BIR Ruling [DA-124-04]

March 22, 2004 BIR RULING [DA-124-04] 32 (B) (7) (g) 035-01; 017-02; 026-02; 02-03 Punongbayan & Araullo 20th Floor, Tower 1 The Enterprise Center, 6766 Ayala Avenue Makati City Attention: Atty. Benedicta Du-Baladad Tax Partner Gentlemen : This refers to your letter dated February 10, 2004 stating that your client, Metropolitan Bank and Trust Company (Metrobank) is a domestic corporation organized and existing under the laws of the Philippines and operating as a universal bank; that its principal place of business is located at Metrobank Plaza, Sen. Gil Puyat Avenue, Makati City; that it provides services such as deposit products, loans and trade finance, domestic and foreign fund transfers, treasury, foreign exchange, trading and remittances, trust services incident to its operation as a bank; that Metrobank is registered with the BIR as a payor of income tax and other taxes arising from its operations; that it operates a Regular Banking Unit (RBU) and a Foreign Currency Deposit Unit (FCDU) for which separate tax identification numbers (TINs) were secured as required. under existing BIR Rules; that FCDU is a unit of the bank authorized by the Bangko Sentral ng Pilipinas (BSP) to engage in foreign currency-denominated transactions pursuant to the provisions of R.A. No. 6426, as amended; that in the course of its business operations, Metrobank regularly invests in debt securities, such as bonds, debentures, or other certificate of indebtedness, issued by private entities and by the government, or any of its political subdivisions, agencies and instrumentalities; that these are purchased either from the primary or secondary markets; that the investments in foreign currency-denominated debt instruments are transacted through the FCDU; and that the debt securities are either held until maturity or held principally with the intention of selling them in the near future. In connection therewith, you now request for an opinion as to whether or not the gains realized by the FCDU of Metrobank from the sale or exchange or retirement of bonds, debentures or other certificate of indebtedness with a maturity of more than five (5) years fall within the ambit of the exclusion from gross income as provided for in Section 32(B)(7)(g) of the Tax Code of 1997. In reply thereto, please be informed that the taxation of income of an FCDU of a domestic bank is governed by Section 27(D)(3) of the Tax Code of 1997, to wit: "(3) Tax on Income Derived under the Expanded Foreign Currency Deposit System. Income derived by a depository bank under the expanded foreign currency transactions with local commercial banks, including branches of foreign banks that may be authorized by the Bangko Sentral ng Pilipinas (BSP) to transact business with foreign currency depository system units and other depository banks under the expanded foreign currency deposit system, including interest income from foreign currency loans granted by such depository banks under said expanded foreign currency deposit system to residents, shall be subject to is final income tax at the rate of ten percent (10%) of such income. "Any income of nonresidents, whether individuals or corporations, from transactions with depository banks under the expanded system shall be exempt from income tax." From the foregoing provisions as implemented by Revenue Regulations No. 10-98, it is clear that income derived by an FCDU from foreign currency transactions with residents of the Philippines, including commercial banks, local branches of foreign banks and other depository banks under the foreign currency deposit system, shall be subject to final withholding tax of ten percent (10%) based on gross income. Moreover, should the concerned FCDUs realize a trading gain or the subsequent sale of the FCDU T-Notes, then the net trading gain would also be subject to the 10% final tax under Section 27(D)(3) and Section 28(A)(7)(b), both of the Tax Code of 1997. This, however, is not without exception. Gains realized from the sale or exchange or retirement of bonds, debentures or other certificate of indebtedness with a maturity of more than five (5) years are excluded from gross income by clear provision of Section 32(B)(7)(g) of the Tax Code of 1997, to wit: "Sec. 32. Gross Income . xxx xxx xxx (B) Exclusion from Gross income. The following items shall not be included in gross income and shall be exempt from taxation under Title II of the Tax Code: (7) Miscellaneous Items . xxx xxx xxx (g) Gains from the Sale of Bonds, Debentures or other Certificate of Indebtedness. gains realized from the sale or exchange or retirement of bonds, debentures or other certificate of indebtedness with a maturity of more than five (5) years. A careful scrutiny of the above-cited sections disclosed that Section 27(D)(3) of the Tax Code of 1997 subjects foreign currency deposit units from the 10% final income tax. On the other hand, Section 32(B)(7)(g) excludes whatever gains derived from the sale, exchange or retirement of bonds, debentures or other certificate of indebtedness with a maturity of more than five (5) years from gross income. The application of this exclusion from gross income and the corresponding exemption from income tax had been consistently confirmed by this Office in various rulings, to cite few examples: (a) BIR Ruling No. 035-01 dated. August 16, 2001 Section 32(B)(7)(g) of the Tax Code of 1997 exempts from income tax gains realized from the sale or exchange or retirement of PEACe Bonds issued by the Republic of the Philippines with maturity of more than 5 years; (b) BIR Ruling No. 017-02 dated April 29, 2002 Any gain realized from the sale or exchange or retirement of the BCDA Bonds '07 issued by the Bases Conversion and Development Authority with tenor of 5 years and 1 day, is excluded from the gross income; hence, exempts from income tax pursuant to the above-cited Section 32(B)(7)(g) of the Tax Code; (c) BIR Ruling No. 026-02 dated June 27, 2002 Since zero coupon bonds to be issued by Home Guaranty Corporation have a tenor of 5 years and 1 day, any gain realized from their sale or exchange or retirement is excluded from gross income; hence, exempt from income tax pursuant to the above-cited Section 2(B)(7)(g) of the Tax Code. The items enumerated in Section 32(B) of the Tax Code are excluded from gross income and therefore exempt from tax imposable under Title II, i.e. , Section 22 to Section 83 of the Tax Code of 1997, inclusive. The exemption applies to all tax on income that would otherwise be payable under Title II of the Tax Code of 1997, without providing for exception. The taxation of income of an FCDU of a domestic bank is governed by Section 27(D)(3) of the Tax Code of 1997 which is embraced under Title II of the Tax Code of 1997. Accordingly, any income derived by an FCDU, while generally subject to 10% final tax under Section 27(D)(3) of the Tax Code of 1997, are exempt from income tax if falling under Section 32(B) of the same Code. Moreover, in BIR Ruling No. 020-01 dated May 31, 2001, this Office, in applying and interpreting Section 32(B)(7)(g) of the Tax Code of 1997, ruled that "The exemption from income tax and from the withholding tax on the income derived from the sale of bonds with maturity of more than five (5) years is given by law as an incentive to encourage cash savings in such investment securities and to develop both the capital market as well as the secondary market for these investments. Thus, the appellation, kind or form under which the bonds come is immaterial for the purpose of recognition of the income tax exemption for so long as the gains are derived from bonds with maturity of more than five (5) years ." (emphasis supplied) The exemption does not distinguish as to the type of currency the bond, debentures or other certificate of indebtedness is made nor does it discriminate as to the nature of the business of the taxpayer involved in the transaction. Accordingly, the exemption in Section 32(B)(7)(g) applies to the transaction itself regardless as to who derives the gains such that, as long as the gain is derived from the sale or exchange or retirement of bonds, debentures or other certificate of indebtedness, it is exempt from income tax without qualification. IN VIEW OF THE FOREGOING, this Office holds that gains realized by Metrobank on its FCDU transactions, from the sale, exchange or retirement of bonds, debentures or other certificate of indebtedness with a maturity of more than five (5) years shall be excluded from gross income as prescribed in Section 32(B)(7)(g) of the Tax Code of 997 and consequently from the final income tax of 10% imposed under Section 27(D)(3) of the same Code. This ruling is being issued on the basis of the forgoing 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. TcHCIS Very truly yours, (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal & Inspection Group