TeaM Sual Corporation

December 19, 2008 BIR RULING [DA-(C-182) 559-08] 27 (D) (4); 34 (B); 73; 179; RR 13-2000; DA-196-2003; 175-2003; DA-30-2006; DA-340-2007 TeaM Sual Corporation CTC Building 2232 Roxas Boulevard Pasay City Attention: Kazunobu Takijima VP-Controller Gentlemen : This refers to your letter dated August 17, 2008 requesting for confirmation of your opinion that 1. The cash dividend declaration by TeaM Sual Corporation (TSC), formerly Mirant Sual Corporation, to TeaM Energy Corporation (TEC) is an intercorporate dividend exempt from tax in accordance with Section 27 (D) (4) of the National Internal Revenue Code of 1997 (Tax Code), as amended; 2. The Intercompany Note evidencing the conversion of the dividends payable into an interest bearing loan is subject to documentary stamp tax (DST) at the rate of One Peso (P1.00) for every Two hundred Pesos (P200.000) pursuant to Section 179 of the Tax Code, as amended; and 3. The TSC's interest payment on the loan it acquired to finance its legitimate business expansion is deductible from the gross income of TSC on the ground that it is incurred within a taxable year on indebtedness in connection with TSC's trade or business in accordance with Section 34 (B) of the Tax Code, as amended, and implemented by Revenue Regulations No. 13-2000 dated November 20, 2000. Based on your representations, as well as from the documents submitted, the facts, are as follows: TSC is a domestic corporation organized and existing under the laws of the Philippines with principal address at Sual, Pangasinan. It is engaged in the business of power generation and operates the power generation plant located in Sual, Pangasinan. TEC is a domestic corporation duly registered with the Securities and Exchange Commission to engage principally in the business of power generation services with principal place of business at Ibabang Polo, Grande Island, Pagbilao, Quezon Province. It is also represented that TSC and TEC have their own separate corporate personalities and also have their respective accounting for their payables and liabilities, as can be shown in the Notes to Financial Statements of TEC and TSC. SDcITH TEC is owned by Marubeni Corporation (Marubeni), a non-resident foreign corporation organized and existing under the laws of Japan, and Tokyo Electric Power Company International B.V. (TEPCI), a non-resident corporation organized and existing under the laws of Netherlands. Marubeni and TEPCI are owned by various corporate entities and no individual owns directly or indirectly more than 50% of the outstanding capital stock of both TEC and TSC. Upon adoption of IFRIC 12 in 2008, the Company's Power Agreement with NPC will be accounted for under the financial asset model. Under this model, the Company will derecognize its Power station included as part of the "Property, Plant and Equipment" account and recognize a financial asset to the extent that the Company has an unconditional contractual right to receive cash for its construction services in respect to the Power station. Thus, the Company will continue to recognize energy and operating fees as "service revenues" while the related operating and maintenance cost are charged to expense when incurred. Subsequently, on July 31, 2008, TSC declared cash dividends to TEC out of its unrestricted retained earnings resulting from the adoption of IFRIC 12. On the other hand, TSC has a commitment to JBIC, its creditor, to declare cash dividends, and to the Government, for business expansion. However, TSC did not make any appropriation of its retained earnings as of December 31, 2007 for the said expansion. Instead, the parties agreed that TSC's dividends payable to TEC be converted into an interest bearing inter-company loan, subject to the payment of interest at the annual rate of 12%. Pursuant to this, the appropriate Intercompany Note has been executed by TSC. In support of your request, you submitted the following documents: 1. TSC's Financial Statements for the years 2007 and 2008; 2. TSC's Board Resolution dated August 1, 2008 of its declaration of cash dividends; 3. TSC's Board Resolution dated August 11, 2008 which converted the dividends payable into an interest bearing loan; and 4. Intercompany Note dated August 11, 2008. In reply thereto, please be informed as follows: 1. The cash dividends declared and to be distributed by TSC to TEC is an inter-corporate dividend not subject to income tax pursuant to Section 27 (D) (4) of the 1997 Tax Code, as amended, to wit: "SEC. 27. Rates of Income Tax on Domestic Corporations. xxx xxx xxx (D) Rates of Tax on Certain Passive Incomes. xxx xxx xxx (4) Intercorporate Dividends. Dividends received by a domestic corporation from another domestic corporation shall not be subject to tax." In BIR Ruling No. DA-030-06 dated February 2, 2006, wherein the taxpayer which is a domestic corporation sought clarification whether the cash and property dividends declared and distributed to its stockholders which are all domestic corporations is subject to income tax and consequently to withholding tax, this Office had the occasion to rule that: LLphil "The stockholders of CII shall not be subject to any income tax, capital gains tax or withholding tax upon their receipt of the cash and real properties by way of dividends pursuant to Section 27(D)(4) of the Tax Code; Accordingly, the cash and property dividends declared and distributed by CII to its stockholders which are domestic corporations shall not be subject to income tax pursuant to Section 27(D)(4) of the Tax Code of 1997. Consequently, the subject cash dividends in the amount of P8,120,000.00 and the property dividends in the amount of P5,500,000.00 shall not be subject to any withholding tax. . . ." It should be noted that although a corporation should not declare dividends out of profits earned during an interim period or before the end of the fiscal year, a SEC Opinion dated October 22, 1974 provides that a corporation may declare dividends even before the end of the fiscal year, provided it has sufficient earned surplus for the purpose which will not be impaired by losses, whether expected or not, during the remaining period of the fiscal year. Accordingly, the cash dividends declaration by TSC to TEC, shall not be subject to income tax pursuant to Section 27 (D) (4) of the 1997 Tax Code, as amended, and consequently to withholding tax. Furthermore, it is a well-settled rule that the right of the stockholders of a corporation to a dividend becomes vested as soon as the dividend has been fully declared by the directors, and the corporation becomes their debtor for their respective shares. (SEC Opinion dated April 29, 1987 citing Fletchers, Vol. 11, p. 736 citing U.S. v. Southwestern Portland Cement Co., 97 F 2d 413 revg. 22F Supp. 846; Brown v. Lee Mfg. Co., 231 259, 96 SW 2d 1098; Mc. Laran v. Crescent Planning Mill Co., 117 Mo. App. 40, 93 SW 819 (1906) When a corporation declares cash dividends, the assets of the corporation diminish by exactly the amount paid out and correspondingly, the property of the individual stockholder increases. (11 Fletcher, P. 1110.) The declaration itself of cash dividends is considered effective to create a debt from the corporation to each of its stockholders and segregate the amount thereof from the assets, even though the resolution provides that the dividend is payable to the stockholders in the corporate assets. Clearly, upon the declaration of dividends by the Board of Directors of TSC, TSC becomes a debtor of TEC, and as such liable to pay the indebtedness. In accordance with this, TSC executed the Intercompany Note and undertook to pay interest to TEC at the annual rate of twelve percent (12%). 2. The inter-company note executed by TSC is subject to DST at the rate of one peso (P1.00) for every two hundred pesos (P200.000) pursuant to Section 179 of the Tax Code, as amended, to wit: "SEC. 179. Stamp Tax on All Debt Instruments. On every original issue of debt instruments, there shall be collected a documentary stamp tax of One peso (P1.00) on each Two hundred pesos (P200), or fractional part thereof, of the issue price of any such debt instrument: Provided, That for such debt instruments with terms of less than one (1) year, the documentary stamp tax to be collected shall be of a proportional amount in accordance with the ratio of its term in number of days to three hundred sixty-five (365) days: Provided, further, That only one documentary stamp tax shall be imposed on either loan agreement, or promissory notes issued to secure such loan. For purposes of this section, the term debt instrument shall mean instruments representing borrowing and lending transactions including but not limited to debentures, certificates of indebtedness, due bills, bonds, loan agreements, including those signed abroad wherein the object of contract is located or used in the Philippines, instruments and securities issued by the government of any of its instrumentalities, deposit substitute debt instruments, certificates or other evidences of deposits that are either drawing interest significantly higher than the regular savings deposit taking into consideration the size of the deposit and the risks involved or drawing interest and having a specific maturity date, orders for payment of any sum of money otherwise than at sight or on demand, promissory notes, whether negotiable or non-negotiable, except bank notes issued for circulation. HDAaIc In BIR Ruling No. DA-175-03 dated May 4, 2003, in answering whether the conversion of the deposit for future stock subscription into an interest bearing inter-company US Dollar denominated loan is subject to documentary stamp tax, this Office ruled in this wise "An inter-company memorandum covering advances granted by a corporation to an affiliate company or an inter-office memo evidencing lendings/borrowings is in the nature of a promissory note subject to the DST imposed under Section 180 (now Section 179) of the Tax Code, as amended [BIR Ruling No. 108-99 dated July 15, 1999]. The inter-company memorandum between Essilor and Essidev is in the nature of a loan agreement that is subject to the DST imposed under Section 180 [now Section 179] of the 1997 Tax Code, as amended." Verily, the Intercompany Note executed by and between TSC and TEC evidencing the conversion of the dividends payable into an interest bearing loan is in the nature of a loan agreement subject to DST imposed under Section 179 of the Tax Code, as amended. 3. The interest payment on the loan is an allowable deduction. 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. Provided, however, that the taxpayer's allowable deduction for interest expense shall be reduced by 42% of the interest income subjected to final tax. For interest to be deductible from gross income, the following are the requisites, viz.: (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; (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) (b), 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. (Sec. 3, Revenue Regulations No. 13-2000). EHTIcD In general, the amount of interest expense paid or incurred within a taxable year on indebtedness in connection with the TSC's trade or business shall be allowed as deduction from its gross income. The term "interest" shall refer to the payment for the use or forbearance or detention of money, regardless of the name it is called or denominated. However, for the interest to be deductible, said interest payments should not be among the exceptions to deductibility under Section 34 (B) (2) (b) and (c) of the Tax Code, which provide (a) . . . (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 (c) If the indebtedness is incurred to finance petroleum exploration. Section 36 (B) of the 1997 Tax Code, as amended, provides for the instances of related taxpayers who are not allowed to claim deductions for losses from sales or exchanges or property incurred by and between them. This provision on related party taxpayer is also made applicable to deductions for interest and bad debts as provided in the same Code. Thus, Section 36 (B) states that: "(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 (1) Between members of a family. For purposes of this paragraph, the family of an individual shall include only his brothers and sisters (whether by the whole or half-blood), spouse, ancestors, and lineal descendants; or (2) Except in the case of distributions in liquidation, between an individual and a corporation more than fifty percent (50%) in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual; or (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 corporations, 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; (4) Between the grantor and a fiduciary of any trust; or (5) Between the fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect to each trust; or (6) Between a fiduciary of a trust and a beneficiary of such trust." The word "individual" in Section 36 (B) (3) of the Tax Code above, which is applicable to this case, 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, to wit: "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: SEIacA (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 . . ." 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, as amended, applies, the ownership of TEC and TSC must be traced to the level of the individual shareholder. Since TEC is owned by Marubeni Corporation and Tokyo Electric Power Company International B.V. which are ultimately owned by various corporate entities, no individual owns directly or indirectly more than 50% of the outstanding capital stock of both TEC and TSC. (BIR Ruling No. DA-196-03 dated June 26, 2003) Hence, TEC and TSC are not considered related taxpayers within the contemplation of Section 36 (B) (3) of the Tax Code, as amended. The prohibition does not apply and the interest payments by TSC to TEC on the loan are deductible from its gross income for income tax purposes. It being clearly established that the requisites for deductibility have been sufficiently met, TSC is thus entitled to claim its interest expense on its loan payment to TEC in accordance with Section 34 (B) of the Tax Code, as amended. Accordingly, the interest payments by TSC to TEC on the financing loan are deductible from its gross income for income tax purposes. Section 3 (d) of P.D. No. 87 provides that the term "petroleum operations" is defined as searching for and obtaining petroleum within the Philippines through drilling, and pressure or suction or the like, and all other operations incidental thereto. It includes the transportation, storage, handling and sale (whether for export or for domestic consumption) of petroleum so obtained but does not include any: (1) transportation of petroleum outside the Philippines; (2) processing or refining at a refinery; or (3) any transactions in the products so refined. It is clear from the aforesaid definition that petroleum operations refer only to upstream activities ( i.e., search and obtaining of petroleum) and not to downstream activities ( i.e., importing, exporting, shipping, transporting, processing, refining, storing, distributing, marketing, selling). Hence, interest on loans used to finance, upstream activities is non-deductible while interest relating to loans used for downstream activities is deductible. (BIR Ruling No. DA-112-A-04 dated March 11, 2004) Accordingly, since the proceeds of the interest bearing loan were used to finance TSC's business expansion of its power generation services, which are clearly not upstream activities, the interest paid thereon may be claimed as a tax deduction by TSC in the year the interest is paid or incurred. In fine, the interest to be paid by TSC on the loans to be extended by TEC for purposes of financing TSC's business expansion shall be deductible from its gross income pursuant to Section 34 (B) of the Tax Code of 1997. (BIR Ruling No. DA 196-03 dated June 26, 2003) DcCHTa Based on the foregoing, this Office hereby confirms your opinions that: (1) The cash dividends declaration by TeaM Sual Corporation (TSC) to TEC is an intercorporate dividend exempt from tax in accordance with Section 27 (D) (4) of the Tax Code, as amended; (2) The Intercompany Note evidencing the conversion of the dividends payable into an interest bearing loan is subject to documentary stamp tax (DST) at the rate of One Peso (P1.00) for every Two Hundred Pesos (P200.000) pursuant to Section 179 of the Tax Code, as amended; and (3) The interest paid or incurred during the taxable year on the loan it acquired to finance its legitimate business expansion in its downstream activities is deductible from its gross income pursuant to Section 34 (B) of the Tax Code, as amended, as implemented by Revenue Regulations (RR) No. 13-2000 dated November 20, 2000. This ruling is being issued on the basis of the foregoing facts as represented. If upon investigation, however, it is disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) GREGORIO V. CABANTAC Deputy Commissioner Legal & Inspection Group