Taxability of Proposed Issuance by the Rep. of the Phil. of PhP30 Billion US Dollar Linked Peso Notes Program

November 16, 2001 BIR RULING NO. 052-01 24 (B) (1); 27 (D) (1); 28 (A) (7); 39 000-00 Hon. Sergio G. Edeza National Treasurer Roxas Boulevard Corner Vito Cruz Street Manila S i r : This refers to your letter dated October 16, 2001 requesting for a ruling on the taxability of the proposed issuance by the Republic of the Philippines of PhP30 billion US Dollar linked Peso Notes Program with Deutsche Bank A.G., Manila Branch, Multinational Investment Bancorporation (MIB) and Rizal Commercial Banking Corporation (RCBC) as Joint Financial Advisors and Issue Managers to finance the budgetary requirements of the National Government. It is represented that the issuance of the said US-dollar Indexed Philippine Peso Notes (Notes) has been approved-in-principle by the Monetary Board (MB) last 25th September 2001; and that the salient features of the Notes are as follows: Principal Terms and Conditions of Tranche 1 Issuer : The Republic of the Philippines Description : US-Dollar Indexed Philippine Peso Notes Joint Financial Advisors : Deutsche Bank AG Manila Branch Issue Managers and Multinational Investment Bancorporation Arrangers : Rizal Commercial Banking Corporation Selling Agents : To be determined. Total Issue Size : Minimum of PHP5,000,000,000 up to a maximum of PHP20,000,000,000 Initial Issue : Series A PHP2,500,000,000 with tenor of two (2) years Series B PHP2,500,000,000 with tenor of three (3) years Each series will be issued one business day apart within the same week and the size and timing of the succeeding series will be determined by the Issuer in consultation with the Arrangers. The Issuer, in consultation with the Arrangers, reserves the right to increase the issue size of this Tranche 1 or to do a re-offering in the subsequent week, subject to the same conditions as discussed above, up to PHP20,000,000,000. If the Arrangers do not agree with the Issuer on the terms and conditions of a subsequent re-offering, the Issuer reserve the right to replace the Arrangers. Issue Date : To be determined jointly by the Issuer and Arrangers. Coupon Rate : Base Rate * Foreign Exchange Factor * 180/360 Where : Base rate means the mid yield reference US dollar denominated securities, including notes, bonds and such Other similar debt securities, offered by the Issuer and/or the Bangko Sentral ng Pilipinas, and outstanding, with the same or similar tenor as of that of the proposed Notes to be issued, as mutually agreed between the Issuer and the Joint financial Advisors and the Issue managers one business day prior to the launch of the Notes, which appears on the Bloomberg Prebon Page at approximately 11:00 a.m., Manila time, on Rate Calculation Date divided by .8 plus Spread. The Spread is up to a maximum of 50 basis points for the two and three-year Notes. Mid yield = arithmetic mean of the market bid and offer quotes. Should such a rate not be available, or should the Calculation Agent determine that the rate published does not accurately reflect the mid yield of reference US Dollar denominated bonds of the Issuer and/or the Bangko Sentral ng Pilipinas, the rate will be the average mid yield obtained by the Calculation Agent by polling five (5) reference banks, after excluding the maximum and the minimum quote obtained, one Manila Business Day prior to Issue Date. Foreign Exchange Factor means PHP _B_ Val divided by PHP_A_Val where PHP_B_Val means the spot PHP:USD exchange rate one Business Day prior to each Coupon Date PHP_A_Val means the spot PHP:USD exchange rate one Business Day prior to Issue Date. Coupon Amount : PHP Face Amount * Coupon Rate Interest will be paid in Philippine Pesos and will accrue daily on a 30/360-day basis and will be paid semi-annually in arrears, following business day convention. Form of the Notes : Scripless Issue Price : Par Maturity : The Notes will be redeemed at their Redemption Amount of two (2) and three (3) years from Issue Date. Final Redemption : The Notes will be redeemed at their Redemption Amount in Philippine Pesos on the relevant Maturity Date. Redemption Amount : [PHP Face Amount/PHP_A_Val] * PHP_C_Val Where : PHP_A_Val means the spot PHP:USD exchange rate one Business Day prior to Issue Date. PHP_C_Val means the spot PHP:USD exchange rate one Business Day prior to Maturity Date. Spot PHP:USD : The Spot Rate for a Rate Calculation Date will Exchange Rate be the Philippine Pesos/US Dollar value tom rate (mid market), expressed as the amount of Philippine Peso per one US dollar, for settlement in one Business Day which appears on the Telerate Page 15439 at approximately 11:00 a.m., Manila time, on that Rate Calculation Date. "Rate Calculation Date means one Business Day prior to the relevant Coupon Date or Maturity Date. Calculation Agent : to be agreed upon by the Issuer and the Joint Financial Advisors and Issue Managers. Reference Banks : Citibank, Hongkong Shanghai Banking Corporation, ING Bank, Metropolitan Bank and Trust Company, Equitable-PCI Bank, Chase Manhattan Bank, land Bank of the Philippines. Status : The Notes will rank (other than in the case of obligations preferred by mandatory provision of law applying to companies generally) at least pari passu with all other present and future unsecured and unsubordinated indebtedness of or guaranteed by the Issuer, except those preferred by applicable law. Negative Pledge : As will be more fully set out as in the Terms and Conditions of the Notes and as customary for transactions of this nature. Cross Default : As will be more fully set out in the Terms and Conditions of the Notes and as customary for transactions of this nature. Other Covenants : As will be more fully set out in the Terms and Conditions of the Notes and as customary for transactions of this nature. Taxes & Additional Amounts m : Coupon amount payable by the Issuer in respect of the Notes shall be subject to a 20% final withholding tax. Any gain on the Redemption Amount that may be delivered due to fluctuations of the USD:PHP Exchange Rate shall not be subject to the 20% final withholding tax, but to tax the regular income tax rates when derived by a Philippine residents taxpayer. AcHaTE Documentary stamp tax (DST) for the primary issue of the Notes and the documentation, if any, shall be for the Issuer's account. Governing Law : The Notes and documentation will be governed by the laws of the Republic of the Philippines and the Issuer shall enter into customary waivers of immunity from suit, execution, attachment or other legal process. Denomination of the Notes : Face Amount of PHP100,000.00 Clearing/Settlement : Ross and DDa Fees and Expenses : The Issuer will pay a fee equivalent to 0.25% and 0.30% of the total amount of two-year and three-year Notes, respectively, issued per series, payable to the Joint Financial Advisors and Issue Managers on the date of the issuance of the Notes. The above fee is inclusive of the legal fees, auditor's fees and printing expenses associated with the management of the Notes will be for the account of the Issuer. In the event the initial issuance of the Notes is cancelled or terminated by the Issuer upon 5 days prior notice, other than by reason of a material adverse change in the assets, condition (financial or otherwise) or prospects of the Issuer or in the national, political or economic situation in or sovereign rating of the Issuer from the date of the mandate until the date of signing the documentation for the initials issuance of Series A and B, and the Issuer does not give the Joint Financial Advisors and Issue Managers the first right of refusal over the provisions of other financial products to replace this Programme, the Issuer agrees to reimburse the Joint Financial Advisors and Issue Managers for all expenses associate with the establishment of this Programme (including without limitation, legal, printing, and auditor's fees and agency fees). Eligibilities : The Notes will have the same eligibilities as all other eligibilities of all outstanding fixed rate treasury bonds of the Issuer. However, the Notes may qualify as eligible reserve for trust duties only when they already meet the three year remaining maturity requirements to ensure that such bonds can be liquefied easily. Clear Market : From thirty (30) days prior to Issue Date until the date of issue of Tanche 1 of the Notes, the Issuer shall not engage in any similarly structure instrument that may compete with this notes issuance, which in the opinion of the Joint Financial Advisors & Issue Managers may adversely affect the successful launch of the Notes. The above described Notes will be offered to the public. In reply, please be informed that, for purposes of taxation, the returns from the investment in the above-described Notes shall consist of the interest earned at coupon date based on the Coupon Rate and the gain, if any, at maturity date which is the difference between the equivalent Philippine Peso amount of the principal one Business Day prior to redemption date and at issue date. Under Sections 24(B)(1), 27(D)(1), 28(A)(7) of the Tax Code of 1977, the 20% final tax is imposed on "interest on any currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements". Section 22(Y) of the same Tax Code defines "deposit substitutes" as follows" "The term "deposit substitutes" refers to an alternative form of obtaining funds from the public (the term public means borrowing from 20 or more individuals or corporate lenders at any one time), other than deposits, through the issuance, endorsement, or acceptance of debt instruments for the borrower's own account, for the purpose of relending or purchasing of receivables and other obligations, or financing their own needs or the needs of their agent or dealer. . . ." Section 2(h)(iii))(b) of Revenue Regulations No. 17-84 considers all borrowings of the national and local government and its instrumentalities including the Central bank of the Philippines (now Bangko Sentral ng Pilipinas), evidenced by debt instruments denoted as treasury bonds, bills, notes, certificates of indebtedness and similar instruments as "Deposit substitutes". Considering the foregoing, the interest income derived on each coupon date is subject to the twenty percent (20%) final withholding tax on yield on deposit substitutes imposed in Sections 24(B)(1), 27(D)(1), and 28(A)(7) of the 1997 tax Code. The amount of interest to be received by an investor on each Coupon Date depends in part on the PHP/USD exchange rate prevailing at one business day prior to Coupon Date. The exchange rate is therefore merely a factor in calculating the interest or yield due on a coupon for each Coupon Date. In this regard, Section 2(j) of Rev. Regs. No. 17-84 defines yield as follows: "(j) 'Yield' shall mean the difference between the amount which the lender/investor loaned/placed and the amount to be received by him upon maturity of the deposit substitutes/debt instruments which shall in no case be lower than the interest rate prevailing at the time of the issuance or renewal of the said debt instruments." It is clear from the foregoing definition that "yield" is that amount which an investor is certain to receive upon Maturity Date of the deposit substitute instrument. While the term used is "yield", it is synonymous to interest. This is apparent from the last sentence of the above definition which specified that in no case shall yield be lower than the interest rate prevailing at the time of issuance or renewal of the deposit substitute. In other words, it is the amount which the issuer or the debtor is obligated to pay an investor as payment for use or forbearance of the money, which the latter loaned or placed. Clearly, by the nature of the above Notes, the yield or interest to be received by an investor on each Coupon Date includes the foreign exchange differential, which is a factor in determining the interest or Coupon Amount due on each coupon. In effect, because in part the peso amount of the interest is linked to the PHP:USD rate on a given date, the interest on the Notes in question is a floating interest rate. Accordingly, this Office rules that the entire amount paid on each coupon on each Coupon Date is considered as yield or interest on deposit substitutes as defined under Section 22(Y) of the 1997 tax Code and Specifically elaborated under Section 2 of Rev. Regs. No. 17-84. Such being the case, it is subject to the 20% final withholding tax imposed under the aforementioned Sections 24(B)(1), 27(D)(1) and 28(A)(7) of the 1997 Tax Code. On the other hand, as provided for under Section 39(E) of the same Tax Code, which reads as follows: "(E) Retirement of bonds, etc . For purposes of this Title, amounts received by a holder upon retirement of bonds, debentures or certificates of indebtedness by a corporation (including those issued by a government or political subdivision thereof) with interest coupons or in registered from, shall be considered amounts received in exchange therefor". the amounts paid by the Republic of the Philippines through the Bureau of Treasury to an investor upon retirement of the Notes are considered payments in exchange for such Notes. This is to be distinguished from "yield or other monetary benefit", because it is not income derived from use or forbearance of money, but rather from the depreciation of the PHP versus USD. In fact, the investor may even suffer a loss if the PHP appreciates against the USD. Hence, the gain, if any, that may be derived with respect to the principal, in the event the Philippine Peso depreciates against the US Dollar one business day prior to Maturity Date does not fall within the meaning of "yield or other monetary benefit". Consequently, the gain, if any, shall be taxed at the regular income tax rates depending on the status of the investor (that is, whether individual, corporation, resident, or non-resident), and not to the 20% final withholding tax imposed on "yield or other monetary benefit from deposit substitutes". This is because the gain on the principal is not interest, but rather gain realized from the redemption of the Notes by the Issuer upon Maturity Date. In addition, if the Notes are capital assets in the hand of the investor, the rules on capital gains and losses provided in Section 39 of the Tax Code of 1997 shall apply. TAECSD Moreover, the gains, if any, on sale or exchange of the Notes shall not be subject to final withholding tax but to the ordinary income tax rates. Finally, the issuance of the Notes 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 of 1997. 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