Factoring accounts receivable from realty sales
Factoring accounts receivable from realty sales
by Tata D. Panlilio
Since the 1997 Asian financial crisis, the Philippine real estate industry has slowly but surely rebounded to post a 17% growth last year, outperforming the previous year’s 15.4% growth and even the 2004 boom year growth of 16%. This robust performance was driven by increased leasing as a result of expansion of malls and commercial centers; high sales and occupancy of office spaces spurred by the growing Business Process Outsourcing (BPO) sector; and strong demand for residential developments (both horizontal and vertical) fueled by a growing market of urban professionals and surging remittances of Overseas Filipino Workers (OFWs) and Filipino immigrants.
Because of this impressive performance, undoubtedly, the real estate industry is now one of the most important sectors of the economy and a significant source of taxes for the government. As such, it is important that the tax treatment of this sector and all its transactions be made clear. The tax treatment of one of the more common transactions of realty companies, the sale or assignment of accounts receivable (AR) arising from installment and deferred-payment (not on installment) sales of real property to a bank or finance company (the “Factor”) has already been addressed to a large extent in a 2004 ruling issued by the BIR.
Generally, for income tax purposes, gain on installment sales (i.e., payments in the year of sale do not exceed 25% of the selling price) is reported on installment basis and the buyer of the real property, if engaged in business, withholds the 5% creditable withholding tax (CWT) on their installment payments. The VAT on the other hand, is imposed on each installment payment by the buyer, with the realty company issuing its VAT official receipts (OR).
In the case of deferred-payment sales (i.e., payments in the year of sale exceed 25% of the selling price), the gain is reported on cash basis in the year of sale. The buyer withholds the 5% CWT and the VAT is paid up front based on the entire selling price. The realty company issues a VAT-registered invoice for the entire selling price.
In the BIR ruling, the real estate company wanted to sell its AR evidenced by postdated checks (PDCs) of the buyers for both sales made on installment and deferred-payment plans to a Factor on a without recourse
basis in order to increase its liquidity to finance its operations as well as to free itself from the administrative burden of monitoring the AR. “Without recourse
” meant that the risk of insolvency is transferred to the Factor who cannot hold the realty company liable for payment in case the buyers failed to pay.
In resolving the tax issues, the BIR explained in this wise:
1. Sale of AR on Installment Sales
The transfer or assignment of the AR to the Factor effectively resulted in the collection of the balance of the installment price of the realty. The proceeds from the transfer of the AR will be reported as income during the year the AR was sold and should no longer be reported on the installment basis for income tax purposes. Relying on a 2000 Supreme Court ruling, the BIR emphasized that “[W]here an installment obligation is discounted at a bank or finance company, a taxable disposition results xxx as the indebtedness of the buyer is discharged, while the seller acquires money for the settlement of his receivables.” Accordingly, the proceeds of the sale of the AR are not subject to CWT because such payments are for the purchase of AR and not for the sale or assignment of realty. The buyer of the real property is no longer required to withhold the CWT on the installment payments to the Factor because the realty company has already reported for tax purposes the entire income/gain from the sale of the real property upon the sale of t he AR to the Factor.
of VAT, the proceeds of the sale or discounting of the AR without recourse are deemed collections of what would have comprised the realty company’s gross receipts and as such, is subject to VAT.
2. Sale of AR on Deferred-Payment Sales
Inasmuch as the deferred-payment sales are treated as cash sales for tax purposes, the entire gain is reported, and consequently, the entire CWT is paid, in the year of the sale. CWT should no longer be due on the subsequent deferred payments. The sale of the AR did not result in any taxable income for the realty company because the amounts received represent only a collection of previously reported and taxed income. Accordingly, the buyer is no longer required to withhold CWT on their subsequent payments to the Factor because these are being paid not to the realty company-seller but only to the assignee or buyer of the AR.
The sale of the AR is no longer subject to VAT because the tax on the entire selling price of the real property has already been paid at the time of sale.
The ruling also addressed the practical and administrative issue of VAT invoicing requirements.
For installment sales, the realty company should still issue its own VAT ORs in favor of the buyer upon receipt of the report from the Factor confirming the installment payments due. A segregated series of ORs within the BIR-approved series should be set aside for this purpose. This should bear a notation that the ORs are issued as evidence of installment payments made in connection with the transfer of ARs to the Factor and do not constitute additional income for the issuer. This will allow the VAT-registered buyer to credit the input VAT paid on installments falling due after the sale of the AR to the Factor. More importantly, there would be no double availment of input VAT by the buyer nor a double declaration of output VAT by the realty company inasmuch as the latter has already paid in advance the VAT on the remaining installment payments upon the sale of the AR.
For deferred-payment sales, since the full input VAT benefit has already been availed of in the year of purchase, subsequent payments to the Factor will no longer generate input taxes for the VAT-registered buyer. As such, the realty company will be allowed to issue non-VAT receipts but using the segregated OR number series. The OR should indicate that the same were issued as evidence of subsequent payments made by the buyer to the Factor when the latter submits a report to the realty company of the clearing of the PDCs issued by the buyer and do not constitute additional receipts of the issuer.
While the BIR was quite comprehensive in discussing the tax and related invoicing issues arising from sale of AR on installment and deferred-payment sales of realty, the fundamental question regarding the basis of the VAT, whether it should be based on the consideration received for the sale of the AR which would normally be discounted or the face value of the AR sold, was not resolved. Also, the tax treatment of sale of AR on with recourse basis was not covered in the ruling. Under existing Bangko Sentral ng Pilipinas (BSP) circulars, “purchase of receivables executed between real estate developers and buyers on a ‘with recourse’ basis shall be considered loans to real estate developers.”
With the projected growth of the real estate industry, property developers stand to accumulate substantial AR and may find that in the long-run, it may be more cost-efficient to sell their AR to banks or finance companies to enable them to focus solely on the marketing and selling activities. More importantly, if the BSP will be constrained to raise interest rates to tame rising inflation, discounting AR affords realty companies a relatively easy means of raising funds to finance their immediate needs and future expansion plans. The BIR must realize that forging a mutu
ally beneficial partnership with industries that drive economic growth will enable it effectively discharge its mandate. And this partnership begins with tax pronouncements and rulings that are receptive to the needs of taxpayers and fully addresses their concerns.
(The author is a senior tax manager at Punongbayan & Araullo, a member firm within Grant Thornton International Ltd. For comments and inquiries, please e-mail Cristina.Panlilio@pna.ph or call 886-5511.)