SGV & Co.

July 7, 2009 BIR RULING [DA-(C-119) 354-09] Section 34 (B); BIR Ruling No. 116-98, DA-(FIT-004) 076-08, DA-196-03, DA-112-a-04 & DA-274-08 SGV & Co. 6760 Ayala Avenue 1226 Makati City Attention: W. U. Villanueva Principal Gentlemen : This refers to your letter dated May 19, 2009 requesting confirmation of your opinion that: 1) The existing loan transaction between Calamba Premiere Realty Corporation ("CPRC" or the "Company") and Samsung Electro-Mechanics Philippines Corporation ("Semphil") is not deemed an arrangement between related parties as defined under Section 36 (B) (3) in relation to Section 34 (B) (2) (b) of the Tax Code; and EICSTa 2) The interest paid and incurred by CPRC from said loan is an allowable deduction from gross income pursuant to Section 34 (B) (1) of the Tax Code. As represented, CPRC is a domestic corporation primarily engaged in the real estate business registered with BIR Revenue District Office No. 56 with Tax Identification Number 005-303-970-000. The Company has two major stockholders: 59.7% of its issued and outstanding capital is owned by Samsung Electro-Mechanics Philippines Corporation Employees' Retirement Benefit Plan ("Retirement Plan") while 39.8% is owned by Samsung Electro-Mechanics Company Limited of Korea ("Semco"), a foreign corporation listed at the Korean Stock Exchange. Semphil is a domestic corporation registered with the Philippine Economic Zone Authority (PEZA) as an Ecozone Export Enterprise, to engage in the manufacture of multi-layer chip capacitor and thick film chip resistor, micro-chip tantalum capacitor, crystal oscillator, as well as the trading and distribution of Samsung electronic parts and components for various electronic and communication devices to PEZA-registered export enterprises at the Calamba Premier International Park ("CPIP") in Calamba, Laguna. Semphil established the non-contributory employees' retirement benefit plan which the Bureau of Internal Revenue ("BIR") confirmed as a "reasonable private benefit plan" under Section 32 (B) (6) (a) of the Tax Code. Semphil executed a trust agreement with the Far East Bank and Trust Company ("FEBTC", now merged into Bank of the Philippine Islands), appointing FEBTC as the trustee-bank to handle the trust account of the benefit plan. To finance the acquisition of real property, CPRC obtained loans from Semphil on September 4, 1997 and June 19, 2001. The proceeds of the loan were used by the Company to acquire the land at the CPIP on which the Semphil manufacturing facility currently stands. CPRC fully paid the documentary stamp tax (DST) due on the loans. CPRC derives rental income from the lease of the property, which is appropriately declared and subjected to tax. The Company continues to service the loans and considers the interest paid and incurred as allowable deductions for income tax purposes. In reply, please be informed that Section 34 (B) (1) of the Tax Code of 1997, as implemented by Revenue Regulations No. 13-2000, provides that the amount of interest paid or incurred within a taxable year on indebtedness in connection with the taxpayer's profession, trade or business shall be allowed as deduction from gross income. Moreover, Section 3 of Revenue Regulations No. 13-2000 enumerates the following requisites for interest to be deductible from gross income: 1. There must be an indebtedness; 2. There should be an interest expense paid or incurred upon such indebtedness; 3. The indebtedness must be that of the taxpayer; cHCaIE 4. The indebtedness must be connected with the taxpayer's trade, business or exercise of profession; 5. The interest expense must have been paid or incurred during the taxable year; 6. The interest must have been stipulated in writing; 7. The interest must be legally due; 8. The interest payment arrangement must not be between related taxpayers as mandated in Section 34 (B) (2), in relation to Section 36 (B), both of the Tax Code of 1997; 9. The interest must not be incurred to finance petroleum operations; and 10. In case of interest incurred to acquire property used in trade, business or exercise of profession, the same was not treated as a capital expenditure. As a rule, interest payments should be treated as allowable deductions from gross income provided all the above-enumerated requisites are complied with [BIR Rulings (DA-FIT-004) 076-08 dated July 24, 2008, DA-274-08 dated May 2, 2008, DA-112-A-04 dated March 11, 2004, and DA-196-03 dated June 20, 2003]. All the conditions required for deductibility of interest for income tax purposes have been fully satisfied and thus, the interest paid and incurred by CPRC to Semphil arising from the loan obtained to finance the acquisition of real property should be allowed as deductions from its gross income. The loans entered into between CPRC and Semphil are evidenced by written loan agreements, which specifies, among others, the terms agreed upon by the parties including the payment of the principal and interests. The Company utilized the loan proceeds to fund the purchase of a parcel of land, the acquisition of which is reasonably connected with its trade or business as a real estate company. CPRC derives rental income from the lease of the property. The loan transaction between CPRC Semphil is not deemed an arrangement between related parties as defined under Section 36 (B) (3) in relation to Section 34 (B) (2) (b) of the Tax Code. Section 34 (B) (2) (b) of the Tax Code states: "(B) Interest. xxx xxx xxx (2) Exceptions. No deduction shall be allowed in respect of interest under the succeeding subparagraphs: aHSCcE xxx xxx xxx (b) If both the taxpayer and the person to whom the payment has been made or is to be made are persons specified under Section 36(B); or xxx xxx xxx" On the other hand, Section 36 (B) provides: "SEC. 36. Items not Deductible . xxx xxx xxx (B) Losses from Sales or Exchanges of Property. In computing net income, no deduction shall in any case be allowed in respect of losses from sales or exchanges of property directly or indirectly xxx xxx xxx (3) Except in the case of distributions in liquidation, between two corporations more than fifty percent (50%) in value of the outstanding stock of each of which is owned, directly or indirectly, by or for the same individual if either one of such corporation , with respect to the taxable year of the corporation preceding the date of the sale or exchange was , under the law applicable to such taxable year, a personal holding company or a foreign personal holding company ;" [Underscoring supplied] The word "individual" in Section 36 (B) (3) above, refers to natural persons only, excluding therefrom estates, trusts or corporations. Relevant to this section is the provision on personal holding company found in the Tax Code of 1939 to determine whether a corporation is a personal holding company, the attribution rule prescribed in Section 66 of the Tax Code of 1939, as implemented by Section 224 of Revenue Regulations No. 2 should be followed "SEC. 66. Stock ownership. For the purpose of determining whether a corporation is a personal holding company, insofar as such determination is based on stock ownership, the following rules shall be observed: (a) Stock not owned by individual. Stock owned, directly or indirectly, by or for a corporation, estate, or trust shall be considered as being owned proportionately by its shareholders, partners, or beneficiaries. xxx xxx xxx" "SEC. 224. Stock not owned by individual. In determining the ownership of stock for any of the purposes set forth in the preceding section, stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by its shareholders, partners, or beneficiaries. . . ." ISaTCD Therefore, in the case of multi-tiered corporation, the attribution rule must be allowed to run continuously along the chain of ownership until it finally reaches the individual stockholders. [BIR Ruling No. 072-97 dated July 2, 1997]. Such being the case, it may be said that the term "individual" pertains to a natural person as distinguished from a corporate or juridical person. Prescinding from the above-cited provisions, it is apparent that to determine whether the prohibition against the deductibility of interest between related taxpayer provided under Section 36 (B) (3) of the Tax Code applies, the ownership of both corporations (CPRC and Semphil) must be traced to the level of the individual shareholder. Section 36 (B) (3) of the Tax Code requires that in order for two corporations to be considered related taxpayers, more than fifty (50) percent of the outstanding stock of each must be owned, directly or indirectly, by or for the same individual. The exception to deductibility of interest expense does not apply to the Company considering that more than 50% of the issued and outstanding capital stock of both CPRC and Semphil are not owned, directly or indirectly, by or for the same individual and that both CPRC and Semphil are not personal holding companies or foreign personal holding companies. Based on the capital structure of both CPRC and Semphil, it is clear that no one individual owns more than 50% of the issued and outstanding capital stock of both companies. While the Retirement Plan owns 59.7% of CPRC, such fact cannot be considered a violation of Section 36 (B) (3) as the said shareholding cannot be attributed either to Semphil or to Semco. As an established retirement plan duly approved by the BIR, all benefits under the Retirement Plan are payable to Semphil employees and therefore neither Semphil nor Semco derive any benefit from the fund. Furthermore, they do not exercise control, either individually or together, over the fund since it is managed by an independent trustee, BPI as successor-in-interest of FEBTC ( Katuparan Realty Corporation vs. CIR, CTA Case No. 4373 dated February 14, 1993). DTCAES Both CPRC and Semphil cannot likewise be considered as personal holding companies. A personal holding company is one which meets the stock ownership and gross income requirements in Sections 220 to 221 of Revenue Regulations 2. Under the stock ownership requirement, it is necessary that more than 50% in value of its outstanding stock is owned, directly or indirectly, by not more than five (5) individuals. The Retirement Plan owns 59.7% of CPRC. The stock ownership must be attributed only to the Semphil employees who are the beneficiaries of the Trust Fund and not to Semphil. The only other shareholder of CPRC is Semco (which owns 39.8% of CPRC) a company listed at the Korean Stock Exchange. Under the gross income requirement, it is necessary that 70% or more of the gross income of CPRC must be classified as personal holding company income. Under Section 222 of RR 2-40, "rents do not constitute personal holding company income if constituting 50 percent or more of the gross income of the corporation". It is undisputed that the gross income of CPRC consists entirely of rental income, and therefore, is much more than the limit required by law to qualify as personal holding company income. Thus, while CPRC and Semphil are affiliated corporations, they are not considered related taxpayers within the contemplation of Section 36 (B) (3) of the Tax Code. Consequently, the interest payments by CPRC to Semphil on the loan contracts shall be deductible from the Company's gross income pursuant to Section 34 (B) (2) (b) of the same Code. 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.) JAMES H. ROLDAN Assistant Commissioner Legal Service