December 19, 2008

BIR RULING [DA-(C-182) 559-08]

27 (D) (4); 34 (B); 73; 179; RR 13-2000;

DA-196-2003; 175-2003; DA-30-2006;
DA-340-2007

TeaM Sual Corporation

CTC Building
2232 Roxas Boulevard
Pasay City

Attention: Kazunobu Takijima

VP-Controller

Gentlemen :

This refers to your letter dated August 17, 2008 requesting for
confirmation of your opinion that —
1. The cash dividend declaration by TeaM Sual Corporation (TSC),
formerly Mirant Sual Corporation, to TeaM Energy Corporation
(TEC) is an intercorporate dividend exempt from tax in
accordance with Section 27 (D) (4) of the National Internal
Revenue Code of 1997 (Tax Code), as amended;
2. The Intercompany Note evidencing the conversion of the dividends
payable into an interest bearing loan is subject to documentary
stamp tax (DST) at the rate of One Peso (P1.00) for every Two
hundred Pesos (P200.000) pursuant to Section 179 of the Tax
Code, as amended; and
3. The TSC's interest payment on the loan it acquired to finance its
legitimate business expansion is deductible from the gross
income of TSC on the ground that it is incurred within a taxable
year on indebtedness in connection with TSC's trade or business
in accordance with Section 34 (B) of the Tax Code, as amended,
and implemented by Revenue Regulations No. 13-2000 dated
November 20, 2000.
Based on your representations, as well as from the documents
submitted, the facts, are as follows:
TSC is a domestic corporation organized and existing under the laws of
the Philippines with principal address at Sual, Pangasinan. It is engaged in
the business of power generation and operates the power generation plant
located in Sual, Pangasinan.
TEC is a domestic corporation duly registered with the Securities and
Exchange Commission to engage principally in the business of power
generation services with principal place of business at Ibabang Polo, Grande
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 Island, Pagbilao, Quezon Province.
It is also represented that TSC and TEC have their own separate
corporate personalities and also have their respective accounting for their
payables and liabilities, as can be shown in the Notes to Financial
Statements of TEC and TSC. SDcITH

TEC is owned by Marubeni Corporation (Marubeni), a non-resident

foreign corporation organized and existing under the laws of Japan, and
Tokyo Electric Power Company International B.V. (TEPCI), a non-resident
corporation organized and existing under the laws of Netherlands. Marubeni
and TEPCI are owned by various corporate entities and no individual owns
directly or indirectly more than 50% of the outstanding capital stock of both
TEC and TSC.
Upon adoption of IFRIC 12 in 2008, the Company's Power Agreement
with NPC will be accounted for under the financial asset model. Under this
model, the Company will derecognize its Power station included as part of
the "Property, Plant and Equipment" account and recognize a financial asset
to the extent that the Company has an unconditional contractual right to
receive cash for its construction services in respect to the Power station.
Thus, the Company will continue to recognize energy and operating fees as
"service revenues" while the related operating and maintenance cost are
charged to expense when incurred.
Subsequently, on July 31, 2008, TSC declared cash dividends to TEC out
of its unrestricted retained earnings resulting from the adoption of IFRIC 12.
On the other hand, TSC has a commitment to JBIC, its creditor, to declare
cash dividends, and to the Government, for business expansion. However,
TSC did not make any appropriation of its retained earnings as of December
31, 2007 for the said expansion.
Instead, the parties agreed that TSC's dividends payable to TEC be
converted into an interest bearing inter-company loan, subject to the
payment of interest at the annual rate of 12%. Pursuant to this, the
appropriate Intercompany Note has been executed by TSC.
In support of your request, you submitted the following documents:
1. TSC's Financial Statements for the years 2007 and 2008;
2. TSC's Board Resolution dated August 1, 2008 of its declaration of
cash dividends;
3. TSC's Board Resolution dated August 11, 2008 which converted the
dividends payable into an interest bearing loan; and
4. Intercompany Note dated August 11, 2008.
In reply thereto, please be informed as follows:
1. The cash dividends declared and to be distributed by TSC to TEC is
an inter-corporate dividend not subject to income tax pursuant to Section 27
(D) (4) of the 1997 Tax Code, as amended, to wit:
"SEC. 27. Rates of Income Tax on Domestic Corporations. —

xxx xxx xxx

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 (D) Rates of Tax on Certain Passive Incomes. —

xxx xxx xxx

(4) Intercorporate Dividends. — Dividends received by a
domestic corporation from another domestic corporation
shall not be subject to tax."

In BIR Ruling No. DA-030-06 dated February 2, 2006, wherein the

taxpayer which is a domestic corporation sought clarification whether the
cash and property dividends declared and distributed to its stockholders
which are all domestic corporations is subject to income tax and
consequently to withholding tax, this Office had the occasion to rule that: LLphil

"The stockholders of CII shall not be subject to any income tax,

capital gains tax or withholding tax upon their receipt of the cash and
real properties by way of dividends pursuant to Section 27(D)(4) of
the Tax Code;
Accordingly, the cash and property dividends declared and
distributed by CII to its stockholders which are domestic corporations
shall not be subject to income tax pursuant to Section 27(D)(4) of the
Tax Code of 1997. Consequently, the subject cash dividends in the
amount of P8,120,000.00 and the property dividends in the amount of
P5,500,000.00 shall not be subject to any withholding tax. . . ."

It should be noted that although a corporation should not declare

dividends out of profits earned during an interim period or before the end of
the fiscal year, a SEC Opinion dated October 22, 1974 provides that a
corporation may declare dividends even before the end of the fiscal year,
provided it has sufficient earned surplus for the purpose which will not be
impaired by losses, whether expected or not, during the remaining period of
the fiscal year.
Accordingly, the cash dividends declaration by TSC to TEC, shall not be
subject to income tax pursuant to Section 27 (D) (4) of the 1997 Tax Code,
as amended, and consequently to withholding tax.
Furthermore, it is a well-settled rule that the right of the stockholders
of a corporation to a dividend becomes vested as soon as the dividend has
been fully declared by the directors, and the corporation becomes their
debtor for their respective shares. (SEC Opinion dated April 29, 1987 citing
Fletchers, Vol. 11, p. 736 citing U.S. v. Southwestern Portland Cement Co.,
97 F 2d 413 revg. 22F Supp. 846; Brown v. Lee Mfg. Co., 231 259, 96 SW 2d
1098; Mc. Laran v. Crescent Planning Mill Co., 117 Mo. App. 40, 93 SW 819
(1906)
When a corporation declares cash dividends, the assets of the
corporation diminish by exactly the amount paid out and correspondingly,
the property of the individual stockholder increases. (11 Fletcher, P. 1110.)
The declaration itself of cash dividends is considered effective to create a
debt from the corporation to each of its stockholders and segregate the
amount thereof from the assets, even though the resolution provides that
the dividend is payable to the stockholders in the corporate assets.
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 Clearly, upon the declaration of dividends by the Board of Directors of
TSC, TSC becomes a debtor of TEC, and as such liable to pay the
indebtedness. In accordance with this, TSC executed the Intercompany Note
and undertook to pay interest to TEC at the annual rate of twelve percent
(12%).
2. The inter-company note executed by TSC is subject to DST at the
rate of one peso (P1.00) for every two hundred pesos (P200.000) pursuant to
Section 179 of the Tax Code, as amended, to wit:
"SEC. 179. Stamp Tax on All Debt Instruments. — On every
original issue of debt instruments, there shall be collected a
documentary stamp tax of One peso (P1.00) on each Two hundred
pesos (P200), or fractional part thereof, of the issue price of any such
debt instrument: Provided, That for such debt instruments with terms
of less than one (1) year, the documentary stamp tax to be collected
shall be of a proportional amount in accordance with the ratio of its
term in number of days to three hundred sixty-five (365) days:
Provided, further, That only one documentary stamp tax shall be
imposed on either loan agreement, or promissory notes issued to
secure such loan.
For purposes of this section, the term debt instrument shall
mean instruments representing borrowing and lending transactions
including but not limited to debentures, certificates of indebtedness,
due bills, bonds, loan agreements, including those signed abroad
wherein the object of contract is located or used in the Philippines,
instruments and securities issued by the government of any of its
instrumentalities, deposit substitute debt instruments, certificates or
other evidences of deposits that are either drawing interest
significantly higher than the regular savings deposit taking into
consideration the size of the deposit and the risks involved or drawing
interest and having a specific maturity date, orders for payment of
any sum of money otherwise than at sight or on demand, promissory
notes, whether negotiable or non-negotiable, except bank notes
issued for circulation.
HDAaIc

In BIR Ruling No. DA-175-03 dated May 4, 2003, in answering whether

the conversion of the deposit for future stock subscription into an interest
bearing inter-company US Dollar denominated loan is subject to
documentary stamp tax, this Office ruled in this wise —
"An inter-company memorandum covering advances granted by
a corporation to an affiliate company or an inter-office memo
evidencing lendings/borrowings is in the nature of a promissory note
subject to the DST imposed under Section 180 (now Section 179) of
the Tax Code, as amended [BIR Ruling No. 108-99 dated July 15,
1999].
The inter-company memorandum between Essilor and Essidev
is in the nature of a loan agreement that is subject to the DST
imposed under Section 180 [now Section 179] of the 1997 Tax Code,
as amended."

Verily, the Intercompany Note executed by and between TSC and TEC
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 evidencing the conversion of the dividends payable into an interest bearing
loan is in the nature of a loan agreement subject to DST imposed under
Section 179 of the Tax Code, as amended.
3. The interest payment on the loan is an allowable deduction. Section
34 (B) (1) of the Tax Code of 1997, as implemented by Revenue Regulations
No. 13-2000, provides that the amount of interest paid or incurred within a
taxable year on indebtedness in connection with the taxpayer's profession,
trade or business shall be allowed as deduction from gross income. Provided,
however, that the taxpayer's allowable deduction for interest expense shall
be reduced by 42% of the interest income subjected to final tax.
For interest to be deductible from gross income, the following are the
requisites, viz.:
(1) There must be an indebtedness;
(2) There should be an interest expense paid or incurred upon such
indebtedness;
(3) The indebtedness must be that of the taxpayer;
(4) The indebtedness must be connected with the taxpayer's trade,
business or exercise of profession;
(5) The interest expense must have been paid or incurred during the
taxable year;
(6) The interest must have been stipulated in writing;
(7) The interest must be legally due;
(8) The interest payment arrangement must not be between related
taxpayers as mandated in Section 34 (B) (2) (b), in relation to
Section 36 (B), both of the Tax Code of 1997;
(9) The interest must not be incurred to finance petroleum operations;
and
(10) In case of interest incurred to acquire property used in trade,
business or exercise of profession, the same was not treated as a
capital expenditure. (Sec. 3, Revenue Regulations No. 13-2000).
EHTIcD

In general, the amount of interest expense paid or incurred within a

taxable year on indebtedness in connection with the TSC's trade or business
shall be allowed as deduction from its gross income. The term "interest"
shall refer to the payment for the use or forbearance or detention of money,
regardless of the name it is called or denominated.
However, for the interest to be deductible, said interest payments
should not be among the exceptions to deductibility under Section 34 (B) (2)
(b) and (c) of the Tax Code, which provide —
(a) . . .
(b) If both the taxpayer and the person to whom the payment has been
made or is to be made are persons specified under Section 36
(B); or
(c) If the indebtedness is incurred to finance petroleum exploration.
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 Section 36 (B) of the 1997 Tax Code, as amended, provides for the
instances of related taxpayers who are not allowed to claim deductions for
losses from sales or exchanges or property incurred by and between them.
This provision on related party taxpayer is also made applicable to
deductions for interest and bad debts as provided in the same Code. Thus,
Section 36 (B) states that:
"(B) Losses from Sales or Exchanges of Property. — In computing net
income, no deduction shall in any case be allowed in respect of losses
from sales or exchanges of property directly or indirectly —
(1) Between members of a family. For purposes of this
paragraph, the family of an individual shall include
only his brothers and sisters (whether by the
whole or half-blood), spouse, ancestors, and lineal
descendants; or
(2) Except in the case of distributions in liquidation,
between an individual and a corporation more
than fifty percent (50%) in value of the
outstanding stock of which is owned, directly or
indirectly, by or for such individual; or
(3) Except in the case of distributions in liquidation,
between two corporations more than fifty percent
(50%) in value of the outstanding stock of each of
which is owned, directly or indirectly, by or for the
same individual, if either one of such corporations,
with respect to the taxable year of the corporation
preceding the date of the sale or exchange was,
under the law applicable to such taxable year, a
personal holding company or a foreign personal
holding company;
(4) Between the grantor and a fiduciary of any trust; or
(5) Between the fiduciary of a trust and the fiduciary of
another trust if the same person is a grantor with
respect to each trust; or
(6) Between a fiduciary of a trust and a beneficiary of
such trust."
The word "individual" in Section 36 (B) (3) of the Tax Code above,
which is applicable to this case, refers to natural persons only, excluding
therefrom estates, trusts or corporations. Relevant to this section is the
provision on personal holding company found in the Tax Code of 1939. To
determine whether a corporation is a personal holding company, the
attribution rule prescribed in Section 66 of the Tax Code of 1939, as
implemented by Section 224 of Revenue Regulations No. 2 should be
followed, to wit:
"SEC. 66. Stock ownership. — For the purpose of determining whether
a corporation is a personal holding company, insofar as such
determination is based on stock ownership, the following rules shall
be observed: SEIacA

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 (a) Stock not owned by individual. — Stock owned, directly or
indirectly, by or for a corporation, estate, or trust shall be considered
as being owned proportionately by its shareholders, partners, or
beneficiaries.
xxx xxx xxx
"SEC. 224. Stock not owned by individual. — In determining the
ownership of stock for any of the purposes set forth in the preceding
section, stock owned, directly or indirectly, by or for a corporation,
partnership, estate, or trust shall be considered as being owned
proportionately by its shareholders, partners, or beneficiaries . . ."
Therefore, in the case of multi-tiered corporation, the attribution rule
must be allowed to run continuously along the chain of ownership until it
finally reaches the individual stockholders. [BIR Ruling No. 072-97 dated July
2, 1997]. Such being the case, it may be said that the term "individual"
pertains to a natural person as distinguished from a corporate or juridical
person.
Prescinding from the above-cited provisions, it is apparent that to
determine whether the prohibition against the deductibility of interest
between related taxpayer provided under Section 36 (B) (3) of the Tax Code,
as amended, applies, the ownership of TEC and TSC must be traced to the
level of the individual shareholder. Since TEC is owned by Marubeni
Corporation and Tokyo Electric Power Company International B.V. which are
ultimately owned by various corporate entities, no individual owns directly or
indirectly more than 50% of the outstanding capital stock of both TEC and
TSC. (BIR Ruling No. DA-196-03 dated June 26, 2003)
Hence, TEC and TSC are not considered related taxpayers within the
contemplation of Section 36 (B) (3) of the Tax Code, as amended. The
prohibition does not apply and the interest payments by TSC to TEC on the
loan are deductible from its gross income for income tax purposes.
It being clearly established that the requisites for deductibility have
been sufficiently met, TSC is thus entitled to claim its interest expense on its
loan payment to TEC in accordance with Section 34 (B) of the Tax Code, as
amended.
Accordingly, the interest payments by TSC to TEC on the financing loan
are deductible from its gross income for income tax purposes.
Section 3 (d) of P.D. No. 87 provides that the term "petroleum
operations" is defined as searching for and obtaining petroleum within the
Philippines through drilling, and pressure or suction or the like, and all other
operations incidental thereto. It includes the transportation, storage,
handling and sale (whether for export or for domestic consumption) of
petroleum so obtained but does not include any: (1) transportation of
petroleum outside the Philippines; (2) processing or refining at a refinery; or
(3) any transactions in the products so refined.
It is clear from the aforesaid definition that petroleum operations refer
only to upstream activities (i.e., search and obtaining of petroleum) and not
to downstream activities (i.e., importing, exporting, shipping, transporting,
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 processing, refining, storing, distributing, marketing, selling). Hence, interest
on loans used to finance, upstream activities is non-deductible while interest
relating to loans used for downstream activities is deductible. (BIR Ruling No.
DA-112-A-04 dated March 11, 2004)
Accordingly, since the proceeds of the interest bearing loan were used
to finance TSC's business expansion of its power generation services, which
are clearly not upstream activities, the interest paid thereon may be claimed
as a tax deduction by TSC in the year the interest is paid or incurred.
In fine, the interest to be paid by TSC on the loans to be extended by
TEC for purposes of financing TSC's business expansion shall be deductible
from its gross income pursuant to Section 34 (B) of the Tax Code of 1997.
(BIR Ruling No. DA 196-03 dated June 26, 2003) DcCHTa

Based on the foregoing, this Office hereby confirms your opinions that:
(1) The cash dividends declaration by TeaM Sual Corporation (TSC) to
TEC is an intercorporate dividend exempt from tax in accordance
with Section 27 (D) (4) of the Tax Code, as amended;
(2) The Intercompany Note evidencing the conversion of the dividends
payable into an interest bearing loan is subject to documentary
stamp tax (DST) at the rate of One Peso (P1.00) for every Two
Hundred Pesos (P200.000) pursuant to Section 179 of the Tax
Code, as amended; and
(3) The interest paid or incurred during the taxable year on the loan it
acquired to finance its legitimate business expansion in its
downstream activities is deductible from its gross income
pursuant to Section 34 (B) of the Tax Code, as amended, as
implemented by Revenue Regulations (RR) No. 13-2000 dated
November 20, 2000.
This ruling is being issued on the basis of the foregoing facts as
represented. If upon investigation, however, it is disclosed that the facts are
different, then this ruling shall be considered null and void.

Very truly yours,

Commissioner of Internal Revenue

By:

(SGD.) GREGORIO V. CABANTAC

Deputy Commissioner
Legal & Inspection Group

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