BIR Ruling [UN-380-95]

October 23, 1995 BIR RULING [UN-380-95] MEMORANDUM FOR The Commissioner This refers to the internal revenue tax case of the HONGKONG AND SHANGHAI BANKING CORPORATION, LTD. (HSBC) involving the amounts of P840,842.71, P11,610,366.46, P50,580,676.84 and P42,705,777.90 representing deficiency withholding taxes on interest expense on deposits for the years 1988 and 1989 and deficiency gross onshore taxes also for the years 1988 and 1989, respectively, both inclusive of surcharge, interest and compromise penalty, details of which are as follows: cdtech 1988 1989 A. Def. W/T on interest expense on deposits P380,215.86 P6,035,911.00 Add: 25% surcharge 95,053.96 1,508,977.80 20% interest 349,572.89 4,040,477.44 Compromise penalty 16,000.00 25,000.00 Total Amt. due & Collectible P840,842.71 P11,610,366.46 =========== =========== B. Def. gross onshore tax P23,917,463.90 P22,900,413.80 Add: 25% surcharge 5,979,365.97 5,900,413.80 20% interest 20,658,846.97 14,055,260.65 Compromise penalty 25,000.00 25,000.00 Total Amt. due & collectible P50,580,676.84 P42,705,777.90 =========== =========== The revenue enforcement officers who investigated these 1988 and 1989 cases of HSBC did not explain in detail the factual basis involved in the deficiency assessments in question although their computations are summarized in their audit reports. All that the enforcement officers stated in their joint Memoranda both dated September 15, 1992 is that "The subject is a branch of foreign bank engaged in commercial banking activities pursuant to the provision of the General Banking Act. As a banking entity, it maintains separate set of books for its regular banking unit and foreign currency deposit unit (FCDU) in accordance with existing regulations. Initial verification disclosed that the financial statements attached to the income tax return filed were sufficiently adequate to reflect the results of operation and financial condition of the bank for the year under review". "xxx xxx xxx" re: deficiency withholding tax on interest expense on deposits In HSBC's Audited Financial Statements for the years 1988 & 1989, the respective amounts of P87,079.649 and P170,072,071 were reported as "Interest Expenses on Deposits". The revenue enforcement officers computed the deficiency withholding taxes by simply applying the 20% tax rate to the aforesaid interest expense on deposits. There is no way by which we could determine the factual basis of said computation since no explanation was made by our investigating examiners. We are, therefore inclined to agree with the contention of taxpayer's counsel when he argues that ". . . It must be noted, however, that this amount (interest expense on deposits) represents total interest accrued as of the end of the year as it is a standard accounting practice to bring nominal accounts up to date at the end of the year when financial statements are prepared. A portion of the said amount pertains to interest on time deposits which are accrued for accounting purposes but are credited to the depositors' account only upon maturity. The accounting accrual of interest on term deposit as of December 31 was not subjected by our client to 20% final withholding tax. It was only when said interest was paid or credited to the depositors' account in the following quarter of the succeeding year when the term deposit matures that the 20% final withholding tax was withheld by our client. Clearly, this is only a case of timing difference. xxx xxx xxx "There would also be a practical problem if banks would withhold on the basis of mere accrual in the light of possible pretermination by its clients. If a bank withholds on the basis of accrual and the client decides to preterminate, there would result an overwithholding of the tax since the preterminated account is subjected to a lower interest rate. There is no way for banks to foresee a pretermination of account. In fact, for gross receipts tax purposes, in case of pretermination, the maturity period is reckoned from the date of pretermination in determining whether the transaction as short, medium or long term. (Section 5, Revenue Regulations No. 12-80) More importantly, it should be emphasized that, legally speaking, banks should only withhold upon maturity of the term deposits since it is only this latter instance that there is legal obligation on the part of banks to pay the interest but not before its maturity. Before maturity of the term deposit, banks are under no obligation to pay and the customers have only an inchoate right to the interest income unless they decided to preterminate the account." xxx xxx xxx "Similar to our position in the 1988 BIR assessments on withholding taxes, the audited figures include interest accrued on term deposits which have not matured on December 29, 1989. The procedure, however, was modified as a result of a change in our client's computer system in November 1989 from the old CIF system to the HUB system. Under the new system automatically on a daily basis. The accrual, however, is for internal monitoring purposes only. Recognition of the tax liability, as in the clients' accounts on maturity (which was in 1980) consistent with the industry practice and in line with the CB regulations. The interest amount corresponding to the tax accrued, however, formed part of the 1989 reported Interest Expense as per audited statements." In addition to timing difference with regards HSBC's 1989 withholding tax assessment, the following were shown to explain the discrepancy in what was stated as "interest expense" per its financial statement and what was subjected to 20% final tax withheld and remitted to the Bureau, to wit: 1. Interest income of Siemens AG, was subject to 15% final withholding tax pursuant to the RP-West Germany Tax Treaty Return of 1989 (Annex "C"); 2. HSBC's interest expense in 1989 was overstated due to erroneous credit of interest to its depositor, A. Guerrero, amounting to P4,083.329.37. This was reflected in Section IV the Prior Period Adjustment of the Bank's Profit and Loss Statement of 1990. (Annex "C"); 3. Finally, it was proven that HSBC actually withheld and remitted P29,978,502.99 final tax and not P27,978,502.99. (Annexes "E" and "F") Re: deficiency gross onshore tax Our revenue enforcement officers assessed HSBC for deficiency gross onshore tax on its onshore income derived by its FCDU from dollar loans granted to Philippine resident borrowers, the bulk of which are dollar loans to tax exempt entities, i.e., the Republic of the Philippines, Central Bank of the Philippines (CB) and Philippine Airlines (PAL) and also from foreign currency loans where the borrowers, who are non-exempt, assumed the payment of the withholding tax. This Office has repeatedly ruled that pursuant to Section 5(b) of Revenue Regulations No. 10-76, as amended by Revenue Regulations No. 14-77, onshore income realized by all offshore banking unit (OBU) or by an expanded foreign currency deposit unit (FCDU) need not be included in the quarterly income tax return to be filed by the OBU/FCDU. The local commercial banks, as the payor-borrower in this instant case, are constituted as the withholding agents charged with the obligation of deducting, withholding and remitting to the Commissioner of Internal Revenue the income tax due thereon, pursuant to Section 50, in relation to Section 51 of the Tax Code, as amended. The aforesaid onshore income is, therefore, NOT TAXABLE to the OBU/FCDU even if the borrower is not tax-exempt. Moreover, it has likewise been ruled by this Office that where the domestic borrowers of OBUs and FCDUs are tax-exempt entities and such borrowers assumed to pay the tax due on the foreign currency loan transaction, the Bureau will not run after the lending OBUs should the domestic borrowers default in the payment of their assumed liability. This is the policy enunciated in Revenue Memorandum Circular No. 46-77, which published the answers to the suggestions/questions regarding the interpretation of certain provisions of P.D. Nos. 1034 and 1035, as implemented by Revenue Regulations No. 10-76. Such being the case, the tax-exempt domestic borrowers of the subject taxpayer in this instant case, as the payor-borrowers, are constituted as the withholding agent charged with the obligation of deducting, withholding and remitting to this Office the income tax due on the onshore income of the subject taxpayer. But considering that they are specifically exempt under the special laws creating them from any and all taxes if the payment of such taxes has been assumed by them, the subject taxpayer CANNOT, therefore, BE HELD LIABLE TO THE PAYMENT of the aforementioned deficiency 10% final withholding tax on its gross onshore income derived from foreign currency loans granted to the said resident tax-exempt entities. IN VIEW OF THE FOREGOING, it is respectfully recommended that Assessment Notices Nos. FAS-1-88-92-003937, FAS-1-89-92-003940, FAS-4-88-92-003938 and FAS-4-89-92-003939 requiring Hongkong & Shanghai Banking Corporation to pay the respective amounts of P840,842.71, P11,610,366.46, P50,580,576.84 and P42,705,777.90 as deficiency withholding taxes on interest expense on deposits and deficiency gross onshore taxes, both inclusive of surcharge, interest and compromise penalty for the years 1988 and 1989, be withdrawn and cancelled and these cases considered closed and terminated. cdta Respectfully submitted: MILAGROS V. REGALADO Chief, Law Division I CONCUR: ALICIA P. CLEMENO Assistant Commissioner (Legal Service) RECOMMENDATION: APPROVED LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue