ASB Development Corp. Not a Lending Investor and Its Borrowing-Lending Activity Not a "Deposit Substitute"

July 30, 1998 BIR RULING NO. 116-98 22 (X)-34 (B) (1)-116-98 ASB Development Corp. ASB Center 114 Benavidez St., Legaspi Village 1229 Makati City Attention: Mr . Rolando P . Domingo Sr . Vice President Gentlemen : This refers to your undated letter received by this Office on April 30, 1998 requesting a ruling on the following: "1. Whether a real estate developer could, for tax purposes, be considered as lending investor merely because it derives interest income from advances to its own affiliate (Sister Company) considering that the interest rates so charged are only sufficient to cover the interest expenses that the company itself pays to the bank and other affiliates, for the funds so advanced; "2. In this connection, is the real estate company required to withhold the 20% final tax on interest paid for advances from affiliate (sister company), and from bank loans considering that the final tax referred to under Section 24(e) of the Tax Code, as amended [now Section 27(D)(1) of the Tax Code of 1997], is for the interest income on the part of lending institutions and banks on their interest derived from deposits and yield from deposit substitutes; "3. Whether or not the same is subject to final tax of 20% on the basis that the above interest expenses are part of the company's legitimate business expenses. It is our view, that even if it is not subject to 20% final tax, it shall still be treated as an expense on the part of the company and therefore, it can be deducted from the Gross Income in computing the income tax; "4. Whether or not advances granted by an affiliate company, which are payable on demand, are subject to documentary stamp tax; and "5. Whether or not the 8.5% of interest income from term buyers accounts which are enrolled with the HIGC exempt from income tax?" It is represented that ASB Development Corporation (formerly Tiffany Tower Realty Corporation) [the " Corporation "] is a corporation organized under Philippine laws, and is duly engaged in a real estate development, with the following primary purposes, viz: "To buy, sell, lease or otherwise acquire and own real estate, improve and develop the same, erect and construct buildings and other improvements thereon, to rent, sell or otherwise dispose of real estate and deal generally in all contracts pertaining to the purpose, sale, management and disposition of real estate: to erect, repair, remodel, construct, improve and develop homes, business industries and commercial buildings, hereditaments, easements and appurtenances thereto, wherein situated, to the fullest extent permitted by law." that the Corporation is registered with the Housing and Land Use Regulatory Board (HLURB) and was granted a License to Sell for each project it developed; that in connection thereto, it has been selling housing units on installment basis, which are duly insured under the mortgage insurance program of the Home Insurance Guaranty Corporation (HIGC); that every installment receive includes the principal and the interest therefor; that copies of the certificates of mortgage insurance issued to the Corporation by HIGC, indicate however, that the interest is exempt from all taxes up to 8.5%; that in the course of the Corporation's commercial operations, particularly in 1995 and in order to finance its various construction developments projects, whether commercial, industrial socialized housing/real estate, it had restored to fund borrowings from various commercial banks as well as from its affiliate which is not lending or financing institution; that the affiliate's sources of funds which are being lent to the Corporation also come from various borrowings and back loans; that in these instances, the Corporation paid the corresponding interest on such bank loans of its affiliate who had lent its own funds, that as a result, the interest paid to the affiliate are substantially the same as what had been borrowed by the affiliate from the banks or from the financing institutions; that this arrangements has been practically done by and between the Corporation and its affiliate; that on the part of the Corporation , whenever an affiliate is practically in need of operational funds, and in the meantime that it has "idle funds", it likewise, lends to an affiliate the money originally borrowed from the bank; that for the use of the funds it borrowed from the bank, it charges its affiliate the corresponding interest it is likely to pay to the bank, without any additional cost, or the interest first assumed from the affiliate's borrowings; that the said arrangement is covered by an inter-office memo whereby the borrower acknowledged the receipt of the amount so advanced; that it is your contention that the said inter-office memo evidencing traditional lendings/borrowings is not a deposit substitutes instrument since the Corporation and/or its affiliate do not borrow funds from the public but only from the bank and between themselves, nor the loans from banks be considered deposit substitutes since the Corporation is engaged in the real estate business and not in the business of lending money; and that the aforesaid lending is just incidental to its main business and therefore should not be taxed as an independent business. In reply, please be informed that pursuant to Section 27(D)(1) of the Tax Code of 1997 [then Section 24(e) of the Tax Code, as amended], a final tax at the rate of twenty percent (20%) is imposed upon the amount of interest on currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangement. The above provision refers to the 20% final tax being imposed on the interest income on currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangement derived by lending institutions and banks. Thus, it has been ruled that borrowings/lendings obtained by a lending investor is in the nature of deposit substitutes. (BIR Ruling No. 106-90 dated May 29, 1990). As to who is considered lending investor, this Office defined the term as " as one who makes practice of lending money for themselves or others at interest ". (BIR Ruling No. 452-88 dated September 15, 1988) In view of the above-mentioned BIR rulings, this Office hereby holds that since the arrangement between the Corporation and its affiliate is in the nature of cash advances wherein the interest that is being charged to the affiliate-borrower is substantially the same interest the bank or financing institution charges the corporate debtor (i.e., the Corporation or its affiliate, as the case may be), the latter having merely passed on the same to its affiliate, ASB Development Corporation is not a lending investor and its activity of borrowing from or lending money to its affiliate is not a "deposit substitute" contemplated under Section 22(Y) of the Tax Code of 1997 [then Sec. 20(y) of the Tax Code, as amended, and as implemented by Revenue Regulations No. 17-84]. Neither will this kind of arrangement between affiliates be considered as " similar arrangement " mentioned in said Section 27(D)(1) of the same Code. For the purpose therefore, of understanding the phrase similar arrangement in relation to the phrase "interest on currency bank deposit and yield or any other monetary benefit from deposit substitutes", Section 2 of Revenue Regulations No. 17-84 (Income Taxation of interest income derived from deposits and yield from deposit substitutes) defines "(h) "Deposit substitutes" shall mean "(i) In case of banks and non-financial intermediaries, all alternative forms of obtaining funds from the public, other than deposits, through the issuance , endorsement , acceptance of debt instruments for the borrower ' s account , for the purpose of relending or purchasing of receivables and other obligations . These instruments may include , but need not be limited to promissory notes , repurchase agreements , certificates of assignment or participation , and similar instruments with or without recourse as may be authorized by the Central Bank of the Philippines. "(ii) In case of finance companies, other than those specified in (i) above, lending investors , investment houses , thrust companies and similar institutions and corporations engaged in commercial, industrial, and other activities, all borrowings to finance its own needs or the needs of its agents thru commercial papers issued as evidence of indebtedness with Securities and Exchange Commission of the Philippines , or not regardless of maturity period and with or without recourse basis. "(iii) In the case of other non-financial companies, including the national and local government and its instrumentalities, all borrowings through the issuance of debt instruments denoted as treasury bonds , treasury bills , treasury notes , and similar instruments ." (Emphasis supplied) Conclusively, the term "similar arrangement" must necessarily be within the context of the foregoing definitions. But since the activity of borrowings and lending exclusive to the Corporation and its affiliate, it cannot be categorized as activity falling under "similar arrangement" nor shall the Corporation and its affiliate be considered as non-bank financial intermediaries performing quasi-banking functions defined under Section 2 of the same Rev. Regs., viz. : "(b) "Non-bank financial intermediary" shall mean every financial intermediary as defined in Section 2-(D)(c) of the General Banking Act, Republic Act No. 337, as amended, authorized by the Central Bank of the Philippines to perform quasi-banking functions." In this connection, the term quasi-banking activities has been defined in Section 22(X) of the Tax Code 1997 as "borrowing funds from twenty (20) or more personal or corporate lenders at any one time, through the issuance, endorsement or acceptance of debt instruments of any kind other than deposits for the borrower's own account, or through the issuance of certificates of assignment or similar instruments, with recourse or repurchase agreements for purposes of relending or purchasing receivables and other similar obligations. Provided , however , That commercial , industrial and other non-financial companies , which borrow funds through any of these means for the limited purpose of financing their own needs or the needs of their agents or dealers , shall not be considered as performing quasi-banking functions ." (Emphasis supplied) prLL The term has also been previously defined in Section 2(c) of Rev. Regs. 17-84. Moreover, the interest which the Corporation or its affiliate charges from each other, depending as to who is the affiliate-borrower, do not constitute additional or real income to the affiliate-lender since it merely passes on to affiliate-borrower the interest which the creditor bank actually charges. It is therefore, clear that the interest which the Corporation collects on the amount it lends to its affiliate is basically the interest it is liable to pay as the original corporate-debtor of the creditor bank and/or other financial institutions. It must be noted that the corporate-debtor relends its funds to its affiliate only when it does not make use of its fund and in the meantime that it is idle. Moreover, while the Corporation or its affiliate charges the corresponding interest from either of them depending on who is the affiliate-borrower, the same is computed in such number of days the fund is actually used by the affiliate-borrower. While the fund is in the possession of the corporate-debtor, it shall have to pay the corresponding interest to the creditor bank or financial institution, whether it makes use of the fund or not. Such being the case, this customary practice of borrowing/lending with interest being charged or paid by the Corporation or its affiliate, as the case may be, at the rate substantially equal to the rate of the affiliate-debtor is liable to pay to the creditor bank, does not constitute as being engaged in lending or quasi-lending activities. Likewise, there being no income attributable from such arrangement, the Corporation or its affiliate-borrower, as the case may be, is not required to withhold the 20% final tax on the said interest paid considering that neither of them is a lending investor. (BIR Ruling No. 452-88 dated September 15, 1988) dctai On the matter of whether the corresponding interest on the amount so borrowed can be deducted as legitimate business expense, this Office opines that the corporate-debtor (i.e., the affiliate-lender) which initially borrowed the fund from the bank or any lending/financing institution and thereafter pays the corresponding interest thereon, may claim the same as legitimate business expense provided, however, that such interest receive from its affiliate-borrower but which thereafter is paid to the bank/financial institution, is reported as interest income for the purpose of computing the regular corporate income tax. If, however, it does not relend the amount so borrowed but instead uses it, then it shall be entitled to deduct the same as legitimate business expense; otherwise, it shall be the affiliate-borrower who borrows and makes use of the fund and hereafter pays the interest being passed on to it that can claim such interest as legitimate business expense subject, however, to the provisions of Section 34(B) of the Tax Code of 1997 [then Section 29(g) of the Tax Code, as amended] which states in part, viz: "Sec. 34. Deductions from Gross Income . "(B) Interest "(1) In General . The amount of interest paid or incurred within a taxable year on indebtedness in connection with the taxpayer's profession, trade or business shall be allowed as deductions from gross income. Provided, however, That the taxpayer's otherwise allowable deduction for interest expense shall be reduced by an amount equal to the following percentages of the interest income subjected to final tax: "xxx xxx xxx." In the meantime however, that the corporate-debtor is in possession of the fund, it shall also be entitled to deduct such interest expense it pays for the amount so borrowed before it was lent to the affiliate-borrower. However, if the first borrower does not actually make use of its fund but instead relends it to an affiliate, it shall only be allowed interest expense duly deductible from its gross income if such relending activity actually generates income to it as the affiliate-lender. Otherwise, if no interest income is reported by an affiliate-lender from such activity, it cannot deduct as legitimate business expense the interest it initially paid to the bank since it did not actually assume such interest. On the matter of whether or not the inter-office memo covering the advances granted by an affiliate company is subject to documentary stamp tax, it is informed that nothing in Regulations No. 26 (Documentary Stamp Tax Regulations) and Revenue Regulations No. 9-94 states that the same is subject to documentary stamp tax. Such being the case, said inter-office memo evidencing the lendings/borrowings which is neither a form of promissory note nor a certificate of indebtedness issued by the corporation-affiliate or a certificate of obligation, which are, more or less, categorized as "securities", is not subject to documentary stamp tax imposed under Sections 180, 174 and 176 of the Tax Code of 1997, respectively. Rather, the inter-office memo is being prepared for accounting purposes only in order to avoid the co-mingling of funds of the corporate affiliates. 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. LexLib Very truly yours, (SGD.) BEETHOVEN L. RUALO Commissioner of Internal Revenue