BIR Ruling No. 003-07

January 29, 2007 BIR RULING NO. 003-07 32 (A) & (B) 000-00 San Miguel Corporation 40 San Miguel Avenue Mandaluyong City Attention: Atty. Alfredo R. Villacorte Tax Manager Gentlemen : This refers to your letter dated September 14, 2006 requesting confirmation of your opinion on the tax consequences arising from the Employees Stock Purchase Plan (ESPP) granted by San Miguel Corporation (SMC) to the employees of the San Miguel Group of Companies (SMG). SMG consists of SMC and its domestic subsidiaries. tax2007cdasia It is represented that SMC, a corporation duly organized and existing under the laws of the Philippines, is engaged in the food, beverage and packaging businesses. The ESPP was conceptualized in order to attain a two-pronged business objective of SMC: first , to generate additional capital for the company through the additional subscription and second , to increase the company's profitability through motivation of the employees toward greater productivity, loyalty and concern for the Company's well-being by allowing the employees to participate directly in the growth of the company through the ESPP. Specifically, the ESPP program aims to: (a) Provide additional steady source of funds for, and broaden ownership base of the company; (b) Increase company's profitability through: (b.1) Motivation of employees to greater productivity by creating a sense of ownership; (b.2) Encourage existing employees to remain with company and thus save on expenses of training employees; (c) Benefit existing shareholders from the greater productivity and growth to be gained from employee stock ownership. Under the ESPP, an employee of SMG may subscribe quarterly to a maximum of 1,900 shares of the capital stock of SMC, payable in five (5) years through salary deductions. The shares subscribed by the employees will be issued from the unissued shares of the capital stock of SMC, which are reserved for the ESPP. Participation in the ESPP is neither automatic nor compulsory. An employee who wishes to participate shall do so by giving a written notice stating, among others, his decision to participate and the number of shares he desires to subscribe. The price that the SMG employees participating in the ESPP shall pay on their subscription is 15% less than the price at which the SMC shares are quoted at the stock exchange on the exercise date. The difference in the price, which is aimed at stirring up the participation of the SMG employees in the Plan thereby facilitating the attainment of SMC's above-mentioned business objectives, will not result to watered SMC stocks since the subscription price will still be substantially higher than its par value of P5.00 per share. aHSTID The difference in price paid for by the SMG employees participating in the ESPP compared to the price at which SMC shares are quoted at the stock exchange is not treated as an expense by SMC as the same is just a mere reduction of premium on subscription or paid-in-surplus. Illustration: Assume that the price of SMC shares quoted in the stock exchange is P60.00 and the number of shares subscribed is 1,000 shares. Given: Par value is P5.00 per share and the subscription price is 15% less than the price quoted in the stock exchange. Comparison of the accounting entry upon subscription would show that the price difference is not an expense on the part of SMC but reduction of the paid in surplus on said subscription, to wit: Price @ Stock Price at ESPP Exchange Dr. Subscription Receivable P60,000 P51,000 Cr. Subscribed Capital Stock P5,000 P5,000 Cr. Paid in Surplus 55,000 46,000 Even before their subscriptions are fully paid, ESPP participants shall be paid cash and/or stock dividends declared by SMC on their subscribed shares. However, in case of cancellation of the subscription, the cash and/or stock dividends paid on the cancelled subscription shall be returned to SMC. In view of the foregoing, it is your opinion that the subscription to the SMC shares by the SMG employees participating in the ESPP at a price 15% less than the price thereof quoted in the stock exchange does not give rise yet to a taxable event at the time of subscription because the said 15% difference is a reduction of the cost of their subscriptions to the SMC shares, therefore, it is not yet a realized income. The taxable event will arise when the ESPP participants sell the SMC shares and collect the proceeds thereof. The economic and/or financial benefit of the 15% price difference is actually realized at the time of sale of the SMC shares by the ESPP participants. The gain that the ESPP participants will realize is the excess of the selling price over the subscription costs, which is less by 15% than the price at which the SMC shares were quoted at the time of subscription. In reply, please be informed that under Section 32 (A) of the 1997 Tax Code, as amended, gross income includes compensation for services in whatever form paid, including, but not limited to fees, salaries, wages, commissions and similar items. The term "compensation" as defined under Sec. 2.78.1 of Revenue Regulations ("RR") No. 2-98, as amended, means all remuneration for services performed by an employee for his employer under an employer-employee relationship, unless specifically excluded under Section 32 (B) [Exclusions from Gross Income] of the Tax Code. It is provided further under the same regulations that the name by which remuneration for services is designated is immaterial. Thus, salaries, wages, emoluments and honoraria, bonuses, allowances (e.g., transportation, representation, entertainment and the like), fees including directors' fees, if the director is at the same time an employee of the employer/corporation, taxable bonuses and fringe benefits (except those which are subject to the FBT under Section 33 of the Tax Code), taxable pensions, and retirement pay, and other income of a similar nature constitute compensation income. In the case at hand, the 15% reduction on premium relative to the subscriptions of the SMG employees participating in the ESPP could not be considered as income forming part of their compensation in accordance with Section 32 (A) of the 1997 Tax Code, as amended. It is noted that SMC's main objectives in conceptualizing the ESPP were to generate additional capital for the company through the additional subscription and to motivate the employees toward greater productivity, loyalty and concern for the Company's well-being by allowing the SMG employees to participate directly in the growth of the company. Moreover, the participation in the ESPP is neither automatic nor compulsory on the part of the SMG employees, thus, the same could be appropriately characterized as an investment portfolio created for the benefit of SMC and for the participating SMG employees only. By that characterization, said reduction on premium could not be treated as an additional compensation granted to the SMG employees as the same negates the very nature of a compensation as defined in Revenue Regulations No. 2-98. The reduction on premium is not given as a remuneration for services performed by the SMG employees under the employer-employee relationship, rather it is given based on a mutual contractual relationship arising from the subscription by the SMG employees to the authorized capital stock of SMC. In the event, however, that the participating SMG employees sell the SMC shares, the gain, if any, derived from the exercise of the stock options granted under the ESPP is subject to capital gains tax. The gain that the ESPP participants will realize is the excess of the selling price over the subscription costs, which is less by 15% than the price at which the SMC shares were quoted at the time of subscription. cCTESa 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. Very truly yours, (SGD.) JOSE MARIO C. BUAG Commissioner of Internal Revenue