Quiason Makalintal Barot Torres & Ibarra

February 12, 2009 BIR RULING [DA-(C-024) 079-09] 28 (B); 42 (C); 105; 108; DA-036-07; DA-117-06 Quiason Makalintal Barot Torres & Ibarra 21st Floor, Robinsons-Equitable Tower 4 ADB Avenue corner Pedro Poveda Street 1605 Ortigas Center, Pasig City Attention: Attys. Ruelito Q. Soriano Benedict R. Tugonon and Mark S. Gorriceta Gentlemen : This refers to your letter dated February 2, 2009 requesting on behalf of your client, First Gas Power Corporation with TIN No. 004-470-601-000 ("First Gas Power" for brevity), for a ruling confirming the tax implications of the interest rate swap or hedging agreements it entered into with various non-resident banks or financial institutions acting as counterparties to hedge against the floating interest rate obligation of First Gas Power in its US$ loan obligation under the Bank Facility Agreement dated November 17, 2008 ("Bank Facility Agreement"). Background First Gas Power is a corporation duly organized and existing under and by virtue of the laws of the Republic of the Philippines, with office address at 3rd Floor Benpres Building, Meralco Ave. cor. Exchange Road, Ortigas Center, Pasig City, Philippines. The Permitted Hedge Providers ("Hedge Providers") under the Common Terms Agreement are the following: a. CALYON is a bank and a public limited liability company organized under the laws of France; b. Socit Gnrale Singapore Branch is a bank and a public limited liability company organized under the laws of France. c. Bayerische Hypo-Und Vereinsbank AG, Hongkong Branch, is a bank and a public limited liability company organized under the laws of the Federal Republic of Germany; with head office address at the Munich, Germany, and is acting through its Hongkong branch with office located at 26 Floor, Man Yee Building 68 Des Voeux Road Central, Hong Kong and its Hongkong Branch are not engaged in trade or business in the Philippines; and d. Standard Chartered Bank is a bank and a public limited liability company organized under the laws of the United Kingdom; and CAIHaE Under the Bank Facility Agreement, First Gas Power obligated itself to pay to the various loan facility lenders a floating interest rate computed as the aggregate amount of the 6th month US$ LIBOR plus a fixed margin of 3.25% for covered lenders or 3.5% to 3.90% for uncovered lenders. In order to cushion the impact of potential increases in the floating interest rate under the Bank Facility Agreement, First Gas Power entered into an interest swap or hedging arrangement ("Swap Arrangement") with the Hedge Providers such that First Gas Power will pay each of the Hedge Providers an agreed amount fixed as a percentage of the loan, ranging from 4.1% to 4.4% per annum, more or less ("Swap Cost"). In exchange, the Hedge Providers will absorb the floating rate liability of First Gas Power. Under the Hedging Arrangement, the excess of the Swap Cost over the floating interest, if any, will be the income or gain that the Hedge Providers will realize from entering into the Swap Arrangement. However, the Hedge Providers will absorb the risk of loss in the event the floating interest rate will exceed the Swap Cost. The nature of the Swap Arrangement is that of a guarantee, whereby the Hedge Providers guarantee to fix the interest liability of First Gas Power. In view of the foregoing, you now request for confirmation of your opinions regarding the tax consequences of the Swap Arrangement, as follows: 1. The documents embodying the Swap Arrangement are not subject to DST since an interest swap agreement is not a loan; 2. The Swap Cost which First Gas Power pays to the Hedge Providers is not interest payment since the Swap Arrangement is not a loan agreement. 3. The Swap Cost is not income of the Hedge Providers derived from Philippine sources and is not subject to income tax in the Philippines and consequently to any withholding tax; 4. The Swap Cost is likewise not subject to VAT in the Philippines since it is a payment or consideration for the hedging arrangement or services performed outside the Philippines. We reply, as follows: Documentary Stamp Tax Consequence The Hedging Arrangement and the documents embodying the interest swap are not loan documents and are not subject to documentary stamp tax. The Swap Arrangement is merely an exchange of cash flow arrangement between the parties, since there is no active delivery of the principal, it being merely notional. On the other hand, a loan requires the delivery of the object of the loan in order for the loan to be perfected. Under Article 1933 of the Civil Code of the Philippines, the essential elements of a loan are: a. the delivery by the lender to the borrower of money; b. the borrower becomes the owner of the delivered goods; and c. the same amount or a greater amount (if with the interest) of goods is returned to the lender. As such, a loan is generally the use and/or forbearance of money with interests payments representing the price paid for such use. CIcEHS Since an interest rate swap is not a loan, the Swap Arrangement is not subject to documentary stamp tax ("DST"). In BIR Ruling No. DA-381-98, this Office declared a similar interest swap agreement as exempt from DST since the interest rate swap is not a loan but merely an exchange of cash flows between the parties. Thus: "As far as the DST is concerned, the Agreement embodying the interest swap is not a loan but merely an exchange of cash flows between the parties (BIR Ruling No. 146-95 dated September 19, 1995). Neither does this instrument fall under any of the enumerated document, contract or agreement that is subject to a specific DST rate to which Section 198 of the Tax Code, as amended, can be correlated. Hence, no DST is due on the agreement. " Income Tax Consequence The Swap Cost is not interest income on the part of the Hedge Providers since the Swap Arrangement is not a loan agreement but merely a guarantee arrangement or a cash flow swap or exchange arrangement. Considering that the Hedge Providers are non-resident foreign corporations not engaged in trade or business in the Philippines, the income, fee or gain that the Hedge Providers will earn from the Swap Arrangement is an income derived by each of the Hedge Providers for services rendered outside the Philippines and is not subject to income tax in the Philippines. The National Internal Revenue Code ("Tax Code") clearly states that the income of a non-resident foreign corporation is taxed in the Philippines only if the said income is derived from sources within the Philippines. This is pursuant to the provisions of Section 28 (B) (1) of the Tax Code, which provides: "(B) Tax on Nonresident Foreign Corporation. "(1) In General. Except as otherwise provided in this Code, a foreign corporation not engaged in trade or business in the Philippines shall pay a tax equal to thirty-five percent (35%) of the gross income received during each taxable year from all sources within the Philippines, such as interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and capital gains, except capital gains subject to tax under subparagraph 5(c): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). (Underscoring ours) In defining what income payments are considered from sources without the Philippines, Section 42 (C) of the Tax Code provides: "Section 42 (C) Gross income from sources without the Philippines. The following items of gross income shall be treated as income from sources without the Philippines: (1) Interests other than those derived from sources within the Philippines as provided in paragraph (1) of subsection (A) of this Section; (2) Dividends other than those derived from sources within the Philippines as provided in paragraph (2) of subsection (A) of this Section; TEacSA (3) Compensation for labor or personal services performed without the Philippines ; (4) Rentals or royalties from property located without the Philippines or from any interest in such property including rentals or royalties for the use of or for the privilege of using without the Philippines patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises and other like properties; and (5) Gain, profits and income from the sale of real property located without the Philippines. (Underscoring ours) In providing for the hedging services, the Hedge Providers will perform their scope of work outside the Philippines. Thus, the Swap Cost paid to the Hedge Providers is income from sources outside the Philippines, being compensation for personal services performed without the Philippines. In BIR Ruling No. DA-036-07, it was ruled that the guarantee fees and upfront fees paid to the lender as consideration for arranging a loan, are not subject to Philippine income tax, viz: As a general rule, foreign corporations not engaged in trade or business in the Philippines such as Calyon, ING Bank N.V., Singapore Branch, Mizuho Corporate Bank Ltd. and Sumitomo Mitsui Banking Corporation are taxed only on Philippine-sourced income (Sec. 28(B)(1), 1997 Tax Code, as amended). In the case of services, the situs of taxation is the place where the service is rendered, regardless where the payment is made. Thus, fees for services rendered outside the Philippines are considered foreign-sourced income and will not be subject to Philippine income tax (Sec. 42(C), 1997 Tax Code, as amended) . xxx xxx xxx In BIR Ruling No. 097-87 dated April 6, 1987, the BIR held that guarantee fees, commitment fees and agent fees paid by NPI (a domestic corporation), upon satisfactory proof that said fees were paid not only to the lenders, but also to other parties for services performed outside the Philippines, do not form part of interest income but rather constitute income sourced from outside the Philippines, thus exempt from Philippine income tax. Moreover, in ITAD Ruling No. 113-03 dated August 1, 2003, the BIR held that guarantee fees received by JEXIM (now JBIC) for services performed outside of the Philippines, all paid by San Roque Power Corporation (SRPC), are considered income derived from sources outside the Philippines and therefore not subject to final withholding tax in the Philippines. Accordingly, this Office hereby confirms that since the Agents' Fees to be paid to Mizuho Corporate Bank, Ltd. and the Upfront Fee and Cancellation Fee as well as the Commitment Fee to be paid to Calyon, ING Bank N.V., Singapore Branch, Mizuho Corporate Bank Ltd. and Sumitomo Mitsui Banking Corporation are for services performed outside of the Philippines, they are considered income derived from sources outside the Philippines and therefore, are not subject to final withholding tax in the Philippines, pursuant to Section 28 (B) (1) in relation to Section 42 (C) of the 1997 Tax Code, as amended. (Underscoring ours) Furthermore, in BIR Ruling No. DA-117-06, the BIR confirmed that semi-annual payments paid to a non-resident corporation as consideration for securing the payment of a loan obligation are not taxable in the Philippines, to wit: ISaCTE "It is clear from the above-cited sections that a non-resident foreign corporation is liable to Philippine tax only on income derived from sources within the Philippines. Income from services rendered in the Philippines shall be considered derived from sources within the Philippines. Conversely, income from services performed outside the Philippines are considered derived from sources outside the Philippines. Thus, compensation for services performed outside the Philippines is not taxable when received by a non-resident foreign corporation. The semi-annual fees being paid by FG Financial to RGHL are in the nature of service fees. Accordingly, the said fees paid by FG Financial to RGHL in consideration for securing a loan obligation are payment for services performed outside the Philippines and therefore are not taxable in the Philippines. Value-Added Tax Consequence The Swap Cost is not subject to VAT since it is payment or consideration for the arrangement or services rendered outside the Philippines. In defining the phrase "sale or exchange of services" subject to 12% VAT, Section 108 of the Tax Code provides: xxx xxx xxx "The phrase "sale or exchange of services" means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration, . . . " (Underscoring ours) The VAT imposed under Section 108 of the Tax Code applies only to services performed in the Philippines and not to services rendered outside the Philippines. In BIR Ruling No. DA 037-04, this Office ruled that the payments for services performed outside the Philippines are not subject to the 12% VAT, thus: "2. Pursuant to Section 108(A) of the Tax Code of 1997 a VAT equivalent to ten percent (10%) of gross receipts is imposed on the sale or exchange of services, and the use or lease of properties. The phrase "sale or exchange of services" means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration. Conversely, services performed outside the Philippines are not subject to VAT. Accordingly, VSLPH's payment of service fee to VSLHK pursuant to the aforementioned Services Agreement, shall not be subject to VAT. Consequently, no VAT may be passed on by VSLHK to VSLPH, as conversely suggested under Section 105 of the Tax Code of 1997. (Underscoring ours) This ruling is 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. HAaDTE Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service