BIR Ruling No. 016-10

June 29, 2010 BIR RULING NO. 016-10 22 (Y); 121; 199 (h); 000-00 Punongbayan & Araullo 20th Floor, Tower 1, The Enterprise Center 6766 Ayala Avenue Makati City Attention: Atty. Benedicta Du-Baladad Tax Partner Gentlemen : This refers to your letter dated April 7, 2009 requesting on behalf of your client Metropolitan Bank and Trust Company ("MBTC") for confirmation of your opinion relative to the proper tax treatment of the PDEx Inter-Professional Market Repurchase Program. It is represented that MBTC is a domestic corporation duly organized and existing under and by virtue of the laws of the Republic of the Philippines. It is registered with the Securities and Exchange Commission (SEC) and has its principal address at Metrobank Plaza, Sen. Gil Puyat Avenue, Makati City. On February 20, 2008, the Philippine Dealing & Exchange Corp. (PDEx) and the Philippine Depository & Trust Corp. (PDTC) executed the PDEx Inter-Professional Repurchase Agreement Master Agreement and the Collateral Management Agreement. To regulate the repurchase transactions under the Master Agreement, and to govern the relationship among participants, the PDEx has issued the Inter-Professional Repo Market Program. Under the Repo Program, handling and management of collateral security will be administered by the PDTC. On July 23, 2008, MBTC executed its Participation Agreement consenting to be bound by the Master Agreement, the Program Rules and other accessory agreements when relevant. Thus, the Company has been admitted as a Repo participant, as both Repo Seller or Cash Borrower and Repo Buyer or Cash Lender, in the PDEx Repo Facility. CEDHTa The Repo Program has basically the following features: 1) There are two transactions and two settlement dates involved: a. A "near leg" wherein a Repo Seller/Cash Borrower delivers the Collateral Security and the Repo Buyer/Cash Lender pays the Repo Amount; and b. A "far leg" wherein the Repo Buyer/Cash Lender returns the Collateral Security and unblocks the relevant portion of the General Collateral, if any, and the Repo Seller/Cash Borrower pays the Repo Amount plus Repo Interest on the Maturity Date. 2) The Repo Amount received by a Repo Seller/Cash Borrower is entirely secured during the Repo Tenor by Collateral Securities, including General Collateral. 3) For receipt of the Repo Amount on the Near Date, the Repo Seller/Cash Borrower delivers the Collateral Securities to the Collateral Management System Operator and agrees to repurchase the Collateral Securities on the Maturity Date. 4) Despite the delivery of the Collateral Securities to the Repo Buyer/Cash Lender, a Repo Seller/Cash Borrower shall continue to recognize the economic risks and rewards of the Collateral Securities and book the daily mark-to-market (MTM) valuation of the Collateral Securities and the accrued interest on the Collateral Securities. 5) The substitution of Collateral Securities shall be allowed with the consent of the Repo Buyer/Cash Lender, provided that the assets offered as substitutes are also eligible as Collateral Securities under these Program Rules and such substitution shall not prejudice the adequacy of the Collateral Securities and applicable General Collateral. The cash proceeds received by a Repo Seller/Cash Borrower are entirely secured during the Repo Tenor by Collateral Securities. Each PDEx Repo shall have the following standard tenors: Overnight, 1 week, 2 weeks, 3 weeks, 1 month, 2 months and 3 months. DHETIS The future price for the repurchase of the Collateral Securities shall differ from the original purchase price based on an agreed Repo Rate, which represents an interest rate for the Repo Amount received from the Repo Buyer. This Repo Rate refers to an interest rate per annum, computed on a 360-day year that the Repo Seller and Repo Buyer negotiate, agree and confirm through orders they enter into the Repo Trading System. It is effectively the Repo Buyer's cash lending rate for the Repo Seller's use of the funds during the Repo Tenor. 1 Repo Interest should be accrued daily as income for the Repo Buyer and as expense for the Repo Seller. As provided in the Repo Program, the general approach in accounting for interbank repo transactions shall be for the Repo Buyer/Cash Lender to recognize a loan receivable, while the Repo Seller/Cash Borrower records a loan payable. In reply, please be informed as follows: 1. The repurchase transaction is a loan transaction with securities as underlying collaterals . A repo transaction as contained in the Master Agreement is one where a party known as the Repo Seller/Cash Borrower receives money from another party, the Repo Buyer/Cash Lender, with an obligation to pay the same plus interest at a future date. The interest to be paid is computed based on an interest rate per annum, computed on a 360-day year. To secure the loan, the Repo Seller/Cash Borrower delivers collateral securities to the PDTC which shall hold the securities for the Repo Seller/Cash Borrower. While there is a transfer of legal title over the collateral securities to the Repo Buyer/Cash Lender from the Repo Seller/Cash Borrower, the economic benefits such as interest income over the securities remain with the real owner which is the Repo Seller/Cash Borrower. The Repo Seller/Cash Borrower, as the real owner of the securities, continues to receive the interest income from those collateral securities. The transfer of legal title is done only as a precautionary measure to secure the rights of the Repo Buyer/Cash Lender in the event the Repo Seller/Cash Borrower defaults on the payment of loan. The Repo Buyer/Cash Lender does not exercise the rights of ownership over the collaterals. It cannot dispose the securities. Based on the foregoing, it is clear that all the elements of a loan, specifically a collateralized loan, are present in the repo transaction. Thus, the repurchase transaction under the PDEx Repo Program shall be treated as a loan transaction for tax purposes and not a sale. HESCcA 2. The income from the repurchase transaction, which is an interest income, shall be subject to the 20% final withholding tax . Under the Repo Program, the Repo Seller/Cash Borrower shall pay the original purchase price plus an agreed Repo rate, which represents an interest rate for the cash value "lent" out by the Repo Buyer/Cash Lender. Thus, the Repo Buyer/Cash Lender shall receive the original purchase price plus a certain income equal to the agreed Repo rate. This income is an interest income for the use of the cash lent to the Repo Seller/Cash Borrower. Under Section 22 (Y) of the NIRC, deposit substitutes shall mean alternative forms of obtaining funds from the public other than deposits, through the issuance, endorsement, or acceptance of debt instruments. This may include repurchase agreements and reverse repurchase agreements entered into by and between the BSP and any authorized agent bank. Clearly then, repurchase agreements are considered as deposit substitutes and should be subjected to the same tax as deposit substitutes. Under Section 27 (D) of the same Code, interest from deposits and yield or any other monetary benefit from deposit substitutes shall be subject to a final tax rate of 20% of the amount received as interest, yield or other monetary benefit. Based on the foregoing, the interest income or any monetary benefit derived by the Repo Buyer/Cash Lender from repurchase agreements shall be subject to the 20% final withholding tax. Likewise, the Repo Seller/Cash Borrower shall withhold the 20% final withholding tax on interest payments to the Repo Buyer/Cash Lender. 3. The income from the repurchase transaction shall be subject to Gross Receipts Tax of 5% . Under Section 121 of the Tax Code, the Gross Receipts Tax (GRT) on interest, commissions and discounts from lending activities as well as income from financial leasing, shall be on the basis of the remaining maturities of instruments from which such receipts are derived as follows: a) with maturity of five years or less 5% b) with maturity of more than five years 1% Considering that the interest on the Repo transaction is considered as income from lending activities, and considering further that Repo transactions are with a tenor of not more than 3 months, the interest income received from such transaction shall be subject to GRT of 5%. IHEaAc 4. The transaction is a derivative transaction which is exempt from documentary stamp tax under Section 199 (h) of the Tax Code . Section 199 of the Tax Code, as amended, provides for the exemption of certain documents and papers from documentary stamp tax (DST). Under this provision, derivatives are exempted from the DST. Furthermore, it is specifically provided that for purposes of the exemption from DST, repurchase agreements shall be treated similarly as derivatives, and thus also exempt from DST. The exemption is worded, thus: "Section 199. Documents and Papers Not Subject to Stamp Tax . xxx xxx xxx (h) Derivatives: Provided, that for purposes of this exemption repurchase agreements and reverse repurchase agreements shall be treated similarly as derivatives." The exemption granted to derivatives was further clarified in Revenue Regulations No. 13-2004, Section 9, to wit: "Derivatives exempted from DST under Section 199 (h) of the Code, as amended, shall refer only to those derivatives issued by entities duly licensed by the Bangko Sentral ng Pilipinas (BSP) to issue and trade in derivatives, and whose issuance is duly authorized by the BSP." MBTC is duly licensed by the BSP to issue and trade in derivatives. Likewise, the Repo Program was approved by BSP and SEC. Thus, the Repo transaction under the PDEx Repo Program shall be considered as falling within the exemption from DST. 5. The transfer of collateral securities from the Repo Seller/Cash Borrower to the Repo Buyer/Cash Lender shall not be subject to capital gains tax, but subject to documentary stamp tax . As already established, the Repo transaction is a loan transaction and not a sale. The securities delivered from the Repo Seller/Cash Borrower to the Repo Buyer/Cash Lender are only collateral for the loan. While there is a transfer of legal title over the collateral securities to the Repo Buyer/Cash Lender from the Repo Seller/Cash Borrower, the Repo Program specifically provides that the interest income from said collateral securities shall accrue for the benefit of its original owner, the Repo Seller/Cash Borrower, as if the securities never left his hands. On the other hand, the Repo Buyer/Cash Lender has the obligation to return the same and that, during the duration of the repo transaction, the Repo Buyer/Cash Lender does not have free disposal of the securities. These features negate the existence of a sale, and instead show that the securities remain to be collateral to secure the loan transactions of the repo parties. cSATEH Hence, there being no sale, there would be no actual disposition of the securities, and as such no gain upon which the capital gains tax may be imposed. However, the repo transaction, more specifically the transfer of the securities, should be subject to DST under Section 195 of the Tax Code of 1997, as amended by Republic Act No. 9243, for being in the form of pledge. The intention of the parties in the Repo Program is governed more by the rules on contract of pledge. A pledge agreement does not speak of divestment of ownership or right but of security of loan. It is defined as "an accessory, real and unilateral contract by virtue of which the debtor or a third person delivers to the creditor or to a third person movable property as security for the performance of the principal obligation, upon the fulfillment of which the thing pledged, with all its accessions and accessories, shall be returned to the debtor or to the third person." The Civil Code gives the following requisites for a contract of pledge: a) that they be constituted to secure the fulfillment of a principal obligation; b) that the pledgor be the absolute owner of the thing pledged; c) that the persons constituting the pledge have the free disposal of their property, and in the absence thereof, that they be legally authorized for the purpose; d) that the thing pledged be placed in the possession of the creditor or of a third person by common agreement. The character of the transactions between the Repo Buyer/Cash Lender and the Repo Seller/Cash Borrower is to be determined by their intention regardless of the language used or the form of the transfer. Even if sufficient on its face to make an absolute conveyance, the transfer shall not be treated as an absolute conveyance if executed under a valid contract of pledge, and therefore, should not be subject to capital gains tax. Based on the foregoing, we therefore confirm your opinion as follows: 1. The repurchase transaction is a loan transaction with securities as underlying collaterals. 2. The income from the repurchase transaction, which is an interest income, shall be subject to 20% final withholding tax. 3. The income from the repurchase transaction shall be subject to Gross Receipts Tax of 5%. acADIT 4. The transaction is a derivative transaction which is exempt from documentary stamp tax under Sec. 199 (h) of the Tax Code. 5. The transfer of collateral securities from the Repo Seller/Cash Borrower to the Repo Buyer/Cash Lender shall not be subject to capital gains tax but to documentary stamp tax under Section 195 of the Tax Code, as amended. 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.) JOEL L. TAN-TORRES Commissioner of Internal Revenue Footnotes 1. Inter-Professional Repo Market Program Manual, paragraph 7.2.4.