Taxability of Long-Term Deposit or Investments' Interest Income

July 24, 2001 BIR RULING NO. 030-01 Equitable PCI Bank P.O. Box 3616 Manila Attention: Ms . Clarissa Emerita G . Ocampo Senior Vice-President and Trust Officer Gentlemen : This refers to your letters dated March 20, 2000 and March 27, 2001 requesting for a ruling/opinion on the following issues: 1. Which do the banks need to submit to BIR for tax exemption? Is it the trust instrument to be used to generate long-term accounts? Or is it the investment instruments which the trust accounts are to be invested? What are the procedures for securing such tax exemptions? 2. Can the funds of a long-term trust accounts accepted by a bank be invested in short term investment instruments not necessarily coterminous with the trust account, and still avail of the tax exemption by mere presentation of the tax exemption certificate issued by the BIR in favor of the trust account? 3. Is tax exemption of BIR-approved trust accounts retroactive to the date of the effectivity of the fund? 4. May the income earned by long-term trust accounts be withdrawn prior to the end of the five-year term of the trust agreement or investment management account without affecting the tax-exempt status of the fund?" In reply thereto, please be informed of the following: 1. In all trust agreements, the investor appoints a person (trustee bank) with whom he grants the authority to invest his money (trust fund) for him. The trustee bank, using its investment expertise, organization, size and presence in the financial market place, invests the individual investor's trust fund in one or more types of investment outlets. The kind of investment outlets in which the trustee bank may invest is stipulated in the trust agreement by the investor. In other words, no income is generated simply because the investor puts his money in the trust fund but income is generated only when the trustee bank makes investments by using the investor's trust fund. The term "long-term deposit or investment certificate" is defined under Section 22(FF) of the Tax Code, viz: " The term long-term deposit or investment certificate shall refer to certificate of time deposit or investment in the form of savings, common or individual trust funds, deposit substitutes, investment management accounts and other investments with a maturity period of not less than five (5) years, the form of which shall be prescribed by the Bangko Sentral ng Pilipinas (BSP) and issued by banks only (not by nonbank financial intermediaries and finance companies) to individuals in denominations of Ten thousands pesos (P10,000) and other denominations as may be prescribed by the BSP ." cSIADH The trust instrument to be used to generate long-term deposit or investment determines the income tax exemption of the individual investor in the income earned. Thus, Sections 24(B)(1) and 25(A)(2) of the Tax Code provide for the following requirements which must be strictly complied: The long-term deposit or investment 1. Must have a maturity of not less than five (5) years; 2. Must be in the form of savings, common or individual trust fund, deposit substitutes, investment management accounts or other forms which must be prescribed by the Bangko Sentral ng Pilipinas; 3. Must be issued by banks only (not by nonbank financial intermediaries and finance companies); 4. Must be issued to individual citizen or resident alien or non-resident alien engaged in trade or business within the Philippines only; 5. Must be in denominations of Ten Thousand Pesos (P10,000) or other denominations as may be prescribed by the Bangko Sentral ng Pilipinas; and 6. Should not be pre-terminated by the holder before the fifth year. Issuance of a tax exemption certificate is not necessary as the taxability of long-term deposit or investments' interest income of the abovestated individuals is dependent on the full compliance of the above requisites, otherwise a final tax of twenty percent (20%) shall be imposed, or, if the investment of deposit is pre-terminated before maturity, the following rates shall apply (based on the holding period of the instrument): Four (4) years to less than (5) years 5% Three (3) years to less than four (4) years 12% and Less than three (3) years 20%" 2. You have represented that the trust instruments to be used to generate long-term accounts with your bank are common trust fund, investment management account and revocable trust account described hereunder: a. Common Trust Fund (CTF) is a fund maintained by a bank authorized to perform trust functions under a written and formally established plan, exclusively for the collective investment and reinvestment of certain money representing participation in the plan received by it in its capacity as the trustee. It is a form of collective investment whereby monies solicited from the public are pooled with pro rata participation in the total fund. The investment of fund is purely for return of income. b. Investment Management Account (IMA) involves an agreement primarily for financial return whereby the bank (investment manager).binds itself to handle or manage investible funds or any investment portfolio in a representative capacity as financial or managing agent, adviser, consultant or administrator of financial or investment management, advisory, consultancy or any similar arrangement which does not create or result in a trusteeship but rather a principal-agent relationship. The instruments into which the funds are invested are in the name of the principal or investment manager as agent for the principal. Commingling of funds is not allowed which explains a higher minimum amount. c. Revocable Trust Account (RTA) involves the appointment of a trustee by a trustor for the administration, holding, management of funds and/or properties of the trustor by the trustee for the use, benefit or advantage of the trustor or of others called beneficiaries. A trust relationship is created. Legal title is with the trustee but the beneficial ownership is maintained with the trustor and/or beneficiaries. The provisions of Sections 24(B)(1) and 25(A)(2) of the Tax Code of 1997 expressly exempt from final withholding tax the interest income from long-term deposit or investment of subject individual taxpayers. Thus, interest income earned by them from such long-term deposit or investment in the form described above are exempt from income tax even if invested by the bank in short term instruments for as long as the maturity period of the subject individuals long-term deposit is not less than five (5) years, and the 5-year maturity period is expressly indicated in the certificates, trust instrument, or agreement covering the above-mentioned trust products. 3. The exemption under Section 24(B)(1) and 25(A)(2) of the Tax Code shall apply on long-term savings and investment interest income of subject individuals beginning January 1, 1998. 4. Subject Sections 24(B)(1) and 25(A)(2) of the same Tax Code provide that a final tax at the rate of twenty percent (20%) is hereby imposed upon the amount of interest from any currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements; . . . Provided, further, that interest income from long-term deposit or investment in the form of savings, common or individual trust funds, deposit substitutes, investment management accounts and other investments evidenced by certificates in such form prescribed by the Bangko Sentral ng Pilipinas (BSP) shall be exempt from the tax imposed under this Subsection (supra); Provided, finally, that should the holder of the certificate pre-terminate the deposit or investment before the fifth (5th) year, a final tax shall be imposed on the entire income and shall be deducted and withheld by the depository bank from the proceeds (that is, principal and undistributed interest) of the long-term deposit or investment certificate based on the holding period thereof. STEacI Four (4) years to less than five (5) years 5% Three (3) years to less than four (4) years 12% Less than three (3) years 20% A meticulous study of the above-cited section disclosed that there is nothing which prohibits the holder of the certificate to pre-terminate the deposit or investment or withdraw the income earned before the fifth (5th) year period. The withdrawal of the principal, however, would subject the interest income to a final tax depending on the holding period of the instrument as stated above. Finally, for monitoring purposes, the bank shall set up a separate numbering system in its trust books for its long-term trust products. Very truly yours, (SGD.) REN G. BAEZ Commissioner of Internal Revenue