Capital Asset vs.

Ordinary asset
One of the frequent concerns of a taxpayer who disposes or transfers his property is the resulting tax
consequences. Proper classification of the property to be disposed of or transferred is imperative in order
to determine the correct applicable tax. A question which must be first addressed is whether it is a capital
asset or ordinary asset.
Section 39 of the Tax Code defines the term capital assets by the process of exclusion. The term capital
assets means property held by the taxpayer (whether or not connected with his trade or business), but
does not include the following: stock in trade of the taxpayer or other property of a kind which would
properly be included in the inventory of the taxpayer if on hand at the close of the taxable year; property
held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business;
property used in the trade or business, of a character which is subject to the allowance for depreciation ;
and real property used in trade or business of the taxpayer.
From the foregoing, capital assets are generally properties that are not used in trade or business of the
taxpayer. On the other hand, ordinary assets are properties used in trade or business or primarily held for
sale by the taxpayer.
The sale of capital assets (land and/ or building) is subject to capital gains tax at the rate of six percent
based on the gross selling price or fair market value at the time of sale, whichever is higher and the
corresponding documentary stamp tax (DST). Conversely, sale of ordinary assets is subject to the
creditable withholding tax at a rate ranging from 1.5 percent- 6 percent and consequently to ordinary
income tax, corresponding DST and likewise to the 12 percent VAT.
Nevertheless, one vital point which must also be considered is the conversion of the classification of the
properties. Take for instance, if a taxpayer suffering from financial distress decides to cease its business
operations leaving its properties formerly used in business as idle and abandoned. If those properties
were subsequently disposed of, what would then be the classification? Would they maintain their
classification as ordinary assets? Or will they be converted into capital assets?
Section 3(4) (e) of Revenue Regulations (RR) No. 07-2003 provides for the guidelines in determining
whether a particular real property is a capital asset or an ordinary asset. It provides that real properties
formerly forming part of the stock in trade of a taxpayer engaged in the real estate business, or formerly
being used in the trade or business of a taxpayer engaged or not engaged in the real estate business,
which were later on abandoned and became idle, shall nonetheless continue to be treated as ordinary
assets. Real property initially acquired by a taxpayer engaged in real estate business shall not result in its
conversion into a capital asset even if the same is subsequently abandoned or becomes idle. However,
properties classified as ordinary assets for being used in business by a taxpayer engaged in the business
other than real estate business are automatically converted into capital assets upon showing of proof that
the same have not been used in business for more than two (2) years prior to the consummation of the
taxable transactions involving said properties.

Ordinary Tax vs. Final Tax

Section 24. Income Tax Rates.
(A) Rates of Income Tax on Individual Citizen and Individual Resident Alien of the
Philippines.
(1) An income tax is hereby imposed:
(a) On the taxable income defined in Section 31 of this Code, other than
income subject to tax under Subsections (B), (C) and (D) of this Section,
derived for each taxable year from all sources within and without the
Philippines be every individual citizen of the Philippines residing therein;
(b) On the taxable income defined in Section 31 of this Code, other than
income subject to tax under Subsections (B), (C) and (D) of this Section,
derived for each taxable year from all sources within the Philippines by an
individual citizen of the Philippines who is residing outside of the Philippines
including overseas contract workers referred to in Subsection(C) of Section
23 hereof; and
(c) On the taxable income defined in Section 31 of this Code, other than
income subject to tax under Subsections (b), (C) and (D) of this Section,
derived for each taxable year from all sources within the Philippines by an
individual alien who is a resident of the Philippines.
The tax shall be computed in accordance with and at the rates established in the
following schedule:

Not over P10,000

5%

Over P10,000 but not over P30,000

P500+10% of the excess over P10,000

Over P30,000 but not over P70,000

P2,500+15% of the excess over P30,000

Over P70,000 but not over P140,000

P8,500+20% of the excess over P70,000

Over P140,000 but not over P250,000

P22,500+25% of the excess over P140,000

Over P250,000 but not over P500,000

P50,000+30% of the excess over P250,000

Over P500,000

P125,000+34% of the excess over P500,000 in

1998.

Provided, That effective January 1, 1999, the top marginal rate shall be thirty-three
percent (33%) and effective January 1, 2000, the said rate shall be thirty-two percent
(32%).
For married individuals, the husband and wife, subject to the provision of Section 51
(D) hereof, shall compute separately their individual income tax based on their
respective total taxable income: Provided, That if any income cannot be definitely
attributed to or identified as income exclusively earned or realized by either of the
spouses, the same shall be divided equally between the spouses for the purpose of
determining their respective taxable income.