Professional Documents
Culture Documents
The way governments regulate and tax firms and transactions play a big role in shaping the investment climate. o Sound regulation addresses market failures that inhibit productive investment and reconciles the interest of firms with those of society o Sound taxation generates the revenues to finance public services that improve the investment climate and meet other social goals o The challenge how to meet these objectives without undermining the opportunities an incentives for firms to invest productively
Information Problems arise when contracting parties have unequal access to information o Monopoly arise when a firm has enough market power to raise prices above the competitive level and thereby extract higher profits at the expense of consumers and economic efficiency Government failure Even market failure exists, it makes sense to intervene only when the expected benefits exceed the likely cost o Information and capacity problems governments will never have as much information as firms about the impact of interventions on their costs or incentives o Rent-seeking firms may seek regulation to protect themselves from competition. Officials accept bribes o Rigidity regulation tends to be rigid, making it hard to keep up with changes in technology or way business is conducted The institutional fit challenge o Interventions that work well in one country may lead to very different results in others o Local conditions should be taken into account o
REGULATING FIRMS Why regulate to restrict who may participate, where firms may locate, production process used, quality of products. Etc Regulatory problems o Partial enforcement evident in the huge informal sectors o Extraordinary requirements causes long delays o Creates monopolies and cartels o Imposes costs on consumers and stifles incentives for firms Studies show that developing countries tend to regulate more than richer countries. How then can govts make progress? o Strike a better balance between market failures and govt failures o Ensure good institutional fit Balancing market and govt failures & achieving good institutional fit Market failure usual rationale for regulation. 3 most common types: o Externalities arise when producing or consuming a product imposes costs (negative externatlities) or confers benefits (positive externalites) on others. Ex: pollution
How to solve these? Addressing regulatory costs and informality o All regulations can impose costs on firms o A good investment climate does not seek to eliminate those costs o Instead, it seeks to ensure they are no higher than necessary to meet social interests. o Goal better regulation, not no regulation o Both investment and the productivity of the investment are lower in countries where he regulatory burden is greater o When compliance costs are the same for firms of different sizes, they impose a disproportionate burden on smaller firms o Informality results when it is costly to comply with regulations By staying informal, firms can reduce costs Widespread in developing countries, accounting for more than half of GDP o Governments should streamline regulatory approval processes Online processing One-stop shops Reducing regulatory uncertainty and risk o Regulations can increase the risks firm face when they change frequently, vaguely drafted or enforced inconsistently
TAXING FIRMS Taxes represent a cost to firms and reduce their incentives to invest Taxation problems o Benefit favored groups distorts competition o Tax administration burdensome Increasing compliance costs Reducing revenues Opening corruption Taxes and the Investment Climate taxes affect the incentives for firms to invest productively by weakening the link between effort and reward and by increasing the costs of inputs in the production process o Tax rates A function of the size of government and the way the burden is allocated among alternative sources Affected by the narrowness of the tax base and problems of tax administration The tax burden of firms vary along several dimensions
How to improve taxation? Broadening the tax base o Reducing impediments to emergence of new firms o Addressing informality of existing firms o More vigorous tax enforcement action Confronting informality o Caveat: forcing them to comply might result to them closing down o Even a big increase in formality may not lead to significant increase in revenue, but would increase the cost of collecting Simplifying tax structures o Tax systems riddled with exemptions are not transparent and can act as magnets for rent-seeking behavior o Such system provides significant opportunities for corruption o Complicated systems increase costs of administration Increasing the autonomy of tax agencies o Autonomy improves performance of revenue agencies o Autonomy has to be balanced with accountability Tackling corruption in tax administration o Minimize direct contact between tax officials and taxpayers, by automating and computerization procedures o Organize the agency along functional lines rather than by tax type Improving compliance through computerization o Public satisfaction with tax service improves Regulating and taxing at the border Regulatory barriers to foreign investments o Seeks to encourage FDI to promote spillover to local economy o Seeks to control foreign participation in sensitive industries o Control the destabilizing effects of large, short-term capital flows Regulatory barriers to foreign trade o Trade protection o Improving customs administration
International Corporate Finance Friedrich Schneider, Size and Measurement of the Informal Economy in 110 Countries Around the World (July 2002) 1.2.
Atty. Jose Cochingyan III The Philippine Fiscal Environment Philippine Development Plan, 2011-2016 Rule of Law Index 2012-2013
Philippine Standing Rule of Law Index Factors Limited Government Powers Absence of Corruption Order and Security Fundamental Rights Open Government Regulatory Enforcement Civil Justice Criminal Justice Global Rank 46/97 63/97 77/97 59/97 59/97 52/97 84/97 72/97 Regional Rank 9/14 10/14 14/14 9/14 10/14 8/14 13/14 13/14 Income Group 6/23 8/23 16/23 9/23 9/23 5/23 17/23 10/23
Informal Economy Definition all currently unregistered economic activities which contribute to the official calculated Gross National Product o Smith: market-based production of goods and services, whether legal or illegal that escapes detection in official GDP estimates o Includes unreported income from the production of legal goods and services, either from monetary or barter transactions Principle of running water the informal economy adjusts to changes in taxes, to sanctions from the tax authorities and to general moral attitudes, etc. A large burden of taxation and social security contributions combined with government regulations are the main determinant of the size of the informal economy Average size of informal economy as a percent of official GNI in 2000 o Developing countries 41% o Transition countries 38% o OECD countries 18% Indicators in the change of size of informal economy o Development of monetary indicators if activities in the informal economy rise, additional monetary transactions are required o Development of the labor market increasing participation of workers in the hidden sector results in a decrease in participation in the official economy. Similarly, increase activities in the hidden sector may be expected to be reflected in shorter working hours in the official economy o Development of the production market an increase in the informal economy means that inputs (especially labor) move out of the official economy (at least partly); this displacement might have a depressing effect on the official growth rate of the economy Various methods used: the currency demand, the physical input measure, discrepancy method and the model approach General impression: for all countries, the informal economy (labor force) has reached a remarkably large size over the recent decade An increasing burden of taxation Informal economies are a complex phenomenon, present to an omportant extent even in the industrialized and developed economies. People engage in informal in informal economic activity because of government action, most notable taxation and regulation A government aiming to decrease informal economic activity has to analyze the complex and frequently contradictory relationships among the consequences of its own policy decisions
Latest status of the Philippines in the World Bank Doing Business Report, as well as PH neighbors
DB 2014 Rank 170 99 33 121 86 128 131 42 114 100 108 DB 2013 Rank 166 95 33 119 126 127 144 41 112 164 133
Topics Starting a Business Dealing with Construction Permits Getting Electricity Registering Property Getting Credit Protecting Investors Paying Taxes Trading Across Borders Enforcing Contracts Resolving Insolvency Overall
ARTICLE XII National Economy & Patrimony Section 1. The goals of the national economy are a more equitable distribution of opportunities, income, and wealth; a sustained increase in the amount of goods and services produced by the nation for the benefit of the people; and an
Atty. Jose Cochingyan III 2. General Principles of Corporate Finance 2.1. Managerial Finance and the Business Organization LAWRENCE J. GITMAN, PRINCIPLES OF MANAGERIAL FINANCE, 10th Edition; Chapter 1, The Role and Environment of Managerial Finance, pp. 2-39 (2003)
Section 2. State Policy. - It is hereby declared the policy of the State to promote sustainable economic growth through the rationalization of the Philippine internal revenue tax system, including tax administration; to provide, as much as possible, an equitable relief to a greater number of taxpayers in order to improve levels of disposable income and increase economic activity; and to create a robust environment for business to enable firms to compete better in the regional as well as the global market, at the same time that the State ensures that Government is able to provide for the needs of those under its jurisdiction and care.
Finance and Business Finance art and science of managing money Major Areas and Opportunities in Finance o Financial Services area of finance concerned with the design and delivery of advice and financial products to individuals, businesses and governments o Managerial Finance concerns the duties of the financial manager in the business firm Financial Manager actively manages the financial affairs of any type of business, whether financial or nonfinancial, private or public, large or small profit-seeking or not-for-profit Legal Forms of Business Organization o Sole Proprietorship a business owned by one person who operates it for his own profit; has unlimited liability Unlimited Liability the condition of sole proprietorship (or general partnership) allowing the owners total wealth to be taken to satisfy creditors o Partnership a business owned by two or more people and operated for profit; has unlimited liability for general partners o Corporation artificial being created by law Stockholders owners of a corporation, whose ownership, or equity, is evidenced by either common or preferred stock Common Stock purest and most basic form of corporate ownership Dividends periodic distributions of earnings to the stockholders of a firm Board of Directors group elected by the firms stockholders and having ultimate authority to guide corporate affairs and make general policy President or CEO corporate official responsible for managing the firms day-to-day operations and carrying out the policies established by the board of directors o Other Limited Liability Organizations Limited Partnership a partnership in which one of the partners have limited liability as long as at least one partner (the
The Managerial Finance Function Organization of the Finance Function o Depends on the size of the firm o Treasurer the firms chief financial manager, who is responsible for the firms financial activities, such as financial planning and fund raising, making capital expenditure decisions, and managing cash, credit, the pension fund an foreign exchange (finance) o Controller the firms chief accountant, who is responsible for the firms accounting activities, such as corporate accounting, tax management, financial accounting and cost accounting (accounting) o Foreign Exchange Manager responsible for monitoring and managing the firms exposure to loss from currency flcutuations Relationship to Economics o Marginal Analysis economic principle that states that financial decisions should be made and actions taken only when the added benefits exceed the added costs Relationship to Accounting o Accrual Basis in preparation of financial statements, recognizes revenue at the time of the sale and recognizes expenses when they are incurred o Cash Basis recognizes revenues and expenses only with respect to actual inflows and outflows of cash Primary Activities of the Financial Manager o Involvement in financial analysis and planning o Making investment decisions o Making financing decisions Goal of the Firm Maximize Profit o Earnings per share the amount earned during the period on behalf of each outstanding share of stock, calculated by dividing the periods total earnings available for the firms common stockholders by the number of shares of common stock outstanding o Timing the receipt of funds sooner rather than later is preferred
The Agency Issue In theory, most financial managers would agree with the goal of owner wealth maximization. In practice however natures are also concerned with their personal wealth, job security and fringe benefits. The result is a less-than-maximum return and a potential loss of wealth for the owners. Agency Problem likelihood that managers may place personal goals ahead of corporate goals How to prevent agency problems? o Market forces major shareholders exert pressure on management to perform threat of takeover takeover of another firm that believes it can enhance the target firms value o Agency Costs costs borne by stockholders to minimize agency problems and contribute to the maximization of owners wealth Structure management compensation give managers incentives to act in the best interest of the corporation Incentive Plans management compensation pans that tend to tie compensation to share price; e.g. stock options Performance Plans - plans that tie management compensation to measures such as EPS and other rates in return, e.g., performance shares, cash bonuses Financial Institutions and Markets Financial Institutions an intermediary the channels this savings of individuals, businesses and governments into loans or investments Financial Markets forums in which suppliers of funds and demanders of funds can transact business directly o Private Placement the sale of new security issue, typically bonds or preferred stock, directly to an investor or group of investors
Atty. Jose Cochingyan III DIANE BEAL AND MICHELE GOYEN, INTRODUCING CORPORATE FINANCE Introducing the Firm and Its Goals, pp. 3-30 (2005)
Goals of Firms Profit maximization implies a business is managed to maximize the difference between revenues and expenses any period. Wealth maximization implies that the business is managed so that the present and future cash flows discounted at an appropriate value will get a present value which is maximized Time value of money is the concept that a dollar is worth more the sooner it is received Discounting is the process of calculating the present value of the future amount. The discount factor incorporates the possible or required earning rate for the funds Market capitalization is the total value of the corporation as measured be the price of each issued share multiplied by the number of issued shares Market value is the price that the willing buyers are prepared to pay and willing sellers are prepared to accept Roles of Financial Managers Financial Derivatives contracts that are derived from the value of some underlying assets and are used to manage risk Financial Governance and financial decisions Financial Governance comprises all the financial and management accounting systems and other financial processes that are put in place to achieve the objectives of the firm Principal-Agent Problem Principal agent problem the scope for conflict or division between principals (owners) and agents (managers) over the goals of the firm which are being pursued by its policy and management decisions Agency Costs are the losses borne by the owners of the firm that can be attributed to the agent having different objectives from the owners or principals Ethics in Business Ethics are moral principles or rules of conduct which indicate the acceptability of behavior within the community Whistleblowing means informing (usually the employees of the perpetrators) the relevant authorities of malpractice or dangers to the public or the environment
Business Taxes Ordinary income income earned through the sale of a firms goods or services Double taxation occurs when the already once-taxed earnings of a corporation are distributed as cash dividends to stockholders, who must pay taxes on them Intercorporate dividends dividends received by one corporation on common and preferred stock held in other corporations Capital Gain the amount by which the sale price of an asset exceeds the assets initial purchase price Tax loss carryback/carryforward a tax benefit that allows corporations experiencing operating losses to carry tax losses o In PH, this is called the NOLCO
Atty. Jose Cochingyan III 2.2. Corporate Governance JILL SOLOMON AND ARIS SOLOMON, CORPORATE GOVERNANCE AND ACCOUNTABILITY, pp. 1-43 (2004)
Dividend Imputation Dividend Imputation the system where dividends carry an additional benefit in the form of an attached tax credit for the relevant amount of tax paid by the company on its profits Franked dividend dividend carrying an attached franking or tax credit Fully franked dividend carries a tax credit equal to the full 30% company tax paid on the underlying profit Partly franked dividend carries a tax credit less than the full 30% company tax paid on the underlying profit Unfranked dividend carries no tax credit
Corporate Governance Definition the system of checks and balances, both internal and external to companies, which ensures the companies discharge their accountability to all their stakeholders and act in a socially responsible way in all areas of their business activity Theoretical Frameworks Agency Theory the problem that arises as a result of this system of corporate ownership is that the agents do not necessarily make decisions in the best in interest of the principal o Managers prefer to pursue their own personal objectives o Ex: managers are likely to display a tendency towards egoism resulting in a tendency to focus on project and company investments that provide high short-term profits rather dandy maximization of long-term shareholder wealth through investment in projects that are long-term in nature o Short-termism tendency to foreshorten the time horizon applied to investment decisions or raise the discount date above that appropriate to the firms fortune at the cost of capital o Residual Loss reduction in shareholders welfare o Expensive and difficult for principal to verify what the agent is doing o This presents shareholders with a need to control company management Transaction Cost Theory based on the fact that firms have become so large that be, in effect, substitute for the market in determining the allocation of resources o It is in the interests of the company management to internalize transactions as much as possible. The main reason for this is that such internalization removes risks and uncertainties about future product prices and quality. Stakeholder Theory - companies are so large, and their impact on society so pervasive that they should discharge an accountability to many more sectors of society then solely their shareholders o Stakeholders include shareholders, employees, suppliers, customers, creditors, communities in the vicinity of the companys operations and the general public o Some also advocate that the environment, animals and future generations be included in the term Enron Case Study
PASCAL QUIRY, MARIZIO DALLACCHIO, YANN LE FUR AND ANTONIO SALVI, CORPORATE FINANCE, THEORY AND PRACTICE, pp. 1-11 (2005)
The Financial Manager Primary Role to ensure that his company has a sufficient supply of capital o Traditional view A buyer of capital who seeks to minimize its cost o Financial view A seller of financial securities who tries to maximize their value The cost of capital and the value of securities vary in opposite directions minimizing financial cost is synonymous with maximizing the value of the underlying securities Financial Instrument Defined as a schedule of future cash flows Types of Financial Securities o Debt Instruments contract that ties a lender (investor) to a borrower (the company) o Equity Securities represents the capital injected into a company by an investor who bears the full risk of the companys industrial undertakings o Other Securities holds characteristics of the two above Secondary Markets The market for used financial products Function to ensure that securities are properly priced and traded Liquidity refers to the ability to convert an instrument into cash quickly and without loss of value
International Corporate Finance MARTIN FAHY, JEREMY ROCHE AND ANASTASIA WEINER, CHAPTER 10, BEYOND CORPORATE GOVERNANCE, pp. 225259 (2004)
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Key Influenced Behind the Corporate Responsibility Movement Technology Transparency Sustainability Globalization Borderless Governance Stakeholder Pressure Mega-Risk Benefits of Corporate Responsibility Improved Risk Management Ensuring Compliance Improved Financial Performance Institutional Investment Accountability Employee Attraction and Retention Innovation
CORPORATE
Significance of the term Corporate Governance Corporate feature of centralized management under Sec. 23 of the Corp. Code fiduciary relationship between the Board of Directors and the stockholders Good corporate citizen corporations must behave in a sociallyacceptable way Board of Directors are vested with public interest, and therefore, have a heightened set of duties and responsibilities to society Covered Corporations under the Revised CG Code This Revised Code of Corporate Governance shall apply to registered corporations and to branches or subsidiaries of foreign corporations operating in the Philippines that: a. Sell equity and/or debt securities to the public that are required to be registered to the Commission b. Have assets in excess of Fifty Million Pesos and at least two hundred (200) stockholders who own at least one hundred (100) shares each of equity securities c. Whose securities are listed on the Exchange d. Grantees of secondary licenses from the Commission Theories on Corporate Governance Maximization of Shareholder Value o The primary obligation of the Board of Directors of a stock corporation is to seek the maximum amount of profits for the corporation o Prevailing theory under the PH Corporation Code Corporate Social Responsibility o The continuing commitment by business to behave ethically and contribute to economic development while improving the quality of life of the workforce and their families as well as the society at large Stakeholder Theory o The obligation of business was not merely to seek profit for its stockholders but to coordinate stakeholder interests.
Ajit Singh, The New International Financial Architecture, Corp. Governance and Competition & Emerging Markets: Empirical Anomalies & Policy Issues in HA-JOON CHANG, RETHINKING DEVELOPMENT ECONOMICS, pp. 377-403 (2003)
Corporate Governance in Developing Countries Asian Financial Crisis a more credible explanation of the crisis is that afflicted economies dismantled their controls over the borrowing of the private sector and embraced financial liberalization. o As a consequence, the private sector built up short-term foreign currency debt, which often found its way into the non-tradable sector and into speculative real estate ventures Crony Capitalism results in poor corporate governance o In Asia, firms controlled by families are most likely to have a separation between cash flow and control rights, that its to say,a greater degree of corporate pyramiding o Concentration of economic power in a set of families is not necessarily antithetical to the efficient functioning, transparency and democratic accountability of the industrial system o Crony Capitalism is not strictly a corporate governance problem, since family owners are likely to have the right incentives in firms
Atty. Jose Cochingyan III Partnership Heirs of Jose Lim v. Lim, 614 SCRA 141 (2010) Joint Venture Philex Mining Corp. v. CIR, 551 SCRA 428 (2008) Single Proprietorship Excellent Quality Apparel Inc. v. Win Multi Rich Builders Inc., 578 SCRA 272 (2009) Corporation Pioneer Insurance v. CA, 175 SCRA 668 (1989) Lim Tong Lim v. Philippine Fishing Gear Industries, Inc., 317 SCRA 728 (1999) Koji Yasuma v. Heirs of Cecilio S. De Villa, 499 SCRA 466 (2006)
If a corporation fails to register: Pioneer case passive investors are not liable Lim Tong case passive investors may still be liable, if they benefitted
SEC Memorandum Circular No. 6, Series of 2009: Revised Code of Corporate Governance
2.3.
The Business Organization in the Philippine Context Single Proprietorship Excellent Quality Apparel Inc. v. Win Multi Rich Builders Inc., 578 SCRA 272 (2009)
A sole proprietorship does not possess a juridical personality separate and distinct from the personality of the owner of the enterprise. The law merely recognizes the existence of a sole proprietorship as a form of business organization conducted for profit by a single individual and requires its proprietor or owner to secure licenses and permits, register its business name, and pay taxes to the national government. The law does not vest a separate legal personality on the sole proprietorship or empower it to file or defend an action in court.
Partnerships Advantages o Control the partnership does not separate ownership and control o Simplicity has a separate legal structure, but the partners may agree to conduct business in almost any manner; flexibility o Expenses less operating expenses than a corporation o Taxes the partnership is not taxed separately Disadvantages o Unlimited Liability the partners are subject to unlimited liability for any contractual or tort damage caused by partners or agents o Transferability a partner cannot sell his ownership interest Limited Partnership Advantages o Limited Liability the liability of the limited partners is limited to the amount of their investment; the general partner remains subject to unlimited liability o Separation of ownership and control limited partners may invest capital in an enterprise without becoming involved in management o Expenses simplicity in management is still available since the business may be structured freely under the agreement Disadvantages o Unlimited Liability the general partner is subject to unlimited liability for any contractual or tort damages incurred by partnership o Transferability a limited partner cannot usually readily sell his or her owenership Corporations Advantages o Limited Liability the liability of investors (stockholders) is limited to the amount of their investment o Separation of ownership and control the corporate structure separate ownership and control. Stockholders may invest capital without becoming involved in management o Transferability - stockholdings in a corporation may be transferred o Perpetual Life the corporation continues in existence until it is dissolved. Survives the death of the owner Disadvantages
THOMAS LEE HAZEN, JERRY W. MARKHAM, CORPORATIONS AND OTHER BUSINESS ENTERPRISES, pp. 1-26 (2009)
ADVANTAGES AND DISADVANTAGES OF PARTICULAR ENTERPRISES Sole Proprietorship Advantages o Control the owner of proprietorship directly controls and operates the business o Simplicity lack of a separate legal structure; more flexible o Expenses less operating expenses; no need for reporting o Taxes the proprietorship is not taxed separately Disadvantages
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Creditable Withholding Tax. Under the creditable withholding tax system, taxes withheld on certain income payments are intended to equal or at least approximate the tax due of the payee on said income. The income recipient is still required to file an income tax return, as prescribed in Sec. 51 and Sec. 52 of the NIRC, as amended, to report the income and/or pay the difference between the tax withheld and the tax due on the income. Taxes withheld on income payments covered by the expanded withholding tax (referred to in Sec. 2.57.2 of these regulations) and compensation income (referred to in Sec. 2.78 also of these regulations) are creditable in nature. SECTION 2.57.2. Income Payment Subject to Creditable Withholding Tax and Rates Prescribed Thereon. Except as herein otherwise provided, there shall be withheld a creditable income tax at the rates herein specified for each class of payee from the following items of income payments to persons residing in the Philippines: (M) Income payments made by the top twenty thousand (20,000) private corporations to their local/resident supplier of goods and local/resident supplier of services other than those covered by other rates of withholding tax. Income payments made by any of the 20,000 corporations, as determined by the Commissioner, to their local/resident supplier of goods and local/resident supplier of services, including non-resident aliens engaged in trade or business in the Philippines. Provided, however that for purchases involving agricultural products in their original state, the tax required to be withheld under this sub-section shall only apply to purchases in excess of the cumulative amount of P300,000 within the same taxable year. For this purpose, agricultural products in their original state as used in these regulations, shall only include corn, coconut, copra, palay, rice, cassava, sugar cane, coffee, fruits, vegetables, marine food products, poultry and livestocks.
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a. Persons Required to Submit Summary Lists of Sales/Purchases. (1) Persons Required to Submit Summary Lists of Sales. All persons liable for VAT such as manufacturers, wholesalers, service-providers, among others, with quarterly total sales/receipts (net of VAT) exceeding Two Million Five Hundred Thousand Pesos (P2,500,000.00). (2) Persons Required to Submit Summary Lists of Purchases. All persons liable for VAT such as manufacturers, service-providers, among others, with quarterly total purchases (net of VAT) exceeding One Million Pesos (P 1,000,000.00). b. When and Where to File the Summary Lists of Sales/Purchases. The quarterly summary list of sales or purchases, whichever is applicable, shall be submitted in diskette form to the RDO or LTDO or LTAD having jurisdiction over the taxpayer, on or before the twenty-fifth (25th) day of the month following the close of the taxable quarter (VAT quarter)-calendar quarter or fiscal quarter. However, taxpayers under the jurisdiction of the LTS, and those enrolled under the EFPS, shall, through electronic filing facility submit their Summary List of Sales/Purchases to the RDO/LTDO/LTAD on or before the 30th day of the month following the close of the taxable quarter.
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International Corporate Finance o Speech of Mr. John Gokongwei before Ateneo 2004 Graduates 3. Capital Structure Kenneth H. Marks, Larry E. Robbins, Gonzalo Fernandez and John P. Funkhouser, The Handbook of Financing Growth, 22-43 (2005)
Atty. Jose Cochingyan III KENNETH H. MARKS, LARRY E. ROBBINS, GONZALO FERNANDEZ AND JOHN P. FUNKHOUSER, THE HANDBOOK OF FINANCING GROWTH, 262-278 (2005)
Capital Structure refers to the amount of debt and equity and the types of debt and equity used to fund the operations of the company Optimal Capital Structure Balances the risk of bankruptcy with the tax savings of debt A company should use both equity and debt to fund its operations This provides greater returns to stockholders than what they would receive in an all-equity firm By reducing the amount of equity and increasing the amount of debt, the overall cost of capital is reduced The pool of financing alternatives grows as the critical mass of the company grows The desired capital structure will change as the company moves from one business stage to another Debt-to-equity ratio compares the total liabilities on a companys balance sheet to the companys equity Factors Shaping Capital Structure Company Characteristics Company Stage Use of Funds Capital Markets Favor of the Industry Base Assumptions Industry Leverage Norms Industry Dynamics Shareholder Objectives and Preferences
The Players and their Roles Counsel advocate I negotiations with counsel for third parties Board of Directors composed of individuals who can help the company through a rich network of potential customers, investors, vendors and partners Investment Bankers financial intermediaries (not investors) that act as an underwriter or agent for corporations raising capital or seeking strategic transactions Accountants - compilation, review or audit of the financial statements of the company and preparation of tax returns Consultants/Advisers
4.2.
In Strategic Transactions o MICHAEL E. S. FRANKEL, MERGERS AND ACQUISITIONS BASICS 1-49 (2005)
Strategic Transactions
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Introduction Participants / central figures o Owner has equity or residual interest in the business has control right to decide on how operated o Employees o Lenders / creditors The relationship among the participants involves a joint economic enterprise there is a communality of interest Bargain Elements (deal points) o Risk of loss allocation among the participants of losses o Return salaries, interest and other fixed claims and to shares of the residual (the profit) o Control determines who has the right to make decisions o Duration determines how long the relationships among participants will last and is intended to include the conditions on which the relationship can be terminated and on which a claim may be transferred. Constraints o Conflict of interest arises from the fact that people tend to pursue their own self-interest o Government regulation may limit the freedom of participants in a business venture to adopt chosen rules o Limits on complete specificity complete specificity of all outcomes in all possible situations is not possible and even to the degree it is possible, may not be worth the cost Sole Proprietorship Definition a business owned directly by one individual (sole proprietor) Ownership and management may be separated. Creditors o Liability for debts unlimited liability (personal in nature) o Secured creditor one whose claim is secured by specific property, and who has first claim to the proceeds of the sale of such property o General creditor all other creditors except a secured one o It is possible to avoid personal liability through a nonrecourse loan
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Employees o A principal-agency relationship is created o The agent has power to bind the principal o Agents owe a duty of loyalty or fiduciary obligation to their principal
2. Capital Structure KENNETH H. MARKS, LARRY E. ROBBINS, GONZALO FERNANDEZ AND JOHN P. FUNKHOUSER, THE HANDBOOK OF FINANCING GROWTH, 22-43 (2005)
Capital Structure refers to the amount of debt and equity and the types of debt and equity used to fund the operations of the company Optimal Capital Structure Balances the risk of bankruptcy with the tax savings of debt A company should use both equity and debt to fund its operations
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Factors Shaping Capital Structure Company Characteristics Company Stage Use of Funds Capital Markets Favor of the Industry Base Assumptions Industry Leverage Norms Industry Dynamics Shareholder Objectives and Preferences
As a minimum, the face of the balance sheet should include the following line items: 1. Cash and Cash Equivalents 2. Financial Assets 3. Trade and Other Receivables 4. Inventories 5. Property Plant and Equipment 6. Investments accounted for using the equity method 7. Intangible Assets 8. Trade and Other Payables 9. Tax Liabilities and assets 10. Provisions 11. Non-current interest-bearing liabilities 12. Minority Interest 13. Issues Capital and Reserves Except as otherwise required by the Commission, the various line items and disclosures set forth for this form of statement shall be in accordance with the Philippine Financial Reporting Standards (PFRS) enumerated under paragraph (2)(a) of this Rule. (ii) Income Statement
3. Debt v. Equity KENNETH H. MARKS, LARRY E. ROBBINS, GONZALO FERNANDEZ AND JOHN P. FUNKHOUSER, THE HANDBOOK OF FINANCING GROWTH, 161-163 (2005)
4. The Balance Sheet MARTIN FRIDSON & FERNANDO ALVAREZ, FINANCIAL STATEMENT ANALYSIS, 29-48 (2002) SRC Rule 68, as amended, Rules and Regulations Covering Form and Content of Financial Statements (October 25, 2005) 4d
As a minimum, the face of the balance sheet should include the following line items: 1. Revenue 2. The results of operating activities 3. Finance costs 4. Shares of income and losses of associates and joint ventures accounted for using the equity method 5. Tax expenses 6. Income or loss from ordinary activities 7. Extraordinary items 8. Minority interest 9. Net income or loss for the period Except as otherwise required by the Commission, the various line items and disclosures set forth for this form of statement shall be in accordance with the Philippine Financial Reporting Standards (PFRS) enumerated under paragraph (2)(a) of this Rule. (iii) Statement of Changes in Equity
*Superseded by 2011 amendment (see below); But this gives a complete picture of the parts of a financial statement that is currently required. Basic Financial Statements and Minimum Presentation
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Preparation of Financial Statements 2. In relation to the audit of said financial statements, the management should provide its auditor with the following: a. Complete set of financial statements consisting of (1) Statement of Financial Position; (2) Either a single statement of comprehensive income, or a separate income statements and a separate statement of comprehensive income; (3) Statement of changes in equity; (4) Statement of cash flows; (5) Notes including a summary of significant accounting policies; (6) If applicable, schedules and reconciliation forming part of the financial statements required under the existing rules of the Commission.
3. The requirements above may be met in a number of ways. The approach adopted shall follow a columnar format which reconciles between the opening and closing balances of each element within shareholders equity, including items (a) to (f). An alternative is to present a separate component of the financial statements which presents only items (a) to (c). Under this approach, the items described in (d) to (f) are shown in the notes to the financial statements. Whichever approach is adopted, a sub-total of the items in (b) to enable users to derive the total gains and losses arising from the registrants activities during the period, is required. (iv) Cash Flow Statement
SRC Rule 68, as amended, Rules and Regulations Covering Form and Content of Financial Statements (October 20, 2011) Part 2. B(vi)(a) & 5
I.2.B(vi) In the audit of the companys financial statements, the management shall provide the external auditor with the following documents: (a) Complete set of financial statements as prescribed under the applicable financial reporting framework of the entity, and If applicable, schedules and reconciliation forming part of the financial statements required under the existing rules of the Commission; I.5. Comparative Financial Statements A. The financial statements to be filed with the Commission shall be presented in comparative form. The figures for the most recently ended fiscal year may be presented at the right portion immediately after the accounts name, followed by the figures for the last preceding year. B. Balance Sheet or Statement of Financial Position
Except as otherwise announced by the Commission, the various line items and disclosures set forth for this form of statement shall be in accordance with the PRFS under paragraph (2)(a) of this Rule. (v) Notes to Financial Statement
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MODULE 3: DEBT
1. Interpretation of Contracts Civil Code, Arts. 1370-1379
Article 1370. If the terms of a contract are clear and leave no doubt upon the intention of the contracting parties, the literal meaning of its stipulations shall control. If the words appear to be contrary to the evident intention of the parties, the latter shall prevail over the former. (1281) Article 1371. In order to judge the intention of the contracting parties, their contemporaneous and subsequent acts shall be principally considered. (1282) Article 1372. However general the terms of a contract may be, they shall not be understood to comprehend things that are distinct and cases that are different from those upon which the parties intended to agree. (1283) Article 1373. If some stipulation of any contract should admit of several meanings, it shall be understood as bearing that import which is most adequate to render it effectual. (1284) Article 1374. The various stipulations of a contract shall be interpreted together, attributing to the doubtful ones that sense which may result from all of them taken jointly. (1285) Article 1375. Words which may have different significations shall be understood in that which is most in keeping with the nature and object of the contract. (1286) Article 1376. The usage or custom of the place shall be borne in mind in the interpretation of the ambiguities of a contract, and shall fill the omission of stipulations which are ordinarily established. (1287) Article 1377. The interpretation of obscure words or stipulations in a contract shall not favor the party who caused the obscurity. (1288) Article 1378. When it is absolutely impossible to settle doubts by the rules established in the preceding articles, and the doubts refer to incidental circumstances of a gratuitous contract, the least transmission of rights and interests shall prevail. If the contract is onerous, the doubt shall be settled in favor of the greatest reciprocity of interests. If the doubts are cast upon the principal object of the contract in such a way that it cannot be known what may have been the intention or will of the parties, the
4. Interpretation Of Documents Section 10. Interpretation of a writing according to its legal meaning . The language of a writing is to be interpreted according to the legal meaning it bears in the place of its execution, unless the parties intended otherwise. (8) Section 11. Instrument construed so as to give effect to all provisions . In the construction of an instrument, where there are several provisions or particulars, such a construction is, if possible, to be adopted as will give effect to all. (9) Section 12. Interpretation according to intention; general and particular provisions. In the construction of an instrument, the intention of the parties is to be pursued; and when a general and a particular provision are inconsistent, the latter is paramount to the former. So a particular intent will control a general one that is inconsistent with it. (10) Section 13. Interpretation according to circumstances. For the proper construction of an instrument, the circumstances under which it was made, including the situation of the subject thereof and of the parties to it, may be shown, so that the judge may be placed in the position of those who language he is to interpret. (11) Section 14. Peculiar signification of terms. The terms of a writing are presumed to have been used in their primary and general acceptation, but evidence is admissible to show that they have a local, technical, or otherwise peculiar signification, and were so used and understood in the particular instance, in which case the agreement must be construed accordingly. (12) Section 15. Written words control printed. When an instrument consists partly of written words and partly of a printed form, and the two are inconsistent, the former controls the latter. (13) Section 16. Experts and interpreters to be used in explaining certain writings . When the characters in which an instrument is written are difficult to be deciphered, or the language is not understood by the court, the evidence of persons skilled in deciphering the characters, or who understand the language, is admissible to declare the characters or the meaning of the language. (14)
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2. Basic Statutory Provisions on Loans 2.1. Simple Loan Civil Code, Arts. 1953-1961
Simple Loan or Mutuum Article 1953. A person who receives a loan of money or any other fungible thing acquires the ownership thereof, and is bound to pay to the creditor an equal amount of the same kind and quality. (1753a) Article 1954. A contract whereby one person transfers the ownership of nonfungible things to another with the obligation on the part of the latter to give things of the same kind, quantity, and quality shall be considered a barter. (n) Article 1955. The obligation of a person who borrows money shall be governed by the provisions of articles 1249 and 1250 of this Code. If what was loaned is a fungible thing other than money, the debtor owes another thing of the same kind, quantity and quality, even if it should change in value. In case it is impossible to deliver the same kind, its value at the time of the perfection of the loan shall be paid. (1754a) Article 1956. No interest shall be due unless it has been expressly stipulated in writing. (1755a)
Proceeds of a Loan the principal amount borrowed Is interest automatically due? NO. It should be stipulated and there should be a demand Is there interest on the interest? No. It should be stipulated before there is compounded interest
Solidbank Corp v. Permanent Homes G.R. No. 171935, July 23, 2010
Facts: Permanent Homes, a real estate company, obtained from Solidbank an Omnibus Line credit facility worth P60 million to finance its project, Buena Vida Townhouses isn Merville Subdivision, Paranaque City. Of the P60M available, Permanent availed of P41.5M covered by 3 promissory notes, which contained the following provisions: o We/I irrevocably authorize Solidbank to increase or decrease at any time the interest rate agreed on the basis of, among others, prevailing rates in the local or international markets. o The adjustment of the interest rate shall be effective from the date indicated in the written notice sent to us by the bank, or if no date is indicated, from the time the notice was sent o Should We/I disagree to the interest rate adjustment, We/I shall prepay all amounts due under this Note or Loan within 30 days from the receipt
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Atty. Jose Cochingyan III Spouses Juico v. China Banking Corp. G.R. No. 187678, April 10, 2013
Issue: W/N the increases in interest rates are void for having been unilaterally imposed by Solidbank without basis. NO! Ratio: The Usury Law has been rendered effective by the Central Bank. These circulars removed the ceiling on interest rates for secured and unsecured loans regardless of maturity. The effect of these is to allow parties to agree on any interest on a loan. Although interest rates are no longer subject to a ceiling, the lender still does not have an unbridled license to impose increased interest rates. The lender and the borrower should agree on the imposed rate, in writing. The terms of the Omnibus Credit Line Agreement and the promissory notes regarding the stipulations on interest rate repricing are valid because: o The parties mutually agreed on said stipulations o Repricing takes effect only upon Solidbanks written notice to Permanent of the new interest rate o Permanent has the option to prepay its loan in case of disagreement Moreover, Solidbanks range of lending rates were consistent with prevailing rates in the local or international capital markets. The interest rate repricing happened at the height of the Asian Financial Crisis in late 1997, when banks clamped down on lendings because of higher credit risks across industries, particularly the real estate industry. However, there were instances when Solidbank did not promptly send permanent written notices of the repriced rates. o Thus, Solidbanks computation of the interest due should be adjusted to take effect only upon Permanents receipt of written notice Usury Law Virtual repeal rendered ineffective Congress temporarily suspended its application Central Bank removed the ceiling rate on interest rates
Facts: Spouses Ignacio and Alice Juice obtained a loan from China Bank as evidenced by 2 PNs, secured by a mortgage over their White Plains property They failed to pay, hence the property was sold at public auction and China Bank sent a demand letter for the deficiency amount. Unheeded, China Bank filed a collection suit in the trial court for the amount of P8,901,776.63, plus interests, penalties and cost. In their Answer, the Juicos admitted the debt but stated by way of affirmative defense that there was no cause of action since the extrajudicial foreclosure already answered for the principal. o Assuming there is, it cannot be imposed since it consists only of penalty and/or compounded interest on the accrued interest, which is generally not favored under the Civil Code. China Banks loan officer testified that she called the Juicos every month to inform, them of the prevailing interest rates. The interest rate changes every month based on the prevailing market rate and she notified the Juicos of the prevailing rate by calling them monthly before their account becomes past due. Ignacio admitted that prior to the release of the loan, he was required to sign a blank PN and was informed that the interest rate on the loan will be based on the prevailing market rates. Every month, China Bank informs him via phone of the prevailing rate He was able to pay at first, but eventually started to incur delay RTC/CA Ruled in favor of China Bank. It can collect the deficiency. On appeal to SC, the Juicos contend that the interest rates are invalid for being unilaterally imposed. They argue that the escalation clause in the PN does not give China Bank unbridled authority in increasing the interest rate. Issue: W/N the interest rates imposed are valid NO! Ratio: Escalation clause stipulation allowing an increase in interest agreed upon Such stipulations are not void per se. However, an escalation clause which grants the creditor an unbridled right to adjust the interest independently and upwardly, completely depriving the debtor of the right to assent to the modification is void. o Violates the principle of mutuality of contracts An escalation clause is void where the creditor unilaterally determines and imposes an increase in interest w/o the express conformity of the debtor Here, the PN states that the interest rate may change without notice
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2.2 Pledge, Chattel Mortgage and Antichresis Civil Code, Arts. 2085-2141
CHAPTER 1 Provisions Common to Pledge and Mortgage Article 2085. The following requisites are essential to the contracts of pledge and mortgage: (1) That they be constituted to secure the fulfillment of a principal obligation; (2) That the pledgor or mortgagor be the absolute owner of the thing pledged or mortgaged; (3) That the persons constituting the pledge or mortgage have the free disposal of their property, and in the absence thereof, that they be legally authorized for the purpose. Third persons who are not parties to the principal obligation may secure the latter by pledging or mortgaging their own property. (1857) Article 2086. The provisions of article 2052 are applicable to a pledge or mortgage. (n)
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Article 2102. If the pledge earns or produces fruits, income, dividends, or interests, the creditor shall compensate what he receives with those which are owing him; but if none are owing him, or insofar as the amount may exceed that which is due, he shall apply it to the principal. Unless there is a stipulation to the contrary, the pledge shall extend to the interest and earnings of the right pledged. In case of a pledge of animals, their offspring shall pertain to the pledgor or owner of animals pledged, but shall be subject to the pledge, if there is no stipulation to the contrary. (1868a) Article 2103. Unless the thing pledged is expropriated, the debtor continues to be the owner thereof. Nevertheless, the creditor may bring the actions which pertain to the owner of the thing pledged in order to recover it from, or defend it against a third person.
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ACT NO. 1508 AN ACT PROVIDING FOR THE MORTGAGING OF PERSONAL PROPERTY AND FOR THE REGISTRATION OF THE MORTGAGES SO EXECUTED Section 1. The short title of this Act shall be The Chattel Mortgage Law. Sec. 2. All personal property shall be subject to mortgage, agreeably to the provisions of this Act, and a mortgage executed in pursuance thereof shall be termed chattel mortgage. Sec. 3. Chattel mortgage defined. A chattel mortgage is a conditional sale of personal property as security for the payment of a debt, or the performance of
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Atty. Jose Cochingyan III 2.3. Credit Worthiness RA 8791, The General Banking Law of 2000, 40-43
Section 40. Requirement for Grant Of Loans or Other Credit Accommodations. Before granting a loan or other credit accommodation, a bank must ascertain that the debtor is capable of fulfilling his commitments to the bank. Toward this end, a bank may demand from its credit applicants a statement of their assets and liabilities and of their income and expenditures and such information as may be prescribed by law or by rules and regulations of the Monetary Board to enable the bank to properly evaluate the credit application which includes the corresponding financial statements submitted for taxation purposes to the Bureau of Internal Revenue. Should such statements prove to be false or incorrect in any material detail, the bank may terminate any loan or other credit accommodation granted on the basis of said statements and shall have the right to demand immediate repayment or liquidation of the obligation. In formulating rules and regulations under this Section, the Monetary Board shall recognize the peculiar characteristics of micro financing, such as cash flow-based lending to the basic sectors that are not covered by traditional collateral. (76a) Section 41. Unsecured Loans or Other Credit Accommodations. - The Monetary Board is hereby authorized to issue such regulations as it may deem necessary with respect to unsecured loans or other credit accommodations that may be granted by banks. (n) Section 42. Other Security Requirements for Bank Credits. - The Monetary Board may, by regulation, prescribe further security requirements to which the various types of bank credits shall be subject, and, in accordance with the authority granted to it in Section 106 of the New Central Bank Act, the Board may by regulation, reduce the maximum ratios established in Sections 36 and 37 of this Act, or, in special cases, increase the maximum ratios established therein. (78) Section 43. Authority to Prescribe Terms and Conditions of Loans and Other Credit Accommodations. - The Monetary Board, may, similarly in accordance with the authority granted to it in Section 106 of the New Central Bank Act, and taking into account the requirements of the economy for the effective utilization of longterm funds, prescribe the maturities, as well as related terms and conditions for various types of bank loans and other credit accommodations. Any change by the Board in the maximum maturities, as well as related terms and conditions for various types of bank loans and other credit accommodations. Any change by the Board in the maximum maturities shall apply only to loans and other credit accommodations made after the date of such action. The Monetary Board shall regulate the interest imposed on micro finance borrowers by lending investors and similar lenders such as, but not limited to, the unconscionable rates of interest collected on salary loans and similar credit accommodations. (78a)
PAMECA Wood Treatment Plant, Inc. v. Court of Appeals G.R. No. 106435, July 14, 1999
Facts: PAMECA Wood Treatment Plant obtained a P2M loan from respondent DBP PAMECA, through its officers, executed a PN, promising to pay it in installments. As security, a chattel mortgage was executed over its Dumaguete properties, consisting of inventories, furniture and equipment Upon its failure to pay, DBP extrajudicially foreclosed the chattel mortgage. It was the sole bidder. It then filed a collection suit for the balance RTC/CA Ordered PAMECA to pay the deficiency, plus interest and charges Issue: W/N Art. 1484 should apply to chattel mortgages in relation to Art. 2115 of the Civil Code NO! PAMECA is liable. Ratio: Ablaza v. Ignacio The povisions of the Chattel Mortgage Law regarding the effects of foreclosure of chattel mortgage, being contrary to the provisions of Art. 2115, Art. 2115 in relation to Art 2141 may not be applied The effects of foreclosure under the Sec. 14 of the Chattel Mortgage Law are inconsistent with those of pledge under Art. 2115 o Pledge the sale of the thing pledged extinguished the entire principal obligation, such that the pledger may no longer recover proceeds of sale in excess of the amount of the principal obligation o Sec. 14, CML entitled the mortgagor to the balance of the proceeds, upon satisfaction of the principal obligation and costs Since the CML bars the creditor-mortgagee from retaining the excess of the sale proceeds, there is a corollary obligation on the part of the debtormortgagee to pay the deficiency in case of reduction in the price at auction The chattels included in the chattel mortgage are only given as security and not as a payment of the debt, in case of failure of payment Art. 1484 applies only to the sale of personal property the price of which is payable in installments. Such is not the case here. Finally, the officers of PAMECA are liable jointly and severally with the company since they made themselves solidarily liable under the PN.
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2.4. Finer Points on Mortgages Loan Limits on Real Estate: RA 8971, The General Banking Law of 2000, 37
Section 37. Loans and Other Credit Accommodations Against Real Estate. Except as the Monetary Board may otherwise prescribe, loans and other credit accommodations against real estate shall not exceed seventy-five percent (75%) of the appraised value of the respective real estate security, plus sixty percent (60%) of the appraised value of the insured improvements, and such loans may be made to the owner of the real estate or to his assignees. (78a)
Blanket Mortgage Clause: Spouses Tecklo v. Rural Bank of Pamplona G.R. No. 171201, June 18, 2010
Facts: Sp Issue: Ratio: Blanket Mortgage Clause - Stipulation in the mortgage where the mortgagor can obtain future loans from the bank and the property subject to mortgage is the one already stipulated in the contract. Already covers the future loans.
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Heirs of George Y. Poe v. Malayan Insurance Corp. 584 SCRA 152 (2009)
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PROVIDING FOR THE REGULATION OF TRUST RECEIPTS TRANSACTIONS WHEREAS, the utilization of trust receipts, as a convenient business device to assist importers and merchants solve their financing problems, had gained popular acceptance in international and domestic business practices, particularly in commercial banking transactions; WHEREAS, there is no specific law in the Philippines that governs trust receipt transactions, especially the rights and obligations of the parties involved therein and the enforcement of the said rights in case of default or violation of the terms of the trust receipt agreement; WHEREAS, the recommendations contained in the report on the financial system which have been accepted, with certain modifications by the monetary authorities included, among others, the enactment of a law regulating the trust receipt transactions; NOW, THEREFORE, I, FERDINAND E. MARCOS, President of the Philippines, by virtue of the powers vested in me by the Constitution, as Commander-in-Chief of all the Armed Forces of the Philippines, and pursuant to Proclamation No. 1081, dated September 21, 1972, and General Order No. 1, dated September 22, 1972, as amended, and in order to effect the desired changes and reforms in the social, economic, and political structure of our society, do hereby order and decree and make as part of the law of the land the following: Section 1. Short Title. This Decree shall be known as the Trust Receipts Law. Section 2. Declaration of Policy. It is hereby declared to be the policy of the state (a) to encourage and promote the use of trust receipts as an additional and convenient aid to commerce and trade; (b) to provide for the regulation of trust receipts transactions in order to assure the protection of the rights and enforcement of obligations of the parties involved therein; and (c) to declare the misuse and/or misappropriation of goods or proceeds realized from the sale of goods, documents or instruments released under trust receipts as a criminal
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Article 1233. A debt shall not be understood to have been paid unless the thing or service in which the obligation consists has been completely delivered or rendered, as the case may be. Article 1236. The creditor is not bound to accept payment or performance by a third person who has no interest in the fulfillment of the obligation, unless there is a stipulation to the contrary. Whoever pays for another may demand from the debtor what he has paid, except that if he paid without the knowledge or against the will of the debtor, he can recover only insofar as the payment has been beneficial to the debtor. (1158a) Article 1237. Whoever pays on behalf of the debtor without the knowledge or against the will of the latter, cannot compel the creditor to subrogate him in his rights, such as those arising from a mortgage, guaranty, or penalty. (1159a) Article 1238. Payment made by a third person who does not intend to be reimbursed by the debtor is deemed to be a donation, which requires the debtor's
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International Corporate Finance 2.10. Payment by Cession Civil Code, Arts. 1255
Article 1255. The debtor may cede or assign his property to his creditors in payment of his debts. This cession, unless there is stipulation to the contrary, shall only release the debtor from responsibility for the net proceeds of the thing assigned. The agreements which, on the effect of the cession, are made between the debtor and his creditors shall be governed by special laws. (1175a)
Article 1278. Compensation shall take place when two persons, in their own right, are creditors and debtors of each other. (1195) Article 1279. In order that compensation may be proper, it is necessary: (1) That each one of the obligors be bound principally, and that he be at the same time a principal creditor of the other; (2) That both debts consist in a sum of money, or if the things due are consumable, they be of the same kind, and also of the same quality if the latter has been stated; (3) That the two debts be due; (4) That they be liquidated and demandable; (5) That over neither of them there be any retention or controversy, commenced by third persons and communicated in due time to the debtor. (1196) Article 1280. Notwithstanding the provisions of the preceding article, the guarantor may set up compensation as regards what the creditor may owe the principal debtor. (1197) Article 1281. Compensation may be total or partial. When the two debts are of the same amount, there is a total compensation. (n) Article 1282. The parties may agree upon the compensation of debts which are not yet due. (n) Article 1283. If one of the parties to a suit over an obligation has a claim for damages against the other, the former may set it off by proving his right to said damages and the amount thereof. (n)
Article 1291. Obligations may be modified by: (1) Changing their object or principal conditions; (2) Substituting the person of the debtor;
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3. Economic Attributes of Investment Devices WILLIAM A. KLEIN & JOHN C. COFFEE, JR., ORGANIZATION AND FINANCE, 240-251 (2007) BUSINESS
Expected Return A measure of return that uses rudimentary concepts of probability to take account of risk or uncertainty as to outcome. Technically, expected return is the weighted average (or arithmetic mean) of all possible outcomes. This definition ignores the amount of initial investment, thus telling nothing about the profitability. When concerned with profit, use the concept expected rate of return Risk and Uncertainty Risk is used in the financial world in two different senses: Volatility Risk and Default Risk Volatility Risk o Refers to the degree of dispersion or variation of possible outcomes o Volatility/dispersion refers to a combination of the probability of deviationthat is, the degree of likelihood of receiving an amount which is more or less from the expected return o One investment is said to be more risky than another if the dispersion of potential outcomes is greater. o Term commonly used by financial experts is variance Default Risk o Refers to the possibility of nonpayment of a debt or to the probability of similar kinds of defaults o It may refer to the difference between the promised rate of return (yield) and the expected rate of return Distinction between risk and uncertainty o Risk used to refer to variation depending purely on chance or, more broadly, to measurements as to which there is a large body of data or experience so that the probable outcomes can be estimated in a purely mechanical way o Uncertainty refers to estimates made in situations where there is so little experience that the process of estimation is highly intuitive Probabilities refers to outcomes, in the financial jargon Yield It is a promised rate of return
Risk Premium Defined as the difference between the yield on a particular obligation and the prevailing market rate (yield) on an obligation with identical characteristics but with no risk of default. o Thus, the higher the risk, the greater the return The most important characteristics that must be held constant (identical) in comparing a risky and a risk-free obligation are duration or maturity date and callability o Callability refers to the circumstances in which the borrower is allowed to pay off the loan before maturity and thus deprive the lender of a favorable investment The risk premium compensates both for default risk and for the volatility risk associated with default risk o However, mostly represents compensation for default risk since compensation for volatility risk may be negligible Default risk, distinguished from volatility risk associated with changes in the market rate of interest o With any change in the market rate of interest, the amount of change in the value of existing obligations will depend on the length of time of maturity o The longer the duration of an obligation, the more its market price will change with any change in the market rate of interest Accordingly, the volatility of the price of long-term obligations is greater than that of short-term obligations Illiquidity Premium a premium to compensate for the greater potential price volatility for long-term obligations This is because long-term obligations are less liquid (less close to cash) than short-term obligations and that there is an added amount, a premium, in the long-term interest rate to compensate for the illiquidity Risk Aversion The attitude of dislike towards taking risks, even paying some price just to avoid them.
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Compensation for Volatility Risk Investors are compensated only for volatility risk that cannot be avoided by diversification. Generally, in offering bonds, corporations must lower the price of its obligation to compensate for the default risk and volatility risk Types of Securities A. Bonds, Debentures and Notes Bonds and debentures are manifestations of commitments of funds to a firm for a relatively long period of time (generally, five years or more). o The commitment reflected in bonds and debentures is, however, of limited duration. o There is a fixed date called the maturity date, at which the firm must pay the principal sum Notes are usually shorter-term obligations Bond a long-term obligation secured by a mortgage on some property of the issuer Debenture a long term unsecured obligation
4.1.
4. Debt Instruments and Loan Documentation KENNETH H. MARKS, LARRY E. ROBBINS, GONZALO FERNANDEZ AND JOHN P. FUNKHOUSER, THE HANDBOOK OF FINANCING GROWTH, 164-218 (2005)
Debt Instruments Debt instruments may be categorized into two broad categories: secured debt or unsecured debt Secured Debt
Securing the Commitment The borrower must be able to articulate a rational purpose for the loan request together with a financial plan that supports repayment of the loan Traditional method preparation of a business plan for the borrower that includes info on his business and historical performance, as well as a forecast of future performance o Forecast includes a clear description of the use of loan proceeds o Should include inventory and accounts receivable Evaluating financial forecasts o The lender will make its own determination as to whether the borrowers assumptions on financial performance are reasonable o Small loans the bank and its internal underwriters and credit officers will make the determination o Large loans the bank may rely on outside industry experts
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Commitment Letter After the lender finished a favorable evaluation and review of the loan request, it will issue a commitment letter Its purpose is to provide a borrower with an outline of the fundamental terms and conditions relating to the lenders willingness to extend a loan With a detailed description of the lenders proposal in hand, the borrower may then use the letter to provide third parties with confidence that it is capable of consummating a transaction, particularly in acquisitions Syndication process o If the loan requested is in excess of the amount desired to be advanced by the lender, the letter would normally describe a syndication process o The commitment letter will name the committing lender as the administrative agent for arranging a syndicate of lenders who will participate in making the overall loan After its issuance, there will normally be some period of time that lapses after the actual closing of the loan o May include a variety of conditions, like the lenders completion of due diligence or in terms of market conditions Commitment Letter Summary of Terms and Conditions As the size of the proposed transaction increases, lenders will typically generate a commitment letter that contains general terms and conditions relating to the obligation of the lender to make the loan A summary of specific terms and conditions of the loan will, however, be contained in a separate document Where the commitment letter contains an obligation on the part of the lender to provide several different types of facilities to one borrower, the lender may reserve the right to change the pricing and yield allocation between differing facilities Market flex rights o Where the lender determines that the assumptions regarding market conditions or the borrowers financial performance have changed, the lender will want to reserve some flexibility to change the relative size of the facilities that have been committed. o In exercising market flex, a lender would keep the overall size of a commitment stable, but could vary the size of its components
Fee Letter Where a lender separates information regarding fees from the base commitment letter, the normal reasons stated for the structure will relate to the lenders desire to maintain the confidentiality of the fees quoted as being payable in connection with the loan Examples of fees commitment fees, underwriting fees, structuring fees, financial advisory fees, ticking fees, expense reimbursements and administrative fees Commitment fee Generally payable upon issuance of the commitment letter. Its size normally varies by the risk associated with the type of loan being made Ticking fees similar to payments required by lenders for unused borrowing capacity. They are charged when a commitment is expected to extend over a protracted period of time, and where a closing is anticipated to take place at some distant time in the future May also provide that out of pocket expenses incurred in connection with the underwriting or closing of a loan must be reimbursed by the borrower. o Normally includes legal fees, consultants fees and credit reports
4.2.
Loan Documentation Loan documentation can be as simple as a lenders standard promissory note with blanks filled in describing the loan amount, interest rate, and payment schedule. For larger, complicated loans, a loan documentation package might include a credit agreement, note security agreement, guarantee agreement, collateral assignment agreement, pledge agreement, inter-creditor agreement, subordination agreement and financing statements. Credit Agreement A typical credit agreement will contain five or six primary sections: o A description of the size and type of the credit facility o Applicable interest rates o A covenant section o A section dealing with representations and warranties o A section describing events of default o A section indicating the conditions that must be satisfied in order for the lender to make the loan Contains conditions precedents before closing
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International Corporate Finance 4.3. Types of Credit Facilities o Term Loans 4.6. 4.7. 4.8.
Atty. Jose Cochingyan III Borrowers Financial Statements Borrowers Operations Loan Covenants o Affirmative Covenants o Negative Covenants o Prepayment Covenants o Financial Covenants Liquidity Ratios Leverage Ratios Events of Default Remedies Available Upon an Event of Default The Promissory Note The Security Agreement The Collateral Assignment The Inter-Creditor Agreement Subordination Agreement Categories of Debt Instruments Secured Loans Asset Based Fiancings Cash Flow Based Financings Junior Secured Loans Unsecured Loans High Yield Debt Mezzanine Financings Convertible Debt and Convertible Stock Bridge Loans Specialized Lending Credit Ratings and Reporting Agencies
Credit facilities fall into two primary categories of loans: term or revolving
Term Loans It is a fixed amount of money advanced by a lender to a borrower where the borrower is expected to repay the loan amount plus interest over a specified period of time The repayment terms are negotiated based on the ability of the borrower to repay the loan based on financial projections provided by the borrower and agreed to by the lender It may be repaid in a lump sum at end of a fixed period or amortized and paid in specific periodic payments during the term of the loan Its typical life will in many cases match the life of the asset acquired with the proceeds of the loan
Revolving Loans
Revolving Loans Also known as revolvers or revolving credit facilities. In the Philippines, it is known as a credit line These are loans with stated maximum loan amounts, but variable amounts that can actually be drawn down by a borrower that are determined periodically by reference to certain levels of borrower assets Assets used to determine a borrowers available loan amount normally include accounts receivable and inventory o As these assets increase, the borrowers loan capacity increases up to a maximum predetermined amount In order to determine the actual loan capacity of a borrower at any given time, a lender will review the borrowing base It is customary for a borrower to pay down a revolving loan with the collection of its accounts receivable such that the availability under a loan package increases with collections applied to the loan and decreases as amounts are redrawn Revolving credit facilities will also permit a company to use availability to provide suppliers or customers with letters of credit
4.9. 4.10. 4.11. 4.12. 4.13. 4.14. 4.15. 4.16. 4.17. 4.18. 4.19. 4.20. 4.21. 4.22. 4.23. 4.24. 4.25. 4.26. 4.27. 4.28. 4.29.
o 4.4. 4.5.
(B) Interest (1) In General. - 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 otherwise allowable deduction for interest expense shall be reduced by an amount equal to the following percentages of the interest income subjected to final tax: Forty-one percent (41%) beginning January 1, 1998;
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Sec. 4.109-1. VAT-Exempt Transactions (A) In general. VAT-exempt transactions refer to the sale of goods or properties and/or services and the use or lease of properties that is not subject to VAT (output tax) and the seller is not allowed any tax credit of VAT (input tax) on purchases. The person making the exempt sale of goods, properties or services shall not bill any output tax to his customers because the said transaction is not subject to VAT. (B) Exempt Transactions. (1) Subject to the provisions of Subsection (2) hereof, the following transactions shall be exempt from VAT: xxx (m) Gross receipts from lending activities by credit or multipurpose cooperatives duly registered and in good standing with the Cooperative Development Authority (u) Services of banks, non-bank financial intermediaries performing quasi-banking functions, and other non-bank financial intermediaries subject to percentage tax under Secs. 121 and 122 of the Tax Code, such as money changers and pawnshops. Sec. 4.109-2. A VAT-registered person may elect that the exemption in Subsection (1) hereof shall not apply to his sales of goods or properties or services. Once the election is made, it shall be irrevocable for a period of three (3) years counted from the quarter when the election was made.
5.2.
Indirect Taxes Distribution or transfer of goods to creditors in payment of debt: Revenue Regulation No 16-2005 4.106-7(a)(2)(ii)
Sec. 4.106-7(a)(2)(ii) Transactions Deemed Sale (a) The following transactions shall be deemed sale pursuant to Sec. 106(B) of the Tax Code: (1) xxx (2) Distribution or transfer to: (i) xxx (ii) Creditors in payment of debt or obligation Thus, a distribution or transfer to creditors in payment of a debt or obligation is a deemed sale transaction.
Percentage Taxes; Gross Receipts Tax: 121, 122 (As amended by RA No. 9337)
NIRC
Extent of VAT exemption on interest: NIRC 109(M), (U); Revenue Regulation No. 16-2005 4.109-1(B)(1)(m), (u)
SEC. 121. Tax on Banks and Non-Bank Financial Intermediaries Performing Quasi-Banking Functions. - There shall be collected a tax on gross receipts derived from sources within the Philippines by all banks and non-bank financial intermediaries in accordance with the following schedule: (a) On interest, commissions and discounts from lending activities as well as income from financial leasing, on the basis of remaining maturities of instruments from which such receipts are derived: Maturity period is five years or less 5% Maturity period is more than five years 1% (b) On dividends and equity shares and net income of subsidiaries 0% (c) On royalties, rentals of property, real or personal, profits, from exchange
41
5.3.
Inter-company Loans Revenue Memorandum Order No. 63-99 (July 19, 1999)
42
Arms Length Interest Rate o In general, 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 o 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). o 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.
Interest Period The interest period shall commence at the date the indebtedness arises, except that with respect to indebtedness arising in the ordinary course of business out of sales, leases, or supply of goods and services which are generally considered as trade accounts receivables or payables, the interest period shall not commence if the taxpayer is able to establish that the normal trade practice in a given industry is to allow balances, in the case of similar transactions with unrelated parties, to remain outstanding for a longer period without charging interest. For purposes of determining the period of time for which a balance is outstanding, payments or credits shall be applied against the earliest balance outstanding. The taxpayer may, in accordance with an agreement, apply such payments or credits in some other order in its books only after establishing that the arrangement is customary for parties in that particular business.
(March
8,
2006,
43
BIR Ruling No. DA-320-07 (May 31, 2007, Epson Precision Phils.)
Ratio: [for 3rd issue only (inter-company advances)] The BIR in RMO No. 63-99 provided that for inter-company advances, the interest charge and interest rate to be used shall represent an arm's length rate. The definition of an arm's length rate is provided in RMO No. 63-99: o 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. Considering that EPPI in charging interest on advances made to its affiliates will use the bank reference rate, the imputation of interest based on such bank reference rate shall be considered as at arm's length which is in conformity with the provisions of the above quoted RMO.
Facts: Epson Precision (Phils.) Inc. ("EPPI") is a corporation incorporated and existing under the laws of the Philippines. It is engaged in the manufacturing of electrical, plastic and metal products. On April 2007, EPPI executed a Board Resolution wherein EPPI will provide inter-company cash advances to its affiliates or The Epson Group for financial support. o Under the resolution, EPPI will charge its affiliates monthly interest using the bank reference rate for the cash advances made in order that the transaction will be considered at arm's length. o Aside from charging its affiliates with monthly interest, EPPI shall also, from time to time, demand payment of a portion of the principal amount together with the accrued interest due. o In documenting the transaction, EPPI will issue an inter-office memo and record such transactions in its books as an inter-company advances. Issues: Since the inter-company advances between EPPI and The Epson Group are documented by mere board resolution and inter office memo, the same are not subject to Documentary Stamp Tax ("DST") on loan agreements. YES EPPI is not a lending investor because its grant of cash advance to The Epson Group was not done in pursuit of a business activity nor was it made
Circular
No.
48-2011
Subject: Circularization of the relevant excerpts from the Supreme Court Decision in the case of CIR v. Filinvest Development Corp, date July 19, 2011, on the imposition of Documentary Stamp Tax on inter-office memo covering advances granted by an affiliated corporation Highlights Section 180 of the Tax Code as amended discussing the stamp tax on bonds, loan agreements, promissory notes, bills of exchange, drafts instruments and securities issued by the Government or any of its instrumentalities, deposits substitute debt instruments, certificates of deposits bearing interest and others not payable on sight or demand in conjunction with Section 173 of the 1993 NIRC. In CIR vs. Filinvest Development Corporation, G. R. No. 163653 and 167689 dated July 19, 2011, the Supreme Court held that instructional letters, as well as journal and cash vouchers, evidencing intercompany advances extended to affiliates in 1996 and 1997 qualified as loan agreements, and are subject to DST imposed under Section 180, in relation to Section 173 of the old Tax Code, as implemented under Sections 3(b) and 6 of RR No. 9-94. Accordingly, all employees engaged in the audit and review of audit cases
44
5.4.
Documentary Stamp Tax Rates: NIRC, 179, 180, 199(f) (see Revenue Regulation 13-2004 in relation to RA No. 9243)
SEC. 179. Stamp Tax on Bank Checks, Drafts, Certificates of Deposit not Bearing Interest, and Other Instruments. - On each bank check, draft, or certificate of deposit not drawing interest, or order for the payment of any sum of money drawn upon or issued by any bank, trust company, or any person or persons, companies or corporations, at sight or on demand, there shall be collected a documentary stamp tax of One peso and fifty centavos (P1.50). SEC. 180. Stamp Tax on All Bonds, Loan Agreements, promissory Notes, Bills of Exchange, Drafts, Instruments and Securities Issued by the Government or Any of its Instrumentalities, Deposit Substitute Debt Instruments, Certificates of Deposits Bearing Interest and Others Not Payable on Sight or Demand. - On all bonds, loan agreements, including those signed abroad, wherein the object of the contract is located or used in the Philippines, bills of exchange (between points within the Philippines), drafts, instruments and securities issued by the Government or any of its instrumentalities, deposit substitute debt instruments, certificates of deposits drawing interest, orders for the payment of any sum of money otherwise than at sight or on demand, on all promissory notes, whether negotiable or nonnegotiable, except bank notes issued for circulation, and on each renewal of any such note, there shall be collected a documentary stamp tax of Thirty centavos (P0.30) on each Two hundred pesos (P200), or fractional part thereof, of the face value of any such agreement, bill of exchange, draft, certificate of deposit, or note: Provided, That only one documentary stamp tax shall be imposed on either loan agreement, or promissory notes issued to secure such loan, whichever will yield a higher tax: Provided, however, That loan agreements or promissory notes the aggregate of which does not exceed Two hundred fifty thousand pesos (P250,000) executed by an individual for his purchase on installment for his personal use or that of his family and not for business, resale, barter or hire of a house, lot, motor vehicle, appliance or furniture shall be exempt from the payment of the documentary stamp tax provided under this Section. Sec 199(f) (see rr 13-2004 in relation to RA No. 9243)
This RAMO is issued as a basic guideline for the joint and coordinated examination of interrelated group of companies under RMO No. 61-98. Background The remarkable decrease in collection from interrelated group of companies has seriously affected the collection efforts of the Bureau. Statistics showed that while 'inter-related transaction' accounts for a big percentage of the transfer of goods and services in the country, the revenue collection from related-party groups continue to go on a downtrend. The magnitude of revenue lost has become so alarming that there is a need to immediately address this problem. It is a fact that, because these companies are more interested in their net income as a whole (rather than as individual corporations) there is a desire to minimize tax payments by taking advantage of the loopholes in our tax system and by making use of schemes that allow them to move around the law in order to reduce their tax obligations. It is therefore necessary to conduct a joint and coordinated examination of interrelated group of companies in order to identify the tax avoidance schemes and be able to prescribe the necessary measures in order to avoid the erosion of revenues. General Guidelines General Procedures. The provisions laid down in Volume 1 of the Handbook on Audit Procedures and Techniques must be followed with respect to: o Basic reportorial requirements; and o General audit procedures and techniques.
5.5.
45
Definition of Terms o Controlled any kind of control, direct or indirect, whether legally enforceable and however exercisable or exercised. It is the reality of the control which is decisive, not its form or the mode of its exercise or ownership. A presumption of control arises if income and expenses have been arbitrarily shifted. o Controlled taxpayer any one or two or more organizations or trade, or businesses owned or controlled directly or indirectly by the same interests; o True taxable income the taxable income which would have been reported by the controlled taxpayer, had it in the conduct of its affairs dealt with the other member or members of the group at arm's-length.
Audit Procedures Transfer Pricing in interrelated supply of goods or services. This is relevant if one of the related-party enjoys certain privileges such as tax exemption, lower tax rates, incentives, or is a losing company. o In General. - The method to be used in determining the arm's-length price of a controlled transaction shall rely primarily on the best judgment of the examiner after taking into consideration the prevailing circumstances as well as the availability of information at the time of transaction. o As a guide, the methods under the OECD Guidelines on transfer Pricing may be used, as follows: The Comparable Uncontrolled Price Method (CUP) - this evaluates the arm's length by reference to the amount charged in a comparable uncontrolled transaction. In evaluating comparability, consider the following: trademark product differences geographical differences, and
46
Loans and Advances, and financing arrangements between or among related parties o In General. When one member of a group makes a loan or advance directly or indirectly to, or otherwise becomes a creditor of another member and either party charges an interest which is not at arm's length, there may be a tax advantage to either the lender or borrower. o Loans and Advances may be in the form of: Bona fide indebtedness such as loans or advances of money or other considerations; Indebtedness arising in the ordinary course of business from sales, leases, or the rendition of services by and between members of the group, or any other similar extension of credit; Alleged indebtedness For purposes of this Section, an "arm's length rate of interest" is the rate of interest which would have been charged in independent transactions between unrelated parties under similar circumstances. o Financing Arrangements. A common element in related-party groups is the presence of a finance company (usually a holding company) to provide financial services for the members of the group. Financial services by a holding company may range from serving as a central lender for the group, in which capacity, it may borrow funds from unrelated financial institutions and on-loan such amounts to its subsidiaries. It may also perform financial intermediary services for the group including factoring and hedging. 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.
47
Atty. Jose Cochingyan III CTA Case No. 5082 (January 16, 1997) And CIR v. CTA and Oranbo Realty Corp. CA-GR SP No. 44039 (October 10, 2001)
CTA Case: Facts: This appeal involves petitioner's claim for refund or tax credit of the sum of P922,311.00, representing overpaid creditable withholding tax for calendar year ended December 31, 1991. Petitioner Oranbo Royalty Corp. is a domestic corporation duly organized and existing under the laws of the Philippines During the calendar year 1991, petitioner leases its properties to Aris Philippines, Inc. and Sehwani, Inc. from which it realized a total rental income in the amount of P19,761,612.00. Oranvo alleged that out of the payments of Aris Phil, Inc., a 5% expanded withholding tax was deducted by the latter in the sum of P973,081. On April 15, 1992, Oranbo filed its income tax return for the calendar year ending December 31, 1991 reflecting a net taxable income of P145,058.00 with a corresponding income tax liability of P50,770.00, but with a refundable income tax in the amount of P922,311.00 arising from the unutilized portion of the 5% expanded withholding tax from Aris Inc. This overpaid income tax for 1991 was not utilized by petitioner in the succeeding taxable year 1992. Instead, it opted to file a written claim for refund or tax credit with the Bureau of Internal Revenue on April 28, 1993. The inaction of the CIR on its letter-claim for refund/tax credit compelled Oranbo to file this petition for review in order to preserve its right to judicially claim the refund of excess payment of creditable withholding tax The CIRs investigation eventually found Oranbo liable for deficiency income tax in the total amount of P10,442,959.84 Issue: W/N Oranbo is entitled to refund YES! The issues posed before Us are us follows: 1. Whether or not the revenue examiner's report of investigation can negate petitioner's entitlement for the refund; and if not, 2. Whether or not petitioner has proven its entitlement thereto.
Revenue Audit Memorandum Order No. 1-00 Rule IX. P. 1 (March 11, 2000)
Subject: Updated Handbook on Audit Procedures and Techniques (Vol. 1) IX. Balance Sheet Approach To Examination The following discussion offer guides and techniques in examining asset, liability and net worth accounts. The Revenue Officer, however, is not precluded from applying other techniques which are deemed necessary in a particular case. P. Loans from Shareholders/Officers/Owners 1. Determine whether there is a true debtor-creditor relationship. Excessively large liabilities in relation to capital stock (especially in the case of a new company) may indicate a thin capitalization situation.
Revenue Audit Memorandum Order No. 1-98 Audit Guidelines and Procedures in the Examination of Interrelated Group of Companies (July 7, 1998) 3.5
Thin Capitalization and Earning Stripping In General - The most common form of tax avoidance scheme using corporate structure is high-debt financing of thinly capitalized controlled company. This scheme favors debt over equity as a form of financing mainly because of tax favored treatment of interest payments compared to dividends. Under present laws, interest payments are fully deductible against taxable income while dividends are not. The tax advantages of interest payments in contrast to dividend is an outright savings of 35% (34%-32% under CTRP) in the form of a deductible expense against the taxable base. If interest payments are subjected to 20% Final Tax (while intercorporate dividends are at 0% tax), financing through debt rather than equity would still have an advantage equivalent to 15%. In the absence of rules prescribing guidelines and presumptions as to what constitute thin capitalization (unlike other countries), there is a necessity to determine the reasonable ratio of debt over equity considering all factors surrounding the case.
Ratio: CIR asserts that Oranbo is not entitled to the refund or tax credit because on the report of investigation conducted by the revenue examiner. Pertinent portion of said report is hereby quoted as follows:
48
49
(1) In the general. The amount of interest paid within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations the interest upon which is exempt from taxation as income under this Title: . . .' (Emphasis supplied) Thus, the general rule is that interest expenses are deductible against gross income and this certainly includes interest paid under loans incurred in connection with the carrying on of the business of the taxpayer. In the instant case, the CIR does not dispute that the interest payments were made by Picop on loans incurred in connection with the carrying on of the registered operations of Picop, i.e., the financing of the purchase of machinery and equipment actually used in the registered operations of Picop. Neither does the CIR deny that such interest payments were legally due and demandable under the terms of such loans, and in fact paid by Picop during the tax year 1977. The CIR has been unable to point to any provision of the 1977 Tax Code or any other statute that requires the disallowance of the interest payments made by Picop. The CIR invokes Section 79 of Revenue Regulations No. 2 as amended which reads as follows: 'Section 79. Interest on Capital. Interest calculated for cos-keeping or other purposes on account of capital surplus invested in the business, which does not represent a charge arising under an interest-bearing obligation, is not allowable deduction from gross income.' (Emphasis supplied) We read the above provision of Revenue Regulations No. 2 as referring to so called "theoretical interest," that it to say, interest "calculated" or computed (and
50
51
(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; (6) ours) Between a fiduciary of a trust and a beneficiary of such trust." (Emphasis
This Court noted, based on the examiner's report, that Aris Philippines, Inc. only owns (40%) of the outstanding stock of petitioner-Oranbo. Since Aris Philippines, Inc. does not own more than 50% of the outstanding stock of petitioner then it is not covered under the items not deductible as a business expense. Furthermore, Mr. Rolf H. Schroeder, being the Chairman of petitioner-Oranbo and at the same time President of Aris Philippines, Inc. does not mean that the corporations he represented are related taxpayers. Respondent should have vital evidence to support her contention. cda As regards the second issue, petitioner must prove its entitlement to the refund sought. It therefore, must comply with the following three basic requisites, to wit: "1. That it filed a claim for refund within the two (2) year period from date of payment of the tax as prescribed under Section 299 (now 230) of the National Internal Revenue Code, as amended; 2. That the income upon which the taxes were withheld at source under Section 53 were included as part of the income declared in the income tax return of the recipient; and 3. The fact of withholding is established by a copy of statement (BIR Form 1743.1) duly issued by the payor (withholding agent) to the payee, showing the amount paid and the amount of tax withheld therefrom." [Sec 10, Rev. Regs. 685; see Citytrust Finance Corporation vs. The Commissioner of Internal Revenue, CTA Case No. 4134, November 11, 1991; affirmed by the Court of Appeals in Citytrust Finance Corporation vs. Court of Tax Appeals and the Commissioner of Internal Revenue, CA-G.R. SP No. 28239, March 14, 1994; and Citytrust Finance Corporation (Formerly Investor's Finance Corporation/FNCB Finance) vs. Commissioner of Internal Revenue, CTA Case No. 4046, February 24, 1993; affirmed by the Court of Appeals in Commissioner of Internal Revenue vs. Citytrust Finance Corporation (Formerly Investors Finance Corporation/FNCB Finance) and the Court of Tax Appeals, CA-G.R. SP No. 31104, April 18, 1994].
(2) No deduction shall be allowed in respect of interest under the succeeding sub-paragraphs: (i) ...
(ii) If both the taxpayer and the person to whom the payment has been made or is to be made are persons specified under Section 30 (b)." "SEC. 30. Items not deductible. (a) General rule. In computing taxable income to deduction shall in any case be allowed in respect of 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 (1) Between members of the family. For the 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; (2) Except in the case of distributions in liquidation, between an individual and a corporation more than fifty per centum in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual; (3) Except in the case of distributions in liquidation, between two corporations more than fifty per centum 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
52
Before Us is a petition for review seeking to set aside the January 16, 1997 Decision of public respondent Court of Tax Appeals in C.T.A. Case No. 5038, "Oranbo Realty Corporation vs. Commissioner of Internal Revenue", and the April 7, 1997 Resolution denying reconsideration thereof. In its annual income tax return filed on April 15, 1992 for taxable year 1991. Oranbo Realty Corporation (Oranbo) posted a total rental income of P19,766,498.00 but with total deductions amounting to P19,621,440.00, the taxable income was P145,058.00. Tax liability was thus computed at P50,770.00. TcDHSI Oranbo, however, declared a creditable tax withheld at source in the amount of P973,081.00 and applied the same for the payment of its aforementioned tax liability. This left an overpaid and refundable income tax of P922,311.00 in favor of Oranbo which lodged with the Commissioner of Internal Revenue (petitioner) a written claim for refund or tax credit on April 28, 1993. Petitioner did not act, however, on Oranbo's claim, prompting it to file a petition for review with the Court of Tax Appeals (the CTA) on March 28, 1994. On November 21, 1994, petitioner through a revenue officer released a report finding that Oranbo was not entitled to tax refund or credit. The CTA held, however, that Oranbo was entitled to tax refund or credit and accordingly disposed as follows: "WHEREFORE, in view of the (sic) all the foregoing, respondent is hereby ORDERED to REFUND or in the alternative to ISSUE A TAX CREDIT CERTIFICATE in favor of petitioner the sum of P922,311.00, representing overpaid income tax for the year 1991." Hence, the present petition for review, petitioner contending that Oranbo is not entitled to any refund or credit since the alleged overpaid income tax resulted from improper deductions of Oranbo's supposed interest expense arising from a P40 million loan from the Bank of the Philippine Islands (BPI) and a P27 million loan from the United Coconut Planters Bank (UCPB) against its gross rental income for the 1991 taxable year. cHATSI With respect to the BPI loan, petitioner argues that interests thereon are deductible for the loan itself greatly exceeded Oranbo's capital stock so that loan, coupled with its concomitant interests, should have been treated as lender's capital investment and not a deductible expense on the part of borrower Oranbo. not the the the
53
It has been established, even implicitly admitted by petitioner, that Oranbo contracted loans from BPI and UCPB in 1989 and 1990, respectively in the course of and relative to its business operations for which it paid interests thereon. The general rule is that interest expenses are deductible against gross income, and it certainly includes interest paid under loans incurred in relation to the carrying on of the taxpayer's business (Paper Industries Corporation of the Philippines v. Court of Appeals, 250 SCRA 434, 1995). Thus, under Section 29 (b) of then existing 1997 Tax Code, now section 34 (B-1) of the Tax Reform Act of 1997, the interests paid or incurred within a taxable year on indebtedness in connection with the taxpayer's profession, trade or business may be deducted against gross income. The records of the present case provide no reason why Oranbo's interest payments should not fall under the said rule, such interest payments having been made for loans obtained in connection with Oranbo's business. Petitioner's argument that the BPI loan suspiciously exceed Oranbo's capital stock and so must be considered, together with the interests thereon, as the lender's capital investment deserves scant consideration. No proof had been adduced that the loan was actually the consideration for BPI's acquisition of shares of stock in Oranbo. Petitioner's claim was mere speculation. The loan thus stands as it is an indebtedness incurred by Oranbo for which it paid interests. Petitioner's argument that the UCPB loan the proceeds of which Oranbo used to purchase land is really capital expenditure and so are the interests thereon likewise deserves scant consideration. The Tax Code clearly requires that for interest to be deductible, it must be on business debts (The Law on Income Taxation, Teodoro and De Leon p. 107) or "on indebtedness in connection with the taxpayer's profession, trade or business." As earlier indicated, Oranbo is engaged in the realty business and the loan with which it acquired land or real property is unmistakably a business debt for which interest payments thereon are plainly deductible. TCDcSE In line, as a matter of principle the conclusion reached by an agency such as the CTA will not be set aside, it being by the nature of its function, dedicated
2. Revisiting the Share of Stock in the Philippine Context 2.1. 2.2. 2.3. 2.4. 2.5. Shares and their classification: CESAR L. VILLANUEVA, PHILIPPINE CORPORATE LAW, 591-608 (2013) PLDT v. NTC 539 SCRA 365 (2007) Shares of Stock - CORPORATION CODE 6, 7, 8, 9 Outstanding Capital Stock - CORPORATION CODE 137 Pre-emptive Right - CORPORATION CODE 39 and THOMAS LEE HAZEN, JERRY W. MARKHAM. CORPORATIONS AND OTHER BUSINESS ENTERPRISES, Section 6. Preemptive Rights, 1424-1446 (2009).
Dilution of their equity Dilution of their proportional voting control 3. Basic Taxation 3.1. Capital Gains Tax on Sale of Shares
54
International Corporate Finance 3.1.1. Shares of stock not traded in the exchange: NIRC 27(D)(2), 28 (7)(c), 28(c) stock 3.1.4.
Atty. Jose Cochingyan III Procedural Aspects for Shares Not Traded in the Stock Exchange Payment of Tax and Filing of Returns: Revenue Regulation 6-2008 10(c)
(2) Capital Gains from the Sale of Shares of Stock Not Traded in the Stock Exchange. - A final tax at the rates prescribed below shall be imposed on net capital gains realized during the taxable year from the sale, exchange or other disposition of shares of stock in a domestic corporation except shares sold or disposed of through the stock exchange: Not over P100,000................................... 5% Amount in excess of P100,000................. 10%
BIR Ruling No. 079-2010 (Sept. 23, 2010) (LEA) Revenue Regulation No. 6-2008 (April 22, 2008) 2 (t), 2(y), 2(h), 2(i), 2(v) 2(o), 2(p), 7, as amended by RR No. 006-13 (April 12, 2013)
Persons deriving capital gains from the sale or exchange of listed shares of stock not traded through the Local Stock Exchange as prescribed by these regulations shall file a return within thirty (30) days after each transaction and a final consolidated return of all transactions during the taxable year on or before the fifteenth (15th) day of the fourth (4th) month following the close of the taxable year. In the case of an individual taxpayer, the filing of the final consolidated return of all transactions shall be during the calendar year. However, for corporate taxpayers, the filing of the final consolidated return of all transactions shall be in accordance with the accounting period employed by such taxpayer which may either be calendar or fiscal year basis. Effect of Non-payment / Certificate Authorizing Registration (CAR): RR 6-2008 11; RMC No. 37-2012 (August 3, 2012)
3.1.2.
Donors Tax on Sale of Shares for Inadequate Consideration: BIR Ruling No. 557-12 (Sept 6, 2012) Pacven Walden Ventures III LP Redemption of Shares and Treasury Shares Revenue Regulation No. 6-2008 (April 22, 2008) 2(w), 2(x), 9 Redeemed corporate tax Treasury capital gains / stock transaction tax
Effect of Non-Payment of Tax. No sale, exchange, transfer or similar transaction intended to convey ownership of, or title to any share of stock shall be registered in the books of the corporation unless the receipts of payment of the tax herein imposed is filed with and recorded by the stock transfer agent or secretary of the corporation. It shall be the duty of the aforesaid persons to inform the Bureau of Internal Revenue in case of non-payment of tax. Any stock transfer agent or secretary of the corporation or the stockbroker, who caused the registration of transfer of ownership or title on any share of stock in violation of the aforementioned requirements shall be punished In order to transfer ownership of shares of stock not traded in PSE, it is necessary to secure a CAR pursuant to RMO 15-03. The receipts of payment of the tax should also be filed and recorded with the secretary of the corp pursuant to sec 11 of rr6-2008 3.1.5. Initial Public Offering NIRC 127
3.1.3.
55
International Corporate Finance Over 33 1/3% 1% Base gross seling price or gross value in money 3.1.6. RR 6-2008 2(g), 2(m), 6, 10(b) 2(j), 2(k), 2(l),
Shares of Stock Traded in the local stock exchange: NIRC 127 RR 6-2008 2(g), 2(n), 5, 10(a) Dissolution of the Corporation: RR 6-2008 8
SEC. 174. Stamp Tax on Debentures and Certificates of Indebtedness. - On all debentures and certificates of indebtedness issued by any association, company or corporation, there shall be collected a documentary stamp tax of One peso and fifty centavos (P1.50) on each Two hundred pesos (P200), or fractional part thereof, of the face value of such documents. SEC. 175. Stamp Tax on Original Issue of Shares of Stock. - On every original issue, whether on organization, reorganization or for any lawful purpose, of shares of stock by any association, company or corporation, there shall be collected a documentary stamp tax of Two pesos (P2.00) on each Two hundred pesos (P200), or fractional part thereof, of the par value, of such shares of stock: Provided, That in the case of the original issue of shares of stock without par value the amount of the documentary stamp tax herein prescribed shall be based upon the actual consideration for the issuance of such shares of stock: Provided, further, That in the case of stock dividends, on the actual value represented by each share.
When one party is exempt: o NIRC 173
3.1.7.
Upon surrender by the investor of the shares in exchange for cash and property distributed by the issuing corporation upon its dissolution and liquidation of all assets and liabilities, the investor shall recognize either capital gain or capital loss upon such surrender of shares computed by comparing the cash and fair market value of property received against the cost of the investment in shares. The difference between the sum of the cash and the fair market value of property received and the cost of the investment in shares shall represent the capital gain or capital loss from the investment, whichever is applicable. If the investor is an individual, the rule on holding period shall apply and the percentage of taxable capital gain or deductible capital loss shall depend on the number of months or years the shares are held by the investor. Section 39 of the Tax Code, as amended, shall herein apply in all possible situations. SHADEC The capital gain or loss derived therefrom shall be subject to the regular income tax rates imposed under the Tax Code, as amended, on individual taxpayers or to the corporate income tax rate, in case of corporations.
3.2.
27(D)(4);
28(A)(7)(d);
Final tax 10% Intercorp dividends (domestic to domesctic) no tax Intercorp dividends (domestic to RFC) no tax Intercorp dividends (domestic to NRFC) 15%, subject to credit in NFRCs domicle 3.3. Documentary Stamp Tax Rates NIRC 174, 175 (see RR 13-2004 in relation to RA No. 9243)
whenever one party to the taxable document enjoys exemption from the tax herein imposed, the other party who is not exempt shall be the one directly liable for the tax.
56
International Corporate Finance BIR Ruling No. DA 097-04 Electronics Philippines, Inc.) (ASE Holding
Atty. Jose Cochingyan III The same considerations provided for in this section, insofar as they may be applicable, may be used for the issuance of bonds by the corporation. The issued price of no-par value shares may be fixed in the articles of incorporation or by the board of directors pursuant to authority conferred upon it by the articles of incorporation or the by-laws, or in the absence thereof, by the stockholders representing at least a majority of the outstanding capital stock at a meeting duly called for the purpose. (5 and 16)
o 3.4.
Tax Treatment of Conversion of Common to Preferred Shares BIR Ruling No. DA 030-05 (Jan. 24, 2005) (Golden Arches Development Corp)
4. Consideration for Stocks 4.1. Cash or Property CORPORATION CODE 62 Sec. 62. Considering for stocks. - Stocks shall not be issued for a consideration less than the par or issued price thereof. Consideration for the issuance of stock may be any or a combination of any two or more of the following: 1. Actual cash paid to the corporation; 2. Property, tangible or intangible, actually received by the corporation and necessary or convenient for its use and lawful purposes at a fair valuation equal to the par or issued value of the stock issued; 3. Labor performed for or services actually rendered to the corporation; 4. Previously incurred indebtedness of the corporation; 5. Amounts transferred from unrestricted retained earnings to stated capital; and 6. Outstanding shares exchanged for stocks in the event of reclassification or conversion. Where the consideration is other than actual cash, or consists of intangible property such as patents of copyrights, the valuation thereof shall initially be determined by the incorporators or the board of directors, subject to approval by the Securities and Exchange Commission. Shares of stock shall not be issued in exchange for promissory notes or future service. Carlo Agdamag, A2015 4.2.
SEC Opinion dated Feb. 18, 2002 addressed to Ruben Lara SEC Opinion No.02-08 dated Jan. 3, 2008, addressed to Atty. Reynaldo Suarez, et al. SEC-OGC Opinion No. 03-13 dated April 17, 2013 (Re: Previously Incurred Indebtedness as Payment for Subscription of Shares)
Minimum Amount to Pay Up CORPORATION CODE 12, 13 (last par), 38 (4th par)
Sec. 12. Minimum capital stock required of stock corporations. - Stock corporations incorporated under this Code shall not be required to have any minimum authorized capital stock except as otherwise specifically provided for by special law, and subject to the provisions of the following section. Sec. 13. Amount of capital stock to be subscribed and paid for the purposes of incorporation. - At least twenty-five percent (25%) of the authorized capital stock as stated in the articles of incorporation must be subscribed at the time of incorporation, and at least twenty-five (25%) per cent of the total subscription must be paid upon subscription, the balance to be payable on a date or dates fixed in the contract of subscription without need of call, or in the absence of a fixed date or dates, upon call for payment by the board of directors: Provided, however, That in no case shall the paid-up capital be less than five Thousand (P5,000.00) pesos.
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International Corporate Finance 4.3. SEC Opinion No. 12-03 dated April 14, 2003 (OFW International Holdings, Inc.) 5.2.
Atty. Jose Cochingyan III RR No. 6-2008 7 (c.3.2) CIR Filinvest Development Corp and Filinvest Alabang, Inc. 654 SCRA 56, July 19, 2011 BIR Ruling No. 515-12 (Aug. 3, 2012) (UEM Development Phils, Inc.) BIR Ruling No. 101-12 (Feb. 20, 2012) (Labelworx, Inc.)
Sec. 65. Liability of directors for watered stocks. - Any director or officer of a corporation consenting to the issuance of stocks for a consideration less than its par or issued value or for a consideration in any form other than cash, valued in excess of its fair value, or who, having knowledge thereof, does not forthwith express his objection in writing and file the same with the corporate secretary, shall be solidarily, liable with the stockholder concerned to the corporation and its creditors for the difference between the fair value received at the time of issuance of the stock and the par or issued value of the same. (n)
4.4. Watered Stock In the Matter of Leyte Colleges, Inc. SEC AC No. 11-07-199 (Nov. 25, 2008) Stock Subscriptions THOMAS LEE HAZEN, JERRY W. MARKHAM. CORPORATIONS AND OTHER BUSINESS ENTERPRISES, Section 5. Stock Subscriptions, 1418-1424 (2009)
Value Added Taxes RR No. 16-2005 4.106-8(b)(1) as amended by RR No. 10-2011 (July 1, 2011) Documentary Stamp Taxes NIRC 199(m), as amended by RA No. 9243)
5.3.
6. Additional Paid In Stock 6.1. Nature and Features See definition of paid-in capital in SEC Circular No. 11 series of 2008 2 last par. SEC OGC Opinion No. 34-10, Dec. 22, 2010 (SEC filing requirement) SEC Opinion addressed to Mr. S.U. Salvador, Jr. of SGV & Co., April 15, 1991 SEC Opinion addressed to Ms. Epifania Mendoza, August 16, 1993 SEC Opinion addressed to Atty. Marietta Turingan, March 27, 1995 SEC Opinion addressed to Atty. Efifanio Sedigo, Jr. May 24, 1999 SEC Opinion addressed to Ms. Ma. Ysabel Sylianteng, August 17, 2000 SEC Opinion addressed to Atty. Federico Noel, Jr., March 26, 2001 SEC Opinion No. 47-03 addressed to Atty. Gemma Santos, Sept. 30, 2003 SEC Opinion No. 01-05 addressed to P. Four, Inc. on Reclassification of Paid-in Surplus, Jan. 4, 2005
4.5.
5. Property for Share Exchanges 5.1. Determination of Amount and Recognition of Gains and Loses NIRC 40 Carlo Agdamag, A2015
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International Corporate Finance 6.2. SEC Opinion No. 34-10, addressed Melquiades Malabanan, Dec. 22, 2010 Circular No. to Mr. 35-2011 7. Dividends, Surplus Retained Accumulated Earnings 7.1.
Atty. Jose Cochingyan III Without Issuance of New Stock: BIR Ruling No. DA-(CA-252) 649-09 (Nov. 4, 2009) (Teletech Holdings, Inc.) Earnings and Improperly
As a Treasury Share: BIR Ruling No. 002-05 (July 22, 2005) (JAKA Investments Corp.) Land for APIC: BIR Ruling No. DA-065-05 (February 23, 2005) (Rural Bank of Rosales) Conversion of Debt to Equity: BIR Ruling No. DA 212-05 (April 27, 2005) (Tuls Industries Inc.) Right to Service Contract: BIR Ruling No. DA-278-05 (Unocal) Contribution of Assets: BIR Ruling No. DA-376-05 (Rockwell) (June 23, 2005)
Trust Fund Doctrine CESAR L. VILLANUEVA, PHILIPPINE CORPORATE LAW, 608620 (2013) Power to Declare Dividends CORPORATION CODE 43 Some Concepts CESAR L. VILLANUEVA, PHILIPPINE CORPORATE LAW, 620630 (2013) Comparative Views THOMAS LEE HAZEN, JERRY W. MARKHAM. CORPORATIONS AND OTHER BUSINESS ENTERPRISES, Section 2. Dividends; Section 3. Other Distributions; Section 4. Liability for Wrongful Distributions, 1362-1418 (2009) STEPHEN M. BAINBRIDGE, CORPORATION LAW AND ECONOMICS, Chapter 13 Dividends and Other Legal Arcana, 768-796 (2002) Dividend Tax NIRC 24(B)(2); 28(B)(5)(b), 73 27(D)(4); 28(A)(7)(d);
7.2. 7.3.
7.4.
(Sept.
1,
2005)
Without Issuance of New Stock: BIR Ruling No. DA-398-06 (June (Chevron)
26,
2006) 7.5.
Conversion of Deposit for Future Stock Subscription to Equity: BIR Ruling No. DA-433-07 (August 8, 2007) (P.J. Lhuiller, Inc.) BIR Ruling No. DA-(C-205) 525-09 (Sept. 9, 2009) (Uni-President Philippines Corp) Conversion of Debt to Equity: BIR Ruling No. DA-269-08 (April (Maynilad Water Services, Inc.) 25, 2008)
7.6.
IAET NIRC 29 RR NO. 2-01 (Feb. 12, 2001) RMC No. 35-2011 (March 14, 2011) Rulings BIR Ruling No. 093-13 (March 18, 2013) (Cebu Air Inc.)
7.7.
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International Corporate Finance 7.8. BIR Ruling No. DA-(C-005) 038-10 (March 4, 2010) (Luck Hong Venture Holdings, Inc.) BIR Ruling No. DA-(C-094) 305-09 (June 17, 2009) (Mahle Filter Systems Corp.) BIR Ruling No. DA-(C-181) 467-09 (August 18, 2009) (Santiago Land Development Corp.) BIR Ruling No. DA-323-06 (May 17, 2006) (Schering-Plough Corp & Essex Pharmaceuticals)
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