BIR Ruling [DA-255-05]

June 16, 2005 BIR RULING [DA-255-05] Globe Telecom P.O. Box M-056 MPO Mandaluyong Municipal Building Mandaluyong City Attention: Mr. Delfin C. Gonzales, Jr. Chief Financial Officer Gentlemen : This refers to your letter dated April 11, 2005 stating that Globe Telecom, Inc. (Globe) is a corporation organized and existing under the laws of the Philippines; that Globe's common shares are listed and traded at the Philippine Stock Exchange (PSE); that as an incentive to its executives, to encourage loyalty and continued tenure and as a retention strategy for key talents, Globe established in 2003 an Executive Stock Option Plan (ESOP) under which selected senior personnel of Globe (comprising of managers, directors and heads of the corporate divisions and groups) were granted an option to subscribe to a fixed number of Globe common shares at an exercise price determined at the price at which the shares were traded at the time of the grant of the option (the Option Grant Date); that ESOP provides for a three year accrual or vesting period; that no option may be exercised prior to the lapse of the second anniversary of the Option Grant Date; that thereafter one-half (1/2) of the stock option becomes exercisable with the other half becoming exercisable upon the lapse of the third anniversary; that the option grantee may exercise in whole or in part the option that has vested at any time prior to the lapse of the tenth anniversary of the Option Grant Date except that in cases of resignation, termination other than for cause, or retirement, the option grantee may exercise any vested option on or before the effective date of the resignation, or within ninety (90) days from date of termination, or within three (3) years from date of retirement, as the case may be and that in case of termination for cause, all unexercised options shall be forfeited. Based on the foregoing representations, you now request confirmation of your opinion that "1. The difference between the exercise price and the market value of the Globe common shares at the time of exercise constitutes taxable fringe benefits as defined under Section 33(B) of the Tax Code of 1997; "2. Upon the exercise of the option, Globe is liable to pay the 32% fringe benefits tax on the grossed-up monetary value of the difference between the exercise price and the market value of the Globe common shares at the time of exercise pursuant to Section 33(A) of the Tax Code of 1997; and "3. Under Section 34(A)(1)(i) of the Tax Code of 1997, and as amplified in Section (D) of Revenue Regulations No. 3-98, Globe can claim as ordinary and necessary expense for income tax purposes the grossed-up monetary value of the fringe benefit that accrues to its senior personnel upon the exercise of the option." In reply thereto, please be informed that your opinion is hereby confirmed as follows: (1) Section 2.33(A) of Revenue Regulations No. 3-98 provides that a final withholding tax is hereby imposed on the grossed-up monetary value of fringe benefit furnished, granted or paid by the employer to the employee, except rank and file employees, whether such employer is an individual, professional partnership or a corporation, regardless of whether the corporation is taxable or not, or the government and its instrumentalities except when: (1) the fringe benefit is required by the nature of or necessary to the trade, business or profession of the employer; or (2) when the fringe benefit is for the convenience or advantage of the employer. The term "fringe benefit" means any good, service, or other benefit furnished or granted by an employer in cash or in kind, in addition to basic salaries, to an individual employee (except rank and file employee). In the instant case, the stock option, although granted pursuant to an employer-employee relationship, is not given to the employees (managers, directors or heads of the company's business divisions and groups) for free. The option grantee clearly benefits from the lower exercise price. This is so because if the grantee for instance bought the shares at market, he would have been made to pay for the shares at the prevailing market price. Thus, by exercising his option he realizes a benefit equivalent to the difference between the exercise price and the market value of the shares at the time of exercise. Accordingly, this benefit qualifies under the term fringe benefit as defined under Section 33(B) of the Tax Code of 1997 which is subject to the fringe benefit tax. Such being the case, while the grant of the stock option is not per se a fringe benefit subject to the fringe benefit tax, there is a fringe benefit subject to the fringe benefit tax to the extent that the exercise price is lower than the fair market value of the underlying shares at the time of the exercise of such option by the employee. 2. Section 33(A) of the Tax Code of 1997 provides as follows: "(A) Imposition of Tax. A final tax of thirty-four percent (34%) effective January 1, 1998; thirty-three percent (33%) effective January 1, 1999; and thirty-two percent (32%) effective January 1, 2000 and thereafter, is hereby imposed on the grossed-up monetary value of fringe benefit furnished or granted to the employee (except rank and the employees as defined herein) by the employer, whether an individual or a corporation (unless the fringe benefit is required by the nature of, or necessary to the trade, business or profession of the employer, or when the fringe benefit is or the convenience or advantage of the employer). The tax herein imposed is payable by the employer which tax shall be paid in the same manner as provided for under Section 57(A) of the said Code. The grossed-up monetary value of the fringe benefit shall be determined by dividing the actual monetary value of the fringe benefit by sixty-six percent (66%) effective January 1, 1998; sixty-seven percent (67%) effective January 1, 1999; and sixty-eight percent (68%) effective January 1, 2000 and thereafter. . . " It is clear from the above-quoted provision, that the employer, Globe, is liable to pay a final tax of 32% based on the grossed-up value of the benefit granted, which represents the actual monetary value of the aforesaid benefit equivalent to the difference between the exercise price and the market value of the shares at the time of exercise. Accordingly, the 32% tax is payable upon the exercise of the option which is the time that any benefit from the option is actually realized. 3. Section 34(A)(1) of the Tax Code of 1997 provides that "(a) In General. There shall be allowed as deduction from gross income all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on or which are directly attributable to, the development, management, operation and/or conduct of the trade, business or exercise of a profession, including: (i) A reasonable allowance for salaries, wages, and other forms of compensation from personal services actually rendered, including the grossed-up monetary value of fringe benefit furnished or granted by the employer to the employee: Provided, That the final tax imposed under Section 33 hereof has been paid. xxx xxx xxx" The following are the requisites for deductibility of business expenses from gross income: (1) The expense must be ordinary and necessary; (2) It must be paid or incurred during the taxable year; (3) It may be paid or incurred in carrying on the trade or business; (4) It must be supported by receipts, vouchers or documents. ( see Zamora vs. Collector, L-15280, May 31, 1953 ) For this purpose, it is clear that the deduction shall be made in the year when the related expense is incurred which in this case at the time of the exercise of the option when the senior personnel realizes the benefit as Globe effectively foregoes the difference between the market price and exercise price of the shares. Such being the case, Globe can claim as deduction from gross income the grossed-up monetary value of the benefit that is furnished to its senior personnel under the ESOP, or an amount equivalent to the sum of (i) the difference between the exercise price and market value of the shares at the time of exercise; and (ii) the 32% fringe benefit tax paid. HIEASa 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