BIR Ruling [DA-250-96]

July 17, 1996 BIR RULING [DA-250-96] Sycip Gorres Velayo & Co. 6760 Ayala Avenue Makati City Attention: Mr . C . P . Noel Gentlemen : This refers to your letter dated March 21, 1996 stating that your client, ABC Company (ABC), a leading real estate developer listed on the Philippine Stock Exchange (PSE), plans to issue zero coupon convertible bonds in the international markets; that the bonds will be issued at a discount of approximately 69 per cent to raise approximately USD 100 to 150 million and mature at par (100 per cent) at the end of five and a half years; that there will be no coupon payments on the bonds; that the bonds will have a conversion right that will allow the bond holder to convert each bond into a fixed number of shares of ABC at any time up to maturity; that the number of shares and the conversion price will be fixed at the time of the issue and will change subject only to certain events of dilution in ABC's equity structure; that during the five-year period, the bondholder will have the option to convert the bonds into common stock of ABC; that if the bonds are not converted at maturity, the bonds will mature at par with a resulting yield to bondholders or approximately 100 to 130 basis point over the US Treasury rate at time of issue (equivalent to 7.79 per cent - 8.10 per cent at current US Treasury rates); that the bonds will be denominated in amounts of USD 1,000; that the issuer will have the right to call the bonds any time after the third year, provided that the bonds have been trading for thirty (30) consecutive days at 140 per cent of its conversion price; that if the issuer chooses to call the bonds, the bonds will be redeemed at their par value; that as long as the bonds are outstanding, the issuer will be required to set aside shares of ABC in the event that the bonds are converted; and that the bonds will be listed and traded abroad and issued through an international underwriter and a syndicate. In connection therewith, you now request for a ruling on the following: 1. That for income tax purposes, the discount on the issue of the said bonds should be amortized as interest expense over the life of the bonds by the issuer and that the corresponding amortization for each year is deductible; and 2. That the tax on the discount on the said bonds should be withheld by the issuer at the time of redemption of the bonds, unless there is conversion before maturity in which case the withholding would be upon conversion of the bonds into a fixed number of the issuer's shares. In reply thereto, please be informed as follows: (1) If bonds are issued by a corporation at a discount, the net amount of such discount is deductible and should be prorated or amortized over the life of the bonds. (Section 57 (a) (3) of Revenue Regulations No. 2) Accordingly, for income tax purposes, the net amount of the aforementioned bond discount is deductible and should be amortized over the life of the bonds (BIR Ruling Nos. 152-89 dated July 20, 1989 and 237-81 dated November 20, 1981); (2) The tax on the discount which is considered as interest should be withheld by the issuer at the time of redemption of the ABC Bonds. (BIR Ruling Nos. 186-84 and 152-89 dated December 7, 1984 and July 20, 1989, respectively). In cases where the redemption is made before maturity, the withholding would be upon conversion of the bonds into a fixed number of the ABC's share. cdt Very truly yours, ALICIA P. CLEMENO Assistant Commissioner (Legal Service) By: ALICIA L. TOMACRUZ Head, Revenue Executive Assistant (Legal Service)