Tax Consequence of Bareboat Charterparties with Irrevocable Option to Purchase

July 31, 1985 BIR RULING NO. 114-85 24 (b) (1) (v) 148-83 114-85 Gentlemen : This refers to your letters dated December 6, 1984 and April 2, 1985 requesting a ruling as to the tax consequence of the Bareboat Charterparties with irrevocable option to purchase, respectively entered into by the Philippine OBO Carriers, Inc., Philippine OBO Ventures, Inc. and Philippine OBO Transport, Inc., domestic corporations as charterers, with the Philippine OBO Carriers S. en C.S., Philippine OBO Ventures S. en C.S., and Philippine OBO Transport S. en C.S., limited partnerships formed in the Republic of Panama, as owners. Documentary evidence submitted show that three (3) vessels, namely: the M.V. Philippine OBO "2", M.V. Philippine OBO "3" and M.V. Philippine OBO "4" were built by Uddevallavarbet A.B. of Sweden for, and to be purchased by Philippine Transmarine Carriers, Inc. (PTC) or a nominee of PTCI; that due to the prevailing situation in the foreign currency credits of the country, circumstances do not permit the acquisition of the vessels directly by a Philippine company; that the Philippine Maritime Industry Authority (MARINA) granted its approval to the Philippine OBO Carriers, Inc., Philippine OBO Ventures, Inc., Philippine OBO Transport, Inc., to respectively charter and register M.V. Philippine OBO "2", M.V. Philippine OBO "3" and M.V. Philippine OBO "4" under the laws and flag of the Philippines, subject to the condition that the ownership of the vessels shall be transferred to the Charterers or to PTCI or to another Philippine company in the event that the balance of the payment position of the Philippines would permit such acquisition, as determined by the Philippine monetary authorities; that after such approval by MARINA, Bareboat Charterparties were respectively entered into by and between the abovementioned three (3) domestic corporations and the three (3) Panamian Limited partnerships; that each vessel costs US$31,000,000.00; that a down payment of US$3,100,000 was made upon delivery of the vessel; that the balance of US$27,000,000 of the purchase price for each vessel will be amortized over a period of twelve (12) years (inclusive of a grace period of three years) in sixteen semi-annual installments of US$1,162,500 and a final (balloon) payment of US$8,137,500; that the charterhire of US$60,833.33 payable monthly is utilized by the owner to partly pay for the amortization due to the shipbuilder, the difference between the semi-annual amortization of US$1,162,500 and the bareboat charterhire income for six months equal to US$364,999.98 is made up by the owner from other sources; and that each of the Philippine charterers has an irrevocable option to purchase the vessel at any time during the term of the Bareboat Charter for the greater of the book value of the vessel at the time of the transfer and the remaining portion of the debt owed by the owner in respect of the first and second mortgage. In reply, I have the honor to inform you that under the foregoing facts, the agreements respectively entered into by and between the charterers and the foreign shipowners are in reality contracts of purchase and sale. It has been ruled that "the fact that the price of the machine was fixed in the contract makes the latter not a lease but a purchase and sale, it is plain redundancy to fix or make any mention of the price of the thing given in lease". (H.E. Heacock & Co., vs. Buntal Manufacturing Co., 66 Phil. 245) Moreover, contracts in the form of leases either with options to the buyer to purchase for a small consideration at the end of the term, provided the so-called rent has been duly paid, or with stipulations that if the rent throughout the term is paid, title shall thereupon vest upon the lessee, are leases in name only. The so-called rents must necessarily be regarded as payment of the price in installments, since the due payment of the agreed amount results by the terms of the bargain, in the transfer of title to the lessee. (Teodorica R. Vda. de Jose vs. Julio Veloso Barrueco, 67 Phil. 191) In view thereof, the so-called "rentals" or charterhire to be paid by the charterers to the foreign shipowners are considered installment payments if the sale will be ultimately consummated. Accordingly, they are not subject to the 4-1/2% final tax prescribed by Section 24(b)(1)(v) of the Tax Code which imposes said tax on rentals, lease and charter fees payable to non-resident owners of vessels chartered by Philippine nationals. In this connection, however, should the charterers in this case fail to exercise the option to purchase and, therefore, the foregoing transactions shall remain lease agreements, the rentals or charterhire shall be subject to the 4-1/2% final tax. To guarantee the payment of the said tax, you are requested to urge the aforenamed domestic corporation-charterers, to file within ten (10) days from your receipt hereof, a surety bond the amount of which shall be determined by the Bureau; and, for this purpose, you/they may get in touch with the Chief, Law Division. If they fail to do so, we shall require them to pay the aforesaid 4-1/2% tax under the Tax Code. Very truly yours, (SGD.) RUBEN B. ANCHETA Acting Commissioner