TAX ALERT

July 29, 2005

THERE IS NO PROHIBITION ON THE USE OF FOREIGN CURRENCY IN

THE FINANCIAL STATEMENTS OF PHILIPPINE TAXPAYERS.
Facts: J Company asked the BIR’s permission to use the US Dollar as its functional
currency in the preparation of its financial statement. Held: The Philippine Generally
Accepted Accounting Principles allow the use of foreign currency in financial statements.
The use of foreign currency for companies whose functional currency is a foreign
currency will more clearly reflect income considering that the use of Philippine Pesos
results in artificial foreign exchange losses that distort the real financial condition of
these companies. The use of foreign currency is also revenue neutral. The use of foreign
currency in financial statements is subject to the following conditions: 1) the foreign
currency to be used in the books shall be limited to the US Dollar; 2) the financial
statements shall also be prepared and maintained in US Dollar with a translation in
Philippine pesos using the exchange rate provided under Revenue Memorandum Circular
(“RMC”) No. 26-85; 3) tax returns shall be prepared in Philippine Pesos and taxes due
shall be paid in Philippine Pesos using the exchange rate provided in RMC No. 26-85;
and 4) in any return, statement or other documents in which a conversion is made, the
rate of exchange used shall be indicated. BIR Ruling No. DA-251-2005 dated June 9,
2005.

IMPLEMENTATION OF REVENUE REGULATIONS (“REV. REGS”) NO. 14-

2005 SUSPENDED.
In compliance with the Temporary Restraining Order (TRO) issued by the Supreme
Court on July 1, 2005, the implementation of Rev. Regs. No. 14-2005 is deferred until
such time that the TRO is lifted. However, VAT already collected and for which VAT
invoices/receipts were issued should be remitted to the BIR within the prescribed
deadline for filing the Monthly VAT Declaration. The Bureau shall revert the VAT
status of concerned taxpayers to their registration status prior to July 1, 2005. Revenue
Memorandum Circular No. 30-2005 dated July 2, 2005.

BIR ISSUES POLICIES AND GUIDELINES FOR THE ABATEMENT OF

SURCHARGES IN RELATION TO THE FILING OF AMENDED TAX
RETURNS FILED UNDER CERTAIN CONDITIONS.
Rev. Regs. No. 15-2005 dated June 9, 2005 provide that taxpayers who desire to rectify
their returns to reflect their correct income and/or pay the correct taxes due may file an
amended return and pay the deficiency taxes due thereon inclusive of interest, either in
full or in installments, but shall pay surcharge thereon in accordance with the schedule
and various conditions stated therein.
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A STOCK OPTION IS A FRINGE BENEFIT SUBJECT TO FRINGE BENEFIT

TAX.
A stock option, although granted pursuant to an employer-employee relationship, is not
given to the senior employees for free. The employee-grantee of the option benefits from
a lower exercise price. By exercising his option, he realizes a benefit equivalent to the
difference between the exercise price and the market value of the shares at the time of the
exercise. Accordingly, this benefit qualifies as a fringe benefit, as defined under Section
33(B) of the Tax Code of 1997, which is subject to fringe benefit tax (“FBT”). The FBT
is payable upon the exercise of the option, which is the time that any benefit from the
option is actually realized. The corporation can claim as a deduction from gross income
the grossed-up monetary value of the benefit that it furnished to its senior employees
under the stock option plan, or an amount equivalent to the sum of (i) the difference
between the exercise price and market value of the shares at the time of exercise; and the
(ii) the 32% fringe benefit tax paid. BIR Ruling No. DA-255-2005 dated June 16, 2005.

LIQUIDATING GAIN IS SUBJECT TO THE ORDINARY INCOME TAX

RATES.
AD Company is a Japanese corporation with a wholly owned subsidiary in the
Philippines known as AA Inc. Effective March 31, 2004 AA Inc., ceased operations and
started winding down its business. AA Inc. intends to distribute its net assets by
declaring liquidating dividends in favor of AD Company. AA Inc. sought confirmation
from the BIR that any gain to be derived from liquidating dividends to be declared in
favor of AD Company as an offshoot of the dissolution of AA Inc. is exempt from
income tax under Article 13 of the Philippines-Japan tax treaty. Ruling: The tax
treatment of liquidating dividends depends on the characterization of the income in the
form of such dividends received by shareholders as a result of the dissolution of the
corporation in which they hold shares. In the case of Wise & Co., Inc., et al. vs. Bibiano
L. Meer, Collector of Internal revenue (78 Phil 655 [1947]), the Supreme Court held that
the amounts distributed in the liquidation of a corporation shall be treated as payments in
exchange for shares, and any gain or profit realized thereby shall be taxed to the
distributee as other gains or profits. Therefore, liquidating gain is to be treated as a gain
from the sale or exchange of shares, consistent with the Wise & Co. decision and as such
is subject to the ordinary income tax rates, depending on the status of the shareholder
(corporation or individual, resident or non-resident). In view however of Article 13 of the
Philippines-Japan tax treaty, gains derived by AD Company shall be taxable only in
Japan, considering that AA Inc.’s real property assets in the Philippines is less that 50%
of its total assets. BIR Ruling No. DA-ITAD 65-05 dated June 29, 2005.

THE TRANSFER BY A FOREIGN CORPORATION OF SHARES OF STOCK IN

A DOMESTIC CORPORATION TO ANOTHER FOREIGN CORPORATION IN
EXCHANGE FOR ONE (1) SHARE OF STOCK IN THE LATTER
CORPORATION PURSUANT TO A GLOBAL CORPORATE
RESTRUCTURING IS NOT SUBJECT TO CAPITAL GAINS TAX.
B Germany, a foreign corporation, is the owner of 6,000,000 Class A shares and
5,999,996 Class B shares of B Philippines, a domestic corporation. B Germany entered
into a Deed of Exchange with J Germany, another foreign corporation, over B Germany’s
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shares in B Philippines. The Deed of Exchange was conducted as a preliminary step

towards the eventual merger of B Philippines and S Philippines into SB Philippines as
part of the global corporate merger of B Group and S Group. The transfer by B Germany
of its 6,000,000 Class A shares and 5,999,996 Class B shares in B Philippines, in
exchange for one (1) share of the unissued capital stock of J Germany, is not subject to
capital gains tax inasmuch as the transfer is merely a re-alignment of stock holdings. No
gain is realized from the transaction. However, the assignment of shares is subject to
DST under Section 176 of the Tax Code. BIR Ruling No. 270-2005 dated June 21,
2005.

THE ASSIGNMENT BY A PARENT COMPANY TO ITS WHOLLY OWNED

SUBSIDIARY OF A GEOTHERMAL RESOURCES SALES CONTRACT BY
WAY OF ADDITIONAL CAPITAL CONTRIBUTION BUT WITHOUT THE
ISSUANCE OF ADDITIONAL SHARES IS NOT SUBJECT TO INCOME TAX,
DST, DONOR’S TAX OR VAT.
Section 56 of Rev. Regs. No. 2 provides that “[w]here a corporation requires additional
funds for conducting business and obtains such needed money through voluntary process
payments by its shareholders, the amounts so received being credited to its surplus
account or to a special capital account, will not be considered income, although there is
no increase in the outstanding shares of stock of the corporation.” Consequently, the
assignment by a parent company of its rights and interested in a Geothermal Resources
Sales Contract in favor of its wholly-owned subsidiary in the form of additional paid-in
capital, without the issuance of additional shares, would not result in the recognition of
taxable income both on the part of the parent company or the wholly-owned subsidiary.
Neither is the transaction subject to DST as the transfer of rights in a contract is not
among the transactions subject to DST. Moreover, the transaction is without
consideration. The transaction is not subject to donor’s tax as there is no donative intent
on the part of the parent company. Finally, since the rights and interests of the parent
company in the GRSC are not primarily held for sale or for lease in the ordinary course
of business, the transfer of said property rights is not being made “in the course of trade
or business” and is thus not subject to VAT. BIR Ruling No. DA-278-2005 dated June
23, 2005.

NETTING MANAGEMENT SERVICES PERFORMED OUTSIDE THE

PHILIPPINES IS NOT SUBJECT TO INCOME TAX AND VAT.
S UK and S Phils. entered into a Netting Services Agreement, whereby S UK will
provide netting management services to S Phils. within S UK’s premises in the United
Kingdom through the Citibank website. S UK will not send any personnel in the
Philippines to perform these services. The BIR ruled that the service fee to be paid by S
Phils. to S UK is not an income derived from sources within the Philippines, hence,
exempt from Philippine income tax. The service fee is also not subject to VAT because
the services will be done entirely outside the Philippines. BIR Ruling No. DA-ITAD 66-
05 dated June 29, 2005.
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REV. REGS. NO. 12-2005 AMEND CERTAIN PROVISIONS OF REV. REGS NO.
2-2005 AFFECTING CAGAYAN SPECIAL ECONOMIC ZONE AND
ZAMBOANGA CITY SPECIAL ECONOMIC ZONE.
Rev. Regs. No. 12-2005 redefines gross income to implement the tax incentive provision
under par. (c) of Section 4, Republic Act No. 7922 (otherwise known as Cagayan Special
Economic Zone Act of 1995) and paragraph (f) of Section 4, Republic Act No. 7903
(otherwise known as Zamboanga City Special Economic Zone Act of 1995), thus,
revoking Section 7 of Rev. Regs. No. 2-2005. The effectivity of Sections 3, 4, and 6 of
Rev. Regs. No. 2-2005 is also suspended insofar as they apply to enterprises registered
under R.A. No. 7922 and 7903. Revenue Regulations No. 12-2005 dated April 25, 2005.

REV. REGS. NO. 13-2005 ON THE IMPLEMENTATION OF THE TAX

INCENTIVE PROVISION OF R.A. NO. 7227.
Rev. Regs. No. 13-2005 were promulgated to define “gross income earned” to implement
the tax incentive provision under paragraph (c) of Section 12 of the Bases Conversion
Development Act of 1992 (R.A. No. 7227). Rev. Regs. No. 13-2005 revoked Section 7
of Rev. Regs. No. 2-2005. It further suspended the effectivity of Sections 3, 4, and 6 of
Rev. Regs. No. 2-2005 in so far as these applied to enterprises registered under paragraph
(c) of Section 12 of R.A. No. 7227. Pending the issuance of new regulations, the
provisions of Rev. Regs. No. 1-95, in so far as its provisions are not in conflict with Rev.
Regs. No. 13-2005, shall apply. Revenue Regulations. No. 13-2005 dated April 25,
2005.

INTEREST ON BANK DEPOSITS EARNED BY AN ECOZONE ENTERPRISE

SHALL BE SUBJECT TO REGULAR INCOME TAXES.
Incentives granted under the Bases Conversion and Development Act of 1992 and
Philippine Economic Zone Act of 1995 shall apply only to the registered operations of
ECOZONE enterprises. Thus, income earned from unregistered activities by ECOZONE
enterprises, such as income from Philippine currency or foreign currency bank deposits,
shall be subject to income tax at the regular rates. Revenue Memorandum Circular No.
32-2005 dated June 17, 2005.

AN ECOZONE ENTERPRISE ENJOYING THE 5% PREFERENTIAL TAX

RATE IS EXEMPT FROM WITHHOLDING TAXES.
This is because ECOZONE enterprises enjoy preferential tax treatment and Rev. Regs.
No. 2-98, as amended, explicitly provides that the expanded withholding tax shall not
apply to income payments to persons enjoying exemption from payment of income taxes
pursuant to the provisions of any law, general or special. BIR Ruling No. DA-281-2005
dated June 23, 2005.

ROYALTY PAYMENTS ARE DEDUCTIBLE FROM GROSS REVENUES FOR

PURPOSES OF COMPUTING TAXABLE INCOME OF ECOZONE
ENTERPRISES SUBJECT TO 5% PREFERENTIAL TAX.
When royalties are connected with a product design, logo, formula or process, or are
related to the transfer of technical information and manufacturing know-how, such
royalties should be considered as part of the cost of manufacturing the products and, as
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such, capitalized as part of inventories. Moreover, Section 3 of Rev. Regs. No. 16-99
provides that SBMA trading and manufacturing enterprises are allowed to deduct royalty
payments when calculating gross income subject to 5% final tax. These SBMA
privileges are also extended to PEZA firms by virtue of R.A. No. 7916. Consequently,
royalties relating to know-how in the manufacturing of products are rightfully part of cost
of goods sold and should be deductible when calculating gross income subject to 5% final
tax. BIR Ruling No. DA-280-2005 dated June 23, 2005.

BIR CLARIFIES THAT AN ENTITY MAY NOT SIMULTANEOUSLY ENJOY

INCENTIVES AS A BOI-REGISTERED ENTERPRISE AND AS A PEZA-
REGISTERED ENTERPRISE.
An entity may not simultaneously enjoy an income tax holiday (ITH), which is an
incentive to enterprises registered with the Board of Investments (BOI), with incentives
granted to enterprises registered with the Philippine Economic Zone Authority (PEZA).
Thus, if an entity is still enjoying the ITH, it is subject to internal revenue taxes other
than income tax, such as DST. On the other hand, if it is no longer enjoying the ITH,
then, as a PEZA-registered enterprise, it may claim exemption from DST on its registered
activity since the 5% income tax on gross income applicable to PEZA-registered
enterprises is in lieu of all national and local taxes, including DST. Thus, if an entity
enters into a transaction subject to DST during the period for which it is enjoying the
ITH, it shall be subject to DST on such transaction. BIR Ruling No. DA-279-05 dated
June 23, 2005.

INTEREST ON FOREIGN CURRENCY DEPOSITS MAINTAINED IN A SUBIC

BANK BY PEZA-REGISTERED/SBMA LOCATOR IS SUBJECT TO
WITHHOLDING TAX.
The Commissioner of Internal Revenue ruled that based on Revenue Regulations No. 20-
2002, income earned from unregistered activities by enterprises registered under the
Bases Conversion and Development Act of 1992 and the Philippine Economic Zone Act
of 1995, such as interest income from foreign currency deposits shall be subject to final
income tax at the rate of 7.5% of such interest income. BIR Ruling No. 001-2005 dated
June 16, 2005.

INCOME OF JAPANESE CORPORATION ACTING INDEPENDENTLY OF ITS

PHILIPPINE REPRESENTATIVE OFFICE IS SUBJECT TO THE
PREFERENTIAL TAX RATE UNDER THE RP-JAPAN TAX TREATY.
D Ltd. is a non-resident foreign corporation organized and existing under the laws of
Japan and has a representative office in the Philippines. D Ltd. executed a Loan
Agreement with a domestic corporation, S Corp. whereby D Ltd agreed to lend S Corp.
the amount of Twenty Million Japanese Yen. The representative office is not privy and
does not have any participation whatsoever in the negotiation and implementation of the
Loan Agreement. S Corp. requested confirmation from the BIR that interest payments to
D Ltd. are subject to the preferential withholding tax rate of 15% pursuant to Art. 11 of
the Philippines-Japan tax treaty. Ruling: Any income derived by D Ltd. independently
of its representative office shall be considered income of D Ltd. alone applying the rule
enunciated in the case of Marubeni vs. CIR (G.R. 76573 September 14, 1989) which
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states that when a foreign corporation transacts business in the Philippines independently
of its branch, the principal agent relationship is set aside. Hence, the BIR confirmed that
the interest payments are subject to the 15% preferential tax rate. However, the Loan
Agreement is subject to DST under Section 180 of the Tax Code of 1997. BIR Ruling
No. DA-ITAD 67-05 dated June 29, 2005.

THE CANCELLATION OF INTEREST INCOME ON A NON-PERFORMING

LOAN IS NOT SUBJECT TO INCOME TAX AND DONOR’S TAX.
Bank A cancelled a portion of the accrued interest on a loan it granted to Resort
Company due to the fact that the loan had become a non-performing loan. Section 4 of
Bangko Sentral ng Pilipinas Circular No. 202 restricted Bank A from recognizing interest
income on such loan. Thus, the cancellation of the balance of the interest on the
indebtedness of Resort Company by Bank A is not subject to income tax. Furthermore,
since there was no donative intent on the part of Bank A, the cancellation of the portion
of the accrued interest is not subject to donor’s tax. On the part of Resort Company, the
cancellation of the accrued interest by Bank A does not give rise to a taxable income
considering that the deduction of the interest as expense in the prior years in its books did
not result to a tax benefit in its favor. BIR Ruling No. DA-257-2005 dated June 16,
2005.

BIR RULES ON TAX CONSEQUENCES OF EXPROPRIATION OF REAL

PROPERTY.
G Corp. is the registered owner of real property with improvements with a total area of
2,042.50 square meters. Sometime in 2001, the Light Rail Transit Authority (LRTA)
filed a complaint for eminent domain with the Regional Trial Court of Manila over a
portion measuring 804.90 square meters. When LRTA entered the property in 2001 to
demolish part of the structure therein, G Corp. completely lost its business from the said
property because the tenants immediately relocated and the demolition rendered the
property unfit for occupancy. Inasmuch as the particular portion measuring 804.90
square meters of the aforementioned property of G Corp. had already been abandoned by
tenants, had become idle from the time the LRTA entered the property, could no longer
be used in trade or business of G Corp, and was subsequently demolished to give way to
the Line 2-LRTA Project, the income derived from the expropriation sale of the specified
property is not subject to withholding tax but only to the 6% capital gains tax. It is
likewise subject to DST under Section 196 of the Tax Code based on the gross selling
price or fair market value as determined in accordance with Section 6(E) of the Tax
Code. The receipts from the sale is not subject to VAT, the said sale being involuntary
and forced upon only on the seller by virtue of the exercise of the government’s power of
eminent domain and, therefore, cannot be said to have been conducted in the course of
trade or business. BIR Ruling No. DA-277-2005 dated June 23, 2005.

SALE OF GOODS CONSUMMATED OUTSIDE THE PHILIPPINES IS NOT

SUBJECT TO VAT.
S Co. is a domestic corporation engaged in selling and marketing electronic products
while H Co. is another domestic corporation engaged in buying, selling, marketing,
retailing, and importing, general merchandise. S Co. intends to sell mobile phone units
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and in order to make their phones competitive, S Co. will sell the phones to H Co. while
in transit or outside the Philippines so H Co. will acquire title over the phones prior to
their entry in the Philippines. The shipping documents will indicate S Co. as owner of the
phones but H Co. as the consignee. The BIR held that the sale of phone units by H Co. to
S Co. while in transit is exempt from VAT, the sale having been consummated outside
the Philippines. However, H Co., as the consignee of the phones, will be liable for the
VAT on importation. BIR Ruling No. DA-264-2005 dated June 17, 2005.

BIR DISCUSSES REQUIREMENTS FOR AN UNINCORPORATED JOINT

VENTURE TO BE ABLE TO CLAIM THE INPUT VAT PAID BY JOINT
VENTURE MEMBERS.
To enable the joint venture to credit against its output VAT the input VAT derived from
the separate domestic purchases of goods and services by the joint venture members, the
invoices and/or receipts issued by the third parties or subcontractors must be issued to the
consortium. The invoice and/or official receipt must, among others, indicate the
purchaser of the goods and/or services as follows: “Sold to (name of co-venturer) as
member of the __________ Joint Venture.” In addition, to support the joint venture’s
input tax credits, the VAT registered invoices and/or receipts must comply with the
invoicing requirements provided under Section 113 of the Tax Code. Any unutilized
input VAT of the joint venture cannot be treated as cost by the co-venturers for income
tax purposes but may be the subject of a claim for refund or tax credit. BIR Ruling No.
DA-174-2005 dated June 21, 2005.

INSURANCE CONTRACTS ISSUED BY A BRANCH IN FOREIGN COUNTRY,

BEING IN THE NATURE OF PROPERTY INSURANCE COVERING
PROPERTIES OUTSIDE THE PHILIPPINES, ARE NOT SUBJECT TO DST.
In the case of the Philippine corporation’s branch in Hong Kong, the property insurance
policies issued by the said Hong Kong branch will be subject to DST imposed under
Section 14 of the Tax Code, even if such policies are signed or issued abroad, for as long
as the properties which are the object of insurance are situated in the Philippines.
Conversely, where the property is situated outside the Philippines, the DST imposed on
property insurance under Section 184 will not apply. BIR Ruling No. DA-288-2005
dated June 27, 2005.

SUBSEQUENT TRANSFER OF DEBT INSTRUMENT ISSUED PURSUANT TO

A TAX FREE EXCHANGE IS NOT SUBJECT TO DST PROVIDED THERE IS
NO INCREASE IN THE AMOUNT OR CHANGE IN THE MATURITY DATE
OF THE DEBT INSTRUMENT.
A Inc. and B Inc. entered into a tax-deferred exchange transaction under Section 40(C)(2)
and (C)(6) of the Tax Code of 1997, whereby A Inc. transferred Receivables to B Inc. in
exchange for shares and debt instruments issued by B Inc. The BIR ruled that the DST
due on the issuance of the debt instruments shall be subject to P1.00 for every P200, or a
fractional part thereof, of the issue value. However, the subsequent assignment, transfer
or amendment of such debt instruments by A Inc. shall not be subject to DST provided
that there is no increase in the amount or change in the maturity date from that of the
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original instrument pursuant to Section 199(F) of the Tax Code of 1997, as amended by
Republic Act No. 9243. BIR Ruling No. DA-244-2005 dated June 7, 2005.

THE RECOGNITION OF AN ENTITLEMENT TO A TAX REFUND DOES NOT

MEAN AUTOMATIC PAYMENT OF THE CLAIM.
Facts: For the year 1995, several persons withheld taxes from their income payments to
Taxpayer C and remitted these taxes to the BIR. Due to Taxpayer C’s tax loss position
for the three quarters of 1996, it was unable to use the excess taxes paid for and in its
behalf by the withholding agents. After filing an administrative claim for refund with the
BIR, it filed its judicial claim for refund with the Court of Tax Appeals on April 18,
1997. From the inception of the case to the formal offer of its evidence, Taxpayer C did
not present its 1996 income tax return to disclose its total income tax liability. This made
it difficult to determine whether such excess tax payments were utilized in 1996.
Taxpayer C attached its 1996 final adjustment return to its Reply to Comment when it
appealed the CTA decision on the case to the Court of Appeals. Held: A tax refund
may be claimed even beyond the taxable year following that in which the tax credit
arises. Hence, excess income taxes paid in 1995 that have not been applied to or used in
1996 may still be the subject of a tax refund in 1997 provided that the claim for such
refund is filed with the internal revenue commissioner within two years after payment of
said taxes. As a caveat, the Supreme Court stressed that the recognition of the
entitlement to a tax refund does not necessarily mean the automatic payment of the sum
claimed in the final adjustment return of the taxpayer. The amount of the claim must still
be proven in the normal course. Calamba Steel Center, Inc. (formerly JS Steel
Corporation) vs. Commissioner of Internal Revenue, G.R. No. 151857, dated April 28,
2005.

NOTE:

The information provided herein is general and may not be applicable in all situations. It should
not be acted upon without specific legal advice based on particular situations. If you have any
questions, please feel free to contact any of the following at telephone number (632) 633-9418,
facsimile number (632) 633-1911, or at the indicated e-mail address:

Atty. Carlos G. Baniqued cgbaniqued@baniquedlaw.com

Atty. Laura Victoria A.S. Yuson-Layug
Atty. Terence Conrad H. Bello
Atty. Ma. Carlota Christina G. Laiño-Santiago
Atty. Suzette A. Celicious
Atty. Madeline L. Zialcita-Villapando
Atty. Kathleen L. Saga
lvyusonlayug@baniquedlaw.com
thbello@baniquedlaw.com
cglaino@baniquedlaw.com
sacelicious@baniquedlaw.com
mlzvillapando@baniquedlaw.com
klsaga@baniquedlaw.com