Quiason Makalintal Barot Torres & Ibarra

October 27, 2009 BIR RULING [DA-(C-244) 625-09] 27; 98; #076-89; DA-178-96; DA-419-2004; DA-545-2004; DA-136-2005; DA-028-2005; DA-225-2005; DA-257-2005; DA-643-2007; DA-038-2006; DA-342-2008; DA-269-2008 Quiason Makalintal Barot Torres & Ibarra 21st Floor, Robinsons-Equitable Tower 4 ADB Avenue Corner Pedro Poveda Avenue 1605 Ortigas Center, Pasig City Attention: Attys. Enrique I. Quiason and Benedict R. Tugonon Gentlemen : This refers to your letter dated October 8, 2009 requesting on behalf of your client, Benpres Holdings Corporation (Benpres), for a ruling confirming your position, as follows: aAcHCT 1. the condonation by the holders of the 7.875% Notes and the Long Term Commercial Papers (LTCPs) of at least 35 to 40% of the principal and the interest due on the debt, and the condonation by the holders of at least 35 to 40% of the purchase price of the option shares in Bayantel Telecommunications Holdings Corporation (Bayantel) is not subject to corporate income, including the minimum corporate income tax or to donor's tax, if after the condonation, Benpres remains to be in capital deficit position; and 2. the reversal by Benpres of the provision for Estimated Liabilities is not subject to income tax since Benpres did not and will not realize any taxable income from the reversal of the Estimated Liabilities, which provision was made purely for financial accounting purposes and not for income tax purposes. It is represented that Benpres is a corporation duly organized and existing under and by virtue of the laws of the Philippines, with principal office at 4/F Benpres Building, Meralco Ave., cor. Exchange Road, Pasig City, a publicly listed company listed with the Philippine Stocks Exchange; that in 2002, Benpres defaulted on its principal and interest payments on its long-term direct obligations and its guarantees and commitments to Bayantel Telecommunications Holdings Corporation (Bayantel), an associate; that for taxable year ending December 31, 2008 and 2007, the current liabilities of Benpres exceeded its current assets by P13.587 billion and P17.977 billion, respectively. Regarding the debt instruments, which Benpres bought back from its holders, it is represented that on June 1, 1997, Benpres issued 7.875% Notes of US$150 million listed in the Luxembourg Stock Exchange (7.875% Notes) which matured on December 19, 2002, bearing interest of 7.875% per annum, net of withholding taxes, payable in arrears in equal semi-annual installments in June and December of each year; that at the option of the noteholders, Benpres will redeem all (but not less than all) of such holder's 7.875% Notes at any time upon the occurrence of a restructuring event, pursuant to the Indenture; that as a result of the default of Benpres in 2002 in paying the principal and interest payments on the 7.875% Notes, the principal amount, together with accrued interest and all other amounts immediately became due and payable; that the Philippine Securities and Exchange Commission approved the issuance by Benpres of P3 Billion worth of LTCPs to finance its investments, offered and issued in two series, "A-1" for P1 Billion Pesos and "A-2" for P2 Billion; that Series A-1 was fully paid in 2001 while Series A-2 was supposed to be repaid last October 1, 2003, however Benpres likewise defaulted on its interest payments on the LTCPs in 2002 and on its principal payment in 2003; that in addition to the 7.875% Notes and the LTCPs, another direct obligation of Benpres is the put option of Chase Manhattan Bank (Chase) and Asian Infrastructure Fund (AIF) amounting to US$6,346,618.43 and US$43,029,751.90, respectively; that Chase later assigned its put option rights to the Avenue Capital Group, for which Benpres made a provision in its books since the time the option became due on October 24, 2002, pursuant to the Shareholder's Agreement (SA) with certain shareholders (option holders) of Bayantel where the shareholders have the option to require Benpres and Lopez, Inc. to purchase shares of Bayantel (option shares) from them under certain conditions, which options can be exercised upon the occurrence specified in the SA or in 2002, whichever comes first; that the purchase price of the option shares that Benpres is required to pay shall be the greater of the aggregate cost price in US dollars of the relevant option shares paid by the shareholders thereof amounting to an initial investment of approximately US$20 million plus interest at the US Prime Rate compounded annually from the date of the relevant purchase to the date of the exercise of the option or the fair market value of the option share (Option Price). HEAcDC You likewise informed us that in 2007, Benpres purchased debt from four (4) LTCP holders, namely Wise Capital Investments (formerly Dharmala Citco), BPI Capital Corporation, Lourdes H. Inocentes, and Carmelito P. Mata, holding a total value of P10 million, inclusive of accrued interest of P0.1 million, which debt was purchased for P6 million or at 60% of the principal amount of debt; that in 2008, Benpres purchased debt from five (5) LTCP holders, namely BPI Capital Corporation, Citicorp Financial Services & Insurance Brokerage Phils. Inc., Citibank, N.A., Deutsche Bank AG, and JP Morgan Securities (Asia Pacific) Ltd. (holding a total value of P480 million, inclusive of accrued interest of P4 million, which debt was purchased at a price of P288 million or at 60% of the new principal amount of debt; that in 2009, Benpres purchased LTCP from nine (9) LTCP holders namely Alfredo Aungon, Benjamin Oben, ING Bank NV, Citicorp Financial Services and Insurance Brokerage Phils., Inc., AB Capital & Investment Corp., BPI Capital Corporation, Asset Pool A, Avenue Asia Special Situations Fund III, and Advent Capital & Finance Corp., holding a total value of P643.2 million, inclusive of accrued interest of P1.8 million, at an aggregate price of P409.45 million or at 65% of the new principal amount of debt; that Benpres purchased a total of $109 million of the 7.875% Notes, inclusive of capitalized interest of $3.7 million early this year from eleven (11) bond holders namely ING Asia NV, Citibank NA, JP Morgan Securities (Asia Pacific), BPI, Credit Suisse, Citibank NA, Union Bank of Taiwan, HSBC, ING Bank NV, Deutsche Bank and Avenue Capital Group at a price of $67.1 million; that again last August 2009, Benpres purchased a portion of the 7.875% Notes amounting to US$105 million from Avenue Capital Group at a price of US$62 million or at 65% of the principal amount of debt; that Benpres was able to purchase the Option Shares of Avenue Capital Group at a price of US$4,125,301.98 or at 65% of the option price amounting to US$6,346,618.43; that in November 2007, Benpres together with Lopez, Inc., settled the US$43 million worth of debt held by AIF for US$32 million with Benpres paying US$26 million or 60% of the obligation; that in consideration of the negative financial condition of Benpres, particularly the default event in 2002, the creditors of Benpres have lost interest in collecting the full amount of the loan obligation of Benpres and agreed to condone at least 35% to 40% of their claims against Benpres by accepting the offer of Benpres to purchase the debt instruments only at 60% to 65% of the principal amount of the debt; that the principal and interest condoned in favor of Benpres are reflected as gain on extinguishment and acquisition of debt; that after the condonations, Benpres will still be in a capital deficit position. The Audited Financial Statements of Benpres reflects that the company continually sustained the following business downturn summarized as follows: FY2008 FY2007 (Amounts in Millions) Net income/(losses) P2,852 P3,368 Capital deficiency (3,693) (6,009) Deficit (15,325) (18,177) The unaudited Balance Sheet of Benpres after the condonations, or as of August 30, 2009 is as follows: At Cost Basis (Amounts in Millions) Current Assets P872 Current Liabilities 5,878 Deficit (7,872) It is further represented that Benpres has set up an allowance for impairment of losses on its investments in and advances to Bayantel, including additional claims that may arise from its guarantees and commitments to Bayantel, amounting to P6.905 Billion and P7.107 Billion as of December 31, 2008 and 2007, respectively; that among the guarantee obligations of Benpres is on the convertible preferred shares issued by Bayantel, an associate, amounting to US$160 million (Convertible Preferred Shares); that under the guarantee, Benpres agreed to advance to each holder, on behalf of Bayantel, such amount that the holder is entitled to receive from Bayantel with respect to the dividend payments amounting to US$27 million (equivalent to P1.270 million) and US$23 million (equivalent to P940 million) as of December 31, 2008 and 2007, respectively; that Benpres and Bayantel entered into an Indemnity Agreement where Bayantel agreed to indemnify Benpres in the event that it is required to pay the guaranteed obligations and Bayantel shall indemnify and keep Benpres indemnified by paying the guaranteed obligations actually paid within 45 days from the date of such payment including all costs, liabilities, losses and expenses that it may incur by reason of, in connection with, or in relation to the guarantee; that the convertible preferred shares were subject to mandatory redemption on January 8, 2003 at US$50 per share plus accrued and unpaid dividends and a final dividend that will provide holders with an effective annual yield of 6.5% compounded annually from issue date to the date of redemption; that on January 8, 2003, Bayantel and Benpres were unable to redeem the shares; that Benpres negotiated with the preferred shareholders on its settlement; that by virtue of Benpres' guarantees and commitments to Bayantel, it recognized for financial accounting purposes the indirect obligations as estimated liabilities from guarantees and commitments (Estimated Liabilities) amounting to US$145 million and US$167 million as of December 31, 2008 and 2007, respectively, with equivalent Philippine Peso amounts of P6.905 billion and P7.107 billion, respectively, however, Benpres did not derived any tax benefit arising from the Estimated Liabilities since Benpres did not deduct the provision from its gross income for income tax purposes; that the set up of the allowance or estimated liabilities was made exclusively for financial accounting purposes but not for tax purposes; that last August 21, 2009, Benpres was able to purchase the Convertible Preferred Shares of Bayantel at a purchase price of US$106 million, with a discount of 35% of its redemption price; that as a result of the purchase by Benpres of the Convertible Preferred Shares, Benpres became both the creditor and debtor with respect to the guarantee obligation; that as a result of the merger of the personalities of both creditor/beneficiary and debtor/guarantor in Benpres, the guarantee obligation of Benpres is automatically extinguished as a result of the legal confusion in accordance with the provisions of Article 1275 of the Civil Code of the Philippines, which states that the obligation is extinguished from the time the characters of creditor and debtor are merged in the same person. It is your position that the condonation by the holders of the 7.875% Notes and the LTCPs of at least 35 to 40% of the principal and the interest due on the debt and the condonation by Avenue Capital Group and AIF of 35% and 40%, respectively, of the Option Price is not subject to corporate income, including the minimum corporate income tax or to donor's tax considering that after the condonation, Benpres remains to be in capital deficit position. It is likewise your position that the reversal by Benpres of the provision for Estimated Liabilities is not subject to income tax since Benpres did not derived any tax benefit in setting up the Estimated Liabilities which provision did not at all offset nor reduce the taxable income of Benpres and consequently it will not realize any taxable income from the reversal of the Estimated Liabilities, which provision was made purely for financial accounting purposes and not for income tax purposes. In reply please be informed that in BIR Ruling No. DA-222-2005 dated May 9, 2005, this Office ruled that the condonation of the HLIH's debt to HLIB shall not be subject to income tax considering that HLIH is in a capital deficiency position and will remain insolvent before and after the said condonation, to wit: In reply, please be informed that in BIR Ruling No. DA-419-04 dated August 4, 2004, this Office had the occasion to rule that: "Thus, the condonation of the CPI's debt to SJ shall not be subject to income tax considering that CPI is in a capital deficiency position and will remain insolvent before and after the said condonation considering that the amount to be condoned would only be P84,198,555.20. Moreover, the condonation is likewise not subject to gift tax since there is no donative intent on the part of SJ but solely for business consideration." DHITcS The above ruling was issued by the BIR on the basis of the discussions stated in BIR Ruling No. 076-89 dated April 17, 1989 which states as follows: "Cancellation and forgiveness of indebtedness may amount to a payment of income, to a gift, or to a capital transaction, dependent upon the circumstances. If for example, an individual performs services for a creditor who, in consideration thereof cancels the debt, income to that amount is realized by the debtor as compensation for his services. If, however, a creditor merely desires to benefit a debtor and without any consideration therefor cancels the debt, the amount of the debt is a gift from the creditor to the debtor and need not be included in the latter's gross income. If a corporation to which a stockholder is indebted forgives the debt, the transaction has the effect of the payment of a dividend. (Sec. 50 Revenue Regulations No. 2) The waiver of interest by the banks on non-trade and trade related indebtedness of GMPI is not subject to income tax considering that the deduction of said interest as expense in prior years did not offset nor reduce the taxable income of GMPI since it was in a financial loss position even without the deduction. (See Barnhart-Marrow Consolidated v. Commissioner of Internal Revenue , 47 BTA 590) Moreover, when a creditor cancels a debt as part of a business transaction, the debtor is enriched or its net assets has been increased and, therefore, he realized taxable income (Philippine Fiber Processing Co. v. CIR , CTA Case No. 1407 Dec. 29, 1966). However, a transaction whereby nothing of exchangeable value comes to or is received by a taxpayer does not give rise to or create taxable income. (See Dallas Transfer and Terminal Warehouse Co. v. Commissioner of Internal Revenue, 5 Cir. 70 F 2d 95, 13AFTR 930) Accordingly, the condonation of GMPI's indebtedness by GM-US is not subject to income tax since before and after the condonation GMPI remains insolvent, i.e. , in a capital efficiency position. The condonation is likewise not subject to gift tax since there is no donative interest on the part of GM-US but solely for business consideration since Isuzu will only acquire the GMPI shares from GM-US if GMPI has a "clean" balance sheet with no outstanding liabilities except those to Isuzu." ITSaHC Furthermore, in BIR Ruling No. DA-545-2004 dated November 5, 2004, this Office had the occasion to apply the tax benefit doctrine in ruling that the interest expense reverted or written off will not result in any taxable income since there was no tax benefit derived from the accrual, to wit: The reversal of amounts booked and accrued as interest expenses will call for the application of the "tax benefit doctrine" which is a theory which provides for the inclusion in gross income of amounts deducted in earlier taxable years and recovered in later years, but only to the extent that the earlier deductions resulted in income tax liability of the earlier year. On the basis of the above facts as represented, this Office opines that since UIBC did not and will not derive any tax benefit whether the said accrued expenses are allowed or not, the subsequent reversal/write off of the amount booked will not result in any taxable income subject to tax. Hence, the amounts reverted or written off shall not be considered as part of the outstanding loan which is proposed to be settled by way of dation in payment. Thus, the condonation by the holders of the 7.875% Notes and the LTCPs of at least 35 to 40% of the principal and the interest due on the debt and the condonation by Avenue Capital Group and AIF of 35% and 40%, respectively, of the Option Price is not subject to corporate income, including the minimum corporate income tax if Benpres remains to be in a capital deficiency position before and after the said condonation. Moreover, the said condonation is likewise not subject to gift tax since there is no donative intent on the part of the creditors but is solely for business considerations. However, if after the condonation it is shown that Benpres derived income from the transaction, then the said amount shall be subject to the corporate income tax accordingly. The reversal of amounts booked and accrued as Estimated Liabilities on account of the guarantee commitments of Benpres will call for the application of the "tax benefit doctrine" which is a theory which provides for the inclusion in gross income of amounts deducted in earlier taxable years and recovered in later years, but only to the extent that the earlier deductions resulted in income tax liability of the earlier year. Thus, the reversal by Benpres of the provision for Estimated Liabilities is not subject to income tax since, as represented, Benpres did not deduct the Estimated Liabilities for income tax purposes and that said provision was made purely for financial accounting purposes and not for income tax purposes. 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. aSTAHD Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service