BIR Ruling [UN-070-A-95]

February 16, 1995 BIR RULING [UN-070-A-95] MEMORANDUM FOR The Commissioner This refers to the internal revenue tax case of Hongkong & Shanghai Banking Corporation, 6780 Ayala Avenue, Makati, Metro Manila, involving the respective amounts of P10,141,927.44 and P1,629,701.02 representing deficiency withholding tax, inclusive of surcharge and interest and deficiency documentary stamp tax, inclusive of surcharge, covered by Assessment Notice Nos. FAS-1-82-86-00615 and FAS-1-82-86-00616 both issued on April 12, 1989, for the years 1982 to 1986. Re: Deficiency withholding tax on Swap Transactions The deficiency tax assessment in question arose because of the swap transactions entered into by herein taxpayer with the Central Bank of the Philippines (CB) during the years 1982 to 1986. For an easy understanding of what a swap transaction is, the report of the examiner who conducted the investigation of this case is hereby quoted: "A domestic bank or branch of a foreign bank first applies with Central Bank for approval of the swap arrangement. In a swap arrangement, a local bank, for purposes of liquidity or for loan to persons natural or juridical, either classified under interbank or end-user status, offers to sell to the Central Bank dollars at the guiding rate/cross rate with the stipulation that the local bank would buy back the dollar sold upon the maturity date of the swap arrangement at a specified rate. The dollars, which is the subject matter of the swap arrangement, originates from a foreign bank wherein the local bank maintains a deposit or is a grantee of a credit line for loan availments. The local bank advises the foreign bank to remit the dollar amount of swap to the Federal Reserve Bank for credit to the account of the Central Bank of the Philippines. Upon transmitting the advice by cable, the local bank now prepares the "Offer to Sell Spot Exchange Under SWAP Arrangement" addressed to the Central Bank of the Philippines confirming the document that it has in fact instructed its correspondent bank to remit by telegraphic transfer the dollar to the Federal Reserve Bank. The "Offer to Sell Spot Exchange under SWAP arrangement" is the basis document prepared in support of the swap transaction to which a copy of the tested cable instruction is incorporated by reference and made an integral part of the document aforementioned. On the basis of the representation of the offerer/local bank after having been satisfied that its account with the Federal Reserve Bank had in fact been credited, the Central Bank now prepares its acceptance subject to conditions it may impose on the same document on which the offer was made. This now marks the perfection of the forward exchange contract between the local bank and the Central Bank of the Philippines after which the latter credits the account of the former in Philippine currency in compliance with its undertaking." Due to the protest filed by several commercial banks, thru the Bankers Association of the Philippines (BAP), a Memorandum of Understanding was signed on July 31, 1990 by the BAP-BIR Tax Committees regarding the issue of swap transaction whereby it was agreed that commercial banks shall prove that the foreign exchange used in the swap transaction is funded from the following sources: 1. Dollar Deposits 2. Dollar position which comes from (a) export proceeds purchases (b) foreign exchange floats (c) direct purchases from the trading floor (d) inward remittances (invisibles) 3. FCDU borrowings from a non-resident funder (offshore transaction) 4. Proceeds of a Regular Banking Unit borrowing from an FCDU and/or OBU (both of which are residents) On August 7, 1993, taxpayer's counsel submitted copies of the return covering the final income tax withheld-at-source on interest payments on borrowings from The British Bank of the Middle East, Nassau (TBBMEN) together with the corresponding receipts. In addition, taxpayer submitted a schedule or analysis of interest paid to TBBMEN showing the amount of principal loan, terms, interest in pesos, tax paid in pesos, total taxes remitted to the BIR, number and date of confirmation receipt/s. These documents form part of the records of the case. With the signing of the Memorandum of Understanding between the BAP-BIR Tax Committee and the submission by the taxpayer of the abovementioned documents, the question of whether or not the interest income of Hongkong & Shanghai Banking Corporation on the amount covered by the swap arrangement or forward exchange agreement is subject to the 15% withholding tax at source is now rendered moot and academic. Re: Deficiency documentary stamp tax on telegraphic transfer under the swap agreement The basis of the documentary stamp tax assessment in the amount of P1,629,701.02 is not the document embodying the "Offer to Sell Spot Exchange under SWAP arrangement" but the order or cable/instruction of the local bank, i.e., Hongkong & Shanghai Banking Corporation, to its foreign correspondent bank to remit a specific sum in dollars to the Federal Reserve Bank (which in turn advises the CB that a specific sum in dollars/foreign currency is available to the local bank). The said order or cable is considered a telegraphic transfer subject to the DST under then Section 195 of the Tax Code, as amplified by Sections 50 and 51 of Regulations No. 26 otherwise known as the Documentary Stamp Regulations, reading: "SEC. 195. Stamp tax on Foreign Bills of Exchange and Letters of Credit . On all foreign bills of exchange and letters of credit (including orders, by telegraph or otherwise, for the payment of money issued by express or steamship companies or by any person or persons) drawn in but payable out of the Philippines in a set of three or more according to the custom of merchants and bankers, there shall be collected a documentary stamp tax of thirty centavos on each two hundred pesos, or fractional part thereof of the face value of any such bill of exchange or letter of credit, or the Philippine equivalent of such face value, if expressed in foreign currency. (as amended by P.D. 1457 and P.D. 1959)." (Emphasis supplied) "SEC. 50. Basis of tax in case of telegraphic transfers or orders for the payment of money drawn in but payable out of the Philippine Islands (now Philippines) should be the face value of such telegraphic transfers or orders computed, if expressed in a foreign currency with the rate of exchange taken into consideration." (Emphasis supplied) "SEC. 51. What may be regarded as telegraphic transfer . If a local bank cables to a certain bank in a foreign country with which bank said local bank has a credit, and directs that foreign bank to pay another bank or person in the same locality a certain sum of money, the document for and in respect of such transaction will be regarded as a telegraphic transfer, taxable under the provisions of Section 1449 (i) of the Administrative Code." It is clear from the aforequoted Section 195 (now Section 182) of the Tax Code that foreign bills of exchange and letters of credit (including orders by telegraph or otherwise) for the payment of money drawn in but payable out of the Philippines are subject to DST. Accordingly, the DST prescribed by Section 195 (now Section 182) of the Tax Code is due and payable on the order covering the forward transaction as well as the order covering or leading to the spot sale of foreign exchange and not on the sale or purchase of foreign exchange which are not subject to DST. In the instant case, the real parties to the transaction are the local bank, like herein taxpayer, as drawer which as heretofore discussed has a SWAP arrangement with the CB and the former's foreign correspondent bank as drawee/acceptor. Pursuant to then Section 222 of the Tax Code, before its amendment by PD No. 1994 effective January 1, 1986, the DST is payable indifferently by either party making, signing, issuing, accepting or transferring the taxable document; hence, since the drawee (local bank's foreign correspondent bank) is outside the taxing jurisdiction of the Philippines, the drawer local bank (Hongkong & Shanghai Banking Corporation) is liable to pay the DST on the aforementioned orders. In view thereof, it is respectfully recommended that the assessment against Hongkong and Shanghai Banking Corporation in the amount of P10,141,927.44 as deficiency withholding tax on Swap Transactions during the years 1982-1986 be withdrawn and cancelled but the deficiency documentary stamp tax on telegraphic transfer under the swap arrangement in the amount of P1,629,701.02 for the same period, be reiterated. Respectfully Submitted: MILAGROS V. REGALADO Chief, Law Division I CONCUR: ALICIA P. CLEMENO Assistant Commissioner(Legal Service) APPROVED: LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue