences in taxation with respect to the classification of the taxpayer involved in sales of properties located in the Philippines.

Imposable Taxes. There are two types of income tax that may be imposed on sale of real property – the capital gains tax or the ordinary income tax. These types of taxes depend on the classification of the property involved in a sale – whether capital asset or ordinary asset.

Income Tax. Capital assets are subject to the capital gains tax while ordinary assets are subject to the regular income tax. For capital assets, capital gains presumed to be realized from the sale of real properties (land or building) is subject to the 6% capital gains tax. There is a presumed gain because the tax is imposed not on the gain but on the selling price or fair market value (FMV), whichever is higher. Capital gains tax is a final tax, which means that the seller is not required to file and pay tax again on the related income.

Exemptions and special rules on capital gains tax may apply on specific transactions, such as the sale by individuals of family homes and sales to the government and government-owned or controlled corporations.

On the other hand, sale of ordinary asset is subject to the regular income tax rate applicable to the taxpayer. At the same time, the sale is subject to the creditable withholding taxes. The rate of withholding tax depends on the amount of selling price and whether or not the seller is engaged in real estate business. Incidentally, a purchase of real property is the only instance where even individuals not engaged in business are required to withhold. Hence, in practice, it is actually the seller who does the actual remittance of the withholding tax by receiving the full amount of the consideration from the buyer and then remitting the supposed withholding taxes to the tax authority.

As clarified by the Courts, the tax base of the income tax from the sale of real property classified as ordinary asset remains to be the taxpayer’s net income. The taxes withheld are merely advance income tax payments, which are creditable against the income tax due of the seller. Nonetheless, the payment of the correct amount of withholding tax is necessary in securing the Certificate Authorizing Registration for the transfer of the property to the buyer.

Value-Added Tax. Sale of ordinary assets is, as a rule, subject to VAT, unless exemption or special rule applies. On the other hand, sale of capital asset is not subject to VAT.

Documentary Stamp Tax. Classification of properties does not affect the imposition of DST. This tax is imposable on sale of real properties at the same rates for capital and ordinary assets.

Classification of Taxpayers. The classification of properties as to capital or ordinary asset is significant only with respect to specific types of taxpayers. The importance of classification of real properties between capital or ordinary asset does not apply to all taxpayers. Specifically, classification is needed for real property owners who are citizens of the Philippines (resident or non-resident), resident aliens, non-resident aliens engaged in trade or business in the Philippines, and domestic corporations.

For non-resident aliens not engaged in trade or business in the Philippines, the applicable tax on sale of real property is only the capital gains tax. Regular income tax is not applicable. For resident foreign corporations, only the regular corporate income tax applies. It follows that the creditable withholding tax should be withheld and not the capital gains tax. Likewise, classification is not necessary for sale of real properties located in the Philippines by non-resident foreign corporations. The final tax of 25% should be imposed on their sale. Certainly, capital gains tax and the creditable withholding taxes are irrelevant.

The classification of taxpayer can be easily identified. But the classification of the property involved in a sale or other disposition of property presents some complications. We will discuss that in our next issue.

The timing for the payment of taxes on real property transactions is another important matter. There are rules prescribed for taxpayers to follow. But some of those are already outdated. I hope our tax authorities will devise new rules that are aligned with the new practices in the industry and in accordance with the mandate of new laws. Included in that is the impact of the Ease of Paying Taxes Act on the timing for reporting revenues for VAT purposes.

Like any other taxation rules, non-observance of the real property taxation rules may lead to deficiency tax assessment and delay in the transfer of the title of the property to the new owner. It may even result in criminal offense. Observance of the applicable rules is necessary to avoid these consequences.