Puno and Puno Law Offices

July 24, 2008 BIR RULING [DA-(FIT-004) 076-08] Sec. 34 (B) (1); 179; BIR Ruling No. 116-98; DA 320-07 Puno and Puno Law Offices 12th Floor East Tower, Philippine Stock Exchange Centre Exchange Road, Ortigas Center, Pasig City Attention: Attys. Ma. Elizabeth E. Peralta-Loriega Erikson V. Eustaquio and Dionne Marie M. Sanchez Gentlemen : This refers to your letter dated July 23, 2008 requesting on behalf of your client, First Gas Power Corporation ("FGPC"), confirmation of your opinion on the following concerns: 1. The interest expense of FGPC from the Facilities (as the term is defined below) from various lenders is fully deductible despite the proposed on-loan of a portion of the loan proceeds to FGPC's indirect stockholders, First Gen Corporation ("First Gen") and Lisbon Star Philippine Holdings ("BG"), at a lower interest rate. 2. The proposed on-loan (if evidenced by board resolutions and cash vouchers issued by FGPC with the corresponding acknowledgment thereof by each of First Gen and BG to evidence the disbursement of the on-loans to each of them) does not attract documentary stamp tax. 3. The interest income on the proposed on-loan is taxable to FGPC, while the interest expense on the proposed on-loan is deductible from the gross income of First Gen and BG to the extent of the respective interest rate for each. EHSADa It is represented that FGPC has obtained various loans from various lenders to finance the development, construction, ownership and operation of the Santa Rita power plant (the "Existing Loans"). FGPC intends to refinance the Existing Loans and secure new loans from new and/or existing lenders in the aggregate principal amount of up to US$750,000,000 (the "Facilities") comprising of: (i) an uncovered loan facility, which will be a term loan provided by one or more commercial lenders in the aggregate principal amount of up to US$300,000,000 (the "Uncovered Loan Facility"); (ii) a covered loan facility, which will be a term loan in the aggregate principal amount of up to US$450,000,000 to be guaranteed by private insurance companies as to certain political risks (the "Covered Loan Facility") (together with the Uncovered Loan Facility and the Covered Loan Facility shall be referred to as the "New Facilities"); and (iii) KfW/HERMES facility, which is an existing term loan in the aggregate principal amount of US$44,000,000 guaranteed by HERMES Kreditversicherungs AG ("HERMES") and provided by KfW (the "KfW/HERMES Facility"). Interest on the Facilities shall be computed based on interest rate per annum applicable to any interest period equal to the sum of US Dollar LIBOR for that interest period plus the applicable margin (the "Applicable Margin") as follows: (i) The Applicable Margin for the Covered Loan Facility shall be 1.75% p.a. at any time during the tenor of the Covered Loan Facility (exclusive of Political Risk Insurance cost of 1.25% p.a.). (ii) The Applicable Margin for the Uncovered Loan Facility shall be as follows: Period Applicable Margin From signing date of the financing 2.00% p.a. agreements to the 5th anniversary of the funding date Thereafter until the 7th anniversary of the 2.25% p.a. funding date Thereafter until the final maturity date 2.40% p.a. It is proposed that a portion of the proceeds of the Facilities in the amount of approximately up to Four Hundred Eighty Five Million Three Hundred Fifty Thousand United States Dollars (US$485,350,000) will be re-lent by FGPC to First Gen and BG, its indirect shareholders. The amount of approximately up to Two Hundred Ninety One Million Two Hundred Ten Thousand United States Dollars (US$291,210,000) is proposed to be re-lent by FGPC to First Gen (the "First Gen On-loan"), while the amount of approximately up to One Hundred Ninety Four Million One Hundred Forty Thousand United States Dollars (US$194,140,000) is proposed to be re-lent by FGPC to BG (the "BG On-loan") (The First Gen On-loan and the BG On-loan are collectively referred to herein as "On-loans"). The interest rates applicable to the First Gen On-loan and BG On-loan are lower than the interest rate that will be paid by FGPC to its lenders. Moreover, the interest rate on the First Gen On-loan is higher than the interest rate on the BG On-loan. TaSEHC Finally, the parties propose to document the First Gen On-loan and the BG On-loan by way of board resolutions to be issued by FGPC and acknowledged by each of First Gen and BG (with respect to their separate On-loan) and cash vouchers evidencing the disbursement of the On-loans to each of First Gen and BG. In reply, please be informed as follows: 1. On the deductibility of Interest Expense of FGPC Section 34 (B) (1) of the NIRC of 1997, as amended by Republic Act 9337, provides that the amount of interest paid or incurred within a taxable year on an indebtedness in connection with the taxpayer's profession, trade or business shall be allowed as a deduction from gross income. This provision is implemented by Revenue Regulations (Rev. Regs.) No. 13-00 dated November 20, 2000, Section 3 of which prescribes the requirements for deductibility of interest expense from the gross income of taxpayer, viz.: (a) There must be an indebtedness; (b) There should be an interest expense paid or incurred upon such indebtedness; (c) The indebtedness must be that of the taxpayer; (d) The indebtedness must be connected with the taxpayer's trade, business or exercise of profession; (e) The interest expense must have been paid or incurred during the taxable year; (f) The interest must have been stipulated in writing; (g) The interest must be legally due; (h) The interest payment arrangement must not be between related taxpayers as mandated in Sec. 34 (B) (2) (b), in relation to Sec. 36 (B), both of the Tax Code of 1997; (i) The interest must not be incurred to finance petroleum operations; and SITCcE (j) 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. Generally, as long as the foregoing requirements are met, interest expense incurred by a taxpayer is deductible from its gross income. With respect to interest expense arising from a loan which is subsequently relent by a corporation to affiliates, however, this Office has already ruled that for the interest expense on the loan to be deductible from the corporation's gross income, the corporation should recognize as interest income the interest it charges on the relending activity. In BIR Ruling No. 116-98 dated July 30, 1998, this Office held that: "On the matter of whether the corresponding interest on the amount so borrowed can be deducted as legitimate business expense, this Office opines that the corporate-debtor (i.e., the affiliate-lender) which initially borrowed the fund from the bank or any lending/financing institution and thereafter pays the corresponding interest thereon, may claim the same as legitimate business expense provided, however, that such interest receive from its affiliate-borrower but which thereafter is paid to the bank/financial institution, is reported as interest income for the purpose of computing the regular corporate income tax. If, however, it does not relend the amount so borrowed but instead uses it, then it shall be entitled to deduct the same as legitimate business expense; otherwise, it shall be the affiliate-borrower who borrows and makes use of the fund and hereafter pays the interest being passed on to it that can claim such interest as legitimate business expense subject, however, to the provisions of Section 34 (B) of the Tax Code of 1997 [then Section 29 (g) of the Tax Code, as amended] . . . . In the meantime however, that the corporate-debtor is in possession of the fund, it shall also be entitled to deduct such interest expense it pays for the amount so borrowed before it was lent to the affiliate-borrower. However, if the first borrower does not actually make use of its fund but instead relends it to an affiliate, it shall only be allowed interest expense duly deductible from its gross income if such relending activity actually generates income to it as the affiliate-lender. Otherwise, if no interest income is reported by an affiliate-lender from such activity, it cannot deduct as legitimate business expense the interest it initially paid to the bank since it did not actually assume such interest. (Emphasis supplied.) Based on the foregoing, it is clear that for the interest expense on the Facilities (a portion of the proceeds of which are relent to FGPC's indirect shareholders) to be deductible from FGPC's gross income as a legitimate business expense, the only requirement is for FGPC to recognize as interest income the interest it charges on the relending activity. Hence, as long as the interest income are reported on the relending activity and are at arm's length rate, it is inconsequential that a lower rate of interest is charged on the said relending activity vis--vis the interest on the Facilities for the interest on the Facilities to be fully deductible. It is also irrelevant that the interest rate charged against BG is lower than that charged against First Gen for the interest expense on the Facilities to be fully deductible by FGPC. ScTCIE Thus, inasmuch as the interest that will be charged by FGPC on the On-loans are at arm's length rate and the same are recognized by FGPC as interest income, this Office confirms your opinion and hereby holds that the interest expense of FGPC from the Facilities complies with Section 3 (d) of Revenue Regulations 13-00 and the above requirements of BIR Ruling No. 116-98 and, as such, is fully deductible from FGPC's gross income. 2. On Documentary Stamp Tax. Section 179 of the NIRC of 1997, as amended by Republic Act No. 9243, provides: "SEC. 179. Stamp Tax on All Debt Instruments. On every original issue of debt instruments, there shall be collected a documentary stamp tax . . . xxx xxx xxx 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." The above-quoted provision enumerates the type of documents subject to DST on loan agreements. Rev. Regs. No. 9-94 defined such documents as follows: "Loan agreement refers to a contract in writing where one of the parties delivers to another money or other consumable thing, upon the condition that the same amount of the same kind and quality shall be paid. The term shall include credit facilities, which may be evidenced by credit memo, advice or drawings." "Promissory note" refers to an instrument, whether negotiable or non-negotiable, whereby the maker agrees (promises) to pay a sum certain in money or its equivalent at a definite time." In BIR Ruling No. DA 320-07 dated May 31, 2007, this Office ruled that the inter-company advances documented by mere board resolutions are not subject to documentary stamp tax. Furthermore, in ITAD Ruling No. 145-03 dated September 26, 2003, the BIR reiterated that since the only documents relating to the inter-company advances are the board resolutions of the lenders and the cash vouchers issued by the lenders, the same are not subject to DST pursuant to Section 180 (now Section 179) of the Tax Code of 1997. ACIDTE In the instant case, the on loan transactions (i) between FGPC and First Gen and (i) between FGPC and BG are in the nature of cash advances documented by mere board resolutions (of each of FGPC, First Gen and BG) and cash vouchers to be issued by FGPC with the corresponding acknowledgement thereof by each of First Gen and BG to evidence the disbursement of the On-loans to each of them. Since FGPC will not execute any document that may be considered as a loan agreement or promissory note to which the tax under Section 179 of the Tax Code is imposed, the on-loan transactions evidenced by board resolutions and cash vouchers issued by FGPC with the corresponding acknowledgement thereof by each of First Gen and BG to evidence the disbursement of the On-loans to each of them shall not be subject to documentary stamp tax. 3. On the taxability of Interest Income of FGPC and Deductibility of Interest Expense of First Gen and BG With respect to the interest income received by FGPC on the On-loans, this Office hereby confirms your opinion that the interest income is taxable income of FGPC subject to the regular corporate income tax (BIR Ruling 116-98 supra ). On the other hand, the interest to be paid by First Gen and BG on the On-loans may be allowed as deduction to the extent of their respective interest rate provided that there is a showing that the corporations meet the requirements under Rev. Regs. 13-00. 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 as represented are different, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service