Ruling on Deductibility of Trading Loss and Reporting of Net Trading Gain by a Universal Bank

November 29, 1991 BIR RULING NO. 256-91 24 (a) 119 (b) 119-91 256-91 Gentlemen : This refers to your letter dated August 26, 1990 requesting on behalf of your client, the United Coconut Planters Bank, (Cocobank) a universal bank, for a ruling on: cdti 1) The deductibility of interest expense or trading loss representing trading expense incurred thru the sale to secondary buyer of tax-paid private and government securities by banking institutions for purposes of income tax computation; and 2) Whether it is proper to report the net trading gain (net of trading expenses) it received during a period, considering it as profit derived from trading or exchange transaction, for purposes of the 5% bank tax. It is represented that the main operations of a banking institution as a financial intermediary is to acquire deposits from the public at a cost, and to lend these funds to various borrowers with a spread to cover administrative and operating expenses and give fair return to stockholders of the bank; that as a secondary activity, the bank (Cocobank), being a universal bank, through its investment and money market department, buys and sells private and government securities; that these securities may be tax-exempt or taxable subject to final withholding tax, and that the securities bought are classified according to the bank's intention, either for long-term investments or for trading purposes. Your inquiry is centered in the short term investment of the bank, classified for trading purposes on tax-paid government and private securities considered as commercial papers or money market instruments available in the money market or exchange. As represented, the investment and money market department of the Cocobank (IMMD) buys these securities from the primary issuers on a wholesale basis, and sells them on a retail basis to various secondary buyers or investors at buying/selling rate prevailing in the market or exchange before the maturity date of the primary paper or note. For accounting purpose, the bank recognizes in its books the face value of the securities and the 20% final withholding tax as prepaid income tax upon their acquisition from the primary issuer. On the basis of the liquidity requirement of the bank, it sells them at a selling rate with a spread (if selling interest rate is lower than the buying interest rate) or with a loss (if selling interest rate is higher than the buying interest rate) to the various secondary buyers. In reply thereto, please be informed that in general, all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business shall be allowed as deductions in computing taxable income. (Section 29 (a), National Internal Revenue Code, as amended). In the case of interest, the amount of interest paid or accrued within the taxable year on indebtedness in connection with the taxpayer's profession, trade or business; is a deductible expense, except on indebtedness incurred or continued to purchase or carry obligation on the interest upon which is exempt from taxation as income under Sec. 29 (b) of the Tax Code. Thus, the net income which is the basis of income tax, means the taxable gross income less the statutory deductions which are connected with the production of income, i.e., the taxable income (Sec. 36, Revenue Regulations No. 2) cdti In this case therefore, where your client bank purchases tax-paid government or private securities, and trades them in the secondary market as commercial papers with a spread, that is selling at interest rate lower than the buying interest rate, the bank realizes a premium or income from trading, subject to income tax under Section 24 (a) of the Tax Code. (BIR Ruling No. 119-91) On the other hand, if the selling to secondary buyers of commercial paper is at higher rate than the bank's buying interest rate, the bank incurred a trading loss, which is the difference between the buying interest rate and the selling interest rate. Accordingly, it is our opinion, as we hereby hold that such trading loss/interest expense, is deductible as a trading expense from its taxable income from sales in the secondary market for corporate income tax purposes. Moreover, the net trading gain, i.e. trading gain less trading expenses, shall be considered as to profit derived from trading transaction, subject to the 5% bank tax prescribed by Section 119 (c) of the Tax Code as amended. Very truly yours, (SGD.) VICTOR A. DEOFERIO, JR. (Officer-in-Charge)