Samsung Electronics Philippines Manufacturing Corporation

June 20, 2008 BIR RULING [DA-375-08] R.A. 7916; DA 195-2008 dtd. 3/25/08 Samsung Electronics Philippines Manufacturing Corporation Block 6, Calamba Premiere International Park, Barangay Batino, Calamba City, Laguna Attention: Mr. Sang Ho Park Chief Financial Officer Gentlemen : This refers your letter dated June 12, 2008 requesting, on behalf of your company, Samsung Electronics Philippines Manufacturing Corporation (SEPHIL), confirmation of your opinion that the realized gains arising from transactions directly attributed to your registered activity should be covered by the tax incentives granted by the Philippine Economic Zone Authority (PEZA) to SEPHIL. It is represented that SEPHIL is a corporation duly organized and existing under Philippine laws with office address at the Calamba Premiere International Park-Special Economic Zone; that it is registered with PEZA as an Ecozone Export Enterprise under Registration Certificate No. 01-011 dated February 9, 2001; that it enjoys the 5% preferential tax on gross income earned in lieu of the payment of all other local and national taxes on its registered activity consisting of the design, manufacture, and sale of electronic products, including optical disk drive products, their components and parts; and that it has also registrations for income tax holiday on other registered activities with Supplemental Agreements dated December 22, 2004 and January 09, 2008 under Resolutions No. 04-0436 and 08-030. It is further represented that SEPHIL is engaged in transactions in currencies (Php and YEN) other than its USD functional currency in which foreign exchange (forex) gains can be realized at the time of settlement; that these transactions include trade payables and receivables and non-trade payables; and that the forex gains realized from these transactions are characterized as follows: 1. Realized forex gains on Trade Payables and Receivables Realized forex gains/losses on trade payables are related with the purchases of raw materials to be used in production. This is the difference of exchange rate from the date of recording of payable in SEPHIL's books and the payment date based on agreed payment terms with vendor in the average of 60 days, with payment schedule on every 10th & 25th of the month. SEPHIL is maintaining a daily exchange rate in SAP system using PDS rate. Example: On April 01, SEPHIL purchased raw materials in USD currency in the amount of USD100,000. Upon receipt of raw materials SEPHIL will record the transaction using the current rate in SAP system of USD-Php = 41.20, and automatically convert USD to peso in the amount of Php4,120,000. After 60 days, payable will be overdue but the exchange rate during payment is Php41.10. In this case, upon clearing of recorded payable to the vendor, the system will automatically compute the actual amount paid in peso (USD 100 x 41.10 = Php4,110) and automatically compare the peso converted amount of payable & payment thus, creating an automatic entry in the system for realized gain of Php10,000 (Php4,120,000-Php4,110,000). Realized forex gains on trade receivable or export are related with the sales transaction of SEPHIL's products. This is the difference of exchange rate used in the recording of receivables and collection of the same from customers. Customer's payment term is on the average of 60 days with collection schedule on 15th & 30th of the month. The logic of computation of forex difference is also the same with trade payables. 2. Realized Gain on Non-Trade Payables Realized gains on non-trade payables are composed of the following transactions: a. Spot cash trading transaction SEPHIL is buys or sells foreign currencies like, YEN, USD, GBP & currencies other than peso with the bank ( e.g. Standard Chartered Bank, Bank of America) depending on the needs of the company which are related to the payment of costs directly attributable to the registered activity such as purchasing production machineries. Cash spot transaction is the trading (buying or selling) of 2 different currencies with tenor of 1-2 days only. This is the difference of exchange rate between the deal or agreed rate with the bank and the rate in SAP system at the time of spot transaction. Example: The company needs USD to pay the purchased machines which is due for payment on April 25 with an exchange rate of Php41.25 Based on cash position report, the company is short in USD in the amount of USD50,000. In this case, treasury in charge will do the spot transaction. She will coordinate with the bank on the USD buying transaction and selling Php, for example at an agreed rate of P41.30. In this case, the system will automatically compute the peso amount difference of 2 transactions using 2 different exchange rates in the conversion, and create the entry for realized gain. b. Forward cash transactions This transaction is similar to cash spot transaction except that the settlement date is longer. The company is doing this to manage the foreign exchange risks due to rate fluctuation and minimize the forex gains & losses. It is a company's policy to cover all the open positions (short or excess money) during month- end and need to enter into a forward transaction which is considered as a derivative instrument for accounting purposes. This derivative instrument provides economic hedges under the company's policy but is not designated as accounting hedges. Realized gain is the difference in the exchange rate deal with the bank in selling or buying of 2 different currencies at a fixed rate in the future and the actual rate in the system at the time of settlement date. The logic of computation of forex difference & automatic posting is also the same with the others. c. Non-Trade payables This pertains to the transactions related to the payments of non-trade payables like purchase of production supplies, machineries & equipments, office supplies, payment for utility charges, janitorial fee, consultant fees, security charges & all other payables except purchase of raw materials. This is the difference in exchange rates used at the time of recording of payables and payment to vendor. The logic of computation & automatic posting is also the same with others. Based on the foregoing representations, it is your opinion that the realized forex gains arising from the aforementioned transactions are covered by SEPHIL's tax incentives as a PEZA-registered entity. In reply, please be informed that Section 24 of R.A. No. 7916 provides that no taxes, local and national, shall be imposed on business establishments operating within the ecozone. The same law further provides that PEZA-registered enterprises shall enjoy the fiscal incentives stipulated in the said law with respect to income arising from its registered activity. In the instant case, the difference in the foreign currency translation of costs and sales directly attributable to the registered activity of SEPHIL shall be considered in the computation of its gross income subject to the incentives provided under the PEZA Law. Given that the business of SEPHIL is the design, manufacture and sale of electronic products, its is quite apparent that realized gains arising from trade payables and trade receivables are attributable to the company's registered activity and are thus covered by the 5% gross income tax incentive. With respect to the realized forex gains from spot cash transactions and forward cash transactions, however, only those gains arising from liabilities related to production ( i.e. the purchase of production machineries), may be covered by the preferential tax regime. In the same manner, the tax treatment of realized gains arising from non-trade payables depends on the nature of the cost from which the gains arose. Thus, if it is a cost related to production, the realized gain arising from shall be covered by the income tax incentive ( i.e. income tax holiday and/or 5% gross income tax, whichever is applicable) granted by PEZA to the company. The foregoing position is consistent with PEZA Memorandum Circular No. 2005-032 dated September 15, 2005 herein quoted as follows: "The tax treatment of foreign exchange (forex) gains shall depend on the activities from which there arise. Thus, if the forex gain is attributed to an activity with income tax incentive (Income Tax Holiday or 5% Gross Income Tax), said forex gain shall be covered by the same income tax incentive. On the other hand, if the forex gain is attributed to an activity without income tax incentive, said forex gain shall likewise be without income tax incentive, i.e., therefore, subject to normal corporate income tax". It is worthwhile to mention that SEPHIL's situation is distinct from foreign exchange gain or loss resulting from foreign denominated loans which was consistently held as not forming part of the registered activity of the PEZA company, considering that there was no nexus between the transaction giving rise to the foreign exchange gain or loss and the PEZA entity's registered activity (BIR Ruling DA-166-04 dated April 5, 2004; BIR Ruling DA-209-06 dated April 5, 2006). In the case of SEPHIL, the foreign currency translation arose from the sale of their electronic products and from liabilities incurred by the company which are directly attributable to the registered activity of SEPHIL, such as those relating to, among others, the procurement of raw materials, production equipment and supplies. Accordingly, the realized gains arising the aforementioned transactions that are directly attributable to the registered activity of SEPHIL shall be covered by the tax incentives, provided that if the realized gain arises from settlement of the company's liabilities, such gain is attributable to expenses or costs directly connected to the registered activity of SEPHIL. Provided, further, that any loss arising from other registered activities, which are entitled to an income tax holiday incentive, shall not be allowed as a deduction from the gross income which may be subject to regular corporate income tax; Provided, finally, that the withholding tax pertaining to the payment of its direct cost shall be based on the actual cost paid by SEPHIL. This ruling is being issued in 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, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service