SGV & CO.

November 12, 2008 BIR RULING [DA-(FIT-013) 421-08] Renewal Forex Loans; DA-359-03; DA-209-06 SGV & CO. 6760 Ayala Avenue 1226 Makati City Attention: Atty. J. A. Osana Tax Division Gentlemen : This refers to your letter dated May 6, 2008 requesting on behalf of your client, Enkei Philippines, Inc. ("EPI"), confirmation on your opinion that except for the 20 million and 10 million minimal payments, the renewal of EPI's foreign currency loans with its parent company, Enkei Corporation ("Enkei-Japan"), does not give rise to realized foreign exchange gain or loss. CIHAED It is represented that EPI is a corporation organized and existing under the laws of the Republic of the Philippines, with principal address at 104 Industry Drive, Carmelray Industrial Park, Canlubang, Laguna, Philippines; that Enkei-Japan is a corporation organized and existing under the laws of Japan, with principal address at Act-Tower, 26th floor, 111-2, Itayamachi, Hamamatsu City, Shizuoka Prefecture, Zip 430-7726, Japan; that in 2005, EPI contracted three loans from Enkei-Japan covered by promissory notes; that the first promissory note executed on June 1, 2005 amounted to 130 million with interest rate of 2% p.a. payable quarterly beginning end of September 2005 and to be paid on or before June 14, 2007; that the second promissory note executed on June 16, 2005 amounted to 520 million with interest rate of 1.7% p.a. payable quarterly beginning end of September 2005 and to be paid on or before June 14, 2007; that the third promissory note executed on September 30, 2005 amounted to 600 million with interest rate of 1.7% p.a. payable quarterly beginning end of September 2005 and to be paid on or before September 30, 2007; that when the first two promissory notes dated June 1 and June 16, 2005 matured on June 14, 2007, no payment was made thereon except for the minimal amount of 20 million; that said loans were renewed and consolidated under a promissory note dated June 15, 2007 in the amount of 630 million with interest rate of 2% p.a. payable quarterly beginning end of June 2007 and payable on or before June 14, 2009; that when the third promissory note dated September 30, 2005 matured on September 30, 2007, no payment was likewise made thereon except for the minimal amount of 10 million; that the said loan was renewed under a promissory note dated September 30, 2007 in the amount of 590 million with interest rate of 2% p.a. payable quarterly beginning end of December 2007, to be paid on or before September 30, 2009. In connection with the foregoing, you now request confirmation that the renewal of EPI's foreign currency loans with Enkei-Japan does not result in realized foreign exchange gain or loss except for the 20 million and 10 million minimal payments. In reply, please be informed that fluctuation in values of foreign exchange may be recognized and recorded as income, provided such income has been realized and has arisen from a closed and completed transaction. (BIR Ruling [DA-209-06] dated April 5, 2006). By way of definition, a closed and completed transaction is a taxable event which has been consummated. (Black's Law Dictionary, Fifth Edition, p. 231) In Isuzu Motors Phils., Inc. v. CIR, CTA Case No. 5236 promulgated August 21, 1998, the Court of Tax Appeals (CTA) ruled that the foreign exchange loss is deductible only in the year it is actually sustained. Part of the Decision in the Isuzu case reads: "[I]t is sustained during the year in which the loss occurs as evidenced by a closed and completed transaction and as fixed by identifiable events occurring in that year. A closed transaction is a taxable event which has been consummated. No taxable event has as yet been consummated prior to the remittance of the scheduled amortization. Accordingly, foreign exchange losses sustained as a result of devaluation of the peso vis--vis the foreign currency, e.g. , US dollar, but which remittance of the scheduled amortization consisting of principal and interest payments on a foreign loan has not actually been made are not deductible from income for income tax purposes." (citing BIR Ruling No. 144-85 dated August 26, 1985) caHIAS Moreover, in BIR Ruling No. 144-85, supra, this Office has ruled that foreign exchange losses which have accrued by reason of devaluation are not deductible for income tax purposes. In the said ruling, it was represented that the taxpayer's losses arose from matured but unremitted principal repayments on loans affected by the debt restructuring program in the Philippines. This Office ruled that no taxable event has as yet been consummated prior to the remittance of the scheduled amortization and thus, no foreign exchange loss was sustained as a result of devaluation of the peso, viz. : "[A]nnual increase in value of an asset is not taxable income because such increase has not yet been realized. The increase in value, i.e. , the gain, could only be taxed when a disposition of the property occurred which was of such a nature as to constitute a realization of such gain, that is, a severance of the gain from the original capital invested in the property. The same conclusion obtains as to losses. The annual decrease in the value of property is not normally allowable as a loss. Hence, to be allowable the loss must be realized. (Surrey and Warren, Federal Income Taxation (1950), pp. 422-4) When foreign currency acquired in connection with a transaction in the regular course of business is disposed of ordinary gain or loss results from the fluctuations. (Prentice-Hall Federal Taxes, Vol. 1, par. 6261) The loss is deductible only for the year it is actually sustained. It is sustained during the year in which the loss occurs as evidenced by closed and completed transaction and as fixed by identifiable events occurring in that year. (par. 6570, 34 Am Jur 2d, 1976) A closed transaction is a taxable event which has been consummated. (p. 231 Black's Law Dictionary, Fifth Edition) No taxable event has as yet been consummated prior to the remittance of the scheduled amortization. Accordingly, foreign exchange losses sustained as a result of devaluation of the peso vis-a-vis the foreign currency e.g. , US dollar, but which remittance of scheduled amortization consisting of principal and interests payments on a foreign loan has not actually been made are not deductible from gross income for income tax purposes." Further, this Office has also ruled that while for financial accounting purposes, foreign currency accounts ( e.g. , receivables, liabilities, and deposits) are periodically restated at the rate of exchange prevailing at year-end, any foreign gain/(losses) arising from this restatement shall be taxable or deductible only in the year of collection, payment, or actual conversion into pesos as the case may be. (See BIR Ruling DA-359-03, dated October 10, 2003) Based on the foregoing, prior to the actual remittance or payment on a foreign currency loan, no foreign exchange gain or loss may be recognized and that the renewal of a matured loan does not result in realized foreign exchange gain or loss. Accordingly, this Office hereby confirms your opinion that the renewal of EPI's foreign currency loans with Enkei-Japan does not result in realized foreign exchange gain or loss except for that pertaining to 20 million and 10 million minimal payments. 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. cCSTHA Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service