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June 13, 1995

BIR RULING NO. 085-95

R.A. 7227 000-00 085-95

SYCIP GORRES VELAYO & CO.6760 Ayala AvenueMakati, Metro Manila

Attention : Atty. C . P . Noel

Gentlemen:

This refers to your letter dated September 20, 1994 stating that your client,Subic Power Corporation (SPC) is registered with the Subic Bay MetropolitanAuthority (SBMA) as a Subic Bay Freeport Enterprise under R.A. 7227 (otherwiseknown as the Bases Conversion and Development Act) to engage in the business ofgeneration and sale of electric power; that the SBMA issued to SPC Certificate ofRegistration No. 93-0007; that SPC has a contract with the National PowerCorporation to develop, construct and operate a 108 megawatt power station in theSubic Bay Freeport, Olongapo City; that the estimated cost of the power stationproject is about U.S. $143.0 million; that to finance the project, SPC has undertaken a"Rule 144 A" offering in the U.S. and has issued notes under an IndentureAgreement; that the notes are direct obligation of SPC and are floated in the U.S.; thatunder the Indenture Agreement, SPC will pay interest to the holders of the noteswithout any withholding or deduction for any taxes imposed or levied by thePhilippine Government; that the said tax assumption is not only in conformity withthe international banking practice on foreign loans, but also primarily as aconsideration for the credit and in lieu of additional interest that would have beenimposed had SPC not agreed to assume the Philippine withholding tax; that therefore,the Philippine withholding tax on the interest is passed on to SPC and it assumes thepayment of the tax; that SPC bears the burden of and becomes directly liable to thetax otherwise due from the noteholders; that the Philippine withholding tax on theinterest becomes SPC's additional tax liability, and an addition to its financingcharges associated in the construction of the power plant. llcd

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You now request confirmation of your opinions as follows:

1) Subic Power Corporation should withhold 5% as final withholdingtax on the interest income remitted to U.S. bondholders inconnection with its "Rule 144 A" offering in the U.S.;

2) The assumed 5% final withholding tax is considered additionalfinancing charges of Subic Power Corporation; and

3) The withholding tax base for purposes of applying the 5% finalwithholding tax is the total amount of income to be remittedwithout grossing up the 5% final withholding tax due thereon.

In reply, please be informed as follows:

1. In Suggestion 5 of Revenue Memorandum Circular No. 46-77, thisBureau has recognized and stated that it is aware of the marketconvention that the local borrower assumes the tax on the creditor'sincome in a foreign loan agreement. Thus, the Bureau adoptedmeasures for local institutions to be at par with non-residentcreditors. In this connection, a withholding agent is held to bedirectly and independently liable for the tax that, by law, it shouldwithhold. (Commissioner of Internal Revenue vs. Procter &Gamble Philippine Manufacturing Corporation and the Court ofTax Appeals, G.R. 66838, December 2, 1994). Pursuant toRepublic Act No. 7227, Subic Bay Freeport (SBF) Enterprises,such as SPC, are subject to the maximum tax rate of 5% in lieu ofall other national or local taxes. The 5% tax of SBF Enterprises is acommutation tax which effectively accords the grantee exemptionfrom all other taxes. (Philippine Air Lines vs. Commissioner ofInternal Revenue, CTA Case No. 5 dated February 8, 1956; PNRCvs. CIR, G.R. 10045, 34 Phil 401). Such being the case, youropinion that SPC should withhold 5% as final withholding tax onthe interest income remitted to U.S. bondholders in connectionwith its "Rule 144A" offering in the U.S., is hereby confirmed.

2. This Bureau similarly recognizes that when an enterprise assumespayment of taxes withheld and due from a foreign lender-remitteeon interest payments of foreign loans, the taxes assumed by theregistered enterprise represent necessary and ordinary expenses

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incurred by the enterprise; hence, deductible from its gross income.[Section 2(b), Revenue Memorandum Circular No. 13-80 datedApril 10, 1980]. Therefore, your opinion that the 5% finalwithholding tax assumed by Subic Power Corporation under thecircumstances described above should be considered its additionalfinancing charges is hereby confirmed.

3. The assumption of the tax constitutes an additional income of thenon-resident creditor-bondholders, which in turn should be subjectto tax. (Old Colony Trust Co. vs. Commissioner, 279 U.S. 716).Thus, the tax base should be grossed-up by adding to the interestincome payments the amount of tax assumed. prcd

Very truly yours,

LIWAYWAY VINZONS-CHATOCommissioner of Internal Revenue