BIR Ruling [DA-022-A-06]

February 1, 2006 BIR RULING [DA-022-A-06] BIR Rulings Nos. 007-04, 17-02 Sections 24 (B) (1), 25 (A) (2), (B), 27 (D) (1), 28 (A) (7) (a), (B) (1), 32 (B) (7) (G), 179, NIRC Bureau of the Treasury Intramuros Manila Attention: Omar T. Cruz Treasurer of the Philippines Gentlemen : This refers to your letter dated January 9, 2006, requesting this Office for confirmation of your opinion regarding the tax treatment of your proposed Bond Exchange Offer. It is represented that as part of its Medium Term Capital Market Development initiative, the Department of Finance (DOF) through the Bureau of the Treasury (BTr) is undertaking a Bond Exchange Offer whereby qualified old bonds will be exchanged with fixed principal amount of pre-determined benchmark bonds (Benchmark Bonds) with current market coupon rates. The proposed exchange will involve a par exchange of various small issuances of government securities maturing between 2007 to 2012 for more liquid Benchmark Bonds with three (3), five (5) and seven (7) year maturities, at mid-market prices using MRTN yields and at a face amount equivalent to the value of the Eligible Bonds to be exchanged. The Republic of the Philippines (ROP) intends that each series of Benchmark Bonds will have a minimum principal amount, thus ensuring liquidity for the market. Specifically, under the Exchange, holders of existing Eligible Bonds will receive new Benchmark Bonds based on a ratio of the Clearing Price plus accrued interest of the Eligible Bonds divided by the new issue price of the new Benchmark Bonds. Both the Clearing Price of the Eligible Bonds and the new issue price for the Benchmark Bonds will be calculated after taking into account the effect of withholding tax, as is standard market practice. The price of a bond without withholding tax is calculated by taking all of the future cashflows of the bond and discounting them at a fixed yield to obtain a present value of the cashflows. To determine the price of the benchmark bonds net of the withholding tax, a similar method is followed, the difference being that: (1) the future coupon payments are calculated after the effect of withholding tax has been netted out; and (2) the present value of the cash flows is derived using the net yield of 20% withholding tax. Additionally, the accrued interest on the Eligible Bonds which will be paid in the form of Benchmark Bonds will be calculated after deducting the 20% withholding tax. For instance, the holder of a bond with a 10% stated coupon will only receive payments worth 8% per year after the withholding tax has been deducted. Similarly, if the bond trades at a stated yield of 9%, it would be equivalent to an actual yield of 7.2% following the deduction of the 20% withholding tax. It is further represented that participation in the above exchange is voluntary for holders of Eligible Bonds. The Exchange will be conducted through a Dutch auction process wherein the holders of Eligible Bonds will submit yields at which they offer their bonds in exchange for the Benchmark Bonds, to be accepted by the ROP in accordance with the offering document (the "Offering Circular"). The ROP will set issue yield of the Benchmark Bonds in its sole discretion taking into account the prevailing market rates of comparable securities of 3, 5, and 7-year maturities. caDTSE This bond exchange is intended to spread out the peso obligation of the ROP and enable the National Government to proactively manage its domestic debt and improve and/or build up the peso yield curve by concentrating liquidity on distinct benchmark bonds. Furthermore, the exchange is expected to yield several benefits to the government as well as domestic markets such as: debt management, efficient pricing, development of the government bond market and domestic market enhancement. The salient points of this exchange are enumerated as follows: Principal Commercial Terms Of Benchmark Bonds to be Issued Pursuant to the Exchange Issuer REPUBLIC OF THE PHILIPPINES Issue Amount Target minimum size is an aggregate principal amount of: PhP30 billion for 3-Year Benchmark Bonds; PhP25 billion for 5-Year Benchmark Bonds; and PhP20 billion for 7-Year Benchmark Bonds. Issue Date For the 3-Year Benchmark Bonds, 17 February 2006; For the 5 and 7-Year Benchmark Bonds, 3 March 2006. Form The Benchmark Bonds shall be issued in scripless form. Maturity Date For the 3-Year Benchmark Bonds, 17 February 2009; For the 5-Year Benchmark Bonds, 3 March 2011; and For the 7-Year Benchmark Bonds, 3 March 2013. Issue Price To be determined by the Issuer. Redemption Price At par (or 100%) of face value. Coupon Rate To be determined by the Issuer. Interest Payment Interest on the Benchmark Bonds to be calculated on a 30/360-day basis, will be paid semi-annually in arrears. Each benchmark Bond will cease to bear interest on their respective Maturity Dates. If an Interest Payment Date is not a Business Day, interest will be paid on the next succeeding Business Day, without adjustment to the amount of interest to be paid. Taxation The interest income derived from the Benchmark Bonds shall be subject to the 20% final income tax to be withheld at source at the time the coupon payments are made. The documentary stamp tax on the original issue of the Benchmark Bonds shall be for the account of the Republic. No other taxes shall be collected on an exchange of Eligible Bonds for Benchmark Bonds. Status The Benchmark Bonds constitute direct, unconditional, unsubordinated, and general obligations of the Republic and shall at all times rank pari passu and without any preference among themselves. Sinking Fund The Issuer shall set up and maintain a sinking fund with the Bureau of the Treasury in order to accumulate the amounts necessary to pay the principal of the Benchmark Bonds on their respective Maturity Dates. Eligibilities The Benchmark Bonds qualify in the same manner as all other Treasury Notes and Bonds in respect of: (i) the liquidity floor requirement for government funds and reserves for trust duties under Bangko Sentral ng Pilipinas rules and regulations; (ii) insurance reserves under the Insurance Commission rules and regulations, and (iii) performance and judicial bonds. Finally, it is represented that the above Exchange shall be executed by the ROP through the DOF/BTr on the basis of Republic Act (RA) No. 245, as amended, which authorizes the Secretary of Finance to prescribe the financial terms of any debt instrument, including bonds, to be issued for the purpose. Also, as required under the RA 245, the BTr has already secured the needed Special Authority from the Office of the President and a favorable opinion from the Monetary Board of the Bangko Sentral ng Pilipinas (BSP). You now seek confirmation of your opinion on the following matters: a) that the interest income derived from the new Benchmark Bonds shall only be subject to 20% final withholding tax b) the documentary stamp tax on the original issue of new Benchmark Bonds shall be for the account of the ROP/BTr c) no other taxes shall be collected from the exchange of Eligible Bonds for New Benchmark Bonds In reply, please be informed that the issuance of government debt instruments and securities falls within the coverage of "deposit substitutes" and therefore, interest income derived therefrom shall be subject to the following: (a) 20% final withholding tax imposed under Sections 24 (B)(1) and 25 (A)(2) of the Tax Code of 1997, as amended by RA 9337, if the bondholder is an individual citizen or a non-resident alien engaged in business within the Philippines, respectively; (b) 25% tax imposed under Section 25 (B) of the same Tax Code, if the bond holder is a non-resident alien individual not engaged in trade or business within the Philippines; (c) 20% final tax imposed under Sections 27 (D)(1) and 28 (A)(7)(a), of the same Tax Code, for domestic and resident foreign corporations, respectively; (d) 35% final withholding tax, for non-resident foreign corporation under Section 28 (B)(1) of the same Tax Code, if the bondholder is a non-resident foreign corporation; and, (e) Such other rate that may be imposed under the appropriate tax treaty which the Philippines is a signatory. It bears notice that the final tax on that interest income shall be withheld at source at the time the coupon payments are made, i.e., on a semi-annual basis. Furthermore, any gain that may be derived on the secondary trading of Benchmark Bonds are subject to the following: (1) Benchmark Bonds with a three (3) year maturity date shall be subject to income tax pursuant to the provisions of Sections 24 (A), 25 (A) (1), 27 (A) and 28 (A) of the same Tax Code if the holder-investor is an individual citizen, non-resident alien, domestic corporation, and resident foreign corporation. In case the holder of said Bond is a non-resident individual or corporation whose country/state has tax treaty with the Philippines, the applicable tax treaty provision shall apply. (2) Benchmark Bonds with a five (5) year and 1 day maturity rate as well as those with a seven (7) year maturity date shall be exempt from income tax pursuant to Section 32 (B)(7)(g) of the same Tax Code. On the subject of documentary stamp taxes, Section 6 of RA 9243 provides that: "Sec. 5. Section 180 of the National Internal Revenue Code of 1997, as amended, is hereby renumbered as Section 179 and further amended to read as follows: "SEC. 179. Stamp Tax on All Debt Instruments . On every original issue of debt instruments, there shall be collected a documentary stamp tax of One peso (P1.00) on each Two hundred pesos (P200), or fractional part thereof, of the issue price of any such debt instrument: Provided, That for such debt instruments with terms of less than one (1) year, the documentary stamp tax to be collected shall be of a proportional amount in accordance with the ration of its term in number of days to three hundred sixty-five (365) days: Provided, further, That only one documentary stamp tax shall be imposed on either loan agreement, or promissory notes issued to secure such loan. For purposes of this section, the term debt instrument shall mean instruments representing borrowing and lending transactions including but not limited to debentures, certificates of indebtedness, due bills, bonds, loan agreements, including those signed abroad wherein the object of contract is located or used in the Philippines, instruments and securities issued by the government or any of its instrumentalities, deposit substitute debt instruments, certificates or other evidences of deposits that are either drawing interest significantly higher than the regular savings deposit, taking into consideration the size of the deposit and the risks involved or drawing interest and having a specific maturity date, orders for payment of any sum of money otherwise than at sight or on demand, promissory notes, whether negotiable or non-negotiable, except bank notes issued for circulation." Thus, Benchmark Bonds issued by the ROP are subject to documentary stamp tax pursuant to the aforequoted provision. The payment of the DST shall be made within five (5) days from the close of the month when the taxable document was made, signed, issued, accepted or transferred (Section 5, Revenue Regulations No. 6-2001). However, the retirement of old qualified bonds which will be replaced with the Benchmark Bonds shall not be subject to DST. Neither shall this replacement be subject to income tax, provided that no gain will be realized by the holder from the simple exchange. Any gain shall be subject to income tax; losses are subject to the rules on deductibility. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) JOSE MARIO C. BUAG Commissioner of Internal Revenue