Tax Consequence of the FPC Fund Transaction

March 17, 1988 BIR RULING NO. 104-88 25-b 142-87 104-88 Gentlemen : This refers to your letter dated February 3, 1988 requesting confirmation of your opinion that BIR Ruling No. 142-87 dated May 28, 1987 hearing on the tax consequences of certain transaction of the First Philippine Capital Fund L.P. (FPC Fund) applies to certain transactions of the Philippine Capital Growth Fund (CG Fund) in view of the factual similarity of said Fund. It is represented that the proposed CG Fund is a limited partnership to be formed under the laws of the United States, that the CG Fund will be capitalized at up to US$75 million; that it will be an investment vehicle designed to enable investors, particularly foreign banks and bank-holding companies, to pool their holdings of certain foreign debt obligations of the Philippine private and public sector borrowers (Qualified Debt) in order to facilitate the conversion of those obligations into equity investments in Philippine enterprises pursuant to the Philippine Program for the conversion of Philippine External Debt into Equity Investments set forth in Central Bank Circular No. 1111 (Conversion Program); that the CG Fund will have a general partner (General Partner) and limited partners (Limited Partners); that the General Partner will be general partnership formed under the laws of the United States, Virgin Islands; that the Limited Partners are expected to be United States. European and Asian banks and financial institutions; that some of the Limited Partners may be banks operating offshore banking units (OBU) or foreign currency deposit units (FCDU) in the Philippines, or affiliates of such banks; that the Partners will exchange Qualified Debt which they hold for units of undivided partnership interest in the CG Fund; that the CG Fund will invest substantially all of the Qualified Debt in common stock and preferred stock of Philippine enterprises under the Conversion Program; that it may also invest in debt securities issued by such enterprises, including debt securities convertible into equity; that the CG Fund intends to purchase and hold securities for long-term capital appreciation and does not expect to buy and sell securities for short-term gain, that the stock and debt securities will be in the name of CG Fund; that CG Fund will limit itself to such investment activity; that from said investments, CG Fund will earn income in the form of dividends, interest and gain on the sale or exchange of equity and debt securities; that CG Fund also intends to establish a representative office in the Philippines which will have the following functions in relation to CG Fund's investment activity (1) identifying and seeking out suitable investments (2) negotiating the terms of, and concluding contracts for the acquisition of investments (3) supervising and monitoring the investments, including representing the CG Fund to the extent allowed by law on the board of directors of the corporation in which the investment is made, as well as giving advice to the corporation in which the investment is made, as well as giving advice to the corporation concerned without remuneration (4) liaising with governmental and other institutions with respect to such investments and Qualified Debt; and (5) disposing of the investments in the Philippines (a) in privately negotiated sales transactions (b) in public offerings conducted through broker dealers (in the ordinary course of their business) to whom compensation negotiated at arm's length is paid; or most likely, (c) in secondary offerings conducted through broker/dealers (likewise in the ordinary course of their business) made in conjunction with primary public offerings made by the Philippine company or (d) outside of the Philippines; and that income of the CG Fund as a general rule will be allocated to all partners in proportion to their respective capital accounts. cdta In reply thereto, I have the honor to inform you that your opinion is hereby confirmed. (1) The CG Fund would not be deemed engaged in a trade or business in the Philippines as its activities are purely investment related. The representative office to be established by the CG Fund in the Philippines would not be considered a permanent establishment in the Philippines as this term (permanent establishment) is defined in Article 5 of the RP-US Tax Treaty; hence, its business profits are not taxable in this country (Art. 8(1), RP-US Tax Treaty). (2) The preferential tax rate provided in Article II (dividends), 12 (interest) and 14 (tax exemptions on certain capital gains) of the RP-US Tax Treaty shall apply to the General and Limited Partners of the CG Fund who are U.S. residents with respect to their share of dividends, interest and capital gain of the partnership allocable or allocated to such partners and to the General Partner (which itself is a partnership) to the extent that the income of such partnership is subject to United States tax as the income of a United States resident either in the hands of the respective entity or of its partners or beneficiaries. (3) The preferential tax rates provided in the RP-US Tax Treaty shall be applied to the income of the CG Fund allocable to non-US Limited Partners, to the extent that such income is effectively connected with the conduct of a trade or business in the United States. (4) Non-Us Limited Partners who qualify as residents of countries with which the Philippines has an income tax treaty are entitled to the preferential tax treaty treatment provided for under the specific treaty concerned with respect to their share of partnership income. (5) The CG Fund would be considered as a corporation entitled to the benefit of Article II(2)(b) of the RP-US Tax Treaty. (6) The interest income on Qualified Debt allocable to Limited Partners who have an OBU or FCDU in the Philippines shall continue to be subject to the 10% tax under Sections 23 (a)(A) and 25(a)(6)(D) of the Tax Code, as amended. (7) Limited Partners who have either OBU's or FCDU's in the Philippines, are considered resident foreign corporations. (Sec. 2, Revenue Regulations No. 10-76) Accordingly, the share of the dividend income of the CG Fund allocable to the Limited Partners who have OBU's or FCDU's in the Philippines is not subject to tax under Title II of the Tax Code, pursuant to Section 25(a)(6)(D) of the Tax Code, as amended. Moreover, said Limited Partners are not subject to the branch profit remittance tax on their share of the dividend income because the same is not considered branch profits which are effectively connected with the conduct of its trade or business in the Philippines. [Sec. 25(a)(5), Ibid .] (8) The interest income (other than interest on Qualified Debt) of, and gain on the sale or exchange of personal property which is allocable to the Limited Partners which have CBU's or FCDU's in the Philippines are subject to the preferential tax treatment under tax treaties with respect to interest income and capital gains. (9) The dividend income of the partnership allocable to Limited Partners who are incorporated or residents of countries which do not impose any tax on dividends received from Philippine corporations are subject to a tax of 15% under Section 25(b)(5)(B) of the Tax Code. (BIR Ruling No. 45-85) (10) The Conversion Transactions under Central Bank Circular No. 1111 and described in detail in Sections 21 to 24 thereof which the CG Fund will utilize for purposes of investment in Philippine enterprises will not give rise to any Philippine income tax imposable on the partnership and/or the individual partners. cdtech Very truly yours, (SGD.) BIENVENIDO A. TAN, JR. Commissioner