TeaM Energy Corporation

January 15, 2009 BIR RULING [DA-(FIT-003) 018-09] Sec. 34 (A) (1) (a); DA 166-04 TeaM Energy Corporation TeaM Sual Corporation CTC Building, Roxas Boulevard Pasay City Attention: Kazunobu Takijima Vice President, Controller Gentlemen : This refers to your letter dated November 13, 2008 requesting for confirmation of your opinion that the realized foreign exchange losses of TeaM Energy Corporation (TEC) and TeaM Sual Corporation (TCS) arising from the payment of loans for the period of January to July 2006, pre-termination of their foreign currency debt, and other realized foreign exchange losses from notes payable, inter-company payment and interest payments are deductible expense from their gross income for tax purposes. ACaDTH It is represented that TEC and TSC secured US Dollar currency denominated loans to finance the construction of their respective power generation plant facilities in years 1993 to 1996 for TEC (Pagbilao) and 1996 to 2000 for TSC (Sual). During these periods, the Philippine Peso had a foreign exchange value of approximately Php26.00 and P39.5 against the US Dollar (US$), respectively. When the Philippine Peso suffered devaluation, TEC and TSC incurred heavy foreign exchange losses. Since these loans were obtained to finance the power generation plants, foreign exchange losses were capitalized as part of the power plants. These were subjected to depreciation, however, only the realized portion were claimed as tax deductions and unrealized portion was treated as non-deductible expense and shown as reconciling item for income tax purposes. This practice was in compliance with Statement of Financial Accounting Standards (SFAS) No. 8 and was consistent with the industry practice. It is also represented that beginning January 1, 2005, TEC and TSC adopted Philippine Accounting Standards No. 21, The Effects of Changes in Foreign Exchange Rates, (PAS No. 21). Under PAS No. 21, capitalization of foreign exchange differences resulting from severe devaluation or a depreciation of a currency is no longer allowed. Under PAS No. 21, foreign exchange difference is now recognized in profit or loss in the period in which they arise. In 2006, the loans of TEC and TSC were pre-terminated and loan payments were made by TEC and TSC for the months of January to July 2006. As a result of which TEC and TSC realized foreign exchange losses. Other foreign exchange losses arising from settlement of their notes payable, inter-company payment and interest payments were also sustained by TEC and TSC in 2006. Consistent with PAS No. 21, the foreign exchange differences were recognized by the companies in profit or loss in 2006. It is finally represented that TEC and TSC computed their tax liabilities using the historical rate method (Peso Books) until June 22, 2007, the date when the consortium of Tokyo Electric Power Company International B.V. and Marubeni Corporation completed the acquisition of all outstanding shares in Mirant Asia-Pacific Limited (now known as TeaM Asia Pacific Limited) of which TEC and TSC were then subsidiaries. Based on the foregoing, you now seek an opinion that for tax purposes, the realized foreign exchange losses arising from the aforementioned transactions of TEC and TSC are deductible expense from gross income of the companies. AaEcDS In reply, please be informed that Section 34 (A) (1) (a) and (D) of the 1997 Tax Code provides as follows: "SEC. 34. Deductions from Gross Income. . . . there shall be allowed the following deductions from gross income: (A) Expenses. (1) Ordinary and Necessary Trade, Business or Professional Expenses. (a) In General. There shall be allowed as deduction from gross income all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on or which are directly attributable to, the development, management, operation and/or conduct of the trade, business . . . . (D) Losses. (1) In General. Losses actually sustained during the taxable year and not compensated for by insurance or other forms of indemnity shall be allowed as deductions: . . ." In BIR Ruling No. DA166-04 dated April 5, 2004, this Office ruled that a foreign exchange loss arises from foreign currency denominated liability when the transaction is closed and terminated by the payments of said liability. This ruling found support in the case of The Coca-Cola Export Corporation vs. CIR (CTA Case No. 5238, December 19, 1997), where the Court of Tax Appeals held that: "We find nothing ambiguous nor obscure in the language of Section 29(d)(2) [now Section 34(A)(1)(a) and (D)] of the Tax Code, insofar as the same is brought to bear upon the circumstances of the petitioner in the case at bar. The provision itself furnishes the best means of its own exposition that all losses actually sustained during the taxable year not compensated by insurance or otherwise are deductible from gross income. It does not specify that the loss must be the result of transactions in the taxable year only. What the law requires is that the loss must be actually sustained in the taxable year and not compensated by insurance or otherwise. In other words, what is needed to be entitled to a loss deduction, is for the taxpayer to prove that a closed and completed transaction sets the loss in the taxable year or in the year claimed and it is not compensated by insurance or otherwise. A closed and completed transaction is one in which the facts indicate the transaction sufficiently final to ascertain that a loss has occurred (Mertens, Law of Federal Income Taxation, Chapter 28, Page 3). Thus, applying the latin maxim "Ubi lex non distinguit nec nos distinguere debemos", where the law does not distinguish, we should not distinguish, the loss which is the result of a foreign exchange fluctuation ascertained and realized during the taxable period and not compensated by insurance or otherwise, . . . , is deductible from gross income of said taxable period, albeit it may relate to transactions of prior years." IHaSED Accordingly, this Office held that foreign exchange losses sustained as a result of devaluation of the Philippine peso vis--vis the foreign currency ( e.g. , US dollar) are deductible from gross income for income tax purposes when the remittance of scheduled amortization consisting of principal and interest on the foreign loan has actually been made. It was further held that any realized foreign exchange losses arising from the decrease in the value of the Philippine Peso could be treated as an ordinary and necessary business expense. (BIR Ruling Nos. 144-85, 206-90 and 137-97, In BIR Ruling No. DA-175-2003 dated May 4, 2003) Based on all the foregoing and considering that TEC and TSC were using the historical rate method at the time they incurred foreign exchange losses from the pre-termination and payment of foreign currency denominated loans as well as from the payment of other notes payables, inter-company payments and interest payments, such losses are ordinary and necessary business expenses that are deductible from the gross income of TEC and TSC pursuant to Section 34 (A) (1) (a) and (D) of the Tax Code. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be ascertained that the facts are different, and/or any of the requirements imposed in this letter are not complied with, then this ruling shall be considered as null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service