Tax Treatment of Certain Items of Income Received by OBUs and FCDUs

January 24, 1984 REVENUE AUDIT MEMORANDUM ORDER NO. 1-84 SUBJECT : Tax Treatment of Certain Items of Income Received by OBUs and FCDUs TO : All Internal Revenue Officers and Others Concerned 1. Background 1.1 It has been observed that in the audit of OBUs and FCDUs, some examiners are treating fees, commissions and other charges which are integral parts of the onshore interest income derived by OBUs and FCDUs from foreign currency loan transactions as other income subject to the normal corporate income tax; casia 1.2 In order to clarify the proper tax treatment of such items in the light of the law and regulations, this Revenue Audit Memorandum Order is hereby promulgated. 2. The Law and the Regulations 2.1 Under Section 7 of PD 1034 and Section 2 of PD 1035 , net offshore income derived by OBUs and FCDUs were subject to tax at the rate of 5% which tax is in lieu of all taxes, except net income from such transactions as may be specified by the Minister of Finance, upon recommendation of the Monetary Board, to be subject to the usual income tax payable by banks. Beginning January 14, 1981, net offshore income derived by OBUs and FCDUs from foreign currency transactions are exempted from income tax under Section 24(f) of the Tax Code. (PD 1773 ). Gross onshore income derived by the same units are subject only to the 10% final withholding tax . acd 2.2 Section 2(h) and 3(b) of Revenue Regulations No. 10-76, as amended by Revenue Regulations 14-77, provides that gross (onshore) interest income "shall not include any and all fees, commissions and other charges which are integral parts of the income from the above (foreign currency loan) transaction." In other words, "any and all fees, commissions, and other charges which are integral parts of the charges imposed on foreign currency loan transactions are exempt from the tax herein imposed." 3. Treatment of the Excluded or Exempt Gross Onshore Income 3.1 The exclusion from gross onshore income (which is subject to the 10% final withholding tax) of the said "fees, commissions, and other charges which are integral parts of the interest income" derived by an OBU or FCDU from foreign currency loan transactions does not justify their treatment as net income taxable under Section 24(a) of the Tax Code which imposes the normal income tax on net income at the rate of 25%-35%. In a memorandum to the Minister of Finance dated November 11, 1977, the Acting Commissioner of Internal Revenue in explaining the reason for amending Revenue Regulations No. 10-76 by Revenue Regulations No. 14-77, stated: acd "We have, after due deliberation, opted to exempt from all taxes , commissions, and fees and other charges which form integral part of the charges imposed on foreign loan transactions as this would be more in consonance with our policy of favoring foreign currency transactions of OBUs and FCDUs. 3.2 Moreover, to treat the gross onshore income items which are expressly excluded for purposes of the 10% final withholding tax as taxable under Section 24(a) of the Tax Code will result in taxation of "net income from such transactions as may be specified by the Minister of Finance, upon recommendation of the Monetary Board." Considering that the Minister of Finance has not yet specified, much less the Monetary Board has not recommended, what items of net income derived by OBUs and FCDUs are "subject to the usual income tax payable by banks," the said commissions and fees and other charges which were excluded by Sections 2(h) and 3(b) of Revenue Regulations No. 10-77, as amended by Revenue Regulations No. 14-77, are exempt from all taxes, including the normal corporate income tax of 25%-35% payable by banks. 4. Applicability This Revenue Audit Memorandum Order shall be applicable to OBUs and FCDUs, the tax liabilities of which are subject to audit for the taxable years beginning 1977 . casia RUBEN B. ANCHETA Acting Commissioner