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Gentlemen :
This refers to your letter dated October 28, 1997 requesting clarification
regarding the tax treatment of advance rentals/security deposits in lease contracts,
based on the following facts;
Case 1
Questions —
(a) "Is Mr. A (lessor) required to declare the entire P24,000 as his
taxable income during the year it was received (1997) or can he declare only
such portion as will correspond to the rental income during the taxable year, i.e.
P3,000 for 1997; P12,000 for 1998; and P9,000.00 for 1999?"
In reply, please be informed that in BIR Ruling No. 69-011 dated October 3,
1969, this Office citing US precedents, held that if the advance payment is, in fact,
prepaid rental, then such payment is taxable to the lessor in the year when received,
even though the lessor is on the accrual or cash method of accounting. On the part of
the lessee, such prepaid rental is to be treated as capital expenditure and he cannot
deduct in the year of payment the full amount of the prepaid rent as business expense
but must spread them over the entire remaining term of the lease.
Accordingly, and in line with the said BIR ruling which is still being enforced
by this Office to date, Mr. A (lessor) is required to declare the entire amount of
P24,000.00 as his taxable income for the year 1997 when he received the same. On
the other hand, X company (lessee) cannot deduct the entire amount of P24,000.00 as
deductible expense in its income tax return for the year 1997 but must amortize the
same over the entire period of the lease. ITCHSa
For the same reason, the advance rental payment is reportable as income in the
year of receipt even if there is a stipulation that same is to be applied or credited as
rentals for the last two years of the contract, i.e., for October 1, 2006 to September 30,
2007.
Case II
Questions —
(c) "Is BIR Ruling No. 69-011 dated March 3, 1969 still valid and
applicable? Or has the same been rescinded or amended?"
And in BIR Ruling No. 144-88 dated April 18, 1988, this Office ruled as
follows:
"In reply, please be informed that if the advance payment made pursuant
to a Lease Contract is in the nature of a security deposit for the faithful
performance of certain obligation of the lessee, the lessor realizes no taxable
income in the year the advance payment is received. However, if the advance
payment is a security deposit and the conditions which make the security
deposit the property of the lessor occur; then the lessor realizes a taxable
income to the extent of the security deposit and the lessee is entitled to a
deduction to that same extent. (Estate of George E. Baker, 13 BTA 562 in BIR
Ruling No. 011-69 dated October 3, 1969)". In short, the answer to the question
of whether or not the amount of P15,000.00 will be declared as income on the
part of Lessor B and correspondingly deductible expense on the part of lessee
ABC will depend on the nature of said security deposit. STcAIa
And finally, as aforestated, BIR Ruling No. 069-11 dated March 3, 1969 is still
valid and being enforced by this Office.