BIR Ruling [DA-112-A-04]

March 11, 2004 BIR RULING [DA-112-A-04] 34 (B); DA-196-03 Caltex (Philippines),Inc. 10th Floor 6750 Ayala Avenue Makati City Attention: Atty. Nigel T. Avila Tax Manager Finance and Accounting Services Gentlemen : This refers to your letter dated November 17, 2003 stating that Caltex (Philippines),Inc. (CPI) is a domestic corporation organized and existing under the laws of the Philippines; that it is a wholly-owned subsidiary of Chevron Texaco Global Energy, Inc. (CTGEI),formerly Caltex Corporation, a non-resident corporation organized and existing under U.S. laws; that Chevron Texaco Finance B.V. (CTFBV) is a non-resident foreign corporation organized and existing under the laws of Netherlands; that CTFBV is 100% owned by Chevron Finance Holdings Limited, a non-resident foreign corporation organized and existing under Bermuda laws; that Chevron Finance Holdings Limited is also a wholly-owned subsidiary of CTGEI, that CTFBV, being indirectly owned by CTGEI, is an affiliate of CPI; that CTGEI is 100% owned by Chevron Texaco Corporation (CTC),another non-resident foreign corporation based in the US; that CTC is a publicly held/listed corporation and no individual person owns more than 50% of its outstanding capital stock; that presently, CPI has interest bearing US dollar-denominated loans from international financial institutions, the proceeds of which were used to finance the operations, maintenance and repairs of CPI's refinery (the refinery is to be converted into a storage terminal this year) and other downstream petroleum activities; that these US dollar-denominated loans shall be refinanced with loans to be extended by CTFBV under a credit agreement (the Agreement) to be executed by CPI and CTFBV; that under the aforesaid Agreement, CTFBV undertakes to extend loans to CPI, which shall not exceed an aggregate amount of US$400,000,000 outstanding at any one time; that interest at a market rate shall be paid by CPI to CTFBV on any unpaid amount of the loan principal; that CPI shall pay CTFBV a commitment fee on the daily average unused amount of CTFBV's commitment at the rate of 0.05% per annum; that this loan will be submitted to the Banko Sentral ng Pilipinas (BSP) for approval by the Monetary Board prior to its execution; and that upon drawdown, the loan and other required documentation will be submitted to the BSP for registration. In connection therewith, you now request confirmation of your opinion that the interest to be paid by CPI to CTFBV on the refinancing loans is deductible against the corporate income of CPI for income tax purposes. In reply thereto, please be informed that Section 34(B)(l) 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 taxable year on indebtedness in connection with the taxpayer's profession, trade or business shall be allowed as deduction from gross income. For interest to be deductible from gross income, the following are the requisites, viz : (1) There must be an indebtedness; (2) There should be an interest expense paid or incurred upon such indebtedness; (3) The indebtedness must be that of the taxpayer; (4) The indebtedness must be connected with the taxpayer's trade, business or exercise of profession; (5) The interest expense must have been paid or incurred during the taxable year; (6) The interest must have been stipulated in writing; (7) The interest must be legally due; (8) The interest payment arrangement must not be between related taxpayers as mandated in Section 34(B)(2), in relation to Section 36(B), both of the Tax Code of 1997; (9) The interest must not be incurred to finance petroleum operations; and (10) In case of interest incurred to acquire property used in trade, business or exercise of profession, the same was not treated as a capital expenditure. ( Sec. 3, Revenue Regulations No. 13-2000 ) In general, the amount of interest expense paid or incurred within a taxable year on indebtedness in connection with the CPI's trade or business shall be allowed as deduction from its gross income. The term "interest" shall refer to the payment for the use or forbearance or detention of money, regardless of the name it is called or denominated. acCITS However, for the interest to be deductible, said interest payments should not be among the exceptions to deductibility under Section 34(B)(2)(b) and (c) of the Tax Code, which provide (a) ... (b) If both the taxpayer and the person to whom the payment has been made or is to be made are persons specified under Section 36(B);or (c) If the indebtedness is incurred to finance petroleum exploration. Prescinding from the above-cited provision, it is apparent that for the interest to be deductible, the ownership of both corporations (CTFBV and CPI) must be traced to the level of the individual shareholder. (Sec. 36(B), Tax Code of 1997) Considering that both CPI and CTFBV are 100% owned by CTGEI which in turn is wholly-owned by CTC, which are ultimately owned by a publicly-held or listed US corporation, hence, no individual owns directly or indirectly more than 50% of the outstanding capital stock of both CPI and CTFBV. Accordingly, the interest payments by CPI to CTFBV on the refinancing loan are deductible from its gross income for income tax purposes. In BIR Ruling No. UN251-95 dated July 7, 1995, this Office ruled that the disallowance of interest expense arising from indebtedness incurred by Philodrill, a corporation engaged in the exploration of all kinds of petroleum and petroleum products, to fund the payment of various obligations arising from its investment activities, such as acquisition of shares of stock and subscription payments to companies in which it holds equity, has no legal and factual basis. It was also ruled that interest incurred from indebtedness used to finance petroleum operations are not deductible from gross income. Corollarily, under Section 3(d) of PD No. 87, the term "petroleum operations" is defined as searching for and obtaining petroleum within the Philippines through drilling, and pressure or suction or the like, and all other operations incidental thereto. It includes the transportation, storage, handling and sale (whether for export or for domestic consumption) of petroleum so obtained but does not include any: (1) transportation of petroleum outside the Philippines; (2) processing or refining at a refinery; or (3) any transactions in the products so refined. It is clear from the aforesaid definition that petroleum operations refers only to upstream activities ( i.e. ,search and obtaining of petroleum) and not to downstream activities ( i.e. ,importing, exporting, shipping, transporting, processing, refining, storing, distributing, marketing, selling).Hence, interest on loans used to finance, upstream activities is non-deductible while interest relating to loans used for downstream activities is deductible. Accordingly, since the proceeds of the original US dollar-denominated loans subject of refinancing were used for the repair and maintenance of CPI's refineries and in general, for CPI's operations, which are clearly not upstream activities, the interest paid thereon may be claimed as a tax deduction by CPI in the year the interest is paid or incurred. In fine, the interest to be paid by CPI on the loans to be extended by CTFBV for purposes of refinancing CPI's US dollar denominated loans shall be deductible from its gross income pursuant to Section 34(B) of the Tax Code of 1997. ( BIR Ruling No. DA 196-03 dated June 26, 2003 ) 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 Deputy Commissioner Legal & Inspection Group