Taxability of USD T-bills

October 29, 2001 BIR RULING NO. 050-01 28 (A) (7) (b) RR 10-98 000-00 Hon. Eduardo Sergio G. Edeza Treasurer of the Philippines Bureau of the Treasury 3rd Floor, Palacio de Gobernador Intramuros, Manila S i r : This refers to your letter dated August 13, 2001 requesting for a ruling on the following: "1. Whether the discount on the face value of the USD T-bills shall be subject to the 20% withholding tax rate, which shall be withheld by the Republic upon its issuance under Section 28(7)(a) of the 19 97 Ta x Code or to 10% withholding under Section 28(7)(b) of the same Act. "2. The income earned by the USD T-bills when sold in the secondary market shall no longer be subject to further withholding tax. "3. The issuance of the USD T-bills shall be subject to the documentary stamp tax of P0.30 for every P200.00 or fractional part thereof based on their face value as imposed by Section 180 of the T ax Co de." It is represented that the Republic of the Philippines (the "Republic"), through the Department of Finance, intends to issue discounted dollar denominated Treasury Bills with a face amount of US$100,000,000.00; that the issuance of the USD T-bills will be made by the Republic for its general funding requirements pursuant to Republic Act No. 245, as amended, and Full Powers as issued by the President of the Republic dated July 26, 2001; that the Monetary Board of the BSP also granted the issue on August 2, 2001; that the fiscal agency agreement shall be entered into in relation to the USD T-bills between the Republic and Citicorp Capital Philippines Incorporated ("CCCP") as fiscal agent, agent bank and paying agent; that the issue will be represented by Permanent Certificate to be deposited with a common depository on behalf of the Euroclear Bank S.A./N.V., as operator of the Euroclear System ("Euroclear") and Clearstream Banking societe anonyme ("Clearstream Luxembourg") on or about September, 2001; that the Permanent Certificate shall be exchangeable for definitive Treasury Bills in bearer form in denomination of $5,000.00 under certain limited circumstances; that the USD T-bills shall bear no interest but shall be issued at a discount; that Citibank N.A., Philippine Branch (Citibank FCDU) has agreed to subscribe and pay for 100% of the issued Treasury Bills on Closing Date at a selling price, being the issue price of a certain percent of the principal amount of the USD T-bills using selling concessions; that among the salient features of the USD T-bills as indicated in the Draft Term Sheet submitted by Citibank FCDU are as follows: Issuer : Republic of the Philippines ('RoP", the "Issuer") Issue : Discounted US Dollar Treasury Bills due [August 2002] [or "USD T-bills"] Lead Underwriter : Citicorp Capital Philippines Incorporated ("CCPI") Paying Agent : Citicorp International Limited or any other agent mutually acceptable to the Lead Underwriter and the Issuer Purpose/Use of Proceeds : For general funding requirements Issue Size : Up to USD 100,000,000.00 with a greenshoe option of up to USD 100,000,000.00 in case of over subscription Issue Price : At [ ]% as of Issue Date based on a yield-to maturity ("YTM") calculated as the sum of (a) 12 month LIBOR 2 business days prior to Issue Date and b) 1.70-1.85% p.a. This YTM is subject to the Issue Date being prior to August 31, 2001. The Issue Price will be fixed at a price to be mutually agreed between the Issuer and CCPI so as to achieve the YTM described above. LIBOR shall be defined as the London Interbank Offered Rate determined by reference to Reuters Screen "LIBO" page at or around 11:00 a.m. (London time) or, if not available, as quoted by a group of Reference Banks two business days prior to Issue Price setting date. Redemption Price : 100%. Interest Coupon : None. Interest Calculation : Actual/360. Maturity Date : 364 days from Issue Date. Form and Denomination : The US$ T-Bills Issue will be in scripless form in denominations of US$5,000 and integral multiples thereof. The US$ T-Bills will be evidenced by one or more Permanent Certificates, deposited with a common depositor for Clearstream and Euroclear. Beneficial interests in the US$ T-Bills will be effected through (a) for investors with Clearstream or Euroclear accounts by record maintained by these clearing systems and (b) for investors without Clearstream or Euroclear by records maintained by the financial institution they bought it from. Settlement by Clearstream/Euroclear will be made in immediately available funds. If required to be issued Definitive US$ T-Bills will be issued in bearer form in denominations of US$5,000 and integral multiples thereof. Status of the Issue : The US$ T-bills will constitute direct, unconditional, general, unsecured and unsubordinated obligations of the Republic and will be backed by the full faith and credit of the Republic. The issue will rank pari passu in all respects and ratably without any preference or priority among themselves and with all other outstanding direct, unconditional, general, unsecured and unsubordinated. External indebtedness (as defined in the Issuer's existing loan and bond documentation) of the issuer. Covenants : Customary for financing of this nature including but not limited to the following: Compliance with all relevant laws and performance of obligations: negative pledge covenant; Prompt payment of all amounts due under the issue; Maintenance of all necessary governmental approvals; Events of Default : See section "Events of Default"; Clearing System : Clearstream and Euroclear; Taxation : To be finalized pending BIR opinion; Governing Law for the Issue : English Law. that the purpose of this public borrowing is to boost Philippine gross international reserves, as well as to mop up excess dollar liquidity in the local market in order to help defend the Philippine Peso against speculators in the foreign exchange market; that likewise, Citibank FCDU represented that it will either hold on to the T-bills until maturity or try to sell them down to interested investors; that in case Citibank FCDU decides to sell the USD T-bills it purchased on issue date, the prospective buyers will be composed primarily of other FCDUs/OBUs, domestic corporations, resident foreign corporations and resident individuals who currently maintain FCDU accounts with domestic and foreign banks; that Citibank FCDU may likewise opt to sell the USD T-bills to non-residents; that Citibank FCDU posited that discount on the face value of the USD T-bills shall be subject to the final withholding tax of 10% under Section 28(A)(7)(b) of the 1997 Tax Code, which tax is generally withheld on the date of the issuance of the debt instrument; and that should it incur a trading gain on the sale of the USD T-bills, then the net trading gain is likewise subject to the 10% final tax under the same Section 28(A)(7)(b) of the Tax Code, since it is income earned by an FCDU from a foreign currency transaction. In reply, please be informed of the following: 1. Pursuant to Section 28(A)(7)(b) of the 1997 Tax Code, which reads as follows: EAIaHD "(b) Income Derived under the Expanded Foreign Currency Deposit System . Income derived by a depository bank under the expanded foreign currency deposit system from foreign currency transactions with local commercial banks including branches of foreign banks that may be authorized by the Bangko Sentral ng Pilipinas (BSP) to transact business with foreign currency deposit system units and other depository banks under the expanded foreign currency deposit system, including interest income from foreign currency loans granted by such depository banks under the said expanded foreign currency deposit system to residents, shall be subject to final income tax at the rate of ten percent (10%) of such income." Sections 2.27 and 2.28 of Revenue Regulations No. 10-98, governing the imposition of income tax on income derived under the Foreign Currency Deposit and Offshore Banking Systems, categorically provide that: "(c) Taxation of Income of an FCDU or OBU from Foreign Currency Transactions . In general, income derived by an FCDU or OBU from foreign currency transactions with residents of the Philippines, including commercial banks, local branches of foreign banks, and other depository banks under the foreign currency deposit system, shall be subject to a final withholding tax of ten percent (10%) based on gross income pursuant to Section 27(D) (3) and Section 28 (A) (4) of the Code. Income from foreign currency transactions shall include interest income from lending operations, including bank charges, commissions, service fees, and net foreign exchange transaction gains." "Income from foreign currency transactions with non-residents of the Philippines shall not be subject to income tax. "The person making the income payment shall withhold and remit the tax withheld pursuant to the provisions of Section 57 and 58 of the Code. Thus, in the case of the interest payment by a resident of the Philippines on a foreign currency loan from an OBU or an FCDU, the withholding agent shall be the said resident." Under the same regulation, Foreign Currency Deposit System and FCDU are defined as: "(A) Foreign Currency Deposit System shall refer to the conduct of banking transactions whereby any person whether natural or juridical may deposit foreign currencies forming part of the Philippine International reserves in accordance with the provisions of Republic Act No. 6426 entitled "An Act Instituting a Foreign Currency Deposit System in the Philippines, and for other purposes. "(B) Foreign Currency Deposit Unit (FCDU) shall refer to the unit of a local bank or of local branch of a foreign bank authorized by the Bangko Sentral Ng Pilipinas (BSP) to engage in foreign currency-denominated transactions, pursuant to the provisions of RA 6426, as amended. ("Local Bank" shall refer to a thrift bank or commercial bank organized under the laws of the Republic of the Philippines, "Local branch of a foreign bank" shall refer to a branch of a foreign bank doing business in the Philippines, pursuant to the provisions of RA No. 337, as amended)." Such being the case, the discount earned from the USD T-bills is income of Citibank FCDU from a foreign currency transaction with a resident, which falls within the purview of the aforecited Section 28(A)(7)(b) of the 1997 Tax Code, as implemented by Revenue Regulations No. 10-98. The Republic, through the Bureau of Treasury, shall withhold from such amount of discount, the 10% final tax imposed under Section 28(A)(7)(b) of the 1997 Tax Code at the time of the issuance of the USD T-bills (BIR Ruling No. 186-94 dated December 7, 1984). In this regard, a representation or warranty should be made to the effect that the USD T-Bills are acquired upon their original issuance by Citibank FCDU, for and on its own behalf, and not for the account of other entities. Moreover, should Citibank FCDU realize a trading gain on the subsequent sale of the USD T-bills, then the net trading gain would also be subject to the 10% final tax under Section 28(A)(7)(b) of the Tax Code. For a discounted instrument, which has been subjected to the 10% final tax, it is worthy to note that trading gains arise only when the instrument is sold above par. Otherwise stated, " trading gains " shall be the excess of the selling price over the par value or book value of the instrument. For this purpose, par value of the T-bills is the adjusted value which consists of the original purchase price plus the accumulated discount from the time of purchase up to the time of sale. 2. We likewise confirm that the 10% final tax on the discount shall be imposed only on the original issuance of the bills in the primary market but shall no longer be collected in the secondary trading of said securities (BIR Ruling No. 177-95 dated November 9, 1995). In this respect and considering that the target secondary market includes both OBUs/FCDUs, domestic or foreign corporations, and resident/non-resident individuals who currently maintain FCDU accounts with domestic and foreign banks, any gain derived by them from secondary trading of the USD T-Bills shall be subject to the corresponding taxes applicable to each and every class: Income Tax on Trading Gain Holder (excess of selling price over par) Citibank-FCDU 10% final tax [Sec. 28 (A)(7)(b)] OBU/FCDU 10% final tax [Sec. 28 (A)(7)(b)] Domestic corporation 32% income tax* [Sec. 27 (A)] or 2% MCIT** [Sec. 27(E)], whichever is applicable Resident foreign corporation 32% income tax*{Sec. 28 (A)(1)] or 2% MCIT** [Sec. 28(A)(2)], whichever is applicable Non-resident foreign corporation 32% withholding tax** [Sec. 28 (B)(1)] Resident individuals/non- resident alien not engaged in trade or business in the 5%-32% income tax* [Sec. 24 A)(1)(c)] Philippines Non-resident alien not engaged in trade or business in the 25% income tax** [Sec. 25 (B)] Philippines * based on the net income ** based on the gross income 3. The issuance of the USD Treasury Bills shall be subject to documentary stamp tax of P0.30 for every P200.00, or fractional part thereof based on their face value pursuant to Section 180 of the Tax Code. Finally, the transfer of treasury notes in bearer form in the secondary market by way of simple delivery to the buyer is not subject to the documentary stamp tax. In other words, unless the transfer of treasury note carries with it a renewal and issuance of new treasury notes in the name of the transferee to replace the old ones, no documentary stamp tax shall accrue on such transfer. Hence, for this reason, the secondary trading of other USD T-bills will no longer be subject to DST (BIR Ruling Nos. 119-91 dated June 25, 1991 and 202-99 dated December 16, 1999). This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it shall 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