Philippines: Capital restructuring

Norma Margarita B Patacsil, Aris L Gulapa and Pamela Joy L Alquisada of Caguioa & Gatmaytan assess a recent Philippine court interpretation’s effect on foreign investments

Foreign investors in partly nationalised activities in the Philippines have previously resorted to seemingly permissible – at least in practice – structuring options to comply with nationality restrictions imposed by Philippine law. To avoid breaching the 60%-40% Filipino-alien equity ratio required in many partly nationalised activities, a common shareholding structure was the issuance of non-voting preferred shares to foreign investors.

The recent Supreme Court case of Gamboa v Teves (G.R. 176579, June 28 2011 (main decision) and October 9 2012, (resolution on the motions for reconsideration)) has changed the structuring landscape. In Teves, the Supreme Court interpreted the 60%-40% Filipino-alien equity ratio/requirement in partly nationalised activities as applying to each class of a corporation's shares. With this development, companies engaged in partly nationalised activities which have foreign investors will be constrained to restructure their shareholding to avoid breaching Philippine law, and accordingly foreign investors will have to consider certain rules affecting their restructuring exercise.

Article XII, Section 10 of the 1987 Philippine Constitution states that Congress may, upon recommendation of the economic and planning agency and when the national interest dictates, reserve certain areas of investment to citizens of the Philippines or to corporations or associations at least 60% of whose capital is owned by such citizens, or such higher percentage as Congress may prescribe. Republic Act No. 7042, or the Foreign Investments Act (FIA), enacted in 1991, implemented this Constitutional provision. Under the auspices of the FIA, the President of the Philippines must, every two years, issue the Foreign Investments Negative List (FINL) which sets out wholly nationalised (where no foreign participation is permitted) and partly nationalised (where foreign participation is permitted but limited) activities in the Philippines.

Section 3(a) of the FIA defines the term 'Philippine national' as: (i) a citizen of the Philippines; (ii) a domestic partnership or association wholly owned by citizens of the Philippines; (iii) a corporation organised under Philippine law of which at least 60% of the capital stock outstanding and entitled to vote is owned and held by citizens of the Philippines; or (iv) a corporation organised abroad and registered as doing business in the Philippines under the Philippine Corporation Code, of which 100% of the capital stock outstanding and entitled to vote is wholly owned by Filipinos or a trustee of funds for pension or other employee retirement or separation benefits, where the trustee is a Philippine national and at least 60% of the fund will accrue to the benefit of Philippine nationals. Nonetheless, where a corporation and its non-Filipino stockholders own stocks in a Securities and Exchange Commission (SEC)-registered enterprise, at least 60% of the capital stock outstanding and entitled to vote of each of both corporations must be owned and held by citizens of the Philippines, in order for the corporation to be considered a Philippine national.

Ascertaining the nationality of a corporation for purposes of participating in a wholly or partly nationalised activity begins with the term 'capital'. Over the years, there have been conflicting opinions as regards the proper construction of the term. Such conflicts should now be deemed to have been settled by the Supreme Court's decision in Teves. The principal issue in Teves was whether the entirety of a corporation's outstanding capital stock should be considered in determining its nationality for purposes of participating in wholly or partly nationalised activities. The petitioner there argued that 'capital' should be interpreted to refer only to such stock entitled to vote for the board of directors, because only such class of stock effectively exercises control over the corporation. The Supreme Court agreed with that interpretation and held that in determining a corporation's nationality for purposes of participating in wholly or partly nationalised activities, only such capital stock entitled to vote or elect for a corporation's board of directors shall be considered; thus, the percentage limits for foreign equity indicated in the Constitution, and also the FIA and FINL, should be applied only to such class of stock and not to the corporation's total outstanding stock.

In an October 9, 2012 resolution (which was issued by the Court after the Teves respondents filed motions for reconsideration of the main decision), the Supreme Court went further. The Court ruled that where the law requires a minimum percentage of Philippine ownership for purposes of participation in a wholly or partly nationalised activity, such minimum percentage applies to and must be present for each class of shares, whether common, preferred non-voting, preferred voting or any other class of shares. The Court noted that "outstanding capital stock" under the Philippine Corporation Code includes all classes of stock and is not limited to shares classified as voting shares. In addition, the Court noted that even if preferred non-voting shares are denied the right to vote or elect directors under a corporation's articles of incorporation, such shares are nonetheless entitled to vote on certain fundamental corporate matters under the Philippine Corporation Code. Accordingly, the Supreme Court concluded that the 60%-40% Filipino-alien equity ratio/requirement must apply not only to shares with voting rights but also to shares without voting rights, and each class of shares must comply with the 60%-40% requirement.

As a consequence of Teves, corporations which are engaged in partly nationalised activities and are structured in such a way that its foreign corporate stockholders hold more than the allowable percentage of any class of share (even if owning not more than 40% of the total capital stock) would now be compelled to restructure to comply with this latest interpretation of the term 'capital'. For this purpose, such corporations may, on the one hand, opt to issue to Philippine stockholders any unissued shares (in each class) in order to increase Philippine shareholdings. If there are no longer unissued shares in each class (because the company's capital stock in each class is fully subscribed), or the amount of unissued shares in each class is insufficient, however, a corporation may instead opt to increase its authorised capital stock and issue new shares to Philippine stockholders.

In effecting an increase of its authorised capital stock, a corporation has several options, which include using deposits for future subscriptions, and converting stockholders' advances into equity.

In Commissioner of Internal Revenue v First Express Pawnshop (judgment on June 16 2009), the Supreme Court defined a deposit for future subscription as an amount of money which a company receives with the view of applying it as payment for subscription to any future increase of authorised capital stock. That decision also ruled that deposits for future subscription are not subject to the payment of documentary stamp taxes, which it described as "[taxes] on documents, instruments, loan agreements, and papers evidencing acceptance, assignment, sale or transfer of an obligation, right or property incident thereto". In essence, a documentary stamp tax is a tax imposed on the transaction rather than on the document. In essence, a documentary stamp tax is a tax imposed on the transaction rather than on the document.

Accordingly, documentary stamp taxes may be imposed upon amounts given as deposits for future subscription only when the actual subscription to capital stock has been made. Mere receipt by a corporation of an amount which it has identified as a "deposit for future subscription" does not by itself trigger the application of the tax. In fact, First Express Pawnshop appears to require at least a subscription agreement for unissued shares in order to trigger the imposition of documentary stamp taxes. This pronouncement acknowledged that even when a deposit for future subscription is made, "[t]he person making a deposit on stock subscription does not have the standing of a stockholder and he is not entitled to dividends, voting rights or other prerogatives and attributes of a stockholder. …[T]here is yet no subscription that creates rights and obligations between the subscriber and the corporation."

First Express Pawnshop reiterated Ruling No. 15-2003 of the Bureau of Internal Revenue (BIR), issued on November 17 2003. There, the BIR indicated that before documentary stamp taxes may be imposed upon the amounts deposited as future subscription, actual issuance of stocks must first be made. To facilitate this issuance, the appropriate government authority (the SEC) must have approved the increase of the capital stock and a subscription agreement between the depositor-stockholder and the corporation should have been executed. Without these conditions, no issuance of shares can actually be made and, accordingly, documentary stamp taxes are not due.

On the other hand, advances made by stockholders to a corporation for the latter's use may be treated as loans and thus may be subject to documentary stamp taxes. Section 173 of the National Internal Revenue Code of the Philippines imposes documentary stamp taxes upon loan agreements. Section 3(b) of Revenue Regulations No. 9-94 issued by the BIR defines "loan agreements" as "a contract in writing where one of the parties delivers to another money or other consumable thing, upon the condition that the same amount of the same kind and quality shall be paid. The term shall include credit facilities which may be evidences by credit memo, advice or drawings." In Commissioner of Internal Revenue v Filinvest Development Corporation (judgment on July 19 2011), the Supreme Court held that inter-company advances evidenced by instructional letters and journal and cash vouchers "qualified as loan advances upon which documentary stamp taxes may be imposed." The Supreme Court partly relied on Section 6 of the BIR's Revenue Regulations No. 9-94 which provides that "in cases where no formal agreements or promissory notes have been executed to cover credit facilities, the documentary stamp tax shall be based on the amount of drawings or availment of the facilities, which may be evidenced by credit/debit memo, advice or drawings by any form of cheque or withdrawal slip, under Section 180 of the Tax Code." The BIR issued Revenue Memorandum Circular No. 48-2011 to direct all BIR officials and employees to assess documentary stamp taxes, when warranted under the circumstances described in Filinvest, in their audit of taxpayers. While the Filinvest case specifically dealt with inter-company advances, there appears to be no reason why the ruling therein would not apply to individual shareholders as the basis for the conclusion – sections 3(b) and 6 of Revenue Regulation No. 9-94 do not distinguish between individual and juridical persons.

Despite the Filinvest decision, many questions seem to be left unanswered, particularly in determining the exact date or time of that loan agreement. This is significant because the payment of documentary stamp taxes must be made on or before the fifth day from the close of the month when the document was executed or entered into.

Under Articles 1316 and 1933 of the Civil Code, a loan agreement is considered a real contract, which means the delivery of the loan amount is necessary for its perfection. The precise date of perfection of a loan-shareholder advance could be doubtful if a shareholder remits money to the bank account of the company without any prior agreement with, or even prior notice (such as by way of an inter-company memo). As mentioned, the Supreme Court has relied on Revenue Regulation 9-94 which states that the documentary stamp taxes will be based on the amount of drawings or availment of the facilities, which may be evidenced by credit/debit memo, advice or drawings by any form of cheque or withdrawal slip. This seems to mean that in the absence of an inter-company memo, a loan agreement would have been entered into upon the recipient company's withdrawal of the advances, and in that situation the date of the withdrawal slip is relevant. But, notwithstanding Filinvest, it seems the BIR should examine not only the time of withdrawal but also the intention of the parties. Revenue Regulation 9-94 itself defines a loan agreement as a contract in writing where one of the parties delivers to another money or other consumable thing, upon the condition that the same amount of the same kind and quality is paid. Therefore, unless the parties clearly intended to enter into a loan agreement (that is, money remitted by a shareholder to the company was intended and received as a loan/advance), the transaction should not be deemed as such.

Filinvest was also silent as regards a situation where there is no inter-company memo and the advances to the corporation are made in tranches spanning several months but only a portion of the amount is actually accepted and used by the corporation as an advance. That situation may likewise result in uncertainty as to which amount given by a stockholder the advance corresponds to. Notwithstanding the silence of Filinvest as regards the payment of documentary stamp taxes made in tranches, the ruling by the First Division of the Court of Tax Appeals in Manila Electric Company v Commissioner of Internal Revenue (issued on March 22 2010) may shed some light on the issue. In that case, the court stated that documentary stamp taxes are "due and payable at the time the transaction is had or accomplished, i.e., at the time of the issuance of the document." There, an Omnibus [Loan] Agreement was composed of voluminous documents and various securities corresponding to such documents. The court treated each document – although comprising one loan agreement – as separate taxable documents and separate transactions. Thus, it ruled that payment of documentary stamp taxes on each document was proper. The Court of Tax Appeals en banc affirmed the decision of the First Division on September 21 2011, and ruled that while all documents pertain to one loan, each tranche pertained to a separate transaction and was thus separately subject to the imposition of documentary stamp tax.

Following Filinvest and Meralco, where there is no specific inter-company memo, the advances are made by the shareholder in tranches, and the corporation withdraws the advances also in tranches, then each amount withdrawn by the corporation should be treated as a separate transaction. Thus, the amount of the documentary stamp tax due should only be in proportion to the amount withdrawn by the corporation. This also means that that the corresponding documentary stamp tax is due on or before the fifth day from the close of the month when the withdrawal was made (as evidenced by the date of the withdrawal slip).

If only on the basis of payment of documentary stamp taxes, it appears that using deposits for future subscription is the better option for corporations looking to increase their authorised capital stock. In addition to the fact that documentary stamp taxes need not be paid until such time as the subscription is actually made, the money already deposited may already be used even if the SEC's approval of the increase of authorised capital stock is pending. As early as December 9 1981 the SEC opined that amounts deposited as additional paid-in capital may be used by the company pending the verification of the increase of the authorised capital stock by the SEC. In practice, however, it takes longer for the SEC to verify the application for increase of authorised capital stock when the deposits have been used as the SEC would scrutinise the documents of the company to determine whether the deposits have been used solely for purely business operations and every expense has been accounted for or recorded in the books of the company.

Companies increasing their authorised capital stock (whether by way of utilisation of deposits or conversion of advances/liabilities to equity) should also be aware that the SEC may conduct an on-site verification of their financial records based on SEC Memorandum Circular No. 6, s. of 2008, applications for the increase of authorised capital stock. In practice, if the SEC is dissatisfied with the documentation of the company, it may require the company to produce additional documents or even reject the application for increase of authorised capital stock.

Following the Supreme Court's ruling in Teves, companies engaged in partly nationalised activities which have foreign investors will be constrained to reconsider their shareholding structure to comply with the latest interpretation of the term 'capital'. Increasing their authorised capital stock is a possible solution, and to that end, converting shareholders advances into equity or using deposits for future subscription are available options. The choice between these options will have to be guided by, among other factors, the rules discussed above.

About the author
		Norma Margarita B Patacsil Caguioa & Gatmaytan 30/F 88 Corporate Center Sedeño cor. Valero Streets Salcedo Village, Makati City 1227, Philippines T: +632 894 0377 F: +632 552 1978 W: www.cagatlaw.com Norma Margarita B Patacsil (Norge) is a partner at Caguioa & Gatmaytan. She handles both corporate and litigation matters. Norge advises on share and property acquisitions and conducts-related due diligence. She deals with and is versed in various investment, capital market, competition law, contract-based, land acquisition, mining, and regulatory issues. She recently assisted a large business group acquire the Philippines' leading importer of premium dairy products and handled the acquisition of a savings bank. Her litigation experience encompasses contract disputes, corporate restructuring and rehabilitation, debt recovery, infrastructure disputes, intra-corporate controversies, local-government imposed taxes, mining and real property claims, public utilities and torts. Norge graduated from the University of the Philippines in 1994 (BS Economics, magna cum laude) and 1998 (Bachelor of Laws, cum laude and salutatorian). She was admitted to the Philippine Bar in 1999, placing second in the 1998 Bar examinations.

About the author
		Aris L Gulapa Caguioa & Gatmaytan 30/F 88 Corporate Center Sedeño cor. Valero Streets Salcedo Village, Makati City 1227, Philippines T: +632 894 0377 F: +632 552 1978 W: www.cagatlaw.com Aris L Gulapa is a partner at Caguioa & Gatmaytan, specialising in corporate and commercial transactions, particularly mergers and acquisitions, banking, corporate finance, and corporate restructuring. He has advised and assisted leading banks, financial institutions, and multinational corporations in the course of his practice in Manila, Singapore, Vietnam, and Tokyo. Gulapa recently advised a publicly-listed French company and an Indonesian pharmaceutical company on restructuring their Philippine subsidiaries. He is assisting a leading US-based IT company in a potential share acquisition in the Philippines. Gulapa graduated with honours from Ateneo Law School in 2003 (ranking fifth in his class) and was admitted to the Philippine Bar in 2004. He obtained his Master of Laws (LLM) in 2011 from New York University, where he was a recipient of the Vanderbilt scholarship. He passed the New York bar in 2011 and is awaiting admission.

About the author
		Pamela Joy L Alquisada Caguioa & Gatmaytan 30/F 88 Corporate Center Sedeño cor. Valero Streets Salcedo Village, Makati City 1227, Philippines T: +632 894 0377 F: +632 552 1978 W: www.cagatlaw.com Pamela Joy L Alquisada is an associate at Caguioa & Gatmaytan, specialising in corporate and commercial transactions, particularly mergers and acquisitions and general corporate housekeeping. She advises multinational companies in relation to incorporation, structuring, and regulatory compliance. She provides corporate housekeeping and general corporate advisory services to several foreign-invested Philippine companies. Recently, Alquisada led a team in closing an acquisition by a large US-based manufacturing company of the assets of one of the pioneer equipment manufacturing enterprises in the Philippines. She is assisting a global lighting company in setting up a subsidiary in the Philippines. Alquisada graduated with honours from the Ateneo de Manila University School of Law in 2009. She was admitted to the Philippine bar in 2010.

Return to supplements