Tax Consequences of a "Quasi-Equity Investment Agreement"

June 10, 2002 BIR RULING NO. 022-02 175 Sycip Gorres Velayo & Co. 6760 Ayala Avenue Makati City Attention: Atty. Ma. Victoria A. Villaluz Gentlemen : This refers to your letter dated October 10, 2001 requesting on behalf of your client, Philips Semiconductors Philippines, Inc. (PSPI), for a ruling confirming your opinion that no interest may be imputed on the "Quasi-Equity Investment Agreement" between Koninklijke Philips Electronics N.V. (Philips-Netherlands) and PSPI. It is represented that PSPI is a Philippine domestic corporation; that for purposes of capital expansion and improvement of its overall financial condition, PSPI entered into an agreement called the "Quasi-Equity Investment Agreement" dated April 6, 2001 with its shareholder, Philips-Netherlands, a corporation duly established and existing under the laws of the Netherlands; that pursuant to said agreement Philips-Netherlands shall deposit US$200,000,000 in PSPI as deposit for future subscription to PSPI shares; that said deposit is not subject to repayment or redemption by PSPI; that in the event of dissolution, liquidation and winding up of PSPI, no amount shall be repayable to Philips-Netherlands in respect to such deposit under the aforesaid agreement, but rather, Philips-Netherlands shall participate in any residual profits of PSPI as other shareholders would; and that said amount will be credited in the company books as capital. In this regard, paragraphs 1 to 5 of the Quasi-Equity investment Agreement state: "1. DEPOSIT FOR FUTURE SUBSCRIPTION The proceeds of the Quasi-Equity investment, as defined hereinbelow, shall constitute a deposit for future subscription of new shares in the Receiver. 2. DEPOSIT OF THE QUASI-EQUITY (a) The Payer will deposit the amount of the United States Dollars Two Hundred Million Only (US$200 Million), hereinafter called the "Quasi-Equity", to the Receiver and the Receiver shall accept the Quasi-Equity in one amount before 30 June 2001. Said "deposit for Quasi-Equity" shall alternately refer to the "deposit for future subscription." (b) The Payer shall pay the proceeds of the Quasi-Equity to the bank account designated by the Receiver in writing at least 2 days prior to the date requested for the Quasi-Equity, such payment to constitute the drawdown by the Receiver of the Quasi-Equity in accordance with the terms of this Agreement. 3. INTEREST The Quasi-Equity shall be free of interest. 4. REDEMPTION or REPAYMENT No redemption or repayment of the Quasi-Equity is foreseen. 5. SUBORDINATION (a) The Payer hereby agrees that on the liquidation or winding up of the Receiver, whether or not such winding up occurs before shares are issued against the deposit for future subscription, no amount shall be payable to the Payer in such winding up of the Receiver in respect of the Quasi-Equity until the claims of all other creditors of the Receiver shall have been paid or provided for in full and the Payer accordingly agrees and undertakes not to claim in said liquidation or winding up of the Receiver in respect of the Quasi-Equity until all such other creditors have been satisfied as aforesaid. (b) Upon said satisfaction of all creditors, the Payer shall be entitled to china against the Receiver, either in part or in full, and to participate in any residual profits of the Receiver. The Payer shall in this respect rank pari passu with the shareholders, if there are other shareholders at the time of winding up, of the Receiver with respect to the residual profits of the Receiver. In reply thereto, please be informed; that the foregoing deposit given by Philips-Netherlands under to said agreement is not covered by RMO No. 63-99. Section 2.3 of the RMO states that it does not apply to indebtedness which was in fact a contribution of capital. This section states: "2. Coverage: "This paper applies to all forms of bona fide indebtedness and includes: "2.1 Loans or advances of money or other consideration (whether or not evidenced by a written instrument); "2.2 Indebtedness arising in the ordinary course of business out of sales, leases, or the rendition of services by or between members of the group, or any other similar extension; "2.3 But does not apply to alleged indebtedness which was in fact a contribution of capital or a distribution by a corporation with respect to its shares." (Emphasis supplied) The "Quasi-Equity Investment Agreement" sufficiently discloses that the amount thus given thereunder to PSPI by Philips-Netherlands may not be considered as "bona fide indebtedness" within the ambit of RMO No. 63-99. Rather, the amount to be deposited is analogous to capital contribution considering that the same is not subject to any repayment or redemption by PSPI. Furthermore, the said amount is subordinated to the claims of creditors as provided in paragraph 5 of the agreement quoted above. In addition, the parties agree that the said amount represents deposit for future subscription of shares of PSPI, thereby, constituting it as a capital contribution rather than as an indebtedness. Accordingly, the amount given is not considered a loan or indebtedness covered by Section 4.1 of RMO No. 63-99 which would authorize the Commissioner of Internal Revenue to allocate interest income under Section 50 of the Tax Code of 1997. The nature of a "loan" is defined in Articles 1933 and 1953 of the New Civil Code of the Philippines as follows: "Art. 1933. By the contract of loan, one of the parties delivers to another, either something not consumable so that the latter may use the same for a certain time and return it, in which case the contract is called a commodatum; or money or other consumable thing, upon the condition that the same amount of the same kind and quality shall be paid, in which case the contract is simply called a loan or mutuum . Commodatum is essentially gratuitous. Simple loan may be gratuitous or with a stipulation to pay interest. In commodatum the bailor retains the ownership of the thing loaned, while in simple loan, ownership passes to the borrower." ''Art. 1953. A person who receives a loan of money or any other fungible thing acquires the ownership thereof, and is bound to pay to the creditor an equal amount of the same kind and quality." On the basis of the, foregoing provisions, it is clear that the amount given by Philips-Netherlands to PSPI does not qualify or may not be considered as a loan. Unlike a loan where the person who receives the money has an obligation to repay the amount received, the agreement expressly provides that no redemption or repayment of the Quasi-Equity by PSPI is foreseen (paragraph 4 of the agreement). Without the obligation on the part of PSPI to repay the amount so deposited and the corollary right on the part of Philips-Netherlands to demand payment thereof, no bona fide indebtedness is present under these circumstances. The intent of the parties is clearly manifested in the agreement which provides that the amount received shall constitute a deposit for future subscriptions of new shares (paragraph 1 of the agreement). Philips-Netherlands takes part in the business risk and limits its recovery of the amount given on any residual profits on the liquidation or winding up of PSPI. It is placed in equal footing with any shareholder in PSPI whose return of the contribution given depends upon the existence of residual profits, if any, after all the other creditors shall have been paid. Accordingly, not being considered as "bona fide indebtedness" within the purview of RMO No. 63-99, no interest may be imputed on the Quasi-Equity Investment Agreement between Philips-Netherlands and PSPI. 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.) REN G. BAEZ Commissioner of Internal Revenue