BIR Ruling [DA-083-06]

March 6, 2006 BIR RULING [DA-083-06] 34 (B) (1); DA-315-2004 Luis Caete & Company 3F Oftana Building Jasmin cor. Don Mariano Cui Sts. Cebu City Attention: Mr. Luis A. Caete Gentlemen : This refers to your letter dated January 12, 2006 requesting on behalf of your client, City Savings Bank, Inc. for a ruling that it is not subject to tax arbitrage pursuant to Section 34(B)(1) of the Tax Code of 1997 on its interest expense on savings and time deposits. It appears that City Savings Bank, Inc. (originally Cebu City Savings and Loan Association, Inc.) is a thrift bank registered with the Securities and Exchange Commission (SEC) on December 9, 1965. The Corporation was issued a Certificate of Authority to operate as a stock savings and loan association under Republic Act No. 3779, otherwise known as the Savings and Loan Association Act by the Monetary Board on December 29, 1965. In carrying its purpose as a thrift bank, it solicited savings and time deposits from bank depositors, thus incurring interest expense on such deposits. City Savings Bank, Inc. did not obtain loans from the Bangko Sentral ng Pilipinas (BSP) or other financial institution to finance its operations. The Bank is required to maintain at any given time certain percentage of its cash as deposit with the BSP and/or other financial institutions pursuant to Banking Regulations in relation to its deposit liabilities, the interest income from which deposits is subjected to the final tax of twenty percent (20%). In reply, please be informed that Section 34(B)(1) of the Tax Code of 1997, as implemented by Revenue Regulations No. 13-2000, provides that the amount of interest paid or incurred within a year on indebtedness in connection with the taxpayer's profession, trade or business shall be allowed as deduction from gross income; Provided, however, that the taxpayer's otherwise allowable deduction for interest expense shall be reduced by an amount equal to the following percentages of the interest income subjected to final tax: Forty-one percent (41%) beginning January 01, 1998; Thirty-nine percent (39%) beginning January 01, 1999; and Thirty-eight percent (38%) beginning January 01, 2000. As a rule, the amount of interest expense paid or incurred within a taxable year on indebtedness in connection with a taxpayer's trade, business or practice of profession shall be allowed as a deduction from the gross income. As distinguished from a tax arbitrage scheme, wherein the proceeds of a taxpayer's loan obtained in connection with the operations of his trade, business or exercise of profession is deposited or invested, and the interest income derived from the said investment had been subjected to the final withholding tax, the interest expense incurred from such loan shall be reduced by an amount equal to the above-mentioned percentages of the interest income subjected to final tax. DIETcC The purpose of the tax arbitrage is to equalize the tax liability of the taxpayer on his interest income and the tax benefit on his interest expense. Thus, in order to obtain the objective of the law to equalize the tax liability of the taxpayer of his interest income and the tax benefit on his interest expense, the interest expense shall be reduced by 38% to the extent of the interest income subjected to final tax, provided, that the maximum interest income to be considered for purposes of the said provision shall not be higher than the interest expense. (BIR Ruling No. DA-315-2004 dated June 8, 2004) Since the receipt of savings and time deposits from its depositors is not an arbitrage scheme, interest expense incurred by City Savings Bank, Inc. on its savings and time deposits is therefore, not subject to the tax arbitrage pursuant to Section 34(B) of the Tax Code of 1997. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be ascertained that the facts are different, then this ruling shall be considered as null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service