BIR Ruling [DA-161-04]

April 5, 2004 BIR RULING [DA-161-04] 22 (Y) 035-01; 017-02 Punongbayan & Araullo 20th Floor, Tower I The Enterprise Center 6766 Ayala Avenue Makati City Attention: Atty. Benedicta Du-Baladad Tax Partner Gentlemen : This refers to your letter dated March 26, 2004 stating that your client, Security Bank Corporation (SBC), is a corporation organized under Philippine laws and currently operates as a universal bank; that as of September 2003, SBC is ranked among the top ten (10) private domestic commercial banks in terms of assets, deposits, loan, capital and return of equity based on the data taken from the Bangko Sentral ng Pilipinas (BSP); that SBC issued P300 million worth of "Series B" Unsecured Subordinated Notes (Series B Notes) as Tier 2 capital; that said "Series B" Notes have a maturity of ten (10) years; that the notes constitute direct, unconditional, unsecured and subordinated obligations of the Bank, and at all times, will rank pari passu in right of payment with all existing and future unsecured and subordinated obligations of SBC; that the net proceeds from the issuance will be used by the SBC to provide additional Tier 2 capital in order to strengthen the capital base of the Bank; that these "Series B" Notes were issued by the Bank to only twelve (12) qualified institutional investors at the time of the original issuance; that these institutional investors are limited to domestic corporations and resident foreign corporations only; that the salient features of these "Series B" Notes are tabulated hereunder: Features Series B Notes Total Amount P300,000,000.00 Denomination Minimum P500,000 Governing Regulations BSP Memorandum dated February 17, 2003 and Circular No. 280 on the issuance of unsecured subordinated debt instruments eligible as Tier 2 capital Issue Price 99.541% of the face value of each Note Issue Date January 30, 2004 Settlement Date Issue Date Offer Period From January 19, 2004 to January 23, 2004, or such later day as may be determined by SBC and Lead Manager Interest Rate 11.875% per annum payable for the period from and including the Issue Date up to but excluding the last date of the 10th Interest Period (if call option is not exercised) or the Call Option Date (if Call Option is exercised) Interest Period Consecutive six calendar month from Issue Date up to 6th month from Issue Date, and every succeeding 6 calendar month period thereafter until Maturity Date Call Option On the Call Option Date, upon (1) 30 day prior notice to Noteholders and (2) prior BSP approval subject to the following conditions such as: (a) the capital adequacy ratio of SBC is at least equal to the required minimum ratio; (b) the Note is simultaneously replaced with the issues of new capital which are neither small in size nor lower in quality than the original issue, all outstanding Notes may be redeemed at the instance of the Issuer by paying the face value of the Note plus accrued interest at the Interest Rate Maturity Date Last day of the twentieth (20th) Interest Period from Issue Date Maturity Value Notes redeemed on maturity Date at their face value plus unpaid accrued applicable interest Form Scripless and will be maintained in electronic form with the Registry Public Trustee Trust Services Department of the Development Bank of the Philippines Selling Agents ING Bank N.V., Manila Branch, BDO Capital & Investment Corporation, Multinational Investment Bancorporation and To a limited extent, Security Bank Corporation that the Bank likewise issued "Series A" Notes amounting to P2.7 billion, which is a separate issue from that of "Series B" Notes; that "Series A" and "Series B" Notes have different features in terms of amount, issue price and interest rate; that these were issued separately from each other and at different issue dates; that consequently, they have different maturity dates; that in addition, the notes were issued to two (2) different sets of investors; that "Series A" Notes were issued exclusively to specified eligible noteholders, which include Filipino citizens, resident aliens, non-resident aliens engaged in trade or business; that "Series B" Notes were issued to institutional investors such as domestic corporations and resident and foreign corporations; and that eligible noteholders of Series A are prohibited as noteholders of "Series B" and vice-versa. In connection therewith, you now request confirmation of your opinion that Series B Notes issued by SBC to not more than nineteen (19) institutional investors are not deposit substitutes and therefore, the interest income or yield derived therefrom is not subject to the twenty percent (20%) final withholding tax but forms part of the ordinary income of the institutional investors subject to the regular corporate income tax of 32%. In reply thereto, please be informed that Section 22(Y) of the Tax Code of 1997 defines deposit substitutes as "an alternative form of obtaining funds from the public (the term "public" means borrowing from twenty (20) or more individual or corporate lenders at any one time), other than deposits, through the issuance, endorsement, or acceptance of debt instruments for the borrower's own account, for the purpose of relending or purchasing of receivables and other obligations, or financing their own needs or the needs of their agent or dealer. These instruments may include, but need not be limited to, banker's acceptances, promissory notes, repurchase agreements, including reverse repurchase agreements entered into by and between the Bangko Sentral ng Pilipinas (BSP) and any authorized agent bank, certificates of assignment or participation and similar instruments with recourse: Provided, however , That debt instruments issued for inter-bank call loans with maturity of not more than five (5) days to cover deficiency in reserves against deposit liabilities, including those between or among banks and quasi-banks, shall not be considered as deposit substitute debt instruments." HTSIEa It is clear from the above-cited section that in order to be classified as deposit substitutes, the borrowing of funds must be obtained from twenty (20) or more individuals or corporate lenders at any one time. Thus, for purposes of determining whether the borrowing is from the public, the number of investors shall be counted as of the time of origination or original issuance of the instrument, regardless of whether the bonds are thereafter traded or sold in the secondary market. ( BIR Ruling Nos. 017-02 dated April 29, 2002; 035-01 dated August 16, 2001 ) In the instant case, since these Series B Notes were issued by SBC to only twelve (12) qualified institutional investors at the time of the original issuance, the same are not deposit substitutes as contemplated in Section 22(Y) of the said Code. Consequently, the interest income or yield to be paid by SBC to the institutional investors or corporations will not be subject to the 20% final withholding tax. SUCH BEING THE CASE, the interest income or yield derived by the institutional investors from the Series B Notes, which are not deposit substitutes, issued by SBC are not subject to the 20% final withholding prescribed in Section 27(D)(1) of the Tax Code of 1997. However, it will form part of the gross income of the institutional investors subject to the regular corporate income tax rate of 32% either imposed in Sections 27(A) and 28(A) of the said Code, as the case may be. 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