Bureau of the Treasury

April 28, 2010 BIR RULING [DA-(FIT-002) 054-10] 24 (B) (1), 25 (A) (2), (B), 27 (D) (1), 28 (A) (7) (a), 121, 179; BIR Ruling Nos. 007-04, DA-022-06A, DA 050-07 Bureau of the Treasury Intramuros, Manila Attention: Roberto B. Tan Treasurer of the Philippines Gentlemen : This refers to your letter dated March 8, 2010 requesting confirmation of the tax treatment of the proposed issuance by the Republic of the Philippines (Republic) of the 3-year and 5-year Fixed Rate Multi-Currency Retail Treasury Bonds for Overseas Filipino Workers (OFWs) (hereafter referred to as "rTB for OFWs" or "rTBs" for brevity). cHDAIS It is represented that the Republic, represented by the Secretary of Finance, 1 with the approval of the President, intends to issue the rTB for OFWs to raise funds for the National Government to meet public expenditures authorized by law and to provide local and overseas Filipinos the opportunity to invest in Philippines government securities. Specifically, this maiden offering of the rTB for OFWs will be issued onshore simultaneously in two (2) tranches: (1) US Dollar Tranche; and (2) European Union Euro Tranche. The indicative issue size for the US Dollar Tranche is US$400 Million and the EUR Tranche is 75 Million with a minimum subscription amount of US$100.00 and 100.00, respectively. The rTBs will mature three (3) and five (5) years from issue date tentatively set for April 2010. Interest payments will be made quarterly. It is further represented that the rTBs will be offered only in the Philippines on primary issue to qualified retail investors, domestic and resident foreign corporations and foreign currency depositary units (FCDUs). To provide investment opportunities to OFWs and other qualified retail investors, a certain portion of the issue will be allocated for them. The qualified retail investors here refer to OFWs, migrant Filipinos, their families and beneficiaries, trusts holding funds for and in their behalf and such other individual investors as the Secretary of Finance may determine. It is finally represented that in recognition of the immense contribution of OFWs and migrant Filipinos to our economy, the Republic will assume the final withholding taxes on the rTBs held by OFWs and other qualified retail investors. 2 Thus, interest payments to them shall be net of any taxes. On the other hand, other bondholders including FCDUs shall bear the final withholding tax on the rTBs, which shall be deducted from the interest payments. The salient features of the rTB for OFWs are as follows: " 3-year and 5-year Fixed Rate Multicurrency Retail Treasury Bonds for Overseas Filipino Workers in US Dollar and Euro Denominations due 2013 and 2015 Principal Commercial Terms Issuer: REPUBLIC OF THE PHILIPPINES Selling Agents: Dealers who made a successful bid for both US Dollar and Euro Tranches, with an aggregate minimum principal amount equivalent to US$5,000,000.00 of the US Dollar Tranche or 1,000,000.00 of the 3-year and 5-year Fixed Rate Multicurrency Retail Treasury Bonds for Overseas Filipino Workers (the "Bonds") TIaCcD Dealers who wish to participate in the Auction must submit a duly accomplished Accession Letter substantially in the form of Annex A . Issue Currency and Amount: Target amount of the issue is equivalent to US$500,000,000.00, broken down into the approximate amounts as follows: (i) US Dollar Tranche US$400,000,000.00 (ii) Euro Tranche 75,000,000.00 The Issuer reserves the right to increase the overall size of the Issue. Nature and Amount of Bid: Each Bid shall be unconditional. The minimum Bid for each Tranche shall be: US$ Tranche Euro Tranche US$5,000,000.00 1,000,000.00 and increments of: US$ Tranche Euro Tranche US$1,000,000.00 1,000,000.00 Auction Date: 21 April 2010 Offer Period: 21-27 April 2010. Acceptance of subscriptions shall be on a "first-come-first-serve" basis. When subscription has reached a level deemed sufficient by the Issuer, the Issuer, through the BTr-SOD, shall announce the termination and closure of the offer period through electronic financial information providers chosen by BTr, such as Thomson Reuters, Bloomberg, or any of its successors. The Issuer reserves the right to announce at any time, the remaining volume available for sale on a particular day during the Offer Period." Issue Date: 29 April 2010 ISIN/Series Code: US$ 3-year: USDB0313D010 US$ 5-year: USDB0515D010 3-year: EURB0313D018 5-year: EURB0515D018 Form and Denomination: The Bonds shall be issued in scripless form and will be sold during the public offer period in the following minimum denominations and integral multiples thereof for each Tranche: (i) US Dollar Tranche US$100.00 (ii) Euro Tranche 100.00 Maturity Date: 29 April 2013 and 29 April 2015 for the 3-year and 5-year Bonds, or if the Issue Date does not occur on 29 April 2010, the Maturity Date shall be the date that is 3 and 5 years, respectively, following the Issue Date. Issue Price: At par (or 100%) Redemption Price: At par (or 100%) Interest Rate: The final interest rate for each Tranche shall be determined through Dutch Auction to be participated in by Government Securities Eligible Dealers ("GSEDs") At about 11 am on Auction Date, the Issuer through BTr will issue a pricing guidance which will indicate the maximum bid yield for each tenor for both Tranches. Interest Payment Date: Interest on the Bonds, to be calculated on a 30/360-day basis, will be paid quarterly in arrears on the last day of each 3-month Interest Period. The Bonds will cease to bear interest on the Maturity Date. If the Interest Payment Date is not a Business Day, interest will be paid on the next succeeding Business Day, without adjustment in the amount of interest to be paid. Selling and Transfer Restriction: The selling and transfer restrictions shall be as provided in the Program Mechanics, this Notice of Offering and applicable regulations of the BTr. Pursuant to the Authority of the Secretary of Finance under RA 245, as amended, the issuance of the Bonds to the Selling Agents, and the initial transfer of the Bonds from the Selling Agents to the investors within thirty (30) Business Days from Issue Date, is considered within the coverage of the Primary Market and, accordingly, not covered by the rules on fees of any relevant Exchange. Registry and Transaction Fees: Bondholders will be required to open and maintain a sub-registry securities account for monitoring ownership and settlement of transactions on the Bonds. A Bondholder shall be charged a one-time account opening fee of P100.00; an annual account maintenance fee equivalent to 0.0025% of the face value of the Bonds; tax tracking fees for every transfer of the Bonds recorded in the name of the investor; and miscellaneous fees for non-trade transfers, generation and delivery of written statements and notices. All fees associated with the opening and maintenance of sub-registry securities account shall be for the account of the holder of the Bonds. ACETIa The foregoing notwithstanding, Target Investors whose investment in the Bonds qualify as retail shall be exempt from the account opening fee and account maintenance fee. Eligible Subscribers: Eligible Subscribers shall include: (i) Target Retail Investors, i.e. , (a) Overseas Filipino Workers; (b) migrant Filipinos who have maintained or re-acquired Philippine citizenship; (c) legitimate spouse of either a or b; (d) children of either a or b; (e) parents of either a or b; and (f) allotees of a; (ii) Non-OFW Individuals; (iii) Foreign Currency Depositary Units; (iv) Corporates; (v) Tax-exempt Institutions; (vi) Trusts; and (vii) Other investors as the Issuer may determine. For this purpose, an Overseas Filipino Worker is one who has an existing employment contract as an OFW or whose employment contract as an OFW expired not more than one (1) year prior to the Issue Date or purchase date. For this purpose, an Overseas Filipino Worker is an individual citizen of the Philippines who is working or deriving income from abroad by reason of employment, or who has worked or derived income abroad by reason of employment within the period that is one (1) year preceding the date of subscription or purchase of the Bonds. Migrant Filipinos, on the other hand, shall constitute non-resident Filipinos who have retained or reacquired Philippine citizenship under Republic Act No. 9225. GOCCs and LGUs may only purchase the Bonds directly from the Issuer through over-the-counter facility of BTr. An Application to Purchase shall be duly executed for subscription to the Bonds substantially in the form of Annex B hereof. Retail Investors: The term "Retail Investor" shall refer to: (i) Target Retail Investors, (ii) Non-OFW Individuals, and (iii) trusts. CDHSac Retail Sales Obligations: Each Selling Agent shall be required to sell to Retail Investors (as defined above), at least 20% in aggregate US Dollar value of its subscription in both US Dollar and Euro Tranches of the Bonds (as allocated to it by the Issuer) at any time within a period commencing on the Issue Date up to and including the date that is Thirty (30) Business Days from the Issue. Selling Agency Fees: Dealers acting as Selling Agents shall be paid a selling agency fee in accordance with the Notice of Offering. No Dealer shall cede, pay, share, or compensate third-party investors or purchasers any selling agency fees in exchange for the purchase of the Bonds. Any selling agency fee due to Selling Agents shall be deducted from the proceeds of their Bonds sales in accordance with the BTr's "Settlement Procedures for the RTB Public Offering", attached as Annex B. Taxation: The interest income earned by the investors on the Bonds shall be subject to the prevailing withholding tax, except as otherwise prescribed for Target Retail Investors. Documentary stamp tax (DST) on original issue of the Bonds shall also be for the account of the Issuer. The Issuer shall assume and pay for the final withholding tax on the interest income earned from the Bonds by Target Investors, provided the following eligibility requirements among others are complied with to the satisfaction of the Issuer at the time of subscription to or purchase of the Bonds: (a) For an OFW i. He must be a Filipino citizen registered with the POEA or OWWA as an OFW with a valid Overseas Employment Certificate number; ii. He has a valid and existing overseas employment contract at the time of subscription or purchase of the Bonds, or if the contract has already expired, the same should have expired not more than one (1) year from the subscription or purchase date; (b) For a Migrant Filipino i. He is a non-resident Filipino who retained or reacquired Filipino citizenship; SIaHDA ii. He submits his Philippine passport showing that he is a resident of another country or his Bureau of Immigration ID showing he reacquired Filipino citizenship; iii. He submits a copy of his income tax return duly filed in the country where he now takes residence; (c) For the legitimate spouse, children, parents of OFW and Migrant Filipino and Allottees of OFWs i. He must show compliance of his OFW or Migrant Filipino spouse, child, parent or the OFW who made the allotment with the requirements under 12.3 (a) above; ii. He must submit acceptable proof or relationship with the OFW or Migrant Filipino ( e.g. , marriage contract, birth certificate, Philippine passport or Immigration certification, appointment as Allottee) at the time of subscription or purchase of the Bonds; In addition to the foregoing, each Target Investor shall submit a duly accomplished Application to Purchase setting forth the information required therein. The Issuer shall be deemed to have been granted the authority to verify the truthfulness and accuracy of the information and documents supplied by a Target Investor. If at any time it turns out that the Target Investor did not satisfy the requirements set forth herein, the Target Investor shall not be entitled to avail of the tax incentive. Status: The Bonds shall constitute direct, unconditional, unsubordinated, and general obligations of the Issuer and shall at all times rank pari passu and without any preference among themselves. Sinking Fund: The Issuer shall set up and maintain a sinking fund with the BTr in order to accumulate the amounts necessary to pay the principal of the Bonds on the Maturity Date. Eligibility: The Bonds shall qualify in the same manner as all other treasury notes and bonds in respect of (i) insurance reserves under the rules and regulations of the Insurance Commission, (ii) performance and judicial bonds, and (iii) permitted foreign currency cover for FCDU liabilities DEICaA Settlement Procedures: Settlement shall follow the procedure prescribed in the Settlement Procedures for the Multicurrency RTB Public Offering shown as Annex D hereof. Based on the foregoing representations, you now request for confirmation of the following: 1. That the quarterly interest income to be derived from the rTB shall be subject to Final Withholding Tax ("FWT") at the following rates: a. 20% FWT on interest income to be paid to qualified individual buyers under Section 24 (B) (1) of the 1997 Tax Code, as amended ("Tax Code"); b. 20% FWT on interest income to be paid to buyers that are domestic corporations and resident foreign corporations under Section 27 (D) (1) and Section 28 (A) (7) (a) of the Tax Code; and c. 10% FWT on interest income to be paid to FCDU buyers under Sections 27 (D) (3) and 28 (A) (7) (b) of the Tax Code; 2. That the interest income from the rTB to be derived by FCDUs shall be subject to the Gross Receipts Tax ("GRT") at the rate of 5% under Section 121 (a) of the Tax Code; 3. That the issuance of the rTB shall be subject to Documentary Stamp Tax (DST) imposed under Section 179 of the Tax Code; and 4. That the proposed assumption by the Republic of the FWT due on the rTBs held by qualified retail investors ( e.g. , OFWs) is not contrary to law. DCSTAH We reply as follows: 1. Final Withholding Tax Section 22 (Y) of the Tax Code defines a deposit substitute as follows: "The term "deposit substitutes" * (Y) The term 'deposit substitutes' shall mean an alternative form of obtaining funds from the public (the term 'public' means borrowing from twenty (20) or more individual or corporate lenders at any one time), other than deposits, through the issuance, endorsement, or acceptance of debt instruments for the borrower's own account, for the purpose of relending or purchasing of receivables and other obligations, or financing their own needs or the needs of their agent or dealer. These instruments may include, but need not be limited to, bankers' acceptances, promissory notes, repurchase agreements, including reverse repurchase agreements entered into by and between the Bangko Sentral ng Pilipinas (BSP) and any authorized agent bank, certificates of assignment or participation and similar instruments with recourse: Provided, however, That debt instruments issued for inter-bank call loans with maturity of not more than five (5) days to cover deficiency in reserves against deposit liabilities, including those between or among banks and quasi-banks, shall not be considered as deposit substitute debt instruments." Notwithstanding the above definition, this Office has already ruled that the mere issuance of government debt instruments and securities falls within the coverage of "deposit substitutes" irrespective of the number of lenders at the time of origination. 3 Thus, considering that the rTB for OFWs shall be issued by the Republic, the rTB is classified as a deposit substitute and therefore, interest income derived therefrom shall be subject to the following taxes: a. 20% FWT imposed under Section 24 (B) (1) of the Tax Code, if the buyer (or bondholder) is an individual citizen, e.g. , OFWs, their families and beneficiaries; b. 20% FWT imposed under Sections 27 (D) (1) and 28 (A) (7) (a), of the same Tax Code, for domestic and resident foreign corporations, respectively; and c. 10% FWT imposed under Sections 27 (D) (3) and 28 (A) (7) (b) of the Tax Code if the buyer is an FCDU. It bears notice that the final tax on that interest income shall be withheld at source at the time the coupon payments are made, i.e. , on a quarterly basis. Furthermore, any gain that may be derived on the secondary trading of rTBs shall be subject to income tax pursuant to the provisions of Sections 24 (A), 25 (A) (1), 27 (A) and 28 (A) of the same Tax Code if the holder-investor is an individual citizen, non-resident alien, domestic corporation, and resident foreign corporation, respectively. In case the holder of said Bond is a non-resident individual whose country/state has tax treaty with the Philippines, the applicable tax treaty provision shall apply. 2. Gross Receipts Tax Section 121 of the Tax Code of 1997, as amended by R.A. No. 9337, provides that "SEC. 121. Tax on Banks and Non-Bank Financial Intermediaries Performing Quasi-Banking Functions. There shall be collected a tax on gross receipts derived from sources within the Philippines by all banks and non-bank financial intermediaries in accordance with the following schedule: SIaHTD "(a) On interest, commissions and discounts from lending activities as well as income from financial leasing, on the basis of remaining maturities of instruments from which such receipts are derived: "Maturity period is five years or less 5% "Maturity period is more than five years 1% "(b) On dividends and equity shares and net income of subsidiaries 0% "(c) On royalties, rentals of property, real or personal, profits, from exchange and all other items treated as gross income under Section 32 of this Code 7% "(d) On net trading gains within the taxable year on foreign currency, debt securities, derivatives, and other similar financial instruments 7% It is clear from the above provisions that the gross receipts are classified into four (4) categories, i.e. , (a) interest, commissions and discounts from lending activities and income from financial leasing; (b) dividends and equity shares; (c) royalties, rentals and all other items treated as gross income; and (d) net trading gains, with each category having its own applicable tax rate. Applying the foregoing, the interest earned by FCDUs from the rTBs shall be subject to gross receipts tax of 5% since the interest is derived from a lending activity, i.e. , the purchase of a bond issued by the Republic. On the other hand, net trading gains derived on secondary trading of rTBs are subject to gross receipts tax of 7%. 3. Documentary Stamp Tax Section 179 of the Tax Code reads: "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 ration 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. CHIaTc 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 or 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." Thus, rTBs to be issued by the Republic are subject to DST pursuant to the aforequoted provision. The payment of the DST shall be made within five (5) days from the close of the month when the taxable document was made, signed, issued, accepted or transferred. 4 However, the transfer of rTBs in the secondary market by way of simple delivery to the buyer is not subject to DST, unless the transfer carries with it a renewal and issuance of new treasury notes in the name of the transferee to replace the old ones. Hence, for this reason the secondary trading of rTBs in the name of the transferee will no longer be subject to DST. 4. Assumption of Tax Finally, we confirm your opinion that the proposed assumption by the Republic, through the Bureau of Treasury, of FWT due on interest income from the rTBs to be paid to qualified retail investors is not contrary to law. The tax assumption scheme in respect of government bonds was in fact recognized by this Office in BIR Ruling DA 050-07 dated January 31, 2007 where this Office explained the consequence of a tax assumption scheme in this manner: "The government's guaranty to pay the interest free of any tax entitles the holder or investor of the instrument to receive the agreed interest without any deduction for the tax required to be withheld by the government on deposit substitute. It does not mean, however, that the interest income in itself is exempt from tax. As there is no law or regulation providing for the tax exemption of interest income derived from any government bond or instrument, be it issued in peso or in foreign currency, the tax required to be withheld and remitted to the government is still due and payable to the BIR but to be borne by the government. Thus, notwithstanding the presence of a tax exemption clause in the ROP Global Bonds, the interest payments are still subject to the applicable income and withholding taxes, but the tax is borne by the issuer (ROP) and not deducted from the agreed amount of interest payable to the holder of the bond. (Taxation of Financial Institution in the Philippines by Baladad)" LLphil The proposed tax assumption in the instant case does not purport to make the rTB for OFWs a tax-exempt instrument but simply shifts the burden of the tax from the qualified retail investors ( e.g. , OFWs) to the Republic. This Office is not aware of any law prohibiting a party from entering into an agreement to assume the burden of the tax that may be assessed against the other contracting party, provided that the agency assuming said tax is acting within the authority and mandate by law granted to it, and that such authority includes the assumption of taxes due on particular transactions. 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.) GREGORIO V. CABANTAC Deputy Commissioner Legal and Inspection Group Footnotes 1. Pursuant to Republic Act 245, as amended, the Secretary of Finance is authorized to borrow to meet public expenditures authorized by law and to prescribe the financial terms of any debt instruments, including bonds to be issued for the purpose. 2. See Principal Commercial Terms on Taxation, in relation to Item 8 (d) of the Program Mechanics of the Issuance of the Multicurrency Retail Treasury bonds. 3. BIR Ruling DA-022-06A dated February 1, 2006 citing BIR Ruling No. 007-04 dated July 16, 2004. 4. Section 5, Revenue Regulations No. 6-2001 dated July 31, 2001.