Isla Lipana & Co.

September 30, 2009 BIR RULING [DA-(FIT-021) 573-09] 27 (D) (3); 28 (A) (4); RR 10-98; RR 2-98; BIR Ruling No. 168-82; BIR Ruling No. 046-96 Isla Lipana & Co. 29th Floor Philamlife Tower 8767 Paseo de Roxas Makati City Attention: Atty. Alexander B. Cabrera Managing Partner Tax Services Gentlemen : This refers to your letter dated December 11, 2008 requesting, on behalf of your client, Jollibee Foods Corporation ("JFC") , confirmation of the following opinions with respect to the interest arising from the loans secured by JFC under a credit facility arrangement: cSaCDT a) 10% withholding tax shall apply on the interest since the loans are secured from Foreign Currency Deposit Units ("FCDUs") and Offshore Banking Units ("OBUs"); b) Withholding tax shall be computed based on the fixed rate interest which JFC is liable to pay and not on the floating rate interest which the Swap Bank is liable to pay; and c) Withholding tax is to be computed based on the actual amount of interest payments, excluding the tax shouldered by JFC. It is represented that JFC with Taxpayer Identification No. 000-388-777-000, is a corporation duly organized and existing under the laws of the Republic of the Philippines; that JFC, together with its domestic and international subsidiaries located in the United States, British Virgin Islands, Hong Kong, and China are involved primarily in the development, operation and franchising of Quick Service Restaurants under several trade names; that to support its operations, JFC secured foreign currency funding through a credit facility arranged by UBS AG Hong Kong Branch with Metropolitan Bank and Trust Company (MBTC) as Facility Agent and UBS AG Singapore branch acting as Swap Bank; that the Original Lenders in the Agreement are MBTC, Banco de Oro Unibank, Inc., Rizal Commercial Banking Corporation, The Bank of Tokyo Mitsubishi UFJ, Ltd. Manila Branch, and that the funds are provided by the Lenders, which are either FCDUs of domestic banks or OBUs; that the following are the salient points of the Credit Facility agreement: 1. On behalf of the Lenders, the Facility Agent shall disburse to JFC the Dollar equivalent of the loan amounts. 2. JFC will repay the loans in full on the maturity date to the Facility Agent which the latter shall receive on behalf of the Lenders. DICSaH 3. JFC will pay the Lenders interest in Dollars at a fixed interest rate ("Fixed rate interest") while interest at a floating interest rate ("Floating rate interest") will be paid by the Swap Bank to the Lenders. Both interest payments will be coursed through the Facility Agent. 4. Withholding tax on the interest paid by JFC will be shouldered by JFC. The Lenders, on the other hand, will receive the stipulated interest payments in full. 5. The existing Lenders, which are all FCDUs, may at any time assign their rights or obligations under the agreement to any other bank or financial institution which are likewise FCDUs or OBUs. In reply, please be informed as follows: 1. 10% withholding tax shall apply on interest arising from the loans Sections 27 (D) (3) and 28 (A) (4) of the Tax Code of 1997 provides, as follows: "(3) Tax on Income Derived under the Expanded Foreign Currency Deposit System. Income derived by a depository bank under the expanded foreign currency deposit system from foreign currency transactions with nonresidents, offshore banking units in the Philippines, local commercial banks including branches of foreign banks that may be authorized by the Bangko Sentral ng Pilipinas (BSP) to transact business with foreign currency deposit system units and other depository banks under the expanded foreign currency deposit system shall be exempt from all taxes, except net income from such transactions as may be specified by the Secretary of Finance, upon recommendation by the Monetary Board to be subject to the regular income tax payable by banks: Provided, however , That interest income from foreign currency loans granted by such depository banks under said expanded system to residents other than offshore banking units in the Philippines or other depository banks under the expanded system shall be subject to a final tax at the rate of ten percent (10%) . . . ." "(4) Offshore Banking Units. The provisions of any law to the contrary notwithstanding, income derived by offshore banking units authorized by the Bangko Sentral ng Pilipinas (BSP), from foreign currency transactions with nonresidents, other offshore banking units, local commercial banks, including branches of foreign banks that may be authorized by the Bangko Sentral ng Pilipinas (BSP) to transact business with offshore banking units shall be exempt from all taxes except net income from such transactions as may be specified by the Secretary of Finance, upon recommendation of the Monetary Board which shall be subject to the regular income tax payable by banks: Provided, however, That any interest income derived from foreign currency loans granted to residents other than offshore banking units or local commercial banks, including local branches of foreign banks that may be authorized by the BSP to transact business with offshore banking units, shall be subject only to a final tax at the rate of ten percent (10%) . . . ." (Emphasis supplied) Revenue Regulations No. ("RR") 10-98, implementing the foregoing provisions, similarly reads as follows: "(C) Taxation of Income of an FCDU or OBU from Foreign Currency Transactions. In general, income derived by an FCDU or an OBU from foreign currency transactions with residents of the Philippines , including local commercial banks, local branches of foreign banks, and other depository banks under the foreign currency deposit system, shall be subject to a final withholding tax of ten percent (10%) based on gross income pursuant to Sec. 27(D)(3) and Sec. 28(A)(4) of the Code. Income from foreign currency transactions shall include interest income from lending operations , including bank charges, commissions, service fees, and net foreign exchange transaction gains. Income from foreign currency transactions with non-residents of the Philippines shall not be subject to income tax. The person making the income payment shall withhold and remit the tax withheld pursuant to the provisions of Sections 57 and 58 of the Code. Thus, in the case of interest payment by a resident of the Philippines on a foreign currency loan from an OBU or an FCDU, the withholding agent shall be the said resident. " (Emphasis supplied) SEAHcT In BIR Ruling No. 168-82 dated May 7, 1982 , this Office has held that ". . . that the 10% final withholding tax imposed by Section 24(f) of the Tax Code, as amended, shall be based on the total or gross interest income paid to and received by your Foreign Currency Deposit Unit (FCDU) from its foreign currency loan transactions with residents consisting not only of the spread but also of the stipulated offered and prevailing rate of interest per loan agreement. " (emphasis supplied) From the foregoing, it is clear that interest income derived by the various Lenders, including future lenders who will all be FCDUs or OBUs, from their foreign currency loan transactions with JFC pursuant to the credit facility agreement shall be subject to final withholding tax of ten percent (10%), which JFC, as the borrower, is obligated to withhold and remit to the BIR. 2. Withholding tax shall be computed based on the interest using the fixed rate interest per agreement which JFC is liable to pay to the Lenders Since the floating rate interest does not form part of JFC's interest payments, JFC's obligation to withhold tax shall apply only on the fixed rate interest and not on the floating rate interest. In BIR Ruling No. 046-96 dated April 2, 1996 , the BIR had occasion to rule on the proper way of computing the ten percent (10%) withholding tax, to wit: "In reply thereto, please be informed that your opinion is hereby confirmed. The tax base upon which the appropriate withholding tax rate shall be applied is the total amount of the interest income to be paid without grossing up thereto the corresponding withholding tax due thereon, whether the borrower assumes to pay the tax or not. Thus, in your illustration, if the interest income of PNB is $2,150,334.46, the same shall be the tax base upon which the withholding tax of ten percent (10%) shall be imposed. [BIR Ruling dated January 27, 1978]." Based on the foregoing, JFC has the obligation to withhold the 10% final tax on its interest payments, using the fixed rate pursuant to the Loan Agreement, to the Lenders when such interest is paid, becomes payable, or is accrued/recorded as an expense in its books, whichever comes first. Conversely, it has no obligation to withhold tax on the excess, if any, of the floating rate interest over the fixed rate interest since such difference will never be paid, become payable or accrued by JFC as an expense. 3. Withholding tax is to be computed based on the actual amount of interest payments For purposes of computing the final tax to be withheld on the interest payable to its Lenders which are FCDUs/OBUs, the tax base shall be the actual amount of interest payments made by JFC and not on the grossed-up amount of such interest. This Office, in BIR Ruling 15-2005 dated August 24, 2005 , allowed local borrowers of OBUs and FCDUs not to gross-up the interest payments for purposes of the applicable withholding tax assumed by them with respect to loans obtained from OBUs and FCDUs, thus: "In reply thereto, please be informed that this Office has adopted measures for local institutions to be at par with non-resident creditors and to lessen the tax burden of local borrowers. Thus, the answer in Suggestion 5 of Revenue Memorandum Circular ("RMC") No. 46-77 states that: "This Office, aware of the present international banking practice of making the borrower assumes the tax on the creditor's interest income and considering that one of the reasons for the establishment of OBU's is to lower the cost of borrowed funds, OBU's will be allowed to report for tax purposes only the actual amount of interest without considering as additional taxable income the tax assumed by the borrower. This will place OBU's at par with non-resident creditors and lessen the tax burden of local borrowers." Pursuant to the above-quoted provision, this Bureau has allowed local borrowers of OBUs and FCDUs not to gross-up the interest payments for purposes of the applicable withholding tax assumed by them with respect to loans obtained from OBUs and FCDUs. ICaDHT This Office recognizes that this rule should also apply to the withholding tax assumed by local borrowers of foreign creditor banks not having OBUs and FCDUs in order to make such foreign creditor banks at par with foreign creditor banks having OBUs or FCDUs and to reduce the tax burden of the local borrowers. Otherwise stated, the withholding tax assumed by the local borrowers is not additional taxable income in the hands of such foreign creditor banks. If the assumed withholding tax will be based on the grossed-up amount of the interest payments, then the reason under RMC 46-77 for allowing OBUs and FCDUs not to report the tax assumed as additional taxable income will no longer prevail and will not reduce the local borrower's costs." Based on the foregoing, this Office hereby confirms your opinion that JFC should impose 10% final withholding tax on its interest payments at the fixed rate per Loan Agreement, which tax should be computed based on the actual amount of interest payments, excluding the tax shouldered by JFC. This ruling is being used 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