November 10, 1986 January 1, 1987

REVENUE REGULATION NO. 19-86

SUBJECT : Taxation of Leases

TO : All Internal Revenue Officers and Others Concerned

SECTION 1. Purpose. — These regulations pursuant to Section 277 of

the National Internal Revenue Code, prescribe the rules to govern the tax treatment
and lease agreements and provide guidelines for determining whether certain
transactions purporting to be leases of tangible personal property are in reality
conditional sales contracts.

PART A

INCOME TAX

SECTION 2. Reporting of Income and Deductions by a Lessor or a

Vendor.

2.01 Lessor if contract is a lease — The amount paid for the use of
property under an agreement which is determined under these regulations to be a
lease shall be considered as rental ( and therefor includible in gross income) of
the lessor. Such lessor may deduct all ordinary and necessary expenses paid or
incurred during the taxable year which are attributable to the earning of the
income. In addition, the lessor, with respect to properties subject to an
"operating lease" as defined in subparagraph 2.01/1 of this Section, will be
allowed a deduction for depreciation determined pursuant to Section 30 (f) of
the National Internal Revenue Code (NIRC) and the Regulations thereunder:
Provided, however, that tangible personal properties listed in Annex "A" of
these Regulations which are subject to "finance lease" (as defined in
subparagraph 2.01/2 of this Section) may be depreciated during the primary
lease period but such period shall not be less than 60% of the depreciable life of
the property as indicated in Annex "A". If, under the agreement, the lessee pays
to the lessor a stipulated rental, and in addition pays certain other expenses
which are properly payable by the lessor, the lessor is deemed to have received

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 as rental income not only the stipulated rental but also the amount of such other
expenses paid by the lessee to, or for the account of, the lessor.

2.01/1 Operating lease defined — An "operating

lease" is a contract under which the asset is not wholly
amortized during the primary period of the lease, and where the
lessor does not rely solely on the rentals during the primary
period for his profits, but looks for the recovery of the balance
of his costs and for the rest of his profits from the sale or
re-lease of the returned asset of the primary lease period.

2.01/2 Finance lease defined — "Finance lease"

or full payout lease is a contract involving payment over an
obligatory period (also called primary or basic period) of
specified rental amounts for the use of a lessor's property,
sufficient in total to amortize the capital outlay of the lessor
and to provide for the lessor's borrowing costs and profits. The
obligatory period refers to the primary or basic non-cancellable
period of the lease which in no case shall be less than 730 days.
The lessee, not the lessor, exercises the choice of the asset and
is normally responsible for maintenance, insurance and such
other expenses pertinent to the use, preservation and operation
of the asset. Finance leases may be extended, after the
expiration of the primary period, by non-cancellable secondary
or subsequent periods with the rentals significantly reduced.
The residual value shall in no instance be less than five per
centum (5%) of the lessor's acquisition cost of the leased asset.

2.02 "Packaged lease" not taxable as a

corporation — A "package lease" or "lease package" shall not
be considered as a joint venture or association taxable as a
corporation as defined in Section 20(b) of the National Internal
Revenue Code.

2.03 "Packaged Lease" or "Lease Package"

defined — A lease package refers to that type of finance lease
which has two or more lessors, particularly if the size of the
lease facility is substantial relative to the exposure limits of a
lessor. Under a lease package, the lead lessor either invites one
or more lessors to participate as a co-lessor in the funding
lease. Consequently, two or more lessors may have
co-ownership of a single leased item, proportionate to their

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 participation. For the purpose of this subparagraph, the lessors
in a lease package shall be limited to finance and leasing
companies registered under Republic Act No. 5980.

2.04 Taxation of income derived from

"'package leases" — The rental income derived from a
packaged lease shall be taxable directly to each of the
participating lessors in their individual capacity, the respective
shares of which shall be determined in accordance with their
sharing agreement. Any gain or loss derived by the lessor who
sells the lease contracts or lease receivables to one or more
buyers shall be taxed as ordinary gain or loss. To compute
ordinary gain or loss, the outstanding principal value of the
lease as determined in Annex "B" shall be deducted from the
selling price.

2.05 Vendor, if contract is a conditional sale

— If the agreement is determined to be a sale, the amounts
received under the contract by the vendor will be considered to
be payments which are part of the sales price to the extent such
amounts do not represent interest other charges.

SECTION 3. Deductions Allowable to Lessee or Purchaser.

3.01 Lessee, if contract is a lease — If under the criteria set forth in

these Regulations, an agreement constitutes a lease, the lessee may deduct the
amount of rent paid or accrued, including all expenses which under the terms of
the agreement the lessee is required to pay to, or for the account of, the lessor. If
the payments are so arranged as to constitute advance rentals, such payments
shall be duly apportioned over the lease term. In computing the term of the
lease, all options to renew, shall be taken into consideration if there is a
reasonable expectation that such options will be exercised.

3.02 Vendee, if contract is a conditional sale — If under the provisions

of these Regulations, the agreement is to be treated as a sale, the amounts paid
to the vendor will be considered as payments which are part of the purchase
price to the extent such amounts do not represent interest or other charges. acd

SECTION 4. General criteria for characterizing an agreement as a

conditional sale.

4.01 Statutory basis for distinguishing a lease from a sale — A lease is

a contract whereby one of the parties (lessor) binds himself to give to another
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 (lessee) the enjoyment or use of a thing for a price certain, and for a period
which may be definite or indefinite (Article 1643, Civil Code). In other words, a
lease is an agreement between a lessor and a lessee giving the lessee possession
and use of a specific property upon payment of rentals over a period of time.
The lessor retains ownership of the asset so that it shall not become the property
of the lessee or any related third party during the term of the lease. On the other
hand, a sale is a contract whereby one of the contracting parties (seller or
vendor) obligates himself to transfer ownership of and to deliver a determinate
thing while the other party (buyer or vendee) obligates himself to pay for said
thing a price certain in money or its equivalent. (Article 1458, Civil Code.)

4.02 Characterizing a transaction that does not readily fit statutory

concepts — In cases where the true character of the transaction cannot be
definitely determined from the terms and conditions of the agreement, the
Commissioner shall make the determination on the basis of all relevant facts and
circumstances of each transaction, among which are (but not limited) those
indicated in the following subparagraphs.

4.03 Factors to be considered.

4.03/1 In general. Whether an agreement, which in form is

a lease, is in substance a conditional sales contract depends upon the intent
of the parties as evidenced by the provisions of the agreement, read in the
light of the facts and circumstances existing at the time the agreement was
executed. In ascertaining such intent no single test or any special
combination of tests is absolutely determinative. No general rule,
applicable to all cases can be laid down.

4.03/2 Compelling persuasive factors. A contract or

agreement purported to be a lease shall be treated as conditional sales
contract if one or more of the following compelling persuasive factors are
present:

(A) The lessee is given the option to purchase

the asset at anytime during the obligatory period of the
lease, notwithstanding that the option price is
equivalent to or higher than the current fair market
value of the asset;

(B) The lessee acquires automatic ownership

of the asset upon payment of the stated amount of
"rentals" which under the contract he is required to

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 make;

(C) Portions of the periodic rental payments

are credited to the purchase price of the asset;
cdtai

(D) The receipts of payment indicate that the

payment made were partial or full payments of the
asset.

4.03/3 Absence of compelling persuasive factors. — In the

absence of the above compelling persuasive factors or contrary
implication, an intent warranting treatment of a transaction for tax
purposes as a purchase and sale rather than as a lease or rental agreement,
may in general be said to exist if, for example, one or more of the
following conditions are present:

(a) Portions of the periodic payments are

made specifically applicable to an equity to be acquired
by the lessee.

(b) The property may be acquired under a

purchase option, at a price which is nominal in relation
to the value of the property at the time when the option
may be exercised, as determined at the time entering
into the original agreement, or which is a relatively
small amount when compared with the total payments
which are required to be made.

SECTION 5. Advance Ruling Required to Recognize Existence of a lease.

— The parties to a lease agreement may secure from the Commissioner an advance
ruling recognizing the fact that an agreement actually constitutes a lease for tax
purposes. In cases where a lessor is engaged in the leasing business and frequently
enters into a contract with various lessees under the same or essentially similar terms
and conditions, the lessor may submit a model lease agreement on which to base an
advance ruling. Thereafter, any specific lease agreement entered into by the lessor and
a lessee which does not substantially deviate from the terms and conditions of the
model contract on the basis which the advance ruling had been secured, need not be
submitted for advance ruling. casia

PART B

GROSS RECEIPTS TAX

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 SECTION 6. Basis of the Gross Receipts Tax

6.01 The rental amounts received by a lessor from a lessee under an

agreement qualifying as a finance lease as defined in Section 2.01/2 of these
Regulations shall be divided into two components, namely principal and interest
to be arrived at using either the Annuity or the Sum-of-the-Years-Digits method
of accounting. The amount representing interest shall be determined in
accordance with the formulae prescribed in Annex "B".

6.02 The amount of interest, if the same is derived by a finance and

leasing company registered under R.A. 5980 shall be subject to the gross
receipts tax prescribed in Sections 260 and 261 (as amended by PD 1739) of the
National Internal Revenue Code based on the remaining maturity of the lease.
Amounts which the lessee, under the agreement, pays to the lessor (in addition
to a stipulated rental) for certain other expenses properly payable by the lessor
(as described in Section 2.01) shall be excluded for purposes of the gross
receipts tax determined under this subparagraph.

6.03 If the lessor is a person other than a finance and leasing company
registered under R.A. 5980, then the rentals resulting from the lease agreement
shall be subjected too the 4% contractor's tax imposed under Section 205 of the
National Internal Revenue Code.

6.04 If the lessor is a finance and leasing company registered under R.A.
5980 and sells its lease contract or merely sells its receivables (and therefore
retains title to the equipment), the rental amount received by the buyer shall be
subjected to the pertinent provisions governing corporate taxation under the
NIRC without prejudice to the exemptions and benefits allowed by special laws.
casia

SECTION 7. Effectivity. — These regulations shall take effect on January

1, 1987 and shall be applicable to all leases written on or after the said date." (As
amended by Revenue Regulations No. 22-86 dated December 16, 1986.)

(SGD.) JAIME V. ONGPIN

Minister of Finance

Recommending Approval:

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 (SGD.) BIENVENIDO A. TAN, JR.
Commissioner of Internal Revenue

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