Puno and Puno Law Offices

August 5, 2008 BIR RULING [DA-(IL-011) 107-08] Art. 39, E.O. 226; DA 195-08 dtd. 3/25/08 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 Menchie M. Tormon and Mercedita L. Ona Gentlemen : This refers to your letter dated July 31, 2008 requesting, on behalf of your client, Manila North Tollways Corporation ("MNTC"), confirmation of your opinion that the foreign exchange gains realized by MNTC on the repayment and prepayment of the U.S. Dollar denominated loans obtained exclusively for the upgrading, expansion and operation of Phase I of an expressway, its BOI-registered activity, are generated from its registered activity and are thus covered by the income tax holiday ("ITH"). ICcaST It is represented that MNTC was granted the concession to finance, design, rehabilitate, expand, operate and maintain an expressway (the "Project") under an agreement (the "Agreement") among MNTC, Philippine National Construction Corporation (PNCC), and the Republic of the Philippines, acting through the Toll Regulatory Board ("TRB"). MNTC was subsequently registered with the BOI as an operator of an expressway on a preferred pioneer status with Registration Certificate No. 97-086. As a BOI-registered entity, MNTC was granted, among others, an ITH for six years. Initially, MNTC's registration covers the various phases and segments of the Project. BOI later granted MNTC's request to change the scope of its registration to cover "upgrading and expansion" and "operation" of Phase I of the Project. The BOI likewise approved the amendment of the project timetable and moved the reckoning period for the ITH to the first quarter of 2004. The cost of rehabilitation, expansion and operation of Phase I of the Project was estimated at $371 million. Without local finance entities willing to fund the Project at that time, MNTC was forced to rely heavily on multilateral and export credit agencies to provide the funding for the rehabilitation, expansion and operation of Phase I of the Project. ESTAIH Thus, MNTC obtained US Dollar-denominated term loans of $253.5 million from various institutions, equity of $117.5 million from local and foreign shareholders and subordinated shareholder loans amounting to US$10.4 million to defray additional project costs. In 2006, in light of the enormous exposure to foreign exchange risk, MNTC issued Peso-denominated notes to partially prepay the original project debt and thereby match the structure of its debt service obligations with the foreign exchange adjustment factor in the authorized toll rate formula. Prior to the refinancing, MNTC has periodically repaid a total of $51 million of its $253.5 million long-term debt facilities over the first four scheduled semi-annual repayment dates. As a result of the refinancing, MNTC prepaid a significant portion (around US$102 million) of the balance of its long-term debt facilities and fully paid its shareholder loans using the proceeds of the Peso-denominated notes. Thus, MNTC's outstanding loans, which used to be 100% US Dollar-denominated, became a mix of US Dollar and Peso loans on an almost 50-50 basis, matching the forex pass-on feature that is built into the authorized toll rate formula. DIEcHa Since the loans were booked over the period 2003-2004 when the average Peso to US Dollar exchange rate was at Php55.12 per US$1, and were substantially paid in 2006 when the average exchange rate was at PhP51.31 per US$1, MNTC realized foreign exchange gains of around Php3.80, on the average, for every US Dollar of the repaid/prepaid loan. An inquiry was made by MNTC with the BOI on whether said forex gains are part of those generated by its registered activity, and consequently, covered by the ITH. The BOI, through a letter, confirmed that forex gains, as well as forex losses, on the repayments and prepayments of its loans are parts of those generated by its registered activity, and are thus covered by the ITH. The BOI explained that the US Dollar Loans, reviewed and confirmed by the BSP, were used to finance the rehabilitation, expansion and operation of MNTC's registered activity. On the basis of the foregoing representations, you now request for confirmation that, as affirmed by the BOI, the forex gains realized from MNTC's repayments and prepayments of its loans are part of those generated by MNTC from its registered activity and are consequently covered by the ITH. DSITEH In reply, please be informed that Article 39, Title III of the Omnibus Investments Code of 1987 states, thus: "ART. 39. Incentives to Registered Enterprises. . . . (a) Income Tax Holiday (1) For six (6) years from commercial operation for pioneer firms and four (4) years for non-pioneer firms, new registered firms shall be fully exempt from income taxes levied by the National Government . . . ISCcAT Relative thereto, Section 1 (t), Rule I, Part I of the Rules and Regulations implementing the Code provides that the 'income' of the registered firm entitled to income tax holiday shall be confined to income directly derived from registered operations." Based on the foregoing, the tax treatment of forex gains of BOI-registered enterprises shall depend on the activities from which they arise. Thus, if the forex gain is derived from an activity with an income tax holiday incentive, the forex gain shall be covered by the same incentive. On the other hand, if the forex gain is derived from an activity without income tax incentive, said forex gain shall likewise be without income tax incentive, i.e., therefore, subject to normal corporate income tax. DCScaT In the case at bar, the realized forex gains of MNTC arose from the repayment and prepayment of its loans which is a transaction directly attributable to MNTC's registered activity of "upgrading and expansion" and "operation" of Phase I of the Project. A reading of the Agreement among MNTC, PNCC and TRB establishes MNTC's authority to finance, design, construct, operate and maintain the Project as toll roads during the concession period. The Agreement is clear that part of MNTC's responsibilities as concessionaire is to raise the required financing for the Project. Various provisions of the Agreement refer to MNTC's loans 1 and acknowledge their impact on MNTC's concession rights. These provisions show that the loans, which were incurred to finance the upgrade, rehabilitation and operation of the Project, are integral to the pursuit and continued business of MNTC as concessionaire of the expressway. There is no doubt that the structuring and management of MNTC's loans are intimately related to, if not an essential element of, MNTC's business of operating Phase I of the Project. Consequently, the repayment and prepayment of these loans are necessary and indispensable parts of MNTC's BOI-registered activity. Hence, any gain arising therefrom is covered by the ITH incentive granted by BOI to MNTC. cSHATC It is worthwhile to mention that MNTC's situation is distinct from the situation of PEZA-registered companies whose foreign exchange gain or loss resulting from foreign denominated loans was consistently held by the BIR as not forming part of the registered activity of the company and thus not subject to the applicable tax incentive of either the 5% Gross Income Tax (GIT) or ITH. In BIR Ruling DA-166-04 dated April 5, 2004 and BIR Ruling DA-209-06 dated April 5, 2006, the BIR held that forex gains from foreign currency denominated loans incurred by PEZA-registered entities are subject to the ordinary income tax considering that there was no nexus between the transaction giving rise to the foreign exchange gain or loss and the PEZA entity's registered activity. In the case of MNTC, however, the foreign currency gains arise from the refinancing of dollar denominated loans which is directly attributable to the registered activity of MNTC. Therefore, the foreign exchange gains realized by MNTC from the repayment and prepayment of its loans used exclusively for the upgrading, expansion and operation of Phase I of an expressway, its BOI-registered activity, are generated from its registered activity and are thus covered by the ITH. ESTCDA The foregoing position is consistent with pronouncements of this Office in BIR Ruling DA 195-2008 dated March 25, 2008 and DA 375-2008 dated June 20, 2008, where this Office held that realized foreign exchange gains arising from transactions directly attributable to the registered activity of PEZA-registered companies are covered by the applicable tax incentive, i.e., 5% GIT/ITH. This ruling is being issued in 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. HcSDIE Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. "Loans" is a defined term in the Agreement and refers to "any financial arrangement (except the equity and quasi-equity portion raised from initial members of MNTC, as defined by the Philippine Institute of Certified Public Accountants) entered into from time to time by MNTC to finance the performance of any of its obligations hereunder, including all interest and fees payable thereof." DCcSHE