BIR Ruling [DA-053-04]

February 6, 2004 BIR RULING [DA-053-04] 105 DA 313-97; VAT 026-97; 152-95 SGV & Co . 6760 Ayala Avenue Makati City Attention: Mr. Ruben R. Rubio Gentlemen : This refers to your letter dated November 19, 2003 stating that your client, Climax-Arimco Mining Corporation (CAMC) is a corporation organized and existing under the laws of the Philippines and incorporated on July 5, 1990 primarily to render exploration and other related services as well as aspects of technical and management services to individuals, partnerships, associations, and corporations engaged in mining or in any manner, in the acquisition, conveyance, storage, marketing, processing, refining, and distribution of minerals; that CAMC is established as a wholly owned subsidiary of Arimco NL, an Australian public company; that CAMC is originally established to hold exploration interests in the Philippines including the Didipio project in which it acquired a right to earn a 75% interest in March 1991; that Climax Mining Ltd. (CMX) and related parties acquired 74% of the issued share capital of CAMC from Arimco NL [which subsequently became Australian Resources Limited (ARL)] by share acquisition and subscription; that this Agreement provided that CMX would assume the entire funding of CAMC to complete a bankable feasibility study; that the Agreement also provided that monies advanced by ARL to CAMC would be repaid from the proceeds of commercial production; that in December 1992, CMX acquired the remaining 26% equity of ARL in CAMC for cash plus an undertaking to repay from the net proceeds of commercial production (after costs, debt service, taxes, and royalties) the loans advanced by ARL to CAMC; that later, Petsec Energy Ltd. (Petsec) invested in CAMC and subscribed to a 23.4% shareholding; that in October 1994, Malaysian Mining Corporation (MMC) acquired a 17% interest in the Didipio project by purchasing a company called Aumex Philippines, Inc. (Aumex),the other joint venture participant (in the Didipio project);that the acquisition was contested by CMX under the terms of the joint venture agreements and in October 1995, CMX, CAMC and MMC reached an agreement for CAMC to acquire Didipio, Inc. which held all the issued shares in Aumex and hence the 17% interest in the Dipidio project; that on June 20, 1994, CAMC entered into a Financial or Technical Assistance Agreement (FTAA) with the Government of the Philippines for the large-scale exploration development and utilization of minerals over an area in the provinces of Quirino and Nueva Vizcaya for a period of 25 years, renewable for the same period; that the exploration claims relating to the Didipio project were incorporated into the FTAA; that in mid-1996, Petsec sold its 23.4% interest CAMC to CMX; that, on May 20, 1998, the Securities and Exchange Commission (SEC) approved a statutory merger between CAMC (surviving corporation),Didipio, Inc. and Aumex Philippines, Inc. to consolidate the fragmented corporate ownership of the FTAA; that on August 7, 1998, CAMC amended its Articles of Incorporation (approved by SEC on September 11, 1998) changing its primary purposes to include activities involving larger-scale exploration, development and utilization of mineral resources; that CAMC remains a subsidiary of CMX; that pursuant to the FTAA, it was envisage that the role of CAMC is to apply for and hold the FTAA for the benefit of the ultimate project operating vehicle (operating entity) which the former will establish; that for this purpose, the FTAA defines an operating entity as any entity or entities which may be structured and organized to undertake the management, development, mining and processing of ores on the properties or other areas within the exploration contract area and the marketing of the products; that on December 23, 1996, CAMC entered into an Assignment, Accession and Assumption Agreement with an affiliated company, i.e. , Australasian Philippines Mining, Inc. (APMI) relating to the FTAA; that in BIR Ruling No. 152-95 dated October 10, 1995, the Commissioner of Internal Revenue ruled that the said assignment of the FTAA by then Arimco Mining Corporation (now CAMC) to a wholly-owned Philippine subsidiary pursuant to the provisions of the FTAA, is not subject to income tax and/or donor's tax since it does not involve any consideration there is lack of donative intent on the part of the transferor; that the Assignment, Accession and Assumption Agreement is pending registration with the Department of Environment and Natural Resources (DENR); that the organization and pre-operating expenses and plant and equipment remain recorded in the books of CAMC; that APMI, which is also a subsidiary of CMX, is now the ultimate holder of the FTAA, APMI is deemed the proper entity to record the capitalized expenses as the FTAA's Operating Entity; that CAMC shall transfer the said capitalized expenses at book value to the project operating company, APMI; that it is proposed that this will coincide with the registration of the transfer of the FTAA by the DENR; that APMI, also a subsidiary of CMX, was registered with the SEC on July 24, 1996, under the Foreign Investments Act of 1991; that the APMI was established among others, to render exploration and other related services as well as all aspects of technical and management services to individuals, partnerships, associations, and corporations engaged in mining or, in any manner, in the acquisition, conveyance, storage, marketing, processing, refining, and distribution of minerals; that APMI changed its primary purpose on October 15, 1998 to include activities involving large scale exploration, development and utilization of mineral resources; and that the bulk of the expenses to be transferred to APMI consist of organization and pre-operating expenses which substantially pertain to occupation and regulatory fees, option payments, salaries and wages, travel and accommodation, assays, drilling and other contractor services costs, materials and supplies, and other expenses directly incurred by CAMC in the exploration and development activities for the Didipio project and, in particular, the FTAA. Based on the foregoing representations, you now request confirmation of your opinion that the transfer by CAMC of its capitalized expenses to APMI at cost with no profit element is not subject to income tax and to the value-added tax. In reply thereto, please be informed that your opinion is hereby confirmed that the transfer of the capitalized expenses by CAMC to APMI will not result in a taxable transaction. This is so because the amounts that CAMC will receive pursuant to the transfer are mere reimbursements for the costs incurred by CAMC on behalf of the operating entity, as the existence and establishment of which is sanctioned by the provisions of the FTAA. In BIR Ruling No. DA313-97 dated September 10, 1997 citing BIR Ruling No. 001-90 dated January 4, 1990, payments covering the actual and direct costs and expenses without mark-up or profit element incurred by the party asking for reimbursement as well as third party service providers, are mere reimbursements of actual costs and expenses and, therefore, do not constitute taxable income. In addition, this contention was affirmed by the Court of Tax Appeals in Progressive Development Corporation vs. Commissioner of Internal Revenue (CTA Case No. 1549) where the CTA ruled that advances made on behalf of a sister company which will later on be reimbursed by the newly organized affiliate should not result in a taxable transaction on the part of the party making the advance. Accordingly, all expenses incurred for the mining project prior to and pending the actual establishment of the operating vehicle, and prior to the formal and completed transfer of the FTAA to the operating entity, which were merely advanced by CAMC on behalf of the said operating entity, constitute a valid reimbursement and therefore do not constitute taxable income. Moreover, the assignment by CAMC of the FTAA to the operating entity pursuant to the provisions of the FTAA was ruled in BIR Ruling No. 152-95 as not subject to income tax since it does not involve any consideration, nor is it subject to donor's tax since there is no donative intent. Considering that the transfer of the capitalized expenses from CAMC to the operating entity is a necessary incident to the set-up of the operating entity and the transfer of the FTAA pursuant to the provisions of the FTAA, it shall not also result in a taxable transaction. On the other hand, Section 105 of the Tax Code of 1997 provides that any person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, renders services . . . shall be subject to value-added tax. . . . The phrase in the course of business" means the regular conduct or pursuit of a commercial economic activity, including transactions incidental thereto. Thus, the transfer of the capitalized expenses is not subject to VAT because it is not made in the course of trade or business as the aforesaid transfer is merely consistent with the Assignment, Accession and Assumption Agreement with an affiliated company (APMI) relating to the FTAA and is not one carried on with any degree of regularity. Besides, this Office in BIR VAT Ruling No. 026-97 ruled that "...charges/billings made by SMC to its subsidiaries for their use of utilities, common facilities and services purely at cost and without any profit and being merely reimbursements are not subject to the 10% VAT. ...,since SMC does not sell, barter, exchange, or lease any good or property and neither does it render any service to the subsidiaries, .... IN VIEW OF THE FOREGOING, this Office holds that the transfer by CAMC of its capitalized expenses to its operating entity, APMI, at cost and without any mark up is not subject to income tax and value-added tax. 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. EIcSTD Very truly yours, (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group