Whether Commission Payment May be Amortized Over the Period of the Investment to which It Relates

March 6, 2001 BIR RULING NO. 009-01 SGV & Co. 6760 Ayala Avenue 1226 Makati City Attention: Mr . Joel L . Tan Torres Gentlemen : This refers to your letter dated May 10, 2000 and your follow up letter dated December 14, 2000 requesting for a ruling to the effect that the commission payment by Sun Life Asset Management Company, Inc. ("SLAMC") may be amortized over the period of the investment to which it relates. It is represented that SLAMC is a corporate entity established to manage the portfolio of the Mutual Fund Companies ("MFC") and to act as the principal distributor and seller of the shares of MFC; that the services provided by SLAMC for the MFC include among others the investment and re-investment of the assets of MFC, preparation of reports, accounting, bookkeeping, obtaining applications through its sales representatives for investments in MFC shares, and collection and remittance of payments from investors in MFC shares; that MFC agrees to pay SLAMC as compensation for the services a fee equivalent to two percent (2%) per annum of assets under SLAMC's management; that the value of the assets under management is determined as the total assets less total liabilities of MFC; that MFC being serviced by SLAMC are three (3) companies: Sun Life of Canada Prosperity Bond Fund, Inc., Sun Life of Canada Balanced Bond Fund, Inc., and Sun Life of Canada Philippine Equity Fund, Inc.; that investors buy shares of the MFC through the so called "back-end sales method"; that under the said method, MFC shares are issued to the investor equivalent to the amount of his investment; that no commissions are deducted upfront from the investor's investment and that SLAMC shall treat its payment of commissions as "Deferred Sales Charge/Commission Payment" which shall be amortized over the period that the investment is held; that this is in consideration of the fact that the benefit from advances for commission would be spread over the period when the investor is supposed to maintain his investment in the MFC since for as long as these investments are maintained, SLAMC will be compensated its 2% fee based on the MFC assets under management; that if the investor maintains his investment with MFC for 7 years, he will not be charged any commissions and if the investor redeems his investment before the 7th year, he will pay to SLAMC a redemption fee at a range of 6% scaled down to 0% depending on the holding period of the investment; and that this redemption fee will be reported as income while the unamortized Deferred Sales Charge will be written off at the time of redemption. AaDSTH In reply, please be informed that pursuant to the principles contained in Section 107 of Revenue Regulations No. 2, the commission payment may be the subject of amortization over the period of the investment to which it relates if the following requisites are present: the benefit to SLAMC, although exceeding one year, is limited, in this case to 7 years or the actual holding period of the investment; that the period of benefit can be ascertained with reasonable accuracy, as this is based on the holding period of the investment; and that the commissions have ascertainable value. Furthermore, the amortization of the commission payment finds support in Section 76 of Revenue Regulations No. 2, which provides: "Section 76. When charges are deductible . Each years return, so far as practicable, both as to gross income and deductions therefrom, should be complete in itself, and taxpayers are expected to make every reasonable effort to ascertain the facts necessary to make a correct return. The expenses, liabilities, or deficit of one year cannot be used to reduce the income of a subsequent year. A taxpayer has the right to deduct all authorized allowances and it follows that if he does not within any year deduct certain of his expenses, losses, interest, taxes, or other charges, he can not deduct them from the income of the next or any succeeding year. If it is recognized, however, that particularly, in a going business of any magnitude there are certain overlapping items both of income and deduction, and so long as these overlapping items do not materially distort the income, they may be included in the year in which the taxpayer, pursuant to a consistent policy, takes them into his accounts . . ." (emphasis supplied) Finally, the above-quoted provision is also in consonance with accounting principles. Expenses in accounting, refer to costs that are associated with the revenue of the period, often directly but, frequently indirectly through association with the period to which the revenue has been assigned. Costs to be associated with future revenue or otherwise be associated with future accounting period are deferred to future periods as assets. In the absence of direct means of associating cost and effect, some costs are associated with specific accounting periods as expenses on the basis of an attempt to allocate costs in a systematic and rational manner among the periods in which benefits are provided. If an asset provides benefits for several periods, its cost is allocated to the periods in a systematic and rational manner in the absence of a more direct basis for associating cause and effect. The cost of an asset that provides benefits for only one period is recognized as an expense of that period. [Statement of Financial Accounting Standards (SFAS) No. 1, Section 3] Accordingly, since the requisites prescribed in Section 107 of Revenue Regulations No. 2 are present, the commission payment by SLAMC may be amortized over the period of the investment to which it relates. Nonetheless, an accurate record keeping procedure is necessary in such a way that a particular deferred commission payment can be traced to a particular investor such that if the account or investment of the investor is redeemed, the applicable or matching deferred commission payment is appropriately removed from the asset account. Moreover, it is to be emphasized that the deferred commission payment is subject to expanded withholding tax at the time of its payment to the sales representative despite its being pro-rated or amortized as expense over the period of the actual life of the investment. aEIADT 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.) RENE G. BAEZ Commissioner of Internal Revenue