Maynilad Water Services, Inc.

April 18, 2008 BIR RULING [DA-249-08] 27 (A); 32 (A); DA 209-06; DA-166-04; 117-99 Maynilad Water Services, Inc. G/F Eng'g Bldg., MWSS Compound Katipunan Road, Balara Quezon City Attention: Mr. Randolph Estrellado Chief Financial Officer Gentlemen : This refers to your letter dated February 11, 2008 requesting for confirmation as to the tax consequences of the realization of foreign exchange gain arising from the settlement of your company's outstanding foreign currency-denominated debt. As represented, Maynilad Water Services, Inc. ("MWSI") is registered with the Board of Investments (BOI) as an operator of water supply and sewerage system for the Metro Manila west service area, under BOI Registration Certificate No. 92-201 dated January 13, 1998; that under its BOI registration, MWSI is entitled to income tax holiday (ITH) of six years beginning August 21, 2001 as granted under BOI Management Committee letter dated January 6, 1997; that MWSI has a pending application with the BOI for the extension of its ITH incentive and expects to receive favorable confirmation of this extension within 2008; that on November 13, 2003, MWSI filed a Petition for Rehabilitation with Prayer for Suspension of Actions and Proceedings with the Regional Trial Court of Quezon City Branch 90 (hereinafter, the "Rehabilitation Court"); that subsequently or on April 29, 2005, MWSI entered into a Debt and Capital Restructuring Agreement (DCRA) with its major bank and shareholder creditors, which Agreement constitutes the Company's rehabilitation plan; that the DCRA was approved by the Rehabilitation Court on June 1, 2005; that pursuant to the DCRA and after a process of competitive public bidding and selection, DMCI-MPIC Water Company, Inc. ("DMCI-MPIC") was designated as the assignee of MWSS's subscription right to additional shares of MWSI; that on January 19, 2007, the SEC approved all transactions undertaken by MWSI in relation to its capital restructuring, including the increase in its capital stock, whereupon DMCI-MPIC became the owner of approximately 84% of MWSI's outstanding capital stock; that in compliance with the requirements of MWSS, DMCI-MPIC resolved to achieve the early exit of MWSI from rehabilitation proceedings by contributing cash to MWSI to enable the latter to pre-pay its foreign obligations, thus MWSI entered into a Prepayment and Settlement Agreement ("PSA") with its bank creditors, and other shareholders including MWSS and DMCI-MPIC, whereby DMCI-MPIC obligated itself to make a cash contribution to MWSI, which cash contribution will be used to settle MWSI's outstanding foreign currency denominated loans; that pursuant to the PSA, all of MWSI's foreign-currency-denominated loans were settled as of January 16, 2008; that MWSI expects the settlement of its foreign-currency denominated obligations to generate foreign exchange gains ( "forex gains", for brevity); that MWSI is obliged to pass on the forex gains from the loan settlement to its customers, pursuant to Amendment 1 of the Concession Agreement between MWSI and MWSS; and that the pass on of these forex gains to customers will be in the form of an offset against the billings to its customers. From the foregoing, you are requesting confirmation of your opinion as follows: 1) The foreign exchange gain that will result from the settlement of MWSI's foreign currency-denominated loans will be taxable at the regular corporate income tax rate of 35% or at the minimum corporate income tax rate; and 2) The off-set of the forex gains against billings to customers can be deducted from the foreign exchange gain that will be subjected to the regular corporate income tax /MCIT. In reply, please be informed as follows: (1) The foreign exchange gain that will result from the settlement of MWSI's foreign currency-denominated loans will be taxable at the regular corporate income tax rate of 35% or at the minimum corporate income tax rate . In BIR Ruling No. DA-166-04 dated April 5, 2004, this Office ruled that foreign exchange gain derived by ASE Holding Electronics (Philippines) Incorporated, a PEZA-registered enterprise enjoying ITH, is subject to the regular corporate income tax rate of (then) 32% based on the net taxable income pursuant to Section 27 (A) in relation to Section 32 (A) of the National Internal Revenue Code ("Tax Code"). The foreign exchange gain in this ruling arose from the sale of machineries and equipments and was due to the foreign exchange translation of the US Dollar denominated book value in Pesos of the machineries and equipment. We clarified in this ruling that the definition of "gross income" under the Implementing Rules and Regulations of Republic Act No. 7916 limits the application of the preferential tax rate of 5% to income derived from the registered activity by an Ecozone enterprise. Thus, any income derived by a registered enterprise that is not related to its registered activity is not entitled to the preferential tax rate of 5%. Instead, such income derived from an unregistered activity shall be subject to regular internal revenue tax. TSCIEa Likewise, in BIR Ruling No. DA-209-06 dated April 5, 2006, this Office ruled that gain resulting from the foreign exchange translation of the book value of foreign currency denominated loan into Philippine Peso, which was realized upon actual conversion of the loan receivable from an affiliate company into equity, is subject to regular corporate income tax rate of (then) 32%. This ruling involved Hitachi Cable Philippines Inc., which was a PEZA-registered enterprise enjoying ITH. It was ruled that income derived by a PEZA-registered enterprise from unregistered activity is considered as ordinary income subject to regular corporate income tax (citing BIR Ruling No. DA-023-03 dated January 28, 2003 and BIR Ruling No. 117-99 dated August 10, 1999). Based on the foregoing rulings, this Office therefore confirms that foreign exchange gain realized by MWSI from the repayment of its foreign currency-denominated loans should be taxable income subject to regular corporate income tax and/or the minimum corporate income tax (MCIT). (2) The off-set of the forex gains against billings to customers can be deducted from the foreign exchange gain that will be subjected to the regular corporate income tax/MCIT. In BIR Ruling No. DA-166-04, supra, this Office ruled that forex gain derived by ASE, a PEZA-registered entity, from the sale of machineries and equipment were subject to the regular corporate income tax rate. This Office further stated that ordinary and necessary business expenses paid or incurred in the taxable year such as foreign exchange loss incurred by ASE from the repayment of foreign currency denominated loans as well as net operating loss carried over from past taxable year can be deducted from the company's ordinary income comprising of the gain from the sale of machineries and equipments resulting from the foreign exchange translation of their US Dollar denominated book value in pesos. Accordingly, this Office hereby confirms that the offset of the realized foreign exchange gain against billings to customers should be deductible from the foreign exchange gain to be subjected to the regular corporate income tax or MCIT. 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, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service