BIR Ruling [DA-326-03]

September 30, 2003 BIR RULING [DA-326-03] 27 (D) (3) 78-93; 103-99 Widearth Garments Manufacturing Inc. #22 Serrano St., Serrano Subdivision Marulas, Valenzuela City Attention: Ms. Marichu P. Navarro Corporate Secretary Gentlemen : This refers to your letter dated July 31, 2003 requesting for a clarificatory ruling relative to the interpretation of Section 27(D)(3) of the Tax Code of 1997 in relation to your loan transaction with Hongkong and Shanghai Bank Corporation (HSBC). It is represented that Widearth Manufacturing Garments Inc. (Widearth for brevity) is engaged in manufacturing and exportation of garments. It imports raw materials which is also required by some of its buyers. In order to accommodate the importation of raw materials, Widearth necessarily has to obtain Letters of Credit from the bank. Accordingly, Widearth is an account holder of HSBC for about 10 years now. Every time it pays interest on its dollar loan with HSBC, an amount equivalent to 10% is being added representing withholding tax pursuant to Section 27(D)(3) of the Tax Code of 1997. It is now your contention that the 10% withholding tax imposed should not be charged against your account since it is payable by the lender and not by the borrower, as a tax on the interest income. In reply thereto, please be informed that Section 27(D)(3) provides: "Section 27. Rates of Income Tax on Domestic Corporations . (D) Rates of Tax on Certain Passive Income . xxx xxx xxx (3) Tax on Income Derived under the Expanded Foreign Currency Deposit System. Income derived from a depository bank under the expanded foreign currency deposit system from foreign currency transactions with local commercial banks, including branches of foreign banks that may be authorized by the Banko Sentral ng Pilipinas (BSP) to transact business with foreign currency depository system units and other depository banks under the expanded foreign currency deposit system, including interest income from foreign currency loans granted by such depository banks under said expanded foreign currency deposit system to residents , shall be subject to a final income tax at the rate of ten percent (10%) of such income." (emphasis supplied) It is clear from the aforequoted provision that the final tax of 10% is being imposed on the interest income of the depository banks which in your case is HSBC. In addition, Revenue Memorandum Circular No. 14-2002 was issued to prescribe the procedures for the filing of tax returns for income derived by the FCDU from Foreign Currency and other transactions and the manner of reporting income for income tax purposes pursuant to Sections 27(D)(3) and 28(A)(7)(b) of the Tax Code. RMC 14-2002 makes clear that FCDU is not a branch but a unit or division of the bank and the taxability of the transactions undertaken by this Unit differs from the activities conducted by the bank's Regular Banking Unit (RBU). If a bank is authorized to operate an FCDU, it is considered to have a dual tax status for income tax purposes. Thus, a bank with an FCDU must file two (2) income tax returns for the same taxable year covering two (2) different types of income, namely, the FCDU income and the RBU income. Correlatively, the income of the bank from its RBU is subject to the normal income tax rate or MCIT, as the case may be. On the other hand, interest income from foreign currency loans granted by an FCDU to residents shall be subject to 10% final withholding tax. (BIR Ruling No. 78-93 dated March 1, 1993; BIR Ruling No. 103-99 dated July 13, 1999) TaCIDS In case of interest income from foreign currency loans granted to residents, the payor-borrower is constituted as the withholding agent pursuant to Section 3 of RMC 14-2002, charged with the obligation of deducting, withholding, and remitting to the BIR the tax due thereon. Such interest income shall be reported in the income tax return of the FCDU for information purposes. In turn, a copy of the withholding tax return filed, together with a copy of the official receipts denoting payments thereon, and the Certificate of the Final Tax Withheld at Source (BIR Form 2306) shall be furnished directly to the FCDU concerned. Based on the presentation above, it is clear that what the law and regulations envisage is a withholding procedure whereby the borrower is tasked to withhold and remit the same to the BIR. 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