**************

*************
*************
***********

*********************

Dear Mr. ***************,

This refers to your request for our opinion on the tax implications of the non-interest
bearing loan to be extended by **********, Co., Inc. (the Company) to **************
Corporation (**************).
Background Information and Issues

We understand that the Company is a domestic corporation engaged in investment,

management and disposition of real and personal properties. The Company is 60% owned
by ************** Corporation (**************), a domestic corporation formerly known
as AAAAAAAAAA Consolidated Industries, Inc. and 40% owned by BBBBBBBBB
Company Limited (SCG), a foreign corporation headquartered at Bangkok, Thailand.
The Company plans to provide a non-interest bearing loan to its major stockholder,
**************. The loan is not covered by any loan agreement.
Discussions

Our discussion shall be based on the provisions of the Philippine Corporation Code,
Philippine National Internal Revenue Code of 1997, as amended (Tax Code) and its
implementing rules and regulations, and jurisprudence.
On the imputation of interest income on the loan agreement
The non-interest bearing loan to be provided for by the Company to ************** is
considered in the nature of inter-company advances or loans, which could be the subject of
imputation of interest to the Company as the advancing party.
Section 50 of the 1997 Tax Code, as amended, provides:
Sec. 50. Allocation of Income and Deductions. In the case of two or
more organizations, trades or businesses (whether or not incorporated and
whether or not organized in the Philippines) owned or controlled directly or
indirectly by the same interests, the Commissioner is authorized to
distribute, apportion or allocate gross income or deductions between or

among such organization, trade or business, if he determines that such

distribution, apportionment or allocation is necessary in order to prevent
evasion of taxes or clearly to reflect the income of any such organization,
trade or business.
This power of the Commissioner to allocate income and expenses among related parties
under Section 50 has been implemented through various issuances.
In Revenue Audit Memorandum Order No. 1-98 governing the audit of inter-related
companies, intercompany loans and advances should be subject to interest, viz:
3.2.3.3 Where one member of a group of controlled entities makes a loan or
advance directly or indirectly, or otherwise becomes the creditor of another
member of such group, an arm's length price for the use of money should be
charged. The same is true in the case of indebtedness arising in the ordinary
course of business such as sales, leases, provision of services and other
similar extension of credits.
Revenue Memorandum Order 63-99 was specifically issued to govern the application of
Section 50 on inter-company loans and advances. It provides:
4.2 Arm's Length interest rate.
4.2.1 In general. For purposes of this Order, the arm's length interest rate
shall be the rate of interest which was charged or would have been charged at
the time the indebtedness arose in independent transaction with or between
unrelated parties under similar circumstances. All relevant factors will be
considered, including the amount and duration of the loan, the security
involved, the credit standing of the borrower, and the interest rate prevailing
at the situs of the lender or creditor for comparable loans.
4.2.2 For purposes of determining the arm's length rate in domestic
transactions, the interest rate to be used is the Bank Reference Rate (BRR)
prescribed by the Bangko Sentral ng Pilipinas (BSP).
4.2.3 The fact that the interest rate actually charged on a loan or advance is
expressly indicated on a written instrument does not preclude the
application of Section 50 to such loan or advance.
In 2013, the comprehensive transfer pricing guidelines implementing Section 50 was issued
under Revenue Regulations No. 2-20131. The guidelines are applicable to both domestic and
cross-border transactions between associated enterprises. Further, the transfer pricing
guidelines cover all transactions that affect the revenues, expenses and taxable income of the
entity, including financing arrangements such as loan agreements.
RR 2-2013 provides specific definition of inter-related or associated companies. Two or
more enterprises are associated if one participates directly or indirectly in the management,
control or capital of the other; or if the same persons participate directly or indirectly in the
management, control or capital of the enterprises.

Transfer Pricing Guidelines, dated January 23, 2013

Control, as defined in RR 2-13, refers to any kind of control, direct or indirect, whether or
not legally enforceable, and however exercisable or exercised. Further, control shall be
deemed present if income or deductions have been arbitrarily shifted between two or more
enterprises. Control was also defined as ownership of stocks in a corporation possessing at
least fifty-one per cent of the total voting power of all classes of stock entitled to vote2.
Accordingly, since ************** owns 60% of the Company, the relationship between the
two entities will fall under the definition of associated enterprises in RR 2-13.
In identifying the interest rate to be applied, the arms length principle is adopted as the
standard to determine transfer prices of related parties.
The arms length principle requires the transaction with a related party to be made under
comparable conditions and circumstances to a transaction with an independent party. For
purposes of determining the arms length rate in domestic transactions, such as between the
Company and **************, RR 2-2013 did not specify an arms length interest that
should be applied. In previous regulations and rulings, however, BIR has consistently
referred to the Bank Reference Rate (BRR) prescribed by the Bangko Sentral ng Pilipinas
(BSP)3.
We note that the power of the BIR to impute interest was challenged by the Supreme Court,
in the case of CIR v Filinvest Development Corporation4, which held that intercompany loans or
advances are not subject to tax on the theoretical interest income5 received by the lending
company mainly because the CIRs power of distribution, apportionment or allocation
under Section 50 of the 1997 Tax Code, as amended, does not include the power to impute
theoretical interests to the controlled taxpayers transactions. There must be proof of the
actual or at the very least, probable receipt or realization by the controlled taxpayer of the
item of gross income sought to be distributed, apportioned or allocated by the CIR.
The BIR has not issued any circular adopting the SC decision. Hence, despite the Supreme
Court Ruling, this could indicate that the BIR may still uphold its rules on interest
imputation and assess the Company for interest income on the non- interest bearing loan.
This has a basis in RAMO 2-98, RMC 63-99 and the recent transfer pricing regulations, RR
2-2013.
On liability to pay documentary stamp tax (DST)
The loan will be subject to DST at P1.00 per P200 of the amount of the loan.
Under Section 179 of the 1997 Tax Code, as amended, to wit:
CIR v Filinvest Development Corporation, GR 163653 dated July 19, 2011
RMO 63-99 dated July 19, 1999; BIR Ruling DA 320-07
4 GR 163653 dated July 19, 2011
2
3

"Theoretical interest" refers to interest "calculated" or computed (and not incurred or

paid) for the purpose of determining the "opportunity cost" of investing funds in a given
business. Such "theoretical" or imputed interest does not arise from a legally demandable
interest-bearing obligation incurred by the taxpayer who however wishes to find out, e.g.,
whether he would have been better off by lending out his funds and earning interest rather
than investing such funds in his business
5

Sec. 179. Stamp Tax on All Debt Instruments. On every original issue of
debt instruments, there shall be collected a documentary stamp tax on One
peso (P1.00) on each Two hundred pesos (P200), or fractional part thereof,
of the issue price of any such debt instruments: 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.
As pointed above, the non-interest loan agreement offered by the Company to
************** is in the nature of an inter-company advance and is therefore subject to
documentary stamp tax (DST) under Section 179 of the 1997 Tax Code, as amended.
The loan agreement is considered as a debt instrument. The term debt instrument means
instruments representing borrowing and lending transactions including but not limited to
debentures, certificates of indebtedness, due bills, bonds, and loan agreements6. Further, a
loan agreement refers to a contract in writing where one of the parties delivers to money or
other consumable thing, upon the condition that the same amount of the same kind and
quality shall be paid7.
In the Filinvest case, the Supreme Court ruled that inter-corporate loans evidenced by
instructional letters or journal and cash vouchers or inter-office memos qualify as loan
agreements upon which DST may be imposed since they are akin to promissory notes that
show lendings or borrowings extended by the corporation to its affiliates, based on Section
180 vis--vis Section 179 of the 1997 Tax Code, as amended, and RR 9 -94.
Further, it must be highlighted that DST is imposed on the transaction rather than on the
document8 . Therefore, regardless of the existence of any documentary evidence of the
transaction, as long as the transaction is in the nature of debt or loan, such transaction will
be subject to the DST. Only inter-branch or inter-departmental advances within the same
legal entity may be exempt from the imposition of DST under Section 199 (i) of the 1997
Tax Code, as amended.
In which case, under Section 179 of the 1997 Tax Code, as amended, the non-interest
bearing loan agreement between the Company and ************** shall be subject to DST
at P1.00 on each P200.00, or fractional part thereof, of the issue price of such debt
instrument.
To comply with the requirements, BIR Form 2000 will be submitted with the required
information and the payment should be made on or before the 5th day after the close of the
month when the transaction subject to DST occurs.

Section 179 of the 1997 Tax Code, as amended

Section 3(b) and Section 6 of Revenue Regulations (RR) No. 9-94
8 Philippine Banking Corporation v Commissioner of Internal Revenue, GR 170574 dated January 30,
2009; Fort Bonifacio Development Corporation v CIR, GR 164155 & 175543, dated February 25,
2013; CIR v Manila Bankers Life Insurance Corporation, GR 169103 dated March 16, 2011
6
7

Deductibility of interest expense on loans

Relevant on the side of **************, the debtor, is whether the interest expense, if
imputed, can be deducted as a business expense for purposes of computing its corporate
income tax. The written loan agreement is one of the conditions for the deductibility of the
interest expense. Hence, without a written agreement, ************** cannot have a tax
benefit on the interest that may be imputed on the loan.
Generally, to be considered as deductible interest expense the following are the
requirements laid down by Section 34 (B) of the 1997 Tax Code, as amended and
implemented by RR 13-009, the following are the requisites for deductibility of interest
expense, to wit:
SECTION 3. Requisites for Deductibility of Interest Expense. In
general, subject to certain limitations, the following are the requisites for the
deductibility of interest expense from gross income, viz:
(a) There must be an indebtedness;
(b) There should be an interest expense paid or incurred upon such
indebtedness;
(c) The indebtedness must be that of the taxpayer,
(d) The indebtedness must be connected with the taxpayer's trade,
business or exercise of profession;
(e) The interest expense must have been paid or incurred during the
taxable year;
(f) The interest must have been stipulated in writing;
(g) The interest must be legally due;
(h) The interest payment arrangement must not be between
related taxpayers as mandated in Sec. 34(B)(2)(b), in relation
to Sec. 36(B), both of the Tax Code of 1997;
(i) The interest must not be incurred to finance petroleum operations;
and
(j) 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. (Emphasis ours)
As a rule, the amount of interest expense paid or incurred within a taxable year on
indebtedness in connection with the taxpayers trade, business, or exercise of profession
shall be allowed as a deduction from the gross income, should the above-enumerated
requisites are complied with10.
Item (f) requires that the interest imposed on the loan must have been stipulated in writing
and must be legally due. Since there is no agreement covering the loan, **************
cannot claim a tax deduction on any interest that may be imputed on said loan.

BIR Ruling [DA-(FIT-004) 076-08 dated July 24, 2008

BIR Ruling [DA-(CA-119) 354-09] dated July 7, 2009

10

On the other hand, in relation to item (h) in the above enumeration, neither the Company
nor ************** is considered as related taxpayers since neither is considered as personal
holding company under Section 34 (B) (2) (b) vis--vis Section36 (B) of the Tax Code.
We discuss below our findings.
Section 34 (B) (2) (b) of the Tax Code states:
"(B)

Interest.
xxx

xxx

xxx

(2)
Exceptions. No deduction shall be allowed in respect of interest
under the succeeding subparagraphs:
xxx

xxx

xxx

(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
xxx

xxx

xxx"

On the other hand, Section 36 (B) provides:

"SEC. 36.

Items not Deductible.

xxx

xxx

xxx

(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
xxx

xxx

xxx

(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 corporation, 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;" [Underscoring supplied]
The word "individual" in Section 36 (B) (3) above 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
"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:

(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.
(b)
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.
Based on 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 applies, the ownership of both corporations (the Company and
**************) must be traced to the level of the individual shareholder.
In order for two corporations to be considered as related taxpayers, more than50% of the
outstanding stock of each must be owned, directly or indirectly, by or for the same
individual.
In this case, the exception to deductibility of interest expense does not apply to the
Company considering that more than 50% of the issued and outstanding capital stock of
both the Company and ************** are not owned, directly or indirectly, by or for the
same individual and that both the Company and ************** are not personal holding
companies or foreign personal holding companies11.
Under the stock ownership requirement, it is necessary that more than 50% in value of its
outstanding stock is owned, directly or indirectly, by not more than five (5) individuals. In
this case, the Company is 60% owned by **************, a juridical corporation while 40%
is owned by SCG, another juridical corporation.
Thus, while the Company and ************** are affiliated corporations, they are not
considered related taxpayers within the contemplation of Section 36 (B) (3) of the Tax Code.
Consequently, the interest payments by ************** to the Company on the loan
contracts shall be deductible from the Company's gross income pursuant to Section 34 (B)
(2) (b) of the same Code.
Notwithstanding that the relationship between the Company and ************** will not
prevent the income tax deduction for interest expense on the loan, ************** still
cannot claim a tax deduction for any imputed interest since the loan is not evidenced by a
loan agreement and the interest rate is consequently not expressly stipulated in the contract.
This can be remedied by executing an agreement to evidence the loan.

11

BIR Ruling [DA-(CA-119) 354-09] dated July 7, 2009

* * *

We hope that we have sufficiently addressed your concerns. Should you have clarifications
or questions, please do let us know.
Yours sincerely,