BIR Ruling [DA-398-05]

September 26, 2005 BIR RULING [DA-398-05] BIR Ruling No. 004-2003; Secs. 6 & 43, NIRC San Roque Power Corporation The Enterprise Center, Tower I 36th Floor, 6766 Ayala Avenue Makati City Attention: Mr. Federico E. Puno President & Chief Executive Officer Gentlemen : This refers to your letter, dated September 12, 2005, requesting that San Roque Power Corporation (SRPC) be allowed to continue the use of Japanese Yen (JPY) as functional currency in its financial statements reporting. It is represented that San Roque Power Corporation ("SRPC") was incorporated in the Philippines in October 1997. It has an existing Power Purchase Agreement with National Power Corporation for the design, financing, construction, supply, delivery, installation/creation of equipment/testing/commissioning, management, operation, maintenance and repair of the hydraulic power plant known as the San Roque Multi-Purpose Project in Pangasinan. SRPC is a 100% Japanese owned company. Since 1997, SRPC has been using the Japanese Yen ("JPY") as its functional currency in presenting its financial statements based on the US GAAP Financial Accounting Standards. SRPC considered the currency in which funds from financing activities were generated as basis for determining its functional currency. The funds from financing activities were predominantly in JPY. On December 11, 2003, the Securities and Exchange Commission (SEC) issued Memorandum Circular No. 14, Series of 2003, or the Guidelines on Preparation of Functional Currency Financial Statements" prescribing the primary factors in determining functional currency, to wit: (1) the currency that mainly influences sales price for goods and services and (2) the currency that mainly influences labor, material and other costs of providing goods and services. It also prescribes other factors which may provide supporting evidence to determine functional currency, to wit: (1) the currency in which funds from financing activities are generated and (2) the currency in which receipts from operating activities are usually retained. STaAcC SRPC would like to request permission that it be allowed to continue the use of JPY as its functional currency for the following reasons: 1. In line with the policy behind Memorandum Circular No. 14, the use of JPY as the functional currency of SRPC will prevent the distortion of its financial condition and performance due to foreign exchange factors. According to forecasts, Yen will continue to strengthen in the years to come and SRPC wants to use Yen in its financial reporting otherwise it will be in a very weak position with deficit rising substantially due mainly to forex losses; 2. SRPC will be incurring artificial losses due to foreign exchange fluctuations thereby making its financial statements less attractive to creditors and investors whose support it needs to maintain and further expand operations and generate more employment; 3. Consistent with the US GAAP and the International Financial Reporting Standards ("IFRS") (adopted in the Philippines on January 1, 2005) Memorandum Circular No. 14 provides that when the indicators are mixed and the functional currency is not obvious, management uses its judgment as to which is the dominant currency to determine the functional currency that most faithfully represents the underlying transactions, events and circumstances. SRPC has determined the JPY as its functional currency pursuant to the US GAAP because the funding of its loan and related interest payments was primarily in JPY. The cash flows derived from operations relating to the JPY revenues will be used to pay the JPY denominated loans. Also, the majority shareholder, Marubeni Corporation, has guaranteed the loans of SRPC with a stand-by LC denominated in JPY. 4. As a Japanese owned company, the JPY is the relevant and true currency that will faithfully represent the financial conditions of SRPC with respect to its investors/shareholders. The use of JPY will ensure that there is no misrepresentation or mistake in the presentation of the financial position of SRPC to the Japanese investors/shareholders. 5. The grant of authority to use Yen in favor of Japanese companies like SRPC will further increase the Philippines' attractiveness to Japanese Companies as investment site. 6. Memorandum Circular No. 14 further provides that once a functional currency is determined, it is not changed unless there is a substantial change in the underlying transactions, events and circumstances. Based on SRPC's judgment, there will only be a change in the underlying conditions and circumstances once the JPY denominated loans are fully paid in 2012. At that point in time, SRPC will be in a position to reevaluate its Financial currency. In reply thereto, please be informed that while BIR Ruling No. 004-2003, dated June 3, 2003, limits the use of foreign currency in financial statements to US Dollars, this Office has found no statute or regulation that prohibits the use of other foreign currency in financial statements of the Philippine taxpayers. What the Tax Code requires is that the books be kept in native language, English or Spanish (Section 234, Tax Code). Besides, the prohibition against transaction in foreign currency has been lifted with the repeal of R.A. No. 529, the Uniform Currency Act. The Accounting Standards Council in its letter dated July 18, 2001, confirms that Philippine generally accepted accounting principles (GAAP) allows the use of foreign currency in financial statements. HEaCcD In addition, the SEC in its Memorandum Circular No. 14, or the "Guidelines on Preparation of Functional Currency Financial Statements" has prescribed the following rule in the determination of functional currency, viz: "SEC. 4. Determination of Functional Currency A qualified entity shall consider the following primary factors in determining its functional currency: 1. The currency: (a) That mainly influences sales prices for goods and services (this will often be the currency in which sales prices for its goods and services are denominated and settled). (b) Of the country whose competitive forces and regulations mainly determine the sales price of its goods and services). 2. The currency that mainly influences labor, material and other costs of providing goods or services (this will often be the currency in which such costs are denominated and settled). The following factors may also provide additional supporting evidence to determine a company's functional currency: 1. The currency in which funds from financing activities (i.e., issuing debt and equity instruments) are generated. 2. The currency in which receipts from operating activities are usually retained. xxx xxx xxx For purposes of this Circular, a company initially electing to use its functional currency for statutory reporting purposes must submit to the Commission and assessment that will support the determination of its functional currency based on the criteria aforementioned. Such assessment covering at least two years will follow the format shown in Annex A which shall be signed by the company's external auditor shall issue a report to accompany the assessment following the suggested format in Annex B. The company may attach additional information and analyses that it may deem relevant. The Commission reserves the right to call the attention of the entity as to the propriety of such assessment." Finally, the use of foreign currency for companies whose functional currency is a foreign currency will more clearly reflect income considering that the use of Philippine pesos results in artificial foreign exchange losses which distort the real financial condition of these companies. The use of foreign currency is also revenue neutral. 1 In the light of the foregoing and on the basis of Section 6 in relation to Section 43 both of the Tax Code, this Office hereby grants your request to authorize SRPC to use foreign currency in its financial statements reporting subject to the following conditions: 1. The foreign currency to be used in the books shall be limited to the Japanese Currency (Yen currency); 2. The financial statements shall also be prepared and maintained in Yen currency with a translation in Philippine pesos using the exchange rate provided under Revenue Memorandum Circular (RMC) No. 26-86; 3. Tax returns shall be prepared in the Philippines pesos and taxes due shall be paid in the Philippine pesos the exchange rate provided in the RMC No. 26-85; 4. Or any return, statement or other documents in which a conversion was made, the rate of exchange used shall be indicated thereon. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it shall be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) JOSE MARIO C. BUAG OIC-Commissioner of Internal Revenue