SGV & Co.

April 25, 2008 BIR RULING [DA-269-08] Sec. 56 RR No. 2; DA-444-05; DA-028-05 & DA-260-07 SGV & Co. 6760 Ayala Avenue Makati City Attention: Mr. Joel L. Tan-Torres Partner, Tax Services Gentlemen : This refers to your letter dated April 24, 2007 requesting on behalf of your client, MAYNILAD WATER SERVICES, INC. ("MWSI"), for confirmation that the condonation of MWSI's indebtedness to Benpres Holdings Corporation ("Benpres") and the Suez Group, and the conversion of said indebtedness into additional paid-in capital (APIC) pursuant to a court-mandated/approved Restructuring Agreement, which has been likewise approved by the Securities and Exchange Commission (SEC), does not result in taxable income on the part of the Company. ECaAHS As represented, 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 (the Rehabilitation Court). On November 17, 2003, the Rehabilitation Court issued a Stay Order enjoining the enforcement of all claims against MWSI. In 2004, a Rehabilitation Plan was submitted to the Rehabilitation Court after MWSI and the Metropolitan Waterworks and Sewerage System (MWSS) entered into Amendment No. 2 to their Concession Agreement, under which it was agreed that MWSI will undergo quasi-reorganization and restructuring (which would not constitute a Concessionaire Event of Termination). In June 2004, MWSS withdrew its consent to Amendment No. 2. On August 6, 2004, the Rehabilitation Court ordered MWSI to submit a revised rehabilitation plan. In September of 2004, MWSI submitted a revised Rehabilitation Plan and at the same time withdrew all previous rehabilitation plans submitted. The Rehabilitation Court referred the September 2004 Rehabilitation Plan to the Rehabilitation Receiver for evaluation. On December 20, 2004, the Rehabilitation Receiver recommended approval of the September 2004 Rehabilitation Plan provided that MWSI and its shareholders, the bank creditors and MWSS execute the implementing agreements on December 1, 2004; otherwise, MWSI shall be ordered to submit another revised rehabilitation plan. MWSI, its shareholders, bank creditors and the MWSS failed to execute the implementing agreements that would give effect to the September 2004 Rehabilitation Plan. On January 31, 2005, the Rehabilitation Court ordered MWSI to submit a Modified Rehabilitation Plan by February 28, 2005, which deadline was subsequently extended to April 29, 2005. In compliance with said order, on April 29, 2005, MWSI entered into a Restructuring Agreement with the following shareholders and creditors: ESCTIA 1) Benpres Holdings Corporation ("Benpres"); 2) Suez, S.A. ("Suez"), a resident of France; 3) Suez Environment ("Suez-Env"), a resident of France; 4) Lyonnaise Asia Water (Holdings) Pte. Ltd. ("LAWL"), a resident of Singapore; and 5) Creditors of MWSI, which include Ondeo Services Philippines, Inc. ("OSPI"), a domestic corporation, Metropolitan Waterworks and Sewerage System ("MWSS"), a domestic entity, and other creditor banks. Under the Restructuring Agreement, Benpres, Suez, Suez-Env and LAWL, being shareholders of MWSI, agreed to write-off or condone all existing loans and advances made to MWSI. It was further agreed that the loans and advances written-off or condoned will be credited to additional paid-in capital in MWSI and said APIC applied against MWSI's deficit as of December 31, 2005 in order to totally wipe out the same. The conversion of the loans and advances into additional paid-in capital and the use of said APIC to wipe out MWSI's deficit as of December 31, 2005 was approved by the SEC on January 19, 2007 as evidenced by the SEC Certificate of Approval of Creation of Additional Paid-in Capital and the SEC Certificate of Approval of Equity Restructuring, which were submitted in support of this request. In reply, please be informed that this Office has issued several rulings confirming that the condonation of indebtedness and the simultaneous conversion and/or contribution of the condoned debt into APIC constitutes a capital transaction that does not give rise to either income or donor's tax. The more notable of said rulings are quoted in part below: In BIR Ruling No. DA-028-05 dated January 24, 2005, where Bayan Telecommunications, Inc. ("Bayantel") similarly applied for "corporate rehabilitation" with the court, this Office confirmed that any gain resulting from the condonation of Bayantel's debt through a court-approved restructuring plan is not taxable for income tax purposes. This Office furthermore confirmed that any conversion of debt into equity as a result of the debt restructuring plan is likewise not subject to income tax. EDCcaS Thus, this Office stated in [DA-028-05], to wit "Considering that in the case of your client, Bayantel, it was through court action that the debt rehabilitation plan was approved and is now being implemented. In other words, the restructuring was not a result of the mutual agreement of the debtors and creditors, but of judicial action. Accordingly, the gain resulting from condonation of the Bayantel's debt to its various creditors shall not be subject to income tax nor to gift tax since there is no donative intent on the part of its various creditors but is solely for business consideration." This Office further ruled that: ". . . the conversion of Bayantel's debt into equity as a result of the debt restructuring plan shall not give rise to a taxable income and shall only be considered as an additional capital investment which likewise is not subject to donor's tax since there is no donative intent in the aforesaid transaction." Likewise, in BIR Ruling No. DA-260-07 dated April 25, 2007, where Radio Communications of the Philippines Inc. ("RCPI") entered into a debt restructuring plan with its creditor-shareholders under which plan a portion of its debt were to be converted into equity, the BIR ruled that any gain resulting from the condonation of RCPI's debt is not taxable for income tax purposes; and that any conversion of debt into equity as a result of the debt restructuring plan is likewise not subject to income tax, it being in the nature of a capital transaction. Furthermore, BIR Ruling No. DA-444-05 dated October 27, 2005 involved the conversion of accrued interest expense into equity in the form of APIC and the condonation or suspension of interest not accrued. The BIR extensively ruled on the non-taxability of said transactions, as follows: "In reply thereto, please be informed that your opinion is hereby confirmed as follows: EcTaSC "I. Accrued Interest Converted into Additional Paid in Capital Not Subject To Income Tax and Donor's Tax. "GBCI will not realize any taxable income arising from the conversion into APIC of the accrued interest for the period covering October 2, 2000 to March 31, 2003 amounting to Php83,138,289.00. "The contribution of paid-in surplus in the form of money or property without the issuance of additional shares by GBCI's major stockholders is not subject to any income tax. Capital contribution generally does not give rise to a taxable event pursuant to Section 56 of Revenue Regulations No. 2, otherwise known as the Income Tax Regulations, which provides that 'Section 56. Contributions by shareholders . Where a corporation requires additional funds for conducting its business and obtains such needed money through voluntary process payments by its shareholders, the amounts so received being credited to its surplus account or to a special capital account, will not be considered income, although there is no increase in the outstanding shares of stock of the corporation. The payments in such circumstances are in the nature of voluntary assessments upon, and represent an additional price paid for, in shares of stock held by the individual shareholders, and will be treated as an addition to and as part of the operating capital of the company.' ACcDEa Based on the foregoing, this Office hereby confirms that the condonation of MWSI's indebtedness to Benpres, Suez, Suez-Env and LAWL and the conversion of said indebtedness into APIC pursuant to the Restructuring Agreement, does not give rise to taxable income on the part of MWSI as the entities mentioned are all shareholders of MWSI at the time of the condonation and as said condonation was agreed upon under a Court-ordered rehabilitation and, furthermore, duly approved by the SEC. 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. AcCTaD Very truly yours, Commissioner of Internal Revenue By: (SGD.) GREGORIO V. CABANTAC Deputy Commissioner