BIR Ruling [DA-230-05]

May 19, 2005 BIR RULING [DA-230-05] SGV & Co. 6760 Ayala Avenue Makati City Attention: Atty. R.C. Vinzon Gentlemen : This refers to your letter dated December 29, 2004 stating that your client, Bayan Telecommunications, Inc. (Bayantel) is a corporation duly organized and existing under the laws of the Philippines with principal office address at No. 234 Roosevelt Avenue, Del Monte, Quezon City; that it is a subsidiary of Bayan Telecommunications Holdings Corporation, a holding company that is also incorporated in the Philippines; that Bayantel is the holder of a legislative franchise to provide telecommunications services of all types; that the National Telecommunications Commission has authorized Bayantel to provide and operate the following major services; local exchange carrier, international gateway facility, leased line service, and cellular mobile telephone systems; that Bayantel suffered recurring net losses of P7,713,200 and P5,214,300 during the years ended December 31, 2003 and 2002, respectively; that as of those dates, its current liabilities exceeded its current assets by P33,431,200 and P29,225,700, respectively; that the company's financial position is such that its auditors have expressed the existence of a material uncertainty which may cast doubt on Bayantel's ability to continue operations normally; that in order to address this problem, Bayantel requested its creditors for the restructuring of its bank loans and bonds payable; that the debt restructuring plan includes, among others, the extension of the repayment of terms of Bayantel's outstanding loans and bonds, reduction in interest rates and conversion of certain debt into equity; that on July 30, 2003, one of Bayantel's creditors, for and on behalf of the bond creditors of Bayantel, filed a Petition for Corporate Rehabilitation of Bayan Telecommunications, Inc. with the Pasig Regional Trial Court; that the court approved the financial rehabilitation of the company subject to the following clarifications and/or amendments: 1. All creditors will be treated equally and that this equal treatment will be extended to all payment terms and treatment of past due interest; 2. Secured creditors can continue to hold on to their security or collateral, which can be foreclosed if the rehabilitation fails and creditors resort to liquidation; 3. The level of sustainable debt shall be amortized over a period of 19 years; 4. Unsustainable debt shall be converted into an appropriate instrument that shall not be a financial burden for the company; 5. All provisions relating to equity in the rehabilitation plan must strictly conform to the requirements of the Constitution limiting foreign ownership to 40%;and 6. All Monitoring Committee shall be formed composed of representatives from all classes of the restructured debt. The Receiver's role shall be limited to monitoring and overseeing the implementation of the rehabilitation plan. IaEASH that the change in the payment scheme does not include the reduction of the principal liability but only the reclassification of the debt into sustainable (68.933% of the total debt) and unsustainable debt (31.067% of the total debt),recalculation of interest expense based on lower interest rates provided by the court, which also form part of the unsustainable debt, and the waiver of penalties; and that pursuant to the rehabilitation plan, Bayantel shall continue to pay interest on the portion of its debt classified as sustainable debt. Based on the foregoing, you now request confirmation of your opinion that the interest expense to be paid by the company on its debt payments as mandated by a court-approved debt restructuring plan is an allowable expense for income tax purposes. In reply thereto, please be informed that Section 34 (B) of the Tax Code of 1997, as implemented by Section 3 of Revenue Regulations No. 13-2000 provides that for interest to be deductible from gross income, the following are the requisites: (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) 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. Corollarily, Section 4 (B) of Revenue Regulations No. 13-2000 provides that the amount of interest expense paid or incurred by a taxpayer in connection with his trade, business or exercise of a profession from an existing indebtedness shall be reduced by an amount equal to 38% of the interest income earned which had been subjected to final withholding tax. This limitation shall apply regardless of whether or not a tax arbitrage scheme was entered into by the taxpayer or regardless of the date when the interest bearing loan and the date when the investment was made for as long as, during the taxable year, there is an interest expense incurred on one side and an interest income earned on the other side, which interest income had been subject to final withholding tax. .... In general, the amount of interest expense paid or incurred within a taxable year on indebtedness in connection with the taxpayer's trade or business shall be allowed as deduction from 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. It is clear from the foregoing, that since the conditions prescribed in Revenue Regulations No. 13-2000 had been complied with, as the debt rehabilitation plan of Bayantel was duly approved by the court and is now being implemented, the interest expense to be paid by the company on its debt payments is an allowable expense for income tax purposes. ( BIR Ruling No. DA112-A-04 dated March 11, 2004 ) TIcAaH 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