BIR Ruling [DA-315-04]

June 8, 2004 BIR RULING [DA-315-04] Banaria, Banaria and Company 10 Scout Bayoran Street South Triangle Quezon City Attention: Mr. Alfredo O. Banaria Gentlemen : This refers to your letter dated October 14, 2003 requesting on behalf of your client, La Union Development Bank, Inc. (LUDB), for confirmation of your opinion that its interest expense on savings and time deposit is not subject to interest arbitrage pursuant to Section 34(B)(1) of the Tax Code of 1997. It is represented that LUDB Bank, Inc. was organized on August 21, 1964 as a thrift bank in accordance with the provisions of Republic Act (R.A.) No. 85, as amended by R.A. No. 337 and 2081, with principal office address at Quezon Avenue, San Fernando City, La Union; that per Board Resolution dated December 4, 1998 which was ratified on the same date by majority of stockholders owning or representing at least two-thirds (2/3) of the outstanding capital stock, it was resolved to convert the thrift bank to a rural bank and change its corporate name to LUDB Bank, Inc.; that the conversion was duly approved by the Monetary Board of the Bangko Sentral ng Pilipinas (BSP) on October 27, 2000 and Securities and Exchange Commission (SEC) on August 3, 2001; that in carrying its purpose as a bank, it solicited savings and time deposit from bank depositors thus incurring interest expense in relation to such deposits; that the bank did not obtain loans from the BSP or other financial institutions to finance its operations; that the bank is required by the BSP to maintain at any given time certain percentage of its cash to be deposited with the BSP and/or other financial institution pursuant to the New Banking Act of 2000 in relation to its deposit liabilities; that in the process, the interest income is subjected to the final tax of twenty percent (20%); and that in support of your request, you submitted the following documents, to wit: 1) Notice of approval for conversion from thrift bank to rural bank from the BSP; 2) Amended articles of incorporation; 3) Amended by-laws; and 4) Certificate of authority to operate as a rural bank. In reply thereto, please be informed that Section 34(B)(1) of the Tax Code of 1997, as implemented by Revenue Regulations No. 13-2000, provides that the amount of interest paid or incurred within a taxable year on indebtedness in connection with the taxpayer's profession, trade or business shall be allowed as deduction from gross income: Provided, however, that the taxpayer's otherwise allowable deduction for interest expense shall be reduced by an amount equal to the following percentages of the interest income subjected to final tax: Forty-one percent (41%) beginning January 1, 1998; Thirty-nine percent (39%) beginning January 1, 1999; and Thirty-eight percent (38%) beginning January 1, 2000. There can be no uncertainty that as a rule, the amount of interest expense paid or incurred within a taxable year on indebtedness in connection with the taxpayer's trade, business or practice of profession shall be allowed as a deduction from the gross income. As distinguished from a tax arbitrage scheme, wherein the proceeds of a taxpayer's loan obtained in connection with the operations of his trade, business or exercise of profession is deposited or invested, and the interest income derived from the said investment had been subjected to the final withholding tax, the interest expense incurred from such loan shall be reduced by an amount equal to the above-mentioned percentages of the interest income subjected to final tax. Obviously, the purpose of the tax arbitrage is to equalize the tax liability of the taxpayer on his interest income and the tax benefit on his interest expense. Thus, in order to obtain the objective of the law to equalize the tax liability of the taxpayer of his interest income and the tax benefit on his interest expense, the interest expense shall be reduced by 38% to the extent of the interest income subjected to final tax, provided that the maximum interest income to be considered for purposes of the said provision shall not be higher than the interest expense. Accordingly, there is no tax arbitrage to speak of in the instant case relative to the interest expense on savings and time deposit of LUDB Bank, Inc. CIHTac IN VIEW OF THE FOREGOING, this Office hereby confirms your opinion that the provision in Section 34(B)(1) of the Tax Code of 1997, as implemented by Revenue Regulations No. 13-2000, does not apply to this particular case relative to its interest expense on savings and time deposit of LUDB Bank, Inc. 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