Foreign Direct Investment Classification

August 25, 2022 FIRB ADMINISTRATIVE ORDER NO. 001-2022 FOR : All Heads of Investment Promotion Agencies (IPAs) SUBJECT : Foreign Direct Investment Classification With reference to Part IV, Rule 11, Section 6 of the Corporate Recovery and Tax Incentives for Enterprises Act's (CREATE) Implementing Rules and Regulations (IRR), this administrative order is issued to align and clarify the determination of the source of investments, particularly for the purpose of estimating foreign direct investments (FDI). As a background, FDI is a category of cross-border investments associated with a resident in one economy ( i.e. , the direct investor) having control or a significant degree of influence on the management of an enterprise that is a resident in another economy ( i.e. , the direct investment). (see Annex A for further guidance) In general, there are two main tests in order to determine if an equity investment can be categorized as FDI, as follows: 1. Equity shares owned by the direct investor must be at least 10% of the total equity shares of the direct investment enterprise; and 2. The direct investor must be a non-resident of the Philippines, or in practice, the investing firm must be incorporated or is doing business outside the Philippines, regardless if the investing firm's ultimate stockholders are Filipino. For investments infused through debt, item 2 above will be used as the primary determinant as an assumption. To simplify and to align on the determination of whether an investment can be categorized as FDI, the IPAs are directed to refer to the clarificatory scenarios as shown in the Table 1. HEITAD Table 1 Sample scenarios in determining if an investment can be considered as FDI Residency status of direct investor Place of incorporation or business of the direct investor Nationality of the direct investor Treatment of investment Non-resident of the Philippines Outside the Philippines Filipino Deemed FDI Non-resident of the Philippines Outside the Philippines Non-Filipino Deemed FDI Non-resident of the Philippines Outside the Philippines Mixed (Filipino and non-Filipino) Deemed FDI Non-resident of the Philippines Outside the Philippines Majority stockholder is Filipino Deemed FDI Non-resident of the Philippines Outside the Philippines Majority stockholder is non-Filipino Deemed FDI Resident of the Philippines Within the Philippines Filipino Not considered as FDI Resident of the Philippines Within the Philippines Non-Filipino Not considered as FDI Resident of the Philippines Within the Philippines Mixed (Filipino and non-Filipino) Not considered as FDI Resident of the Philippines Within the Philippines Majority stockholder is Filipino Not considered as FDI Resident of the Philippines Within the Philippines Majority stockholder is non-Filipino Not considered as FDI In summary, the direct investor's residency is integral in determining if an investment can be considered as FDI, owing primarily to the assumption that investments received from non-residents of the Philippines are generated from foreign operations and are therefore foreign-sourced, regardless if the ultimate stockholders are Filipino. The scenarios above and the methodology are based on our consultations with the Bangko Sentral ng Pilipinas (BSP), as aligned with their practice in identifying FDI. However, the BSP employs more sophisticated techniques in estimating FDI, as driven by their use of the International Transactions Reporting System. Further, this approach in determining FDI will impact the accomplishment of the following templates: 1. Annual Tax Incentives Report (ATIR) and Annual Benefits Report (ABR); and 2. Monthly list of projects with investment capital of P1 billion and below. Given that previous submissions involving approved investments did not include the determination of FDI, our IPA focals will be reaching out to identify FDIs based on the methodology. This determination will be applied to previously submitted reports in order to determine the projected FDI based on the approved investments as reported per IPA. This administrative order takes effect immediately. (SGD.) JUVY C. DANOFRATA Assistant Secretary of Finance and Head of the FIRB Secretariat ANNEX A Foreign Direct Investment Determination 1. What is Foreign Direct Investment (FDI)? 1 The balance of payment (BOP) summarizes the economic transactions between residents of the country and non-residents. It consists of data on the Current Account, 2 Capital Account, 3 Financial Account, and changes in reserve assets and liabilities. Direct investments fall under the financial account and is a category of cross-border investments associated with a resident in one economy ( i.e. , the direct investor) having control or a significant degree of influence on the management of an enterprise that is resident in another economy ( i.e. , the direct investment). A foreign investment going into a local firm is considered FDI if equity shares owned reach at least 10 percent. Furthermore, the direct investor must be a non-resident of the Philippines, or in practice, the investing firm is incorporated or is doing business outside the Philippines, regardless if the investing firm's ultimate stockholders are Filipino. 2. What are the components of FDI? FDI is measured by the sum of three components, namely: equity capital, retained earnings, and debt instruments. They are described as follows: ATICcS Net Equity Capital invested by the direct investor in the direct investment enterprise. ( i.e. , placements less withdrawals) Retained Earnings accrued to the direct investor which are earnings generated by the direct investment enterprise. Debt Instruments includes marketable securities such as bonds, debentures, commercial paper, promissory notes, non-participating preference shares, and other tradable non-equity securities, as well as loans, deposits, trade credit and other accounts payable/receivable between the direct investor and the direct investment enterprise. FDI is generally derived from the following accounts: A. Currency and deposits A1. Currency A1.1. Other transferable deposits A2. Other deposits B. Debt securities C. Loans D. Equity and investment fund shares D1. Equity D1.1. Listed shares D1.2. Unlisted shares D1.3. Other equity D2. Investment fund shares/units D2.1. Money market fund shares/units D2.2. Other investment fund shares/units E. Insurance, pension, and stand guarantee schemes E1. Non Life insurance technical reserves E2. Life insurance and annuity entitlement E3. Claims if pension funds on pension managers E4. Provisions for calls under standardized guarantees F. Other accounts receivable/payable F1. Trade credit and advances F2. Other accounts receivable/payable It can be noted that in some instances, FDI becomes negative, such as when the value of debts from the direct investment enterprise to the direct investor is higher than the debts from the direct investors to the direct investment enterprise. 3. Framework on Direct Investment Relationships (FDIR) 4 In order to determine whether the investment transactions of the direct investor are FDI, the BSP uses the Framework on Direct Investment Relationships (FDIR) in the Balance of Payments and International Investments Position Manual, 6th Edition (BPM6), as illustrated below: Figure 1. Identification of Direct Investment Relationships Where: A subsidiary is described as a direct investment enterprise over which the direct investor is able to exercise control ( i.e. , the direct investor owns more than 50% of the voting power in the direct investment enterprise). An associate is described as a direct investment enterprise over which the direct investor is able to exercise a significant degree of influence, but not control ( i.e. , the direct investor owns 10% to 50% of the voting power in the direct investment enterprise) An affiliate of an enterprise consists of: TIADCc (a) its direct investor(s), both immediate and indirect; (b) its direct investment enterprises, whether subsidiaries (including branches and other quasi-corporations), associates, and subsidiaries of associates, both immediate and indirect; and (c) fellow enterprises, that is, those enterprises that are under the control or influence of the same immediate or indirect investor, but neither fellow enterprise controls or influences the other fellow enterprise. The framework indicates that there can be a possible indirect transmission of "control" and "influence" through a chain of ownership, which is the primary basis for determining whether there is a "direct investment relationship" between the investor and the investee. Further, the following points help determine whether direct investments relationships and transactions exist: a. A direct investment relationship arises when an investor resident in one economy makes an investment that gives control or a significant degree of influence on the management of an enterprise that is resident in another economy . Enterprises in a direct investment relationship with each other are called affiliates or affiliated enterprises. In addition, all enterprises that are under the control or influence of the same direct investor are considered to be in a direct investment relationship with each other. b. Control or influence may be achieved directly by owning equity that gives voting power in the enterprise, or indirectly by having voting power in another enterprise that has voting power in the enterprise. Accordingly, two ways of having control or influence are identified: 1.) Immediate direct investment relationships arise when a direct investor directly owns equity that entitles it to 10 percent or more of the voting power in the direct investment enterprise. i.) Control is determined to exist if the direct investor owns more than 50 percent of the voting power in the direct investment enterprise (in which case, the domestic direct investment enterprise is referred to as a "subsidiary" ) . ii.) A significant degree of influence is determined to exist if the direct investor owns from 10 to 50 percent of the voting power in the direct investment enterprise (in which case, the domestic direct investment enterprise is referred to as an "associate" ) . 2.) Indirect direct investment relationships arise through the ownership of voting power in one direct investment enterprise that owns voting power in another enterprise or enterprises, that is, an entity is able to exercise indirect control or influence through a chain of direct investment relationships . For example, an enterprise may have an immediate direct investment relationship with a second enterprise that has an immediate direct investment relationship with a third enterprise. Although the first enterprise has no equity in the third enterprise, it may be able to exercise indirect control or influence, according to the FDIR criteria. In addition to direct investment relationships between two enterprises that arise because one enterprise controls or influences the other, there are also direct investment relationships between two enterprises that do not control or influence each other, but that are both under the control or influence of the same investor ( i.e. , fellow enterprises). c. The principles for indirect transmission of control and influence through a chain of ownership are as follows: (a) Control can be passed down a chain of ownership as long as control exists at each stage; (b) Influence can be generated at any point down a chain of control; and (c) Influence can be passed only through a chain of control but not beyond. AIDSTE Footnotes 1. Based on the Balance of Payments and International Investment Position Manual, 6th Edition (BPM6). 2. Covers those transactions involving goods, services, and income. 3. Consists of grants and donations for investment purposes, purchase or disposal of non-produced and non-financial assets, including copyrights and trademarks. 4. https://www.imf.org/external/pubs/ft/bop/2007/pdf/bpm6.pdf.