Aranas Consunji & Barleta Law Office

May 31, 2007 BIR RULING [DA-320-07] 179; 108; RMO 63-99; 116-98; VAT Ruling No. 015-04 Aranas Consunji & Barleta Law Office Unit 106 G/F Le Metropole Condominium Tordesillas Corner Dela Costa Streets, Salcedo Village, Makati City Attention: Atty. Ma. Louella M. Aranas Gentlemen : This refers to your letter dated 26 April 2007 requesting on behalf of your client, Epson Precision (Phils.) Inc. ("EPPI"), for confirmation of your opinion on the following concerns: 1. Since the inter-company advances between EPPI and The Epson Group are documented by mere board resolution and inter office memo, the same are not subject to Documentary Stamp Tax ("DST") on loan agreements. 2. EPPI is not a lending investor because its grant of cash advance to The Epson Group was not done in pursuit of a business activity nor was it made with intention to practice lending of money to others. As such, any interest derived by EPPI from the transaction shall not be subject to VAT on lending investors. 3. The imputation by EPPI of interest on the inter-company advances based on hank reference rate shall be considered as at arm's length. It is represented that EPPI is a corporation incorporated and existing under the laws of the Philippines. It is engaged in the manufacturing of electrical, plastic and metal products. EPPI is affiliated with the following domestic corporations: Philippines Epson Optical Inc., Epson Imaging Devices (Phils.) Inc., Epson Software Engineering (Phils.) Inc., Philippines Epson Property Holding, Inc., (herein collectively referred to as "Affiliates" and/or "The Epson Group"). On April 2007, EPPI executed a Board Resolution wherein EPPI will provide inter-company cash advances to its affiliates or The Epson Group for financial support. Under the resolution, EPPI will charge its affiliates monthly interest using the bank reference rate for the cash advances made in order that the transaction will be considered at arm's length. Aside from charging its affiliates with monthly interest, EPPI shall also, from time to time, demand payment of a portion of the principal amount together with the accrued interest due. In documenting the transaction, EPPI will issue an inter-office memo and record such transactions in its books as an inter-company advances. In reply, please be informed as follows: 1. On Documentary Stamp Tax . Section 179 of the NIRC of 1997, as amended by Republic Act No. 9243, provides: ""SEC. 179. Stamp Tax on All Debt Instruments . On every original issue of debt instruments, there shall be collected a documentary stamp tax . . ." xxx xxx xxx "For purposes of this section, the term debt instrument shall mean instruments representing borrowing and lending transactions including but not limited to debentures, certificates of indebtedness, due bills, bonds, loan agreements, including those signed abroad wherein the object of contract is located or used in the Philippines, instruments and securities issued by the government of any of its instrumentalities, deposit substitute debt instruments, certificates or other evidences of deposits that are either drawing interest significantly higher than the regular savings deposit taking into consideration the size of the deposit and the risks involved or drawing interest and having a specific maturity date, orders for payment of any sum of money otherwise than at sight or on demand, promissory notes, whether negotiable or non-negotiable, except bank notes issued for circulation." The above-quoted provision enumerates the type of documents subject to DST on loan agreements. RR No. 9-94 defined such documents as follows: "Loan agreement refers to a contract in writing where one of the parties delivers to another money or other consumable thing, upon the condition that the same amount of the same kind and quality shall be paid. The term shall include credit facilities, which may be evidenced by credit memo, advice or drawings." "Promissory note" refers to an instrument, whether negotiable or non-negotiable, whereby the maker agrees (promises) to pay a sum certain in money or its equivalent at a definite time." In relation thereto, BIR Ruling No. 116-98 ruled that an inter-office memo, covering an inter-company advances, is not subject to documentary stamp tax. However, on July 15, 1999, BIR issued BIR Ruling No. 108-99 reversing BIR Ruling 116-98 by stating that an inter-office memo covering the advances granted by a corporation affiliate is in the nature of a promissory note subject to the documentary stamp tax. Both rulings were cited in the case of APC Group, Inc., vs. Commissioner of Internal Revenue (CTA Case No. 6155, March 11, 2002). In the said case, the Court ruled that neither BIR Ruling No. 116-98 nor BIR Ruling No. 108-99, which reversed it, is controlling, Section 180 (now Section 179) of the Tax Code shall prevail. The Court's decision states in pertinent part: "There is nothing in Section 180 that provides that board resolutions, inter-office memoranda, letters of instructions, journal or cash vouchers evidencing lending/borrowings are subject to Documentary Stamp Tax. Clearly, what Section 180 taxes are loan agreements, promissory notes, bill of exchange, drafts, instruments and securities issued by the government or any of its instrumentalities or certificates of deposits drawing interest and others not payable on sight or demand." In the instant case, the inter-company advance transactions between EPPI and its affiliates are documented by mere board resolution and inter office memo. Since EPPI did not execute any document that may be considered as a loan agreement or promissory note to which the tax under Section 180 of the Tax Code is imposed, the cash advances provided by EPPI to its affiliates shall not be subject to documentary stamp tax. 2. On Value-Added Tax VAT is imposed on sale or exchange of services for others for a fee, remuneration or consideration including those performed or rendered by lending investors (Section 108 of the Tax Code). A lending investor is defined under Section 4.108-3 of Revenue Regulation 16-2005 as follows: " Lending investor includes all persons other than banks, non-bank financial intermediaries, finance companies and other financial intermediaries, finance companies and other financial intermediaries not performing quasi-banking functions who make a practice of lending money for themselves or others at interest." In addition, BIR Ruling dated March 31, 1997 provided for the requisites to be considered in determining who are lending investors. The requisites are as follows: "1. One must be engaged in the business of lending money for themselves or others at interest; and 2. The lending of money must be carried on with a view to profit or livelihood." DScTaC This was applied by the BIR in VAT Ruling No. 015-04 dated May 18, 2004 wherein it was held that: "It is clear from the foregoing facts that TDK is not engaged in the practice of lending money. It is organized as a manufacturer of electronic materials and components rather than to engage in lending activities. The lending of money for an interest which is not pursued as a business activity but merely to assist someone in need, will not make the lender a lending investor within the contemplation of Section 108 of the Tax Code. Accordingly, the interest income earned or received by TDK from its loan to PTPI is exempt from the value-added tax." Applying the foregoing pronouncements, EPPI is organized to make, manufacture, assemble, import, export, buy, trade and/or otherwise deal at wholesale in electrical, plastic and metal parts and other electrical, plastic and metal products, etc. Clearly, the advances provided to its affiliates are not activities within EPPI's ordinary course of business. The purpose of the cash advance granted by EPPI is merely to provide financial support to its affiliates and not to generate income. Based on the definition and requisites stated above, EPPI shall not be considered as a lending investor since it does not habitually engage itself in lending transactions and it does not extend cash advances to its affiliates with a view to profit or livelihood. The fact that an interest is charged on the cash advance is in order that the transaction will be considered as at arm's length. Moreover, in Piso Bank vs. Commissioner of Internal Revenue , CTA Case No. 4117 dated June 6, 1989, the case of Molo vs. Yatco , 71 Phil. 468, was cited to read as follows: "Where it appears that on six occasions a person accepted mortgages to guarantee loans to be made to different persons at an interest of 12% and such person does not prove that such transactions were made accidentally or because of certain peculiar circumstances, it should be presumed that he in reality made a practice of lending money at interest, thus becoming a lending investor under the law. (Emphasis supplied)" Based on the above-quoted case, a person who has engaged in lending activities for six times or more shall be presumed as habitually engaged in the practice of lending money to others. Since the grant of cash advance to The Epson Group by EPPI was not done in pursuit of a business activity nor was it made with intention to practice lending of money to others, EPPI cannot be concluded to be a lending investor. Accordingly, the presumption discussed in the above-quoted case does not apply. Any interest derived by EPPI from the transaction shall not be subject to VAT on lending investors. 3. On Arm's Length Interest Rate The BIR in Revenue Memorandum Order (RMO) No. 63-99 dated July 19, 1999 provided that for inter-company advances, the interest charge and interest rate to be used shall represent an arm's length rate. The definition of an arm's length rate is provided in RMO No. 63-99, to wit: "4.2.1 In general. For purposes of this Order, the arm's length, interest rate shall be the rate of interest which was charged or would have been charged at the time the indebtedness arose in independent transaction with or between unrelated parties under similar circumstances. All relevant factors will be considered, including the amount and duration of the loan, the security involved, the credit standing of the borrower, and the interest rate prevailing at the situs of the lender or creditor for comparable loans. 4.2.2 For purposes of determining the arm's length rate in domestic transactions, the interest rate to be used is the Bank Reference Rate (BRR)prescribed by the Bangko Sentral ng Pilipinas (BSP) . (Emphasis ours)" Considering that EPPI in charging interest on advances made to its affiliates will use the bank reference rate, the imputation of interest based on such bank reference rate shall be considered as at arm's length which is in conformity with the provisions of the above quoted RMO. Accordingly, we hereby confirm your opinion that: 1. Since the inter-company advances between EPPI and The Epson Group are documented by mere board resolution and inter office memo, the same are not subject to Documentary Stamp Tax ("DST") on loan agreements as provided for under Section 179 of the National Internal Revenue Code of 1997, as amended by R.A. No. 9243. 2. EPPI is not a lending investor because its grant of cash advance to The Epson Group was not done in pursuit of a business activity nor was it made with intention to practice lending of money to others. As such, any interest derived by EPPI from the transaction shall not be subject to VAT on lending investors under Section 108 of the Tax Code of 1997, as amended by R.A. 9337. EASCDH 3. The imputation by EPPI of interest on the inter-company advances based on the bank reference rate shall be considered as at arm's length. 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 as represented are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service