Amortization of Bond Discounts

July 20, 1989 BIR RULING NO. 152-89 20-y 186-84 152-89 Gentlemen : This refers to your letters dated May 18 and 26, 1989 stating that ABC Company (ABC) plans to issue P300 Million worth of five-year bonds or long-term commercial papers (bonds) payable at face value at maturity, with a nominal interest rate of 3% per annum (payable semi-annually) on the face value of such bonds; that the bonds will be issued at a discount of 50% of the face or par value to underwriter X company and to a syndicate of banks and primary institutional lenders i.e., ABC will receive only P150 Million or 50% of face value of the bonds; that the bonds being assignable and negotiable, the underwriters and primary lenders will "sell down" the bonds at a slightly higher price to money market investors seeking deposit substitutes; that a five-year bond with a face or par value of, say P1,000.00 but an issue price of P500.00 i.e., selling at a discount has an implicit rate of return of about 14.8% assuming there is no nominal interest rate, the present value of P1,000.00 in five years discounted at 14.8% until at maturity, the bond is redeemed at its face value of P1,000.00; that the ABC company's bonds will actually have a yield of 6% (3% nominal rate of interest every 6 months) plus 14.8% or about 20.8% comparable to or better than rates on ordinary term loans; that when bonds are issued above or below their par value, proper accounting treatment requires that the difference between the par value and the selling price should be credited to "Premium on Bonds" or to "Discount on Bonds" respectively; that the difference should then be amortized over the life of the bonds and either deducted from, or added to, the face value of the bonds on the balance sheet of the issuer; that in the case of a bond discount; the issuer at the time of issue records the bond discount on the asset side, but is not really an asset in the usual sense of the term; that it is an asset, however, in the sense of an expense not yet charged to operations; that the bond discount represents an addition to future interest expense and that at the end of each semi-annual interest payment the issuer records interest expense of P4.5 Million, expense of amortizing the bond discount of P15.0 Million, cash of P4.5 Million and bond discount of P15.0 Million. cd In connection therewith, you now request a ruling on the following: "(1) That for income tax purposes, bond discounts should be amortized as interest expense equally over the life of the bond and that the corresponding amortization for each year is deductible for income tax purposes; "(2) That in the case of Original Issue Discount (OID) Bonds or Notes, e.g. 5-year bonds or long-term commercial papers issued at a 50% discount on the face or par value but payable upon maturity at full face or par value, is the original amount of the bond discount considered as interest for tax purposes, subject to the 20% final withholding tax as yield on deposit substitutes at the maturity of the bond or long-term commercial paper, i.e., at the time of redemption of the bond by the issuer for its face or par value." In reply thereto, I have the honor to inform you as follows: (1) If bonds are issued by a corporation at a discount, the net amount of such discount is deductible and should be prorated or amortized over the life of the bonds. (Sec 57(3)(a) Revenue Regulations No. 2) Accordingly, for income tax purposes the net amount of the aforementioned bond discount is deductible and should be amortized over the life of the bonds; (2) Under subsection (b), Section 4 of Revenue Regulations No. 17-84 implementing P.D. 1959, the final withholding tax on yield of deposit substitutes shall be based on the gross interest or yield paid or accrued by banks, non-banks financial intermediaries, finance companies, corporations and government agencies on all of its deposit substitutes or debt instruments issued. Such being the case, the amount of the discount on the aforementioned five year bonds and long-term commercial papers which is considered as yield on deposit substitute instruments shall be subject to a 20% final tax upon the redemption of said bonds when the yield is paid. Very truly yours, (SGD.) EUFRACIO D. SANTOS Deputy Commissioner