Who pays the taxes?

Once upon a time, a seller sold a condo. He was very accommodating to the buyer, agreeing to almost all requests. Among these was a request to deduct the Capital Gains Tax (CGT) from his net proceeds and let their broker handle the transfer, to which he agreed as it was standard practice.

On closing day, the seller received the calculated net proceeds and thought he could now live happily ever after.

Or so he believed.

Four years after the sale was completed, he received a billing from the BIR for value-added tax (VAT), along with significant penalties amounting to millions.

Discussion:

In sale transactions, it is common practice for buyers to deduct taxes from the seller's net proceeds. This ensures taxes are paid within the allowed time frame, especially since many things can go wrong between the closing date and the tax payment deadline. For instance, the seller must find time to spend half a day at the bank to have the Manager's Checks (MCs) made. Therefore, it is in the buyer's best interest to withhold the taxes to ensure taxes are paid on time (and the title transfer is completed).

However, a potential issue arises if the BIR classifies the property as an "ordinary asset" (used for business). In this case, the tax changes from CGT to Creditable Withholding Tax (CWT). Since the tax rates for CGT and CWT are usually the same (i.e., 6%), the amount withheld can ALSO be paid as CWT. When CWT is filed instead of CGT, the transaction almost always becomes subject to VAT—unknown to the seller. Since VAT payment is not a prerequisite for title transfers, the seller almost never receives a bill for it. In this case, the seller received the bill for VAT four years after the transaction.

The lesson here is clear: control is key. As the seller, you want to pay the taxes yourself to ensure the correct ones (i.e., CGT) are paid. As the buyer, you want to handle the tax payment to ensure they are paid on time and to retain the flexibility to pay CWT if necessary.