Publishing the Answers to the Suggestions/Questions Regarding the Interpretation of Certain Provisions of Presidential Decree Nos. 1034 and 1035, as Implemented by Revenue Regulations No. 10-76

November 11, 1977 REVENUE MEMORANDUM CIRCULAR NO. 46-77 SUBJECT : Publishing the Answers to the Suggestions/Questions Regarding the Interpretation of Certain Provisions of Presidential Decree Nos. 1034 and 1035, as Implemented by Revenue Regulations No. 10-76 TO : All Internal Revenue Officers concerned For the information and guidance of all concerned, quoted hereunder are the answers to the suggestions/questions clarifying certain provisions of PD Nos. 1034 and 1035 as implemented by Revenue Regulations No. 10-76. " SUGGESTIONS AND ANSWERS ON OFFSHORE BANKING SYSTEM : Suggestion 1-A The returns, schedules and financial statements accompanying OBU income tax returns should be in U.S. dollars. Answer The Bureau has no objection to the recommendation that the returns, schedules and financial statements accompanying the required corporation returns of all OBU's be stated in U.S.dollars. Suggestion 1-B Payment or remittance of the tax withheld on the onshore interest income of OBU's should be made only through authorized agent banks which should be required to indicate on the receipt the equivalent in U.S. dollars of the peso withholding tax paid. Answer The BIR has no objection to the above suggestion and will take steps to implement the same in coordination with the Central Bank. Suggestion 2 A provision should be incorporated in the law on the OBU's without disturbing the character of tax-exempt borrowers, substantially as follows: "Notwithstanding the provisions of any law to the contrary, onshore income of offshore banking units from tax-exempt borrowers shall also be exempt from taxes of any kind." Answer The proposed suggestion that the onshore income of off-shore banking units from tax-exempt borrowers be exempt from income tax is hereby denied because this is a proposed overly broad additional exemption which is not even dependent on the assumption of the OBU income tax liability by the resident borrower. As regards the suggestion that in cases where the tax-exempt domestic borrower assumes to pay the tax due on the loan transaction, the BIR should not insist on collecting the tax from the lending OBU should the borrower default, please be advised that where the domestic borrower is tax-exempt and such borrower assumes to pay the tax due on the loan transaction, this Office will not run after the lending OBU should the domestic borrower default in the payment of its assumed liability. This will place the OBU's on par with non-resident credit institutions. Suggestion 3-A OBU's should be permitted to deal freely with local non-FCDU banks without need of prior approval by the Central Bank. Answer This is purely a Central Bank matter. Suggestion 3-B Income from such transactions (between OBU's and non-FCDU local banks not authorized by the Central Bank to transact business with OBU's) should be subjected to 5% tax on net income, the 10% tax to be limited in application to transactions with non-bank residents. Answer Pursuant to P.D. 1035, income realized by OBU's on transactions with local commercial banks including branches of foreign banks that may be authorized by the Central Bank to transact business with OBU's, shall generally be taxed only at the rate of 5% based on net income; while OBU transactions with residents (other than OBU's or local commercial banks that may be authorized by Central Bank to transact business with OBU's) shall be taxed at 10% of gross income. No distinction is made in the law between bank and non-bank residents. The suggestion therefore has no legal basis and must be denied. Suggestion 3-C Income from "343 Deposit Banks" should be exempt from any taxes as per R.A. 6426, Section 6. Answer The exemption provided by Section 6 of R.A. 6426 is applicable only to non-residents not engaged in business or trade in the Philippines . Inasmuch as OBU's are engaged in business in the Philippines, the income it derives from transactions with "343 Deposit Banks" are offshore income subject to tax at 5% based on net income. The tax exemption provisions under R.A. 6426 is not applicable to them. Suggestion 4 The 10% tax on interest income of OBU's from onshore loans should be based strictly on interest alone, and should not include commissions and other fees or charges. Answer In defining interest derived from onshore loans, this Office was guided by the Central Bank definition of "interest" which specifically includes commissions and other fees. However, in order to place OBU's on par with non-resident creditors, we are amenable to consider as tax base for purposes of computing the withholding tax of 10% the stipulated interest to the exclusion of commissions, fees and other charges which are not for the use of money, in line with the rule in PD 1034 that the 10% tax on gross shall be based on onshore "interest income". To this end, we will recommend to the higher authorities the revision of the implementing rules on the matter. Suggestion 5 Without charging grossed-up rates, OBU's should be allowed to report for tax purposes only the actual amount received or earned, without adding the tax assumed by the borrower as taxable income. Answer This Office, aware of the present international banking practice of making the borrower assume the tax on the creditor's interest income and considering that one of the reasons for the establishment of OBU's is to lower the cost of borrowed funds, OBU's will be allowed to report for tax purposes only the actual amount of interest without considering as additional taxable income the tax assumed by the borrower. This will place OBU's at par with non-resident creditors and lessen the tax burden of local borrowers. Suggestion 6 The 10% tax on interest income of OBU's from onshore loans should be based strictly on interest alone, and should not include commissions and other fees or charges. (Same as No. 4) Answer Same as the answer to Suggestion No. 4. Suggestion 7 Revenue Regulations No. 10-76 should specifically provide for deduction from gross offshore income of bad debts incurred on offshore accounts. As an added incentive, a provision for carry-back/carry-forward of bad debts losses should be inserted in the regulations with a corresponding amendment to P.D. 1034, if necessary. Answer When the law imposes a 5% tax based on net offshore income, bad debts are implicitly included among the deductible items in order to arrive at the net income. As regards the suggestion for a bad debt carry-back or carry-forward incentive, we believe that such incentive is not warranted under the circumstances. Suggestion 8 Since OBU's may elect to report income the basis of actual receipts and disbursements, Revenue Regulations No. 10-76 should contain provisions applicable to the situation, that is, the 10% withholding tax shall be withheld and remitted only when the interest is actually paid by the borrower in an onshore transaction. Answer We fail to see how the situation pictured in Suggestion No. 8 could materialize considering that the interest income of an OBU in an onshore transaction is subject to withholding tax. Regardless therefore of whether the accounting method of an OBU-creditor is cash or accrual basis, the withholding tax will be withheld and remitted only after the due date of payment of the interest incurred by an onshore borrower. Suggestion 9 (a) Amendment to P.D. 1034 by adopting Section 6 of P.D. 218, instead of the old provision which appears to have been adopted through an oversight; and (b) With such amendment, the National Internal Revenue Code will then be involved, and Revenue Regulations No. 10-76 should also carry provisions relating thereto. Answer These suggestions have already been clarified by the Secretary of Finance in his 1st Indorsement dated June 22, 1977 to the Central Bank Governor, copy enclosed. Question 10-A Is the interest charged by the home office to the OBU branch deductible to the extent of the portion allocable to offshore business of the branch? Answer Yes, interest charged by the home office to the OBU branch will be allowed as a deductible item subject to the condition that such interest expense shall be allocated to offshore and onshore income in accordance with the formula of apportioning expenses. Question 10-B If an OBU branch of a foreign bank (without any other branch or place of business in the Philippines) negotiates a loan between its home office and a local borrower, say, a local non-bank corporation, and the loan is not booked by the OBU: Is the loan an onshore loan subject to 10% on gross income, or a foreign loan, i.e., a loan by a non-resident corporation subject to 15%? Corollary thereto, is the bank considered a resident foreign corporation by reason of its maintaining a branch (an OBU) in the Philippines? Answer A foreign bank which operates an OBU branch in the Philippines is considered as a resident foreign corporation . Revenue Regulations No. 4-75 defines a "foreign loan as loan contracts, . . . which are payable in foreign currency . . . entered into by a Philippine resident, corporate or otherwise, with a non-resident ." Accordingly, a loan extended by the home office to a local non-bank corporation, whether or not booked by the OBU branch will be attributed or imputed to the OBU branch. For income tax purposes, the interest on such loan will be considered as an onshore interest income subject to the 10% withholding tax, not as interest on a foreign loan subject to 15% withholding tax. Question 11-A If an expense is identified as directly incurred in connection with offshore business, can it be deducted directly or must it form part of the expenses to be allocated between offshore and onshore income and, therefore, deductible only in part? Answer As a rule, expenses should be allocated between offshore and onshore income on the basis of the formula prescribed in Revenue Regulations No. 10-76. Question 11-B Conversely, if an expense is directly incurred on onshore business, is the amount thereof totally non-deductible (since no deduction is allowed against on-shore income) or will it also be included in the amount to be allocated between the two types of income? Answer Same answer as given in Answer 11-A. Question 11-C If the OBU lends to a non-resident and the interest income is subjected to a withholding tax in the borrower's country, can the OBU claim a tax credit against the Philippine offshore income tax? Answer No. P.D. 1034 does not allow it. Question 11-D If it chooses to treat the tax as an item of deduction instead of a tax credit, is it allowed to treat it as a direct expense or should it be included in the total general administrative expenses and prorated in the usual manner, notwithstanding that it has no relation to onshore income? Answer A foreign income tax is allowed as a deduction only if the taxpayer is entitled to a tax credit. The Supreme Court held in Commissioner v. V.E. Lednicky and Maria Valero Lednicky (G.R. No. L-18169, July 31, 1964) that unless the resident has a right to claim such tax credit if he chooses, he is precluded from deducting the foreign income tax from gross income. Accordingly, inasmuch as the income taxes paid to a foreign government cannot be allowed as a tax credit, the same is not allowable as a deductible item." All internal revenue officers and others concerned are hereby enjoined to give this Revenue Memorandum Circular as wide a publicity as possible. aisa dc CONRADO P. DIAZ Acting Commissioner of Internal Revenue TAN-D2567-D1025-A-2