BIR Ruling No. 457-14

November 12, 2014 BIR RULING NO. 457-14 Secs. 22 (H) (I), 42 (A) & (C), 27 (D) (1), 28 (A) (7) (a) and 179, NIRC; National Development Company vs. CIR, CTA Case No. 1573; BIR Ruling No. 003-03 Export-Import Bank of Korea 16-1, Yeouido-dong, Yeongdeungpo-Gu Seoul 150-996, Korea Attention: Sang-Ho Lee Director International Finance Department Gentlemen : This refers to your letter dated 11 December 2012 requesting on behalf of the Export-Import Bank of Korea ("KEXIM") , confirmation of your opinion on the tax consequences of KEXIM's proposed domestic issuance of Philippine peso-denominated bonds/notes of up to Php8.0 Billion Pesos (about US$188.52 Million). Background 1. KEXIM is Korea's special governmental financial institution, established in 1976 under the Export-Import Bank of Korea Act. It is an official export credit agency and one of the Korea's three policy banks. It holds office in 16-1 Yeouido-dong, Yeongdeungpo-Gu, Seoul, Korea. 2. KEXIM is supervised by the Korean Government through the Ministry of Strategy and Finance. Its main shareholders are the Korean Government (67.5%), Bank of Korea (16.3%), and Korea Finance Corporation (KoFC) (16.2%). Both the Bank of Korea and KoFC are owned by the Korean Government and thus, KEXIM is directly and indirectly 100% owned by the Korean Government. 3. KEXIM regularly raises resources through the issuance of bonds denominated in the local currency of various countries for issuance in those jurisdictions (domestic issuances), or in other jurisdictions (Euromarket or "offshore" issuances). To date, KEXIM has borrowed in seventeen (17) currencies. This total includes long-established borrowing programs in the major international currencies. LibLex 4. KEXIM has no branch, office or any permanent establishment in the Philippines as evidenced by the Certificate of Corporate Filing/Information dated 22 November 2012 issued by the Securities and Exchange Commission (SEC), certifying that KEXIM's license as a Foreign Corporation in the Philippines has already been cancelled on 20 January 1999. 5. The Philippine peso-denominated bonds/notes would be beneficial to both the Philippines and KEXIM as it would provide diversity and add liquidity to debt capital markets. 6. KEXIM's proposed domestic issuance of Philippine peso-denominated bonds/notes of up to Php8.0 billion Pesos and the conversion of the full bonds/notes proceeds to US dollars for remittance offshore for KEXIM's various funding requirements have been approved by the Monetary Board of the Bangko Sentral ng Pilipinas (BSP) under its Resolution No. 1291.A dated 25 August 2011 (as amended by Resolution No. 605 dated 20 April 2012), and Resolution No. 605.A dated 20 April 2012. Based on the foregoing representations, you now request for the confirmation of the following: 1. That the interest (whether in the form of coupon or discount) that will be paid by KEXIM to the bond/note holders is deemed derived from sources without the Philippines. 2. That the interest payable by KEXIM to the bond/note holders shall not be subject to any Philippine withholding tax, whether final or creditable. The interest income, however, shall form part of the gross income of the bond/note holders which are domestic corporations 1 for purposes of determining their taxable income in the Philippines. 3. That the interest income received by banks and non-bank financial intermediaries which are holders of the bonds/notes is not subject to gross receipts tax (GRT). In reply, please be informed that Section 42 (A) (1) of the 1997 Tax Code, as amended, states: " Section 42. Income from Sources within the Philippines. (A) Gross Income from Sources within the Philippines The following items of gross income shall be treated as gross income from sources within the Philippines: (1) Interests. Interests derived from sources within the Philippines, and interest on bonds, notes or other interest-bearing obligations of residents , corporate or otherwise ; (Underscoring supplied) xxx xxx xxx Thus, there is a need to first determine the residence of KEXIM, the obligor in this case, in order to establish the source of interest income that will be paid on the securities, bonds and notes. Noteworthy is Section 22 (H) and (1) of the Tax Code of 1997 which set forth the definition of resident and non-resident foreign corporations, to wit: "Section 22. Definitions . When used in this Title: xxx xxx xxx (H) The term 'resident foreign corporation' applies to a foreign corporation engaged in trade or business within the Philippines. (I) The term 'nonresident foreign corporation' applies to a foreign corporation not engaged in trade or business within the Philippines." (Emphasis supplied) Based on the above definitions, a foreign corporation, while its offices may be located abroad, becomes a resident of the Philippines when it engages in trade or business within the Philippines. The test therefore in determining whether or not a foreign corporation is a resident of the Philippines, for purposes of taxation, is not the physical location of its offices but the presence of its business activities within the Philippines. Thus, while it is true that KEXIM holds offices in South Korea, it is still considered engaged in trade or business in the Philippines when it sells, offers, and/or distributes bonds or notes in the Philippines, thereby qualifying it a resident foreign corporation under Section 22 (H) of the Tax Code of 1997. Since KEXIM is considered a resident foreign corporation under Section 22 (H) of the Tax Code of 1997, then, its interests payments arising from the bonds or notes it shall issue is considered gross income from sources within the Philippines in the hands of the bond/note holders. The bond/note holders will purchase or subscribe these bonds or notes in the Philippine domestic market, which is further proof that their interest income therefrom is from sources within the Philippines. These interest payments are subject to final withholding tax pursuant to Sections 24 (B) (1), 25 (A) (2), 25 (B), 27 (D) (1), 28 (A) (7) (a), 28 (B) (1) and 28 (B) (5) (a) of the Tax Code of 1997. As held by the Supreme Court in Accenture, Inc. vs. CIR ( G.R. No. 190102 dated July 11, 2012 ): "There is no specific criterion as to what constitutes "doing" or "engaging in" or "transacting" business. We ruled thus in Commissioner of Internal Revenue v. British Overseas Airways Corporation : . . . . There is no specific criterion as to what constitutes "doing" or "engaging in" or "transacting" business. Each case must be judged in the light of its peculiar environmental circumstances. The term implies a continuity of commercial dealings and arrangements, and contemplates, to that extent, the performance of acts or works or the exercise of some of the functions normally incident to, and in progressive prosecution of commercial gain or for the purpose and object of the business organization . "In order that a foreign corporation may be regarded as doing business within a State, there must be continuity of conduct and intention to establish a continuous business, such as the appointment of a local agent, and not one of a temporary character." (Emphasis supplied) In turn, if the interest payments will be received by banks and non-bank financial intermediaries which are holders of the KEXIM bonds/notes, such interest payments received are subject to the GRT pursuant to Section 121 (a) of the Tax Code, to wit: "SEC. 121. Tax on Banks and Non-Bank Financial Intermediaries Performing Quasi-Banking Functions. There shall be a collected tax on gross receipts derived from sources within the Philippines by all banks and non-bank financial intermediaries in accordance with the following schedule: EScAHT a. On interest, commissions and discounts from lending activities as well as income from financial leasing, on the basis of remaining maturities of instruments from which such receipts are derived: Maturity period is five years or less 5% Maturity period is more than five years 1%" Provided, however , That in case the maturity period is shortened thru pretermination, then the maturity period shall be reckoned to end as of the date of pretermination for purposes of classifying the transaction and the correct rate of tax shall be applied accordingly." Considering that the interest earned on the KEXIM bonds/notes by banks and non-bank financial intermediaries, whether or not performing quasi-banking functions, is considered sourced from within the Philippines, the same shall be subject to the GRT imposed under the above-cited provision. Furthermore, the KEXIM bonds/notes constitute debt instruments subject to the payment of DST upon its original issuance pursuant to Section 179 of Tax Code which imposes a tax on all debt instruments amounting to One Peso (Php1.00) for each Two Hundred Pesos (Php200.00) or a fractional part thereof, of the issue price of the debt instrument, to wit: "Sec. 179. Stamp Tax on All Debt Instruments . On every original issue of debt instruments, there shall be collected a documentary stamp tax of One peso (P1.00) on each Two hundred pesos (P200), or fractional part thereof, of the issue price of any such debt instrument . . . . For purposes of this section, the term debt instrument shall mean instruments representing borrowing and lending transactions including but not limited to debentures, certificates of indebtedness, due bills, object of contract is located or used in the Philippines, instruments and securities issued by the government or any of its instrumentalities, deposit substitute debt instrument, certificates or other evidences of deposits that are either drawing interest significantly higher than the regular savings deposit taking into consideration the size of the deposit and the risks involved or drawing interest and having a specific maturity dated, orders for payment of any sum of money otherwise than at sight or on demand, promissory notes, whether negotiable or non-negotiable, except bank notes issued for circulation." (Underscoring supplied) "Section 22. Definitions. When used in this Title: xxx xxx xxx (Y) The term 'deposit substitutes' shall mean an alternative from of obtaining funds from the public (the term 'public' means borrowing from twenty (20) or more individual or corporate lenders at any one time) other than deposits, through the issuance, endorsement, or acceptance of debt instruments for the borrowers own account, for the purpose of relending or purchasing of receivables and other obligations, or financing their own needs or the needs of their agent or dealer. These instruments may include, but need not be limited to bankers' acceptances, promissory notes, repurchase agreements, including reverse repurchase agreements entered into by and between the Bangko Sentral ng Pilipinas (BSP) and any authorized agent bank, certificates of assignment or participation and similar instruments with recourse: Provided, however, That debt instruments issued for interbank call loans with maturity of not more than five (5) days to cover deficiency in reserves against deposit liabilities, including those between or among banks and quasi-banks, shall not be considered as deposit substitute debt instruments." Clearly, the bonds/notes are deposit substitutes and evidence of borrowing transaction of KEXIM. As such, the original issuance thereof is subject to DST. Furthermore, any assignment or re-assignment of the bonds/notes shall be subject to DST at the same rate imposed on the original instrument pursuant to Section 198 of the NIRC of 1997, as amended. This occurs only when the assignment or re-assignment of the debt instrument entails changing the maturity date or remaining period of coverage from that of the original instrument or carries with it a renewal or issuance of new instruments in the name of the transferee to replace the old ones. Otherwise, the assignment or re-assignment shall be exempt from DST by virtue of Section 199 (f) or (g) of the NIRC of 1997, as amended. ( Revenue Memorandum Circular No. 77-2012 ) This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered as null and void. SAHEIc Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner Bureau of Internal Revenue Footnotes 1. The bonds/notes will only be issued to institutional investors. Thus, there will be no individual bond/note holders.