Puyat Jacinto & Santos

September 1, 2008 BIR RULING [DA-(C-055) 191-08] Section 27 (A); DA-381-98 & DA-009-01 Puyat Jacinto & Santos 12/F Manilabank Building, 6772 Ayala Avenue, Makati City Attention: Atty. Virginia B. Viray and Atty. Arnaldo M. Cario Gentlemen : This refers to your letter dated August 16, 2007, on behalf of your client, iN2Power Inc. ("iN2Power"), requesting for a ruling on the tax implications of the Contract for Difference that iN2Power will enter into with wholesale retailers of electricity and generation companies particularly with regard to the application of income tax, value-added tax and documentary stamp tax. IcADSE It is represented that iN2Power Inc. is a corporation duly organized and existing under Philippine laws with principal office address at the 30th Floor, Philippine Stock Exchange Center, Exchange Road, Ortigas Center, Pasig City; that it is primarily engaged in the business of power generation, power trading and power supply to retail customers and end-users as well as to distribution utilities and customers directly connected to the voltage transmission network; that due to the volatile price of electricity in the Philippine Wholesale Electricity Spot Market ("WESM"), iN2Power would like to enter into a Contract for Difference ("CFD" also known as a Swap Agreement), with wholesale retailers of electricity and generation companies ("Counterparties") to be able to hedge the price of electricity and effectively manage electricity price risk. It is further represented that under the CFD, the parties agree to enter into an electricity rate swap; that the CFD is a purely financial contract, that is, there is no physical exchange of commodities (electricity) between the counterparties; that the transaction assumes that both parties continue to operate in the WESM to purchase or sell the required amount of electricity being swapped; that the electricity rate swap itself is totally independent of these underlying physical transactions since the same is a form of financial instrument; that the following are the possible scenarios that may happen under the CFD: For the CFD between iN2Power and the Wholesale Retailer as counterparty 1. The counterparty pays WESM the spot price ("floating price") for electricity. Counterparty pays iN2Power fixed price while iN2Power pays the counterparty the floating price on specified settlement dates. The excess of the fixed over the floating price represents gain on iN2Power and a loss to the counterparty; ECHSDc 2. The counterparty pays WESM the spot price ("floating price") for electricity. Counterparty pays iN2Power fixed price while iN2Power pays the counterparty the floating price on specified settlement dates. The excess of the floating over the fixed price represents gain on the counterparty and loss to iN2Power; and 3. The counterparty pays WESM the spot price ("floating price") for electricity. Counterparty pays iN2Power fixed price while iN2Power pays the counterparty the floating price on specified settlement dates. The fixed and floating price equal yield no income or loss to the counterparty or iN2Power. For the CFD between N2P and the Generation company as counterparty 4. The counterparty receives from WESM the spot price ("floating price") for electricity. Counterparty pays iN2Power fixed price while iN2Power pays the counterparty the floating price on specified settlement dates. The excess of the fixed over the floating price represents gain on iN2Power and a loss to the counterparty; 5. The counterparty receives from WESM the spot price ("floating price") for electricity. Counterparty pays iN2Power fixed price while iN2Power pays the counterparty the floating price on specified settlement dates. The excess of the floating over the fixed price represents gain on the counterparty and loss to iN2Power; 6. The counterparty receives from WESM the spot price ("floating price") for electricity. Counterparty pays iN2Power fixed price while iN2Power pays the counterparty the floating price on specified settlement dates. The fixed and floating price equal yield no income or loss to the counterparty or iN2Power. In reply, please be informed of the following: The CFD to be entered by iN2Power with generation companies and wholesale retailers of electricity is a form of financial instrument known as a Swap. A Swap is pan agreement whereby two parties (called counterparties) agree to exchange periodic payments (Frank J. Fabozzi, Capital Markets: Institutions and Instruments, Third Edition) . While a Swap is commonly used to hedge currency and interest rate fluctuations, it can also be used to hedge the price of non-storable commodities like electricity (Don M. Chance, Analysis of Derivatives for the CFA Program, 2003) . IDaEHC In a Swap Agreement, the gain realized by iN2Power when the counterparty pays the excess of the fixed price over the floating price are considered ordinary income on the part of iN2Power, subject to the ordinary corporate income tax of 35% under Section 27 (A) of the 1997 Tax Code, as amended. On the other hand, the loss incurred by iN2Power when it pays the counterparty the excess of the floating over the fixed price shall be allowed as deductible expenses under Section 34 of the 1997 Tax Code (BIR Ruling No. DA-009-01 dated January 30, 2001). Considering that the parties shall effect payment of the fixed and floating price on a net basis scheme as provided under the CFD, the basis for determining the gain or loss shall be the excess or net swap payment made by either party on each settlement date ( BIR Ruling No. DA-009-01 dated January 30, 2001). With regard to the liability for VAT, as a rule, there shall be levied, assessed and collected, a value-added tax equivalent to twelve percent (12%) of gross receipts derived from the sale or exchange of services (Section 108 of the 1997 Tax Code, as amended). Thus, the gain to be derived by iN2Power from the net swap payments on each settlement date shall be subject to 12% VAT. As far as the DST is concerned, the CFD embodying the electricity rate swap to be entered into by iN2Power and the counterparties is not subject to documentary stamp tax as this is not a loan agreement but merely an exchange of cash flows between the parties (BIR Ruling No. DA-009-01 dated January 30, 2001). Furthermore, electricity rate swap agreements are not one among those instruments falling under any of the documents enumerated under the Tax Code of 1997 that are subject to a specific DST (BIR Ruling No. DA-381-98 dated August 24, 1998). 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. CDcHSa Very truly yours, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service