Proper Categorization and Taxability of Revenue from Equity of Petrolift Holdings, Inc. (PHI)

July 14, 2017 BUREAU OF LOCAL GOVERNMENT FINANCE OPINION Ms. Angelica R. Viado Petrolift Holdings, Inc. 6th Floor Mapfre Insular Corporate Center, 1220 Acacia Ave., Madrigal Business Park, Ayala Alabang, Muntinlupa City SUBJECT : Proper Categorization and Taxability of Revenue from Equity of Petrolift Holdings, Inc. (PHI) Dear Ms. Viado : This refers to your letter seeking this Bureau's confirmation, on behalf of Petrolift Holdings, Inc., (PHI), relative to the proper categorization of "Revenue from Equity in net earnings of an associate" of PHI, as appearing in its financial statement, on which the imposition of local business tax (LBT) was based by Muntinlupa City. It is represented that PHI is a holding company that owns fifty one percent (51%) of Petrolift, Inc., a tanker owning company and, as such, is mandated by accounting rules (Financial Reporting Standards) to adopt the Equity Method of Accounting, wherein the proportionate share in the income of Petrolift, Inc. is reported in the Company's statement of Comprehensive Income as "Revenue from Equity in net earnings of an associate." The "Revenue from Equity in net earnings of an associate" that appears in the Company's financial statement, as claimed by PHI, was only meant to comply with accounting standards and does not fall under the category of "Gross Sales or Receipts," subject to the imposition of LBT as provided under the Local Government Code (LGC) of 1991. Moreover, PHI asserts that, as a holding company, it is not engaged in any business that generates gross receipts, but derives income solely from passive investments in the form of interest and dividends. Notwithstanding, PHI contests the assessment made by Muntinlupa City, subjecting the revenue earned from its net savings to LBT, amounting to Three Million Three Hundred Thirty-Three Thousand Nine Hundred Thirty-Two and 1/100 Pesos (Php3,333,932.01). In addressing the issue at hand, this Bureau finds it important to revisit the recent jurisprudence of the Court of Tax Appeals (CTA) Decision in Fernandez Holdings, Inc. v. City of Davao , CTA AC No. 162, promulgated on 06 April 2017, concerning the taxability of the shares of Fernandez Holdings, Inc. (FHI) from San Miguel Corporation (SMC). In the said case, the CTA ruled that FHI is not a non-banking financial intermediary for the following reasons: (i) it has no secondary license; (ii) it does not hold itself out as a financial intermediary; (iii) it does not perform the functions of a financial intermediary on a regular and recurring basis; and (iv) its primary purpose, as outlined in its Amended Articles of Incorporation, shows that its principal activities cannot fall under the definition of a financial intermediary . In the above-entitled case, the CTA explained why FHI, a holding company, is not subject to LBT, to wit: " The imposition of LBT on banks and other financial institutions is embodied in Section 143(f) 1 in relation to Section 151 2 of the 1991 LGC. Under the aforementioned provisions, a city may impose business tax on banks and other financial institutions on the gross receipts of the preceding calendar year derived from interest, commissions and discounts from lending activities, income from financial leasing, dividends, rentals on property and profit from exchange or sale of property or insurance premium. xxx xxx xxx In determining petitioner's entitlement to its claim for refund or credit of the 0.55% LBT collected for the first and second quarters of 2011 on the dividends from petitioner's SMC preferred shares and on the interest from petitioner's money market placements for 2010, it is imperative to first determine whether petitioner is indeed a bank or other financial institution specifically, a non-bank financial intermediary who is subject to the aforestated business tax as respondent claims . xxx xxx xxx The term "banks and other financial institutions" is defined in Section 131 (e) of the 1991 LGC, as follows : Sec. 131. Definition of Terms. When used in this Title, the term: xxx xxx xxx (e) "Banks and other financial institutions" include nonbank financial intermediaries, lending investors, finance and investment companies, pawnshops, money shops, insurance companies, stock markets, stock brokers and dealers in securities and foreign exchange, as defined under applicable laws, or rules and regulations thereunder; Meanwhile, Section 4101Q.1 of the MORNBFI 3 identifies entities which may be considered non-bank financial intermediaries in this wise: 4101Q.1. Financial intermediaries. Financial intermediaries shall mean persons or entities whose principal functions include the lending, investing or placement of funds or evidences of indebtedness or equity deposited with them, acquired by them, or otherwise coursed through them either for their own account or for the account of others. xxx xxx xxx To be considered a financial intermediary, a person or entity must perform any of the following functions on a regular and recurring, not on an isolated basis: a. Receive funds from one (1) group of persons, irrespective of number, through traditional deposits, or issuance of debt or equity securities; and make available/lend these funds to another person or entity, and in the process acquire debt or equity securities; b. Use principally the funds received for acquiring various types of debt or equity securities; c. Borrow against, or lend on, or buy or sell debt or equity securities; d. Hold assets consisting principally of debt or equity securities such as promissory notes, bills of exchange, mortgages, stocks, bonds, and commercial papers; e. Realize regular income in the nature of, but need not be limited to, interest, discounts, capital gains, underwriting fees, guarantees, fees, commissions, and service fees, principally from transactions in debt or equity securities or by being an intermediary between suppliers and users of funds. " defines what a holding company is, the DOJ, nevertheless, categorically defines such, for instruction purposes, as "a company that owns other companies' outstanding stock. The term usually refers to a company that does not produce goods or services itself rather its purpose is to own shares of other companies to form a corporation group. Holding companies allow the reduction of risk for the owners and can allow the ownership and control of a number of different companies." Accordingly, gross sales or receipts, as defined under Section 131 (n) of the LGC, include the total amount of money or its equivalent representing the contract price, compensation or service fee, including the amount charged or materials supplied with the services and deposits or advance payments actually or constructively received during the taxable quarter for the services performed or to be performed for another person excluding discounts if determinable at the time of sales, sales return, excise tax, and value added tax (VAT). Verily, PHI's reiteration that the revenue appearing in its financial statement are mere "paper entries" mandated by accounting rules. Where an entity holds 20% or more of the voting power (power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies) on an investee, the Equity Method of Accounting is used to report the revenue account of the holding company. To point out, the International Accounting Standards (IAS), particularly IAS 28 Investments in Associates and Joint Ventures (as amended in 2011), outlines how to apply, with certain limited exceptions, the equity method to investments in associates and joint ventures. Equity method, as defined, is a method of accounting whereby the investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the investor's share of the investee's net assets. The investor's profit or loss includes its share of the investee's profit or loss and the investor's other comprehensive income includes its share of the investee's other comprehensive income. 4 Based on these, it can be gleaned that the "revenue from equity in net earnings of an associate" does not fall under the category of gross receipts, and that its indication in the financial statement of PHI is only for the purpose of its compliance with its accounting rules considering that 51% of Petrolift, Inc. is owned by PHI. It may be recalled earlier that the CTA En Banc ruled in Michigan Holdings, Inc. v. City Treasurer of Makati , promulgated as CTA EB Case No. 1093, in a Resolution dated April 13, 2016, that holding companies cannot be subject to LBT on its dividend income. According to the CTA, under Section 133 (a) of the LGC, the taxing powers of LGUs shall not extend to the levy of income tax, except on banks and other financial institutions. The LGC defines "banks and other financial institutions" to include nonbank financial intermediaries, lending investors, finance and investment companies, pawnshops, money shops, insurance companies, stock markets, stock brokers and dealers in securities and foreign exchange. This enumeration appears to be exclusive of other entities as nowhere in the entirety of the definition is a holding company mentioned. In this case, Michigan Holdings elevated the matter to the Regional Trial Court but it ruled that since the lis mota of this case is the validity or constitutionality of Makati Revenue Code, it is beyond its jurisdiction. On appeal, the CTA ruled that the imposition of LBT on dividend income constituted a breach of the limitation of the taxing powers of LGUs. It stated that a local tax on dividend and gains is a form of income tax, a type of tax which can only be imposed by the national government, unless levied on banks and other financial institutions, in accordance with the provisions of the LGC. " Non-banking financial intermediaries shall include the following : (1) A person or entity licensed and/or registered with any government regulatory body as investment house (IH), investment company, financing company, securities dealer/broker, lending investor (IH), pawnshop, money broker, fund manager, cooperative, insurance company, nonstock savings and loan association (NSSLA) and building and loan association. (2) A person or entity which holds itself out as a nonbanking financial intermediary, such as by the use of a business name, which includes the term financing, finance, investment, lending and/or any word/phrase of similar import which connotes financial intermediation, or an entity which advertises itself as a financial intermediary and is engaged in the function(s) where financial intermediation is implied. (3) A person or entity performing any of the functions enumerated in Items "II a to II e" of this Subsection. From the foregoing definitions, it cannot be said that petitioner is a non-banking financial intermediary subject to the 0.55% LBT on the dividends from its SMC preferred shares and on the interest from its money market placements for 2010. The records are bereft of any showing that petitioner's principal activities will qualify it as a financial intermediary, or a non-banking financial intermediary to be specific. Petitioner has no secondary license, it does not hold itself out as a financial intermediary, nor does it perform the functions of a financial intermediary on a regular and recurring basis. Further, petitioner's primary purpose, as outlined in its Amended Articles of Incorporation, shows that its principal activities cannot fall under the definition of a financial intermediary. . ." xxx xxx xxx "Aside from the proviso in its primary purpose that petitioner "shall not act as an investment company or a securities broker and/or dealer nor exercise the functions of a trust corporation," petitioner categorically stated that it is a holding company. The mere fact that petitioner is a holding company does not ipso facto lead to the conclusion that it is a non-bank financial intermediary . Absent any showing that petitioner is actually engaged in activities characteristic of a non-bank financial intermediary especially considering the clause in petitioner's primary purpose that it shall not act as an investment company, securities broker and/or dealer, nor a trust corporation, which clause necessary limits the authorized activities of petitioner in this respect respondent's claim that petitioner is a bank or other financial institution based on the broad wording of petitioner's primary purpose is erroneous . Further, Section 22(W) of the 1997 National Internal Revenue Code, as amended ("1997 NIRC") requires non-bank financial intermediaries to secure authorization from the BSP to perform quasibanking activities . In the present case, however, respondent failed to present such BSP authorization." Applied to the instant case and based on PHI's submitted Amended Articles of Incorporation and a certification dated 11 July 2017, wherein it certified that Petrolift Holdings, Inc. is neither a bank nor a non-bank financial intermediary and does not possess the requisite clearances/permits from the regulatory government to do business as such , it appears that PHI is similarly situated to FHI, for the reasons that it has no secondary license, it does not hold itself out as a financial intermediary, nor does it perform the functions of a financial intermediary on a regular and recurring basis, Further, PHI's primary purpose, as outlined in its Amended Articles of Incorporation, shows that its principal activities cannot fall under the definition of a financial intermediary, to wit: "1. To acquire by purchase, exchange, swap, assignment, or by any other mode of acquisition or transfer, and to hold and use for investment or other business purposes and to sell, assign, transfer, exchange, mortgage, pledge or encumber, or deal in and with, otherwise hold and dispose of any shares of stock or securities, including bonds, debentures, notes or obligations, created, issued or negotiated by any corporation, association, or other entity, foreign or domestic, and while the owner thereof, to exercise all the rights, powers and privileges of ownership of said shares of stock, securities, bonds, debentures, or obligations except broker and dealer of securities ;" (emphasis supplied) By way of information, the letter dated 20 October 2015 of the Department of Justice (DOJ) stated that even though neither the LGC nor the National Internal Revenue Code (NIRC). Premises considered, this Bureau is of the view that PHI is not a bank or a non-bank financial intermediary within the ambit of its category of bank and other financial institutions, as defined under Section 131 (e) and pursuant to Section 143 (f) of the LGC. Moreover, the "Revenue from Equity in net earnings of an associate," appearing in PHI's financial statement, cannot be considered as gross sales or receipts and shall not be subject to LBT. This Opinion is issued based on the information provided and to guide local treasury offices in collecting taxes and other local impositions. If upon subsequent verification or submission of information proves the contrary, this Opinion will be deemed null and void. We hope we have provided clarity on the matter. Very truly yours, (SGD.) NIO RAYMOND B. ALVINA OIC Executive Director Footnotes 1. (f) On banks and other financial institutions, at a rate not exceeding fifty percent (50%) of one percent (1%) on the gross receipts of the preceding calendar year derived from interest, commissions and discounts from lending activities, income from financial leasing, dividends, rentals on property and profit from exchange or sale of property, insurance premium. 2. Section 151 . Scope of Taxing Powers . Except as otherwise provided in this Code, the city, may levy the taxes, fees, and charges which the province or municipality may impose: Provided, however, That the taxes, fees and charges levied and collected by highly urbanized and independent component cities shall accrue to them and distributed in accordance with the provisions of this Code. 3. Manual of Regulations for Non-Bank Financial Institutions. 4. IAS 28 Investments in Associates and Joint Ventures (2011).