In determining whether the assets of the Filipino company whose shares are being sold are primarily real estate or real estate, the audited annual financial statements (AFS) are generally used. While the value of the properties listed in RR 04-86 can easily be derived from the AFS, there are ambiguities in the case of contracts for public works. What is a public works contract and how do you rate a public works contract in terms of a double taxation agreement? For a Filipino corporation that has a public works contract and has concession assets, is the Concession Assets per AFS the value used in determining whether the Filipino corporation’s assets are primarily real estate?
A case of the Tax Appeal Court from 2013 (CTA case 8307 dated November 7, 2013) can be helpful in answering this question. In this case, the tax court stated that public works contracts can be interpreted to cover any fixed structure for public use or fixed public infrastructure for public use. It means that work is being carried out, i.e. the construction and maintenance of infrastructure facilities such as national roads, flood protection, water resource development systems, etc.
However, the tax court ruled that the composition of the concession property needs to be examined as it is an intangible asset that needs to be determined whether the underlying component of the concession property is real estate or personal property. In the aforementioned CTA case from 2013, the concession assets consisted of the present value of the total estimated concession fee payments in accordance with the concession agreement and the costs incurred for renovation work (so-called network assets). The tax court has ruled that only part of the network’s assets can be classified as real estate.
The condition that the assets of the Filipino company whose shares are being sold or transferred should not in principle consist of immovable or real estate is not a uniform consideration in other double taxation agreements. Some tax treaties provide different conditions for qualifying for the CGT exemption when selling or disposing of shares.
Take the case of the double taxation treaties (DTA) between the Philippines and the Netherlands and the United Kingdom. These tax treaties do not stipulate that the property of the Filipino company must not consist in principle of real estate so that the profits from the sale of shares are only taxable in the Netherlands or the United Kingdom.
Another contract that provides a different condition for the CGT exemption is the DTA Philippines-Australia. The prerequisite for the application of the CGT exemption is that the assets of the Philippine company whose shares are being sold do not consist of direct holdings in or over land in the Philippines or from exploitation or exploration rights for natural resources in the Philippines. Note that the tax treaty in question uses the word “land” and “natural resources” instead of the broader term “real estate” or “real estate”.
Given the language used in the Philippines-Australia DTA, should the RR 04-86 listing of real estate or real estate be used to determine if the CGT exemption contract condition is met? Or, since the double taxation treaty clearly deviated from the generic term “real estate” or “real estate”, is there no intention to limit the assets to be considered in determining whether or not the CGT exemption applies to land? Resources in the Philippines?
Equating “land” and “rights to exploit or explore natural resources” (as expressly set out in the DTA Philippines-Australia) with “land” or “real estate” has the effect of adding or expanding the terms set out by the contract . Furthermore, it does not conform to the mere rule of meaning or verba legis as interpreted by law that it is not necessary to go beyond the ordinary and literal meaning if the words themselves are clear, unambiguous and free from ambiguity.
The design of a company structure does not end with the establishment or establishment. The tax effects during the holding period must also be considered. And last but not least, you also have to think about an exit strategy so that taxes don’t stumble on the way out.
Mary Karen E. Quizon-Sakkam is a partner and Hanna Karen V. Almario is a senior manager of the steering group at KPMG RG Manabat & Co. (KPMG RGM & Co.), The Philippine member firm of KPMG International. KPMG RGM & Co. has been recognized by the International Tax Review as a tier 1 tax practice and tier 1 transfer pricing practice.
This article is for general informational purposes only and should not be viewed as professional advice on any particular topic or company.
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