International Corporate Finance Atty. Jose Cochingyan...

International Corporate Finance Atty. Jose Cochingyan III

Carlo Agdamag, A2015 1

INTERNATIONAL CORPORATE FINANCE Based on the Modules for Second Semester, AY 2013-2014

MODULE 1: THE WORLD AROUND US & THE CORPORATE ENTERPRISE

1. The Economic World Around Us

1.1. The Fiscal Climate and Development

World Bank, World Development Report 2005: A

Better Investment Climate for Everyone, Chapter

5: “Regulation and Taxation”

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 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 gov’t 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

o 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

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



o Managing regulatory risks Does not mean that regulations should never change

Instead, to minimize the adverse impact of uncertainty Firms should be consulted on proposed changes Transitions periods should also be provided

o Promoting certainty in the interpretation and application of existing regulations

Laws and regulations must be drafted with as much clarity and precision as possible

Timely publication of decisions precedents

Removing unjustified barriers to competition

o Competition creates opportunities for new firms and provides incentives for existing firms to innovate

o Regulation can create barriers to market entry or exit o Regulatory barriers to market entry

Requirements to set up new business Can open opportunities for individual entrepreneurs

o Regulatory barriers to market exit Ex: When bankruptcy regulations are long costly,

distressed firms are less willing to use them and the market becomes cluttered with failed firms

These block opportunities for new entrants

o Addressing competitive behavior by firms Firms can curb competition by colluding or forming cartels States should enact competition or antitrust laws Predatory pricing should be prevented Proposed mergers should be reviewed by an agency

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

The actual burden can differ from the statutory burden firms can pass them to consumers

Firms benefit from tax exemptions or privileges Firms that are in the informal economy (no tax)

o Tax administration Red tape and corruption in tax administration weaken the

incentive to comply with taxes and contribute to leakages o Taxes and competition

Taxes can affect the level of competition

Developing countries rely on trade taxes (tariffs) because of ease of collection, reducing pressure on local firms

Differential treatment of local firms in the same market 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



Friedrich Schneider, Size and Measurement of the

Informal Economy in 110 Countries Around the

World (July 2002) 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

1.2. The Philippine Fiscal Environment

Philippine Development Plan, 2011-2016

Rule of Law Index 2012-2013

Philippine Standing

Rule of Law Index Factors Global Rank Regional Rank Income Group

Limited Government Powers 46/97 9/14 6/23

Absence of Corruption 63/97 10/14 8/23

Order and Security 77/97 14/14 16/23

Fundamental Rights 59/97 9/14 9/23

Open Government 59/97 10/14 9/23

Regulatory Enforcement 52/97 8/14 5/23

Civil Justice 84/97 13/14 17/23

Criminal Justice 72/97 13/14 10/23

Latest status of the Philippines in the World Bank

Doing Business Report, as well as PH neighbors

Topics DB 2014 Rank DB 2013 Rank

Starting a Business 170 166

Dealing with Construction Permits 99 95

Getting Electricity 33 33

Registering Property 121 119

Getting Credit 86 126

Protecting Investors 128 127

Paying Taxes 131 144

Trading Across Borders 42 41

Enforcing Contracts 114 112

Resolving Insolvency 100 164

Overall 108 133

Constitutionally Mandated Economic Policies

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



expanding productivity as the key to raising the quality of life for all, especially the under- privileged.

The State shall promote industrialization and full employment based on sound agricultural development and agrarian reform, through industries that make full and efficient use of human and natural resources, and which are competitive in both domestic and foreign markets. However, the State shall protect Filipino enterprises against unfair foreign competition and trade practices. In the pursuit of these goals, all sectors of the economy and all regions of the

country shall be given optimum opportunity to develop. Private enterprises, including corporations, cooperatives, and similar collective organizations, shall be

encouraged to broaden the base of their ownership. Section 6. The use of property bears a social function, and all economic agents shall contribute to the common good. Individuals and private groups, including corporations, cooperatives, and similar collective organizations, shall have the

right to own, establish, and operate economic enterprises, subject to the duty of the State to promote distributive justice and to intervene when the common good so demands. Section 12. The State shall promote the preferential use of Filipino labor, domestic materials and locally produced goods, and adopt measures that help

make them competitive. Section 16. The Congress shall not, except by general law, provide for the formation, organization, or regulation of private corporations. Government-owned or controlled corporations may be created or established by special charters in the interest of the common good and subject to the test of economic viability.

Section 19. The State shall regulate or prohibit monopolies when the public interest so requires. No combinations in restraint of trade or unfair competition shall be allowed.

Taxation Policy: RA No. 8424, §2 (1997) 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.

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) 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 owner‘s 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 firm‘s stockholders

and having ultimate authority to guide corporate affairs and make general policy

President or CEO – corporate official responsible for managing the firm‘s 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



general partner) has unlimited liability. The limited partners cannot take an active role in the firm‘s management; they are

passive investors S corporation – (only in US) Limited liability corporation – gives its owners limited liability

and taxation as a partnership. LLCs work well for corporate joint ventures or projects developed through a subsidiary

Limited liability partnership – all partners have limited liability. They are liable for their own acts of malpractice, not for

those of other partners. The LLP is taxed as a partnership.

The Managerial Finance Function Organization of the Finance Function

o Depends on the size of the firm o Treasurer – the firm‘s chief financial manager, who is responsible for

the firm‘s 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 firm‘s chief accountant, who is responsible for the firm‘s accounting activities, such as corporate accounting, tax management, financial accounting and cost accounting (accounting)

o Foreign Exchange Manager – responsible for monitoring and

managing the firm‘s 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 period‘s

total earnings available for the firm‘s common stockholders by the number of shares of common stock outstanding

o Timing – the receipt of funds sooner rather than later is preferred

o Cash Flows – only when earnings increases are accompanied by increased future cash flows would a higher stock price be expected

o Risk – the chance that actual outcomes may differ from those expected

o A trade-off exists between cash flows and risk. Maximize Shareholder Wealth

o Goal of the firm maximize the wealth of the owners o Wealth measured by the share price of the stock, which is based on

timing of returns (cash flows), magnitude and risk o Return and risk are in fact the key determinants of share price, which

represents the wealth of the owners in the firm

Stakeholders – groups such as employees, customers, suppliers, creditors, owners and others who have a direct economic link to the firm

Ethics – standards of conduct or moral judgment

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 firm‘s value

o Agency Costs – costs borne by stockholders to minimize agency problems and contribute to the maximization of owner‘s 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



o Public Offering – the nonexclusive sale of either bonds or stock to the general public

o Primary Market – financial market in which securities are initially issued, the only market in which the issuer is directly involved in the transaction

o Secondary Market – financial market in which pre-owned securities (those that are not new issues) are traded

Money Market - a financial relationship created between suppliers and demanders of short-term funds

o Marketable securities – short-term debt instruments, such as US Treasury bills, commercial paper, and negotiable certificates of

deposit issued by government, business and financial institutions, respectively.

Capital Market – a market that enables suppliers and demanders of long-term funds to make transactions. E.g., bonds and stocks o Bond - long-term debt instrument used by business and government

to raise large sums of money, generally from a diverse group of lenders

o Preferred Stock – special form of ownership having a fixed periodic dividend that must be paid prior to payment of any common stock dividend

o Securities Exchanges – organizations that provide the marketplace

in which firms can raise funds through the sale of new securities and purchasers can resell securities

o Over-the-counter Exchange – an intangible market for the purchase and sale of securities not listed by the organized exchanges

o Efficient market – a market that allocates funds to their most productive uses as a result of competition among wealth-maximizing investors that determines and publicizes prices that are believed to be

close to their true value Business Taxes

Ordinary income – income earned through the sale of a firm‘s 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 asset‘s 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

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



Corporate Social Responsibility - means that the firm has wider responsibilities in relation to objectives and people apart from the owners

or shareholders Corporate Governance – means the management of corporations

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

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 company‘s 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

2.2. Corporate Governance

JILL SOLOMON AND ARIS SOLOMON, CORPORATE

GOVERNANCE AND ACCOUNTABILITY, pp. 1-43 (2004) 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 company‘s

operations and the general public o Some also advocate that the environment, animals and future

generations be included in the term

Enron Case Study



MARTIN FAHY, JEREMY ROCHE AND ANASTASIA WEINER,

CHAPTER 10, BEYOND CORPORATE GOVERNANCE, pp. 225-

259 (2004) 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

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

o Crony capitalism is rather a product of the complex of relations between the business and political elites and could in principle arise in

systems with widely dispersed ownership. o Overall, the experience of Asian countries with family-controlled firms

and strong economic growth suggests that they are an effective vehicle of late development and industrialization.

DEAN CESAR VILLANUEVA, PHILIPPINE CORPORATE

GOVERNANCE pp. 1-46 (2011)

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 socially-

acceptable 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.



Trust Fund Doctrine The recognition of liability to other persons other than the stockholder or

members of the corporation has not been recognized or even operationalized, except in the application of the trust fund doctrine.

Under the trust fund doctrine, the capital stock, property and other assets of the corporation are regarded as equity in trust for the payment of the corporate creditors

The ―trust fund‖ doctrine considers the subscribed capital stock as a trust fund for the payment of the debts of the corporation, to which the

creditors may look for satisfaction. Until the liquidation of the corporation, no part of the subscribed capital stock may be turned over or released to

the stockholder (except in the redemption of the redeemable shares) without violating this principle. Thus dividends must never impair the subscribed capital stock; subscription commitments cannot be condoned or remitted; nor can the corporation buy its own shares using the subscribed capital as the consideration therefore

The requirement of unrestricted retained earnings to cover the shares is based on the trust fund doctrine which means that the capital stock, property and other assets of a corporation are regarded as equtiy in trust for the payment of corporate creditors. The reason is that creditors of a corporation are preferred over the stockholders in the distribution of corporate assets. There can be no distribution of assets among the

stockholders without first paying corporate creditors. Hence, any disposition of corporate funds to the prejudice of creditors is null and void

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.

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

Publicly Listed Corporation

Securities Regulations Code §2, 3.1, 3.7, 8 SEC. 2. Declaration of State Policy. - The State shall establish a socially

conscious, free market that regulates itself, encourage the widest participation of ownership in enterprises, enhance the democratization of wealth, promote the development of the capital market, protect investors, ensure full and fair disclosure about securities, minimize if not totally eliminate insider trading and other fraudulent or manipulative devices and practices which create distortions in the free market.

To achieve these ends, this Securities Regulation Code is hereby enacted.

SEC. 3. Definition of Terms 3.1. "Securities" are shares, participation or interests in a corporation or in a commercial enterprise or profit-making venture and evidenced by a certificate, contract, instrument, whether written or electronic in character. It includes:

a) Shares of stock, bonds, debentures, notes, evidences of indebtedness,

asset-backed securities b) Investment contracts, certificates of interest or participation in a profit

sharing agreement, certificates of deposit for a future subscription; c) Fractional undivided interests in oil, gas or other mineral rights;



d) Derivatives like option and warrants; e) Certificates of assignments, certificates of participation, trust certificates,

voting trust certificates or similar instruments; f) Proprietary or non proprietary membership certificates in corporations; g) Other instruments as may in the future be determined by the

Commission. 3.7. "Exchange" is an organized marketplace or facility that brings together buyers and sellers and executes trades of securities and/or commodities.

SEC. 8. Requirement of Registration of Securities. –

8.1. Securities shall not be sold or offered for sale or distribution within the Philippines, without a registration statement duly filed with and approved by the Commission. Prior to such sale, information on the securities, in such form and with such substance as the Commission may prescribe, shall be made available to each prospective purchaser.

8.2. The Commission may conditionally approve the registration statement under such terms as it may deem necessary. 8.3. The Commission may specify the terms and conditions under which any written communication, including any summary prospectus, shall be deemed not to constitute an offer for sale under this Section. 8.4. A record of the registration of securities shall be kept in a Register of

Securities in which shall be recorded orders entered by the Commission with respect to such securities. Such register and all documents or information with respect to the securities registered therein shall be open to public inspection at reasonable hours on business days. 8.5. The Commission may audit tie financial statements, assets and other information of a firm applying for registration of its securities whenever it deems the same necessary to insure full disclosure or to protect the interest of the

investors and the public in general.

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

o Unlimited Liability – sole proprietor is subject to unlimited liability for any contractual or tort damage caused by the business or agents

o Management – usually dependent on the management of the owner o Transferability – cannot be readily sold

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



o Double Taxation – the corporation is separately taxed for any profits it may receive. The shareholders are then taxed again if the

remaining income is distributed to them o Management – managers of a corporation may mange for their own

interests rather than seeking to maximize shareholder wealth o Expenses – the corporation will encounter more expense in its

operations than required for other business enterprises

Large Taxpayer

NIRC §245(j) Sec. 245(j) The manner in which internal revenue taxes, such as income tax, including withholding tax, estate and donor's taxes, value-added tax, other

percentage taxes, excise taxes and documentary stamp taxes shall be paid through the collection officers of the Bureau of Internal Revenue or through duly authorized agent banks which are hereby deputized to receive payments of such taxes and the returns, papers and statements that may be filed by the taxpayers in connection with the payment of the tax: Provided, however, That notwithstanding the other provisions of this Code prescribing the place of filing of returns and payment of taxes, the Commissioner may, by rules and regulations,

require that the tax returns, papers and statements that may be filed by the

taxpayers in connection with the payment of the tax. Provided, however, That notwithstanding the other provisions of this Code prescribing the place of filing of returns and payment of taxes, the Commissioner may, by rules and regulations require that the tax returns, papers and statements and taxes of large taxpayers be filed and paid, respectively, through collection officers or through duly

authorized agent banks: Provided, further, That the Commissioner can exercise this power within six (6) years from the approval of Republic Act No. 7646 or the completion of its comprehensive computerization program, whichever comes earlier: Provided, finally, That separate venues for the Luzon, Visayas and Mindanao areas may be designated for the filing of tax returns and payment of taxes by said large taxpayers.

For the purpose of this Section, "large taxpayer" means a taxpayer who satisfies any of the following criteria; (1) Value-Added Tax (VAT). - Business establishment with VAT paid or payable of at least One hundred thousand pesos (P100,000) for any quarter of the preceding taxable year; (2) Excise Tax. - Business establishment with excise tax paid or payable of at least One million pesos (P1,000,000) for the preceding taxable year;

(3) Corporate Income Tax. - Business establishment with annual income tax paid or payable of at least One million pesos (P1,000,000) for the preceding taxable year; and

(4) Withholding Tax. - Business establishment with withholding tax payment or

remittance of at least One million pesos (P1,000,000) for the preceding taxable year.

Provided, however, That the Secretary of Finance, upon recommendation of the Commissioner, may modify or add to the above criteria for determining a large taxpayer after considering such factors as inflation, volume of business, wage and employment levels, and similar economic factors. The penalties prescribed under Section 248 of this Code shall be imposed on any violation of the rules and regulations issued by the Secretary of Finance, upon

recommendation of the Commissioner, prescribing the place of filing of returns and payments of taxes by large taxpayers.

Revenue Regulation 02-98 §2.57.2(M) & (W), as

amended by RR 06-09 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.



Supplier of goods 1% Supplier of services 2%

Top 20,000 private corporations shall include a corporate taxpayer who has been determined and notified by the BIR as having satisfied any of the following criteria:

a. Classified and duly notified by the Commissioner as a large taxpayer under RR No. 1-98, as amended, or belonging to the Top 5,000 private

corporations under RR 12-94, or to the Top 10,000 private corporations under RR 17-2003, unless previously declassified as such or had already ceased business operations (automatic inclusion)

b. VAT payment or payable, whichever is higher, of at least P100,000 for the preceding year

c. Annual income tax due of at least P200,000 for the preceding year d. Total percentage tax paid of at least P100,000 for the preceding year

e. Gross sales of P10,000,000 and above for the preceding year f. Gross purchases of P5,000,000 and above for the preceding year g. Total excise tax payment of at least P100,000 for the preceding year

Revenue Regulation 16-2005 §4.114-3 SEC.4.114-3. Submission of Quarterly Summary List of Sales and

Purchases. — 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.

c. Information that Must be Contained in the Quarterly Summary List of Sales to be Submitted. — The quarterly summary list must contain the monthly

total sales generated from regular buyers/customers, regardless of the amount of sale per buyer/customer, as well as from casual buyers/customers with individual sales amounting to P100,000.00 or more. For this purpose, the term "regular buyers/customers" shall refer to buyers/customers who are engaged in business or exercise of profession and those with whom the taxpayer has transacted at least six (6) transactions regardless of amount per transaction either in the previous year or current year. The term "casual buyers/customers", on the other

hand, shall refer to buyers/customers who are engaged in business or exercise of profession but did not qualify as regular buyers/customers as defined in the

preceding statement. The foregoing paragraph, notwithstanding, information pertaining to sales made to buyers not engaged in business or practice of profession (e.g., foreign embassies) may still be required from the seller. The Quarterly Summary List of Sales to Regular Buyers/Customers and Casual

Buyers/Customers and Output Tax shall reflect the following: (1) BIR-registered name of the buyer who is engaged in business/exercise of

profession; (2) TIN of the buyer (Only for sales that are subject to VAT); (3) Exempt

Sales; (3) Zero-rated Sales;

(4) Sales Subject to VAT (exclusive of VAT); (5) Sales Subject to Final VAT Withheld; and (7) Output Tax (VAT on sales

subject to 10%). (The total amount of sales shall be system-generated) d. Information that must be Contained in the Quarterly Summary List of Purchases. (omitted)

e. Rules in the Presentation of the Required Information in the Summary Schedules. (omitted) f. The threshold amounts as herein set for sales and purchases may be

increased/modified by the Commissioner of Internal Revenue if it is necessary for the improvement in tax administration.

g. Required Procedure and Format in the Submission of Quarterly List of Sales/Purchases. (omitted) h. Issuance of Certificate of VAT Withheld at Source The certificate or statement to be issued is the Certificate of Final Tax Withheld at

Source (BIR Form No. 2306), a copy of which should be issued to the payee. i. Penalty Clause (omitted)



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) 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 company‘s

balance sheet to the company‘s 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

4. Players in Corporate Finance

4.1. In General

o KENNETH H. MARKS, LARRY E. ROBBINS, GONZALO

FERNANDEZ AND JOHN P. FUNKHOUSER, THE HANDBOOK OF

FINANCING GROWTH, 262-278 (2005) 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



MODULE 2: THE DEBT AND EQUITY DICHOTOMY

1. Examining the Firm as an Enterprise

William A. Klein & John C. Coffee, Jr.: Business

Organization and Finance, 1-50 (2007) 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

Nonrecourse loan – loan secured by specific property o In the event of bankruptcy, no distinction is made between

business and personal debts, except for exempt personal assets o Leverage – used to describe the financial consequences of the

use of debt and equity. Debt creates financial leverage for the equity The greater the debt, the greater the leverage The greater the leverage, the greater the potential gains

and losses for the equity and the greater the risk of loss

for the debt o Effects of leverage result from the facts that:

the lender has a fixed claim the return on the investment is uncertain the borrower has a residual claim (right to whatever is

left after the debt holder‘s claim is satisfied) o Leverage creates risk. Greater leverage, greater risk

o Equity attributes of debt Creditors are subject to varying degrees of risk of default Degree of risk depends on total value of business as

compared to the amount of the debt As risk rises, creditors will become more concerned with

how the business is run and likely want increasing levels

of control As risk rises, higher interest rate may also be demanded—

a higher return on its investment in the business

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



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 company‘s

balance sheet to the company‘s 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

3. Debt v. Equity



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 *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

(i) Balance Sheet (now called Statements of Assets and Liabilities)

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

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



Except as otherwise required by the Commission, Statements of Changes in Equity shall be prepared in accordance with the generally accepted accounting

principles in the Philippines [See definition in paragraph 1(b)(v) of Rule 68]. This Annex merely emphasizes some requirements as to presentation and disclosures on the Statements of Changes in Equity.

1. A corporation shall present, as a separate component of its financial statements, a statement showing: a. The net income or loss for the period; b. Each item of income and expense, gain or loss which, as required

by other Statements of Financial Accounting Standards, is recognized directly in equity, and the total of these items; and

c. The cumulative effect of changes in accounting policy dealt with under the Benchmark treatment, and the correction of fundamental errors as required by PFRS.

2. In addition, a corporation shall present, either within this statement or

in the notes: a. Capital transactions with owners and distributions to owners; b. The Balance of accumulated income or loss at the beginning of the

period and at the balance sheet date, and the movements for the period; and

c. A reconciliation between the carrying amount of each class of capital stock, additional paid in capital and each reserve at the beginning and the end of the period, separately disclosing each movement.

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 registrant‘s activities during the period, is required.

(iv) Cash Flow Statement

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

(Accounting Policies and Explanatory Notes)

Except as otherwise announced by the Commission, the various disclosures for this part of the financial statement shall be in accordance with the PFRS enumerated under paragraph (2)(a) of this Rule.

SEC Memorandum Circular No. 16-09 (December 10,

2009) II 2(a) 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.

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 company‘s 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



The audited balance sheets or statements of financial position shall be as of the end of each of the two most recently completed fiscal years.

C. Statement of Comprehensive Income, Statement of Cash Flows and

Statement of Changes in Equity If practicable, these statements shall be for each of the two most recent completed fiscal years or such shorter period as the company (including predecessors) has been in existence.

D. An explanation through a note or otherwise shall be made explaining the

reasons for filing a single-period statement, e.g. it is the first period of a new company.

E. When financial statements are presented on a comparative basis for more than the periods required, the auditor's report need not extend to prior

periods for which the financial statements are not required to be audited. i. If the financial statements of the prior year were not audited, such

statements shall be marked prominently as "UNAUDITED." In addition, the auditor shall disclose this in an ―other matter‖ paragraph in the auditor‘s report.

ii. If the financial statements of a prior-period have been examined by

another independent certified public accountant whose report is not presented, the statements shall be marked to disclose prominently that they are not being reported upon by the current auditor. If the auditor of the financial statements for such periods did not give an unqualified opinion on such statements, the auditor for the current year shall indicate in an ―other matter‖ paragraph of his report (I) that the financial statements of the prior-period were examined by

other auditors, (II) the date of their report (III) the type of opinion expressed by the predecessor auditor and (IV) the substantive reasons it was qualified.



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

contract shall be null and void. (1289)

Article 1379. The principles of interpretation stated in Rule 123 of the Rules of Court shall likewise be observed in the construction of contracts. (n)

Rules of Court, Rule 130 §§10-19

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)



Section 17. Of Two constructions, which preferred. — When the terms of an agreement have been intended in a different sense by the different parties to it,

that sense is to prevail against either party in which he supposed the other understood it, and when different constructions of a provision are otherwise equally proper, that is to be taken which is the most favorable to the party in whose favor the provision was made. (15) Section 18. Construction in favor of natural right. — When an instrument is equally susceptible of two interpretations, one in favor of natural right and the

other against it, the former is to be adopted. (16)

Section 19. Interpretation according to usage. — An instrument may be construed according to usage, in order to determine its true character. (17) Primary goal in drafting a contract rely on its literal meaning

Each and every word should be given effect Date and identify each draft of the contract

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 non-fungible 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)

Article 1957. Contracts and stipulations, under any cloak or device whatever, intended to circumvent the laws against usury shall be void. The borrower may

recover in accordance with the laws on usury. (n) Article 1958. In the determination of the interest, if it is payable in kind, its value shall be appraised at the current price of the products or goods at the time and place of payment. (n) Article 1959. Without prejudice to the provisions of article 2212, interest due

and unpaid shall not earn interest. However, the contracting parties may by stipulation capitalize the interest due and unpaid, which as added principal, shall

earn new interest. (n) Article 1960. If the borrower pays interest when there has been no stipulation therefor, the provisions of this Code concerning solutio indebiti, or natural obligations, shall be applied, as the case may be. (n)

Article 1961. Usurious contracts shall be governed by the Usury Law and other special laws, so far as they are not inconsistent with this Code. (n) 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



of the written notice. Otherwise, We/I shall be deemed to have given our consent to the interest rate adjustment.

Contrary, however, to these provisions, there was a standing agreement by the parties that any increase or decrease in interest rates shall be subject to the mutual agreement of the parties.

From the period of March 1997 to January 1998, there were several increases and decreases in the interest rates.

Permanent assailed these saying that Solidbank unilaterally and arbitrarily accelerated the interest rates without any declared basis.

RTC Ruled in favor of Solidbank CA Reversed. Ruled in favor of Permanent. Hence this petition.

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 Solidbank‘s written notice to

Permanent of the new interest rate

o Permanent has the option to prepay its loan in case of disagreement Moreover, Solidbank‘s 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, Solidbank‘s computation of the interest due should be adjusted to

take effect only upon Permanent‘s receipt of written notice Usury Law Virtual repeal rendered ineffective

Congress temporarily suspended its application Central Bank removed the ceiling rate on interest rates

Spouses Juico v. China Banking Corp.

G.R. No. 187678, April 10, 2013 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 Bank‘s 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‖



Any provision in a PN authorizing a bank to change the interest rate from time to time without advance notice to debtor does not give the bank

unrestrained freedom to change the rate other than that agreed upon. Here, the escalation clause in the PN should be read together with the

statement where no rate of interest was fixed, it would be based on prevailing market rates. Thus, the parties intended that the interest be governed by market rates and not dictated by China Bank‘s policy.

The escalation clause here is void because of the lack of written notice. The monthly telephone calls would not suffice. There should be:

o A detailed billing statement based on the new rates o A form signed by the Juicos to indicate their conformity

Modifications in the rate of interest for loans pursuant to an escalation clause must be the result of an agreement between the parties. Unless such important change in the contract terms is mutually agreed upon, it has no binding effect. In the absence of consent on the part of the debtors to the modifications in the interest rates, the adjusted rates cannot bind them.

Hence, we consider as invalid the interest rates in excess of 15%, the rate charged for the first year.

Sir: descalation clause also needed for escalation clause to be valid

2.2 Pledge, Chattel Mortgage and Antichresis


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)

Article 2087. It is also of the essence of these contracts that when the principal obligation becomes due, the things in which the pledge or mortgage consists may

be alienated for the payment to the creditor. (1858) Article 2088. The creditor cannot appropriate the things given by way of pledge or mortgage, or dispose of them. Any stipulation to the contrary is null and void. Article 2089. A pledge or mortgage is indivisible, even though the debt may be divided among the successors in interest of the debtor or of the creditor.

Therefore, the debtor's heir who has paid a part of the debt cannot ask for the proportionate extinguishment of the pledge or mortgage as long as the debt is not

completely satisfied. Neither can the creditor's heir who received his share of the debt return the pledge or cancel the mortgage, to the prejudice of the other heirs who have not been paid. From these provisions is excepted the case in which, there being several things

given in mortgage or pledge, each one of them guarantees only a determinate portion of the credit. The debtor, in this case, shall have a right to the extinguishment of the pledge or mortgage as the portion of the debt for which each thing is specially answerable is satisfied. (1860)

Article 2090. The indivisibility of a pledge or mortgage is not affected by the fact that the debtors are not solidarily liable. (n) Article 2091. The contract of pledge or mortgage may secure all kinds of obligations, be they pure or subject to a suspensive or resolutory condition. Article 2092. A promise to constitute a pledge or mortgage gives rise only to a

personal action between the contracting parties, without prejudice to the criminal responsibility incurred by him who defrauds another, by offering in pledge or mortgage as unencumbered, things which he knew were subject to some burden, or by misrepresenting himself to be the owner of the same. (1862)

CHAPTER 2 Pledge

Article 2093. In addition to the requisites prescribed in article 2085, it is necessary, in order to constitute the contract of pledge, that the thing pledged be placed in the possession of the creditor, or of a third person by common agreement. (1863)

Article 2094. All movables which are within commerce may be pledged, provided they are susceptible of possession. (1864)



Article 2095. Incorporeal rights, evidenced by negotiable instruments, bills of lading, shares of stock, bonds, warehouse receipts and similar documents may

also be pledged. The instrument proving the right pledged shall be delivered to the creditor, and if negotiable, must be indorsed. (n) Article 2096. A pledge shall not take effect against third persons if a description of the thing pledged and the date of the pledge do not appear in a public instrument. (1865a)

Article 2097. With the consent of the pledgee, the thing pledged may be alienated by the pledgor or owner, subject to the pledge. The ownership of the

thing pledged is transmitted to the vendee or transferee as soon as the pledgee consents to the alienation, but the latter shall continue in possession. (n) Article 2098. The contract of pledge gives a right to the creditor to retain the thing in his possession or in that of a third person to whom it has been delivered,

until the debt is paid. (1866a) Article 2099. The creditor shall take care of the thing pledged with the diligence of a good father of a family; he has a right to the reimbursement of the expenses made for its preservation, and is liable for its loss or deterioration, in conformity with the provisions of this Code. (1867)

Article 2100. The pledgee cannot deposit the thing pledged with a third person, unless there is a stipulation authorizing him to do so. The pledgee is responsible for the acts of his agents or employees with respect to the thing pledged. (n) Article 2101. The pledgor has the same responsibility as a bailor in

commodatum in the case under article 1951. (n) 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.

Article 2104. The creditor cannot use the thing pledged, without the authority of

the owner, and if he should do so, or should misuse the thing in any other way, the owner may ask that it be judicially or extrajudicially deposited. When the preservation of the thing pledged requires its use, it must be used by the creditor but only for that purpose. (1870a) Article 2105. The debtor cannot ask for the return of the thing pledged against the will of the creditor, unless and until he has paid the debt and its interest, with

expenses in a proper case. (1871)

Article 2106. If through the negligence or willful act of the pledgee, the thing pledged is in danger of being lost or impaired, the pledgor may require that it be deposited with a third person. (n) Article 2107. If there are reasonable grounds to fear the destruction or

impairment of the thing pledged, without the fault of the pledgee, the pledgor may demand the return of the thing, upon offering another thing in pledge, provided the latter is of the same kind as the former and not of inferior quality, and without prejudice to the right of the pledgee under the provisions of the following article. The pledgee is bound to advise the pledgor, without delay, of any danger to the

thing pledged. (n) Article 2108. If, without the fault of the pledgee, there is danger of destruction, impairment, or diminution in value of the thing pledged, he may cause the same to be sold at a public sale. The proceeds of the auction shall be a security for the principal obligation in the same manner as the thing originally pledged. (n)

Article 2109. If the creditor is deceived on the substance or quality of the thing pledged, he may either claim another thing in its stead, or demand immediate payment of the principal obligation. (n) Article 2110. If the thing pledged is returned by the pledgee to the pledgor or

owner, the pledge is extinguished. Any stipulation to the contrary shall be void. If subsequent to the perfection of the pledge, the thing is in the possession of the

pledgor or owner, there is a prima facie presumption that the same has been returned by the pledgee. This same presumption exists if the thing pledged is in the possession of a third person who has received it from the pledgor or owner after the constitution of the pledge. (n) Article 2111. A statement in writing by the pledgee that he renounces or

abandons the pledge is sufficient to extinguish the pledge. For this purpose, neither the acceptance by the pledgor or owner, nor the return of the thing pledged is necessary, the pledgee becoming a depositary. (n)



Article 2112. The creditor to whom the credit has not been satisfied in due time,

may proceed before a Notary Public to the sale of the thing pledged. This sale shall be made at a public auction, and with notification to the debtor and the owner of the thing pledged in a proper case, stating the amount for which the public sale is to be held. If at the first auction the thing is not sold, a second one with the same formalities shall be held; and if at the second auction there is no sale either, the creditor may appropriate the thing pledged. In this case he shall be obliged to give an acquittance for his entire claim. (1872a)

Article 2113. At the public auction, the pledgor or owner may bid. He shall,

moreover, have a better right if he should offer the same terms as the highest bidder. The pledgee may also bid, but his offer shall not be valid if he is the only bidder. Article 2114. All bids at the public auction shall offer to pay the purchase price

at once. If any other bid is accepted, the pledgee is deemed to have been received the purchase price, as far as the pledgor or owner is concerned. (n) Article 2115. The sale of the thing pledged shall extinguish the principal obligation, whether or not the proceeds of the sale are equal to the amount of the principal obligation, interest and expenses in a proper case. If the price of the sale

is more than said amount, the debtor shall not be entitled to the excess, unless it is otherwise agreed. If the price of the sale is less, neither shall the creditor be entitled to recover the deficiency, notwithstanding any stipulation to the contrary. Article 2116. After the public auction, the pledgee shall promptly advise the pledgor or owner of the result thereof. (n)

Article 2117. Any third person who has any right in or to the thing pledged may satisfy the principal obligation as soon as the latter becomes due and demandable. (n) Article 2118. If a credit which has been pledged becomes due before it is

redeemed, the pledgee may collect and receive the amount due. He shall apply the same to the payment of his claim, and deliver the surplus, should there be

any, to the pledgor. (n) Article 2119. If two or more things are pledged, the pledgee may choose which he will cause to be sold, unless there is a stipulation to the contrary. He may demand the sale of only as many of the things as are necessary for the payment of the debt.

Article 2120. If a third party secures an obligation by pledging his own movable property under the provisions of article 2085 he shall have the same rights as a

guarantor under articles 2066 to 2070, and articles 2077 to 2081. He is not prejudiced by any waiver of defense by the principal obligor. (n)

Article 2121. Pledges created by operation of law, such as those referred to in articles 546, 1731, and 1994, are governed by the foregoing articles on the possession, care and sale of the thing as well as on the termination of the pledge. However, after payment of the debt and expenses, the remainder of the price of the sale shall be delivered to the obligor. (n)

Article 2122. A thing under a pledge by operation of law may be sold only after demand of the amount for which the thing is retained. The public auction shall

take place within one month after such demand. If, without just grounds, the creditor does not cause the public sale to be held within such period, the debtor may require the return of the thing. (n) Article 2123. With regard to pawnshops and other establishments, which are

engaged in making loans secured by pledges, the special laws and regulations concerning them shall be observed, and subsidiarily, the provisions of this Title.

CHAPTER 3 Mortgage

Article 2124. Only the following property may be the object of a contract of mortgage:

(1) Immovables; (2) Alienable real rights in accordance with the laws, imposed upon immovables.

Nevertheless, movables may be the object of a chattel mortgage. (1874a)

Article 2125. In addition to the requisites stated in article 2085, it is indispensable, in order that a mortgage may be validly constituted, that the document in which it appears be recorded in the Registry of Property. If the instrument is not recorded, the mortgage is nevertheless binding between the parties.

The persons in whose favor the law establishes a mortgage have no other right than to demand the execution and the recording of the document in which the

mortgage is formalized. (1875a) Article 2126. The mortgage directly and immediately subjects the property upon which it is imposed, whoever the possessor may be, to the fulfillment of the obligation for whose security it was constituted. (1876)

Article 2127. The mortgage extends to the natural accessions, to the improvements, growing fruits, and the rents or income not yet received when the obligation becomes due, and to the amount of the indemnity granted or owing to



the proprietor from the insurers of the property mortgaged, or in virtue of expropriation for public use, with the declarations, amplifications and limitations

established by law, whether the estate remains in the possession of the mortgagor, or it passes into the hands of a third person. (1877) Article 2128. The mortgage credit may be alienated or assigned to a third person, in whole or in part, with the formalities required by law. (1878) Article 2129. The creditor may claim from a third person in possession of the

mortgaged property, the payment of the part of the credit secured by the property which said third person possesses, in the terms and with the formalities

which the law establishes. (1879) Article 2130. A stipulation forbidding the owner from alienating the immovable mortgaged shall be void. (n)

Article 2131. The form, extent and consequences of a mortgage, both as to its constitution, modification and extinguishment, and as to other matters not included in this Chapter, shall be governed by the provisions of the Mortgage Law and of the Land Registration Law. (1880a)

CHAPTER 4

Antichresis Article 2132. By the contract of antichresis the creditor acquires the right to receive the fruits of an immovable of his debtor, with the obligation to apply them to the payment of the interest, if owing, and thereafter to the principal of his credit. (1881)

Article 2133. The actual market value of the fruits at the time of the application thereof to the interest and principal shall be the measure of such application. (n) Article 2134. The amount of the principal and of the interest shall be specified in writing; otherwise, the contract of antichresis shall be void. (n)

Article 2135. The creditor, unless there is a stipulation to the contrary, is obliged

to pay the taxes and charges upon the estate. He is also bound to bear the expenses necessary for its preservation and repair. The sums spent for the purposes stated in this article shall be deducted from the fruits. (1882) Article 2136. The debtor cannot reacquire the enjoyment of the immovable

without first having totally paid what he owes the creditor.

But the latter, in order to exempt himself from the obligations imposed upon him by the preceding article, may always compel the debtor to enter again upon the

enjoyment of the property, except when there is a stipulation to the contrary. Article 2137. The creditor does not acquire the ownership of the real estate for non-payment of the debt within the period agreed upon. Every stipulation to the contrary shall be void. But the creditor may petition the court for the payment of the debt or the sale of the real property. In this case, the Rules of Court on the foreclosure of mortgages shall apply. (1884a)

Article 2138. The contracting parties may stipulate that the interest upon the

debt be compensated with the fruits of the property which is the object of the antichresis, provided that if the value of the fruits should exceed the amount of interest allowed by the laws against usury, the excess shall be applied to the principal. (1885a)

Article 2139. The last paragraph of article 2085, and articles 2089 to 2091 are applicable to this contract. (1886a)

CHAPTER 5 Chattel Mortgage

Article 2140. By a chattel mortgage, personal property is recorded in the Chattel Mortgage Register as a security for the performance of an obligation. If the movable, instead of being recorded, is delivered to the creditor or a third person, the contract is a pledge and not a chattel mortgage. (n) Article 2141. The provisions of this Code on pledge, insofar as they are not in conflict with the Chattel Mortgage Law shall be applicable to chattel mortgages.

Chattel Mortgage Law, Act 1508, amended by Act 2496

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



some other obligation specified therein, the condition being that the sale shall be void upon the seller paying to the purchaser a sum of money or doing some other

act named. If the condition is performed according to its terms the mortgage and sale immediately become void, and the mortgagee is thereby divested of his title. Sec. 4. Validity. — A chattel mortgage shall not be valid against any person except the mortgagor, his executors or administrators, unless the possession of the property is delivered to and retained by the mortgagee or unless the mortgage is recorded in the office of the register of deeds of the province in which

the mortgagor resides at the time of making the same, or, if he resides without the Philippine Islands, in the province in which the property is situated: Provided,

however, That if the property is situated in a different province from that in which the mortgagor resides, the mortgage shall be recorded in the office of the register of deeds of both the province in which the mortgagor resides and that in which the property is situated, and for the purposes of this Act the city of Manila shall be deemed to be a province.

Sec. 5. Form. — A chattel mortgage shall be deemed to be sufficient when made substantially in accordance with the following form, and shall be signed by the person or persons executing the same, in the presence of two witnesses, who shall sign the mortgage as witnesses to the execution thereof, and each mortgagor and mortgagee, or, in the absence of the mortgagee, his agent or

attorney, shall make and subscribe an affidavit in substance as hereinafter set forth, which affidavit, signed by the parties to the mortgage as above stated, and the certificate of the oath signed by the authority administering the same, shall be appended to such mortgage and recorded therewith. FORM OF CHATTEL MORTGAGE AND AFFIDAVIT. (omitted)

Sec. 6. Corporations. — When a corporation is a party to such mortgage the affidavit required may be made and subscribed by a director, trustee, cashier, treasurer, or manager thereof, or by a person authorized on the part of such corporation to make or to receive such mortgage. When a partnership is a party

to the mortgage the affidavit may be made and subscribed by one member thereof.

Sec. 7. Descriptions of property. — The description of the mortgaged property shall be such as to enable the parties to the mortgage, or any other person, after reasonable inquiry and investigation, to identify the same. If the property mortgaged be large cattle,‖ as defined by section one of Act Numbered Eleven and forty-seven, (now Section 511 of Administrative Code) and

the amendments thereof, the description of said property in the mortgage shall contain the brands, class, sex, age, knots of radiated hair commonly known as remolinos, or cowlicks, and other marks of ownership as described and set forth

in the certificate of ownership of said animal or animals, together with the number and place of issue of such certificates of ownership.

If growing crops be mortgaged the mortgage may contain an agreement stipulating that the mortgagor binds himself properly to tend, care for and protect the crop while growing, and faithfully and without delay to harvest the same, and that in default of the performance of such duties the mortgage may enter upon the premises, take all the necessary measures for the protection of said crop, and retain possession thereof and sell the same, and from the proceeds of such sale pay all expenses incurred in caring for, harvesting, and selling the crop and the

amount of the indebtedness or obligation secured by the mortgage, and the surplus thereof, if any shall be paid to the mortgagor or those entitled to the

same. A chattel mortgage shall be deemed to cover only the property described therein and not like or substituted property thereafter acquired by the mortgagor and placed in the same depository as the property originally mortgaged, anything in the mortgage to the contrary notwithstanding.

Sec. 8. Failure of mortgagee to discharge the mortgage. — If the mortgagee, assign, administrator, executor, or either of them, after performance of the condition before or after the breach thereof, or after tender of the performance of the condition, at or after the time fixed for the performance, does not within ten days after being requested thereto by any person entitled to

redeem, discharge the mortgage in the manner provided by law, the person entitled to redeem may recover of the person whose duty it is to discharge the same twenty pesos for his neglect and all damages occasioned thereby in an action in any court having jurisdiction of the subject-matter thereof. Sec. 9-12. Repealed by Act 3815, Article 367 approved December 8, 1930.

Sec. 13. When the condition of a chattel mortgage is broken, a mortgagor or person holding a subsequent mortgage, or a subsequent attaching creditor may redeem the same by paying or delivering to the mortgagee the amount due on such mortgage and the reasonable costs and expenses incurred by such breach of condition before the sale thereof. An attaching creditor who so redeems shall be

subrogated to the rights of the mortgagee and entitled to foreclose the mortgage in the same manner that the mortgagee could foreclose it by the terms of this

Act. Sec. 14. Sale of property at public auction; Officer’s return; Fees; Disposition of proceeds. — The mortgagee, his executor, administrator, or assign, may, after thirty days from the time of condition broken, cause the mortgaged property, or any part thereof, to be sold at public auction by a public

officer at a public place in the municipality where the mortgagor resides, or where the property is situated, provided at least ten days‘ notice of the time, place, and purpose of such sale has been posted at two or more public places in such



municipality, and the mortgagee, his executor, administrator, or assign, shall notify the mortgagor or person holding under him and the persons holding

subsequent mortgages of the time and place of sale, either by notice in writing directed to him or left at his abode, if within the municipality, or sent by mail if he does not reside in such municipality, at least ten days previous to the sale. The officer making the sale shall, within thirty days thereafter, make in writing a return of his doings and file the same in the office of the register of deeds where the mortgage is recorded, and the register of deeds shall record the same. The fees of the officer for selling the property shall be the same as in the case of sale

on execution as provided in Act Numbered One hundred and ninety, (now Rule 141, Sec.7, RoC) and the amendments thereto, and the fees of the register

of deeds for registering the officer‘s return shall be taxed as a part of the costs of sale, which the officer shall pay to the register of deeds. The return shall particularly describe the articles sold, and state the amount received for each article, and shall operate as a discharge of the lien thereon created by the mortgage. The proceeds of such sale shall be applied to the payment, first, of the

costs and expenses of keeping and sale, and then to the payment of the demand or obligation secured by such mortgage, and the residue shall be paid to persons holding subsequent mortgages in their order, and the balance, after paying the mortgages, shall be paid to the mortgagor or person holding under him on demand. If the sale includes any ―large cattle,‖ a certificate of transfer as required by

section sixteen of Act Numbered Eleven hundred and forty-seven (now Sec. 523 of Administrative Code) shall be issued by the treasurer of the municipality where the sale was held to the purchaser thereof. Sec. 15. Superseded by Sec. 198 of Administrative Code, as follows: SECTION 198. Registration of chattel mortgages and fees collectible in connection therewith. — Every register of deeds shall keep a primary entry

book and a registration book for the chattel mortgages; shall certify on each mortgage filed for record, as well as on its duplicate, the date, hour, and minute when the same was by him received; and shall record in such books any chattel mortgage, assignment, or discharge thereof, and any other instruments relating to a recorded mortgage, and all such instruments shall be presented to him in

duplicate, the original to be filed and the duplicate to be returned to the person concerned.

―The recording of a mortgage shall be effected by making an entry, which shall be given a correlative number, setting forth the names of the mortgagee, and the mortgagor, the sum or obligation guaranteed, date of the instrument, name of the notary before whom it was sworn to or acknowledged, and a note that the property mortgaged, as well as the terms and conditions of the mortgage, is

mentioned in detail in the instrument filed, giving the proper file number thereof. The recording of other instruments relating to a recorded mortgage shall be

effected by way of annotations on the space provided therefor in the registration book, after the same shall have been entered in the primary entry book.

―The register of deeds shall also certify the officer‘s return of sale upon any mortgage, making reference upon the record of such officer‘s return to the volume and page of the record of the mortgage, and a reference of such return on the record of the mortgage itself, and give a certified copy thereof, when requested, upon payment of the lawful fees for such copy; and certify upon each mortgage officer‘s return of sale or discharge of mortgage; and upon any other

instrument relating to such a recorded mortgage, both on the original and on the duplicate, the date, hour, and minute when the same is received for record and

record such certificate with the return itself and keep an alphabetical index of mortgagors and mortgagees, which record and index shall be open to public inspection. ―Duly certified copies of such records and of filed instruments shall be receivable

as evidence in any court. ―The register of deeds shall collect the following fees for services rendered by him under this section: xxx ― Sec. 16. This Act shall take effect on August first, nineteen hundred and six. Enacted, July 2, 1906.

Pledge Generally, it does not affect third persons

o Exception: when the pledge is in a public instrument The pledger can alienate the thing pledged, provided that the thing is still

under the pledge and with consent of the pledgee Pledgee can be liable for acts of its employees or agents

Generally, the pledge cannot be deposited to third persons o Exception: when there is a stipulation agreed by the pledgor

Can pledge be deposited in an escrow? Income: can be applied to principal Pledgee has the right to defend the pledge since it is in his possession

If the pledge is returned to the owner, it is deemed extinguished. Any contrary stipulation is void

Before selling, there should be a demand Pactum Commisorium Agreement which says that upon default of the borrower, the creditor will

be entitled to keep and acquire ownership of the property which has been pledged or mortgaged regardless of the amount of debt or value of property

Void contrary to public policy

It makes the debtor under the power of the creditor since it preys on the borrower‘s weak financial position.



Mortgage: Real property

The thing mortgage can be sold. Any contrary provision is void Antichresis The creditor can apply the fruits of the immovable property of his debtor to

his debt. Interest first then principal

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 debtor-mortgagee 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.

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 long-term 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)



Requirements

Banks are subject to BSP regulations Public trust depositors‘ money

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.

2.5. Guaranty


CHAPTER 1 Nature and Extent of Guaranty

Article 2047. By guaranty a person, called the guarantor, binds himself to the creditor to fulfill the obligation of the principal debtor in case the latter should fail to do so.

If a person binds himself solidarily with the principal debtor, the provisions of Section 4, Chapter 3, Title I of this Book shall be observed. In such case the

contract is called a suretyship. (1822a) Article 2048. A guaranty is gratuitous, unless there is a stipulation to the contrary. (n) Article 2049. A married woman may guarantee an obligation without the husband's consent, but shall not thereby bind the conjugal partnership, except in

cases provided by law. (n)

Article 2050. If a guaranty is entered into without the knowledge or consent, or against the will of the principal debtor, the provisions of articles 1236 and 1237 shall apply. (n) Article 2051. A guaranty may be conventional, legal or judicial, gratuitous, or by

onerous title. It may also be constituted, not only in favor of the principal debtor, but also in favor of the other guarantor, with the latter's consent, or without his knowledge, or even over his objection. (1823) Article 2052. A guaranty cannot exist without a valid obligation.

Nevertheless, a guaranty may be constituted to guarantee the performance of a voidable or an unenforceable contract. It may also guarantee a natural obligation. Article 2053. A guaranty may also be given as security for future debts, the amount of which is not yet known; there can be no claim against the guarantor until the debt is liquidated. A conditional obligation may also be secured. (1825a)

Article 2054. A guarantor may bind himself for less, but not for more than the principal debtor, both as regards the amount and the onerous nature of the conditions. Should he have bound himself for more, his obligations shall be reduced to the limits of that of the debtor. (1826)

Article 2055. A guaranty is not presumed; it must be express and cannot extend

to more than what is stipulated therein. If it be simple or indefinite, it shall compromise not only the principal obligation, but also all its accessories, including the judicial costs, provided with respect to the latter, that the guarantor shall only be liable for those costs incurred after he has been judicially required to pay. (1827a)

Article 2056. One who is obliged to furnish a guarantor shall present a person who possesses integrity, capacity to bind himself, and sufficient property to answer for the obligation which he guarantees. The guarantor shall be subject to



the jurisdiction of the court of the place where this obligation is to be complied with. (1828a)

Article 2057. If the guarantor should be convicted in first instance of a crime involving dishonesty or should become insolvent, the creditor may demand another who has all the qualifications required in the preceding article. The case is excepted where the creditor has required and stipulated that a specified person should be the guarantor. (1829a)

CHAPTER 2 Effects of Guaranty

SECTION 1

Effects of Guaranty Between the Guarantor and the Creditor Article 2058. The guarantor cannot be compelled to pay the creditor unless the

latter has exhausted all the property of the debtor, and has resorted to all the legal remedies against the debtor. (1830a) Article 2059. The excussion shall not take place:

(1) If the guarantor has expressly renounced it; (2) If he has bound himself solidarily with the debtor;

(3) In case of insolvency of the debtor; (4) When he has absconded, or cannot be sued within the Philippines unless he has left a manager or representative; (5) If it may be presumed that an execution on the property of the principal debtor would not result in the satisfaction of the obligation.

Article 2060. In order that the guarantor may make use of the benefit of

exclusion, he must set it up against the creditor upon the latter's demand for payment from him, and point out to the creditor available property of the debtor within Philippine territory, sufficient to cover the amount of the debt. (1832) Article 2061. The guarantor having fulfilled all the conditions required in the

preceding article, the creditor who is negligent in exhausting the property pointed out shall suffer the loss, to the extent of said property, for the insolvency of the

debtor resulting from such negligence. (1833a) Article 2062. In every action by the creditor, which must be against the principal debtor alone, except in the cases mentioned in article 2059, the former shall ask the court to notify the guarantor of the action. The guarantor may appear so that he may, if he so desire, set up such defenses as are granted him by law. The

benefit of excussion mentioned in article 2058 shall always be unimpaired, even if judgment should be rendered against the principal debtor and the guarantor in case of appearance by the latter. (1834a)

Article 2063. A compromise between the creditor and the principal debtor

benefits the guarantor but does not prejudice him. That which is entered into between the guarantor and the creditor benefits but does not prejudice the principal debtor. (1835a) Article 2064. The guarantor of a guarantor shall enjoy the benefit of excussion, both with respect to the guarantor and to the principal debtor. (1836)

Article 2065. Should there be several guarantors of only one debtor and for the same debt, the obligation to answer for the same is divided among all. The

creditor cannot claim from the guarantors except the shares which they are respectively bound to pay, unless solidarity has been expressly stipulated. The benefit of division against the co-guarantors ceases in the same cases and for the same reasons as the benefit of excussion against the principal debtor. (1837)

SECTION 2

Effects of Guaranty Between the Debtor and the Guarantor Article 2066. The guarantor who pays for a debtor must be indemnified by the latter.

The indemnity comprises: (1) The total amount of the debt; (2) The legal interests thereon from the time the payment was made known to the debtor, even though it did not earn interest for the creditor; (3) The expenses incurred by the guarantor after having notified the debtor that payment had been demanded of him; (4) Damages, if they are due. (1838a)

Article 2067. The guarantor who pays is subrogated by virtue thereof to all the rights which the creditor had against the debtor. If the guarantor has compromised with the creditor, he cannot demand of the debtor more than what he has really paid. (1839)

Article 2068. If the guarantor should pay without notifying the debtor, the latter

may enforce against him all the defenses which he could have set up against the creditor at the time the payment was made. (1840) Article 2069. If the debt was for a period and the guarantor paid it before it became due, he cannot demand reimbursement of the debtor until the expiration of the period unless the payment has been ratified by the debtor. (1841a)

Article 2070. If the guarantor has paid without notifying the debtor, and the latter not being aware of the payment, repeats the payment, the former has no



remedy whatever against the debtor, but only against the creditor. Nevertheless, in case of a gratuitous guaranty, if the guarantor was prevented by a fortuitous

event from advising the debtor of the payment, and the creditor becomes insolvent, the debtor shall reimburse the guarantor for the amount paid. (1842a) Article 2071. The guarantor, even before having paid, may proceed against the principal debtor:

(1) When he is sued for the payment; (2) In case of insolvency of the principal debtor;

(3) When the debtor has bound himself to relieve him from the guaranty within a specified period, and this period has expired;

(4) When the debt has become demandable, by reason of the expiration of the period for payment; (5) After the lapse of ten years, when the principal obligation has no fixed period for its maturity, unless it be of such nature that it cannot be extinguished except within a period longer than ten years;

(6) If there are reasonable grounds to fear that the principal debtor intends to abscond; (7) If the principal debtor is in imminent danger of becoming insolvent.

In all these cases, the action of the guarantor is to obtain release from the guaranty, or to demand a security that shall protect him from any proceedings by the creditor and from the danger of insolvency of the debtor. (1834a)

Article 2072. If one, at the request of another, becomes a guarantor for the debt of a third person who is not present, the guarantor who satisfies the debt may sue either the person so requesting or the debtor for reimbursement. (n)

SECTION 3.

Effects of Guaranty as Between Co-Guarantors

Article 2073. When there are two or more guarantors of the same debtor and for the same debt, the one among them who has paid may demand of each of the others the share which is proportionally owing from him. If any of the guarantors should be insolvent, his share shall be borne by the

others, including the payer, in the same proportion. The provisions of this article shall not be applicable, unless the payment has been

made by virtue of a judicial demand or unless the principal debtor is insolvent. Article 2074. In the case of the preceding article, the co-guarantors may set up against the one who paid, the same defenses which would have pertained to the principal debtor against the creditor, and which are not purely personal to the debtor. (1845) ARTICLE 2075. A sub-guarantor, in case of the insolvency of the

guarantor for whom he bound himself, is responsible to the co-guarantors in the same terms as the guarantor. (1846)

CHAPTER 3 Extinguishment of Guaranty

Article 2076. The obligation of the guarantor is extinguished at the same time as that of the debtor, and for the same causes as all other obligations. (1847) Article 2077. If the creditor voluntarily accepts immovable or other property in payment of the debt, even if he should afterwards lose the same through eviction, the guarantor is released. (1849)

Article 2078. A release made by the creditor in favor of one of the guarantors,

without the consent of the others, benefits all to the extent of the share of the guarantor to whom it has been granted. (1850) Article 2079. An extension granted to the debtor by the creditor without the consent of the guarantor extinguishes the guaranty. The mere failure on the part

of the creditor to demand payment after the debt has become due does not of itself constitute any extension of time referred to herein. (1851a) Article 2080. The guarantors, even though they be solidary, are released from their obligation whenever by some act of the creditor they cannot be subrogated to the rights, mortgages, and preference of the latter. (1852)

Article 2081. The guarantor may set up against the creditor all the defenses which pertain to the principal debtor and are inherent in the debt; but not those that are personal to the debtor. (1853)

2.6. Surety


SECTION 4

Joint and Solidary Obligations

Article 1207. The concurrence of two or more creditors or of two or more debtors in one and the same obligation does not imply that each one of the former has a right to demand, or that each one of the latter is bound to render,

entire compliance with the prestation. There is a solidary liability only when the obligation expressly so states, or when the law or the nature of the obligation requires solidarity. (1137a) Article 1208. If from the law, or the nature or the wording of the obligations to which the preceding article refers the contrary does not appear, the credit or debt

shall be presumed to be divided into as many shares as there are creditors or



debtors, the credits or debts being considered distinct from one another, subject to the Rules of Court governing the multiplicity of suits. (1138a)

Article 1209. If the division is impossible, the right of the creditors may be prejudiced only by their collective acts, and the debt can be enforced only by proceeding against all the debtors. If one of the latter should be insolvent, the others shall not be liable for his share. (1139) Article 1210. The indivisibility of an obligation does not necessarily give rise to

solidarity. Nor does solidarity of itself imply indivisibility. (n)

Article 1211. Solidarity may exist although the creditors and the debtors may not be bound in the same manner and by the same periods and conditions. Article 1212. Each one of the solidary creditors may do whatever may be useful to the others, but not anything which may be prejudicial to the latter. (1141a)

Article 1213. A solidary creditor cannot assign his rights without the consent of the others. (n) Article 1214. The debtor may pay any one of the solidary creditors; but if any demand, judicial or extrajudicial, has been made by one of them, payment should

be made to him. (1142a) Article 1215. Novation, compensation, confusion or remission of the debt, made by any of the solidary creditors or with any of the solidary debtors, shall extinguish the obligation, without prejudice to the provisions of article 1219. The creditor who may have executed any of these acts, as well as he who collects the debt, shall be liable to the others for the share in the obligation corresponding

to them. (1143) Article 1216. The creditor may proceed against any one of the solidary debtors or some or all of them simultaneously. The demand made against one of them shall not be an obstacle to those which may subsequently be directed against the

others, so long as the debt has not been fully collected. (1144a)

Article 1217. Payment made by one of the solidary debtors extinguishes the obligation. If two or more solidary debtors offer to pay, the creditor may choose which offer to accept. He who made the payment may claim from his co-debtors only the share which corresponds to each, with the interest for the payment already made. If the payment is made before the debt is due, no interest for the intervening period

may be demanded.

When one of the solidary debtors cannot, because of his insolvency, reimburse his share to the debtor paying the obligation, such share shall be borne by all his co-

debtors, in proportion to the debt of each. (1145a) Article 1218. Payment by a solidary debtor shall not entitle him to reimbursement from his co-debtors if such payment is made after the obligation has prescribed or become illegal. (n) Article 1219. The remission made by the creditor of the share which affects one

of the solidary debtors does not release the latter from his responsibility towards the co-debtors, in case the debt had been totally paid by anyone of them before

the remission was effected. (1146a) Article 1220. The remission of the whole obligation, obtained by one of the solidary debtors, does not entitle him to reimbursement from his co-debtors. (n)

Article 1221. If the thing has been lost or if the prestation has become impossible without the fault of the solidary debtors, the obligation shall be extinguished. If there was fault on the part of any one of them, all shall be responsible to the creditor, for the price and the payment of damages and interest, without prejudice to their action against the guilty or negligent debtor.

If through a fortuitous event, the thing is lost or the performance has become impossible after one of the solidary debtors has incurred in delay through the judicial or extrajudicial demand upon him by the creditor, the provisions of the preceding paragraph shall apply. (1147a) Article 1222. A solidary debtor may, in actions filed by the creditor, avail himself of all defenses which are derived from the nature of the obligation and of those

which are personal to him, or pertain to his own share. With respect to those which personally belong to the others, he may avail himself thereof only as regards that part of the debt for which the latter are responsible. (1148a)

Heirs of George Y. Poe v. Malayan Insurance Corp.

584 SCRA 152 (2009) Facts: Issue:

Ratio:

Escaño v. Ortigas, Jr.

526 SCRA 26 (2007)



Facts:

Issue: Ratio:

2.7. Trust Receipts.

Trust Receipts Law (PD No. 115)

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

offense punishable under Article Three hundred and fifteen of the Revised Penal Code.

Section 3. Definition of terms. As used in this Decree, unless the context otherwise requires, the term

(a) "Document" shall mean written or printed evidence of title to goods. (b) "Entrustee" shall refer to the person having or taking possession of goods, documents or instruments under a trust receipt transaction, and any successor in interest of such person for the purpose or purposes

specified in the trust receipt agreement. (c) "Entruster" shall refer to the person holding title over the goods,

documents, or instruments subject of a trust receipt transaction, and any successor in interest of such person. (d) "Goods" shall include chattels and personal property other than: money, things in action, or things so affixed to land as to become a part thereof.

(e) "Instrument" means any negotiable instrument as defined in the Negotiable Instrument Law; any certificate of stock, or bond or debenture for the payment of money issued by a public or private corporation, or any certificate of deposit, participation certificate or receipt, any credit or investment instrument of a sort marketed in the ordinary course of business or finance, whereby the entrustee, after the issuance of the trust

receipt, appears by virtue of possession and the face of the instrument to be the owner. "Instrument" shall not include a document as defined in this Decree. (f) "Purchase" means taking by sale, conditional sale, lease, mortgage, or pledge, legal or equitable. (g) "Purchaser" means any person taking by purchase. (h) "Security Interest" means a property interest in goods, documents or

instruments to secure performance of some obligations of the entrustee or of some third persons to the entruster and includes title, whether or not expressed to be absolute, whenever such title is in substance taken or retained for security only. (i) "Person" means, as the case may be, an individual, trustee, receiver,

or other fiduciary, partnership, corporation, business trust or other association, and two more persons having a joint or common interest.

(j) "Trust Receipt" shall refer to the written or printed document signed by the entrustee in favor of the entruster containing terms and conditions substantially complying with the provisions of this Decree. No further formality of execution or authentication shall be necessary to the validity of a trust receipt. (k) "Value" means any consideration sufficient to support a simple

contract.



Section 4. What constitutes a trust receipt transaction. A trust receipt transaction, within the meaning of this Decree, is any transaction by and between

a person referred to in this Decree as the entruster, and another person referred to in this Decree as entrustee, whereby the entruster, who owns or holds absolute title or security interests over certain specified goods, documents or instruments, releases the same to the possession of the entrustee upon the latter's execution and delivery to the entruster of a signed document called a "trust receipt" wherein the entrustee binds himself to hold the designated goods, documents or instruments in trust for the entruster and to sell or otherwise dispose of the

goods, documents or instruments with the obligation to turn over to the entruster the proceeds thereof to the extent of the amount owing to the entruster or as

appears in the trust receipt or the goods, documents or instruments themselves if they are unsold or not otherwise disposed of, in accordance with the terms and conditions specified in the trust receipt, or for other purposes substantially equivalent to any of the following:

1. In the case of goods or documents, (a) to sell the goods or procure

their sale; or (b) to manufacture or process the goods with the purpose of ultimate sale: Provided, That, in the case of goods delivered under trust receipt for the purpose of manufacturing or processing before its ultimate sale, the entruster shall retain its title over the goods whether in its original or processed form until the entrustee has complied fully with his obligation under the trust receipt; or (c) to load, unload, ship or

tranship or otherwise deal with them in a manner preliminary or necessary to their sale; or 2. In the case of instruments,

a) to sell or procure their sale or exchange; or b) to deliver them to a principal; or c) to effect the consummation of some transactions involving delivery to a depository or register; or

d) to effect their presentation, collection or renewal The sale of goods, documents or instruments by a person in the business of selling goods, documents or instruments for profit who, at the outset of the transaction, has, as against the buyer, general property rights in such goods, documents or instruments, or who sells the same to the buyer on

credit, retaining title or other interest as security for the payment of the purchase price, does not constitute a trust receipt transaction and is

outside the purview and coverage of this Decree. Section 5. Form of trust receipts; contents. A trust receipt need not be in any particular form, but every such receipt must substantially contain (a) a description of the goods, documents or instruments subject of the trust receipt; (2) the total invoice value of the goods and the amount of the draft to be paid by

the entrustee; (3) an undertaking or a commitment of the entrustee (a) to hold in trust for the entruster the goods, documents or instruments therein described; (b) to dispose of them in the manner provided for in the trust receipt; and (c) to

turn over the proceeds of the sale of the goods, documents or instruments to the entruster to the extent of the amount owing to the entruster or as appears in the

trust receipt or to return the goods, documents or instruments in the event of their non-sale within the period specified therein. The trust receipt may contain other terms and conditions agreed upon by the parties in addition to those hereinabove enumerated provided that such terms and conditions shall not be contrary to the provisions of this Decree, any existing laws, public policy or morals, public order or good customs.

Section 6. Currency in which a trust receipt may be denominated. A trust receipt may be denominated in the Philippine currency or any foreign currency acceptable

and eligible as part of international reserves of the Philippines, the provisions of existing law, executive orders, rules and regulations to the contrary notwithstanding: Provided, however, That in the case of trust receipts denominated in foreign currency, payment shall be made in its equivalent in Philippine currency computed at the prevailing exchange rate on the date the

proceeds of sale of the goods, documents or instruments held in trust by the entrustee are turned over to the entruster or on such other date as may be stipulated in the trust receipt or other agreements executed between the entruster and the entrustee. Section 7. Rights of the entruster. The entruster shall be entitled to the proceeds

from the sale of the goods, documents or instruments released under a trust receipt to the entrustee to the extent of the amount owing to the entruster or as appears in the trust receipt, or to the return of the goods, documents or instruments in case of non-sale, and to the enforcement of all other rights conferred on him in the trust receipt provided such are not contrary to the provisions of this Decree. The entruster may cancel the trust and take possession of the goods, documents

or instruments subject of the trust or of the proceeds realized therefrom at any time upon default or failure of the entrustee to comply with any of the terms and conditions of the trust receipt or any other agreement between the entruster and the entrustee, and the entruster in possession of the goods, documents or instruments may, on or after default, give notice to the entrustee of the intention

to sell, and may, not less than five days after serving or sending of such notice, sell the goods, documents or instruments at public or private sale, and the

entruster may, at a public sale, become a purchaser. The proceeds of any such sale, whether public or private, shall be applied (a) to the payment of the expenses thereof; (b) to the payment of the expenses of re-taking, keeping and storing the goods, documents or instruments; (c) to the satisfaction of the entrustee's indebtedness to the entruster. The entrustee shall receive any surplus but shall be liable to the entruster for any deficiency. Notice of sale shall be

deemed sufficiently given if in writing, and either personally served on the entrustee or sent by post-paid ordinary mail to the entrustee's last known business address.



Section 8. Entruster not responsible on sale by entrustee. The entruster holding

a security interest shall not, merely by virtue of such interest or having given the entrustee liberty of sale or other disposition of the goods, documents or instruments under the terms of the trust receipt transaction be responsible as principal or as vendor under any sale or contract to sell made by the entrustee. Section 9. Obligations of the entrustee. The entrustee shall (1) hold the goods, documents or instruments in trust for the entruster and shall dispose of them

strictly in accordance with the terms and conditions of the trust receipt; (2) receive the proceeds in trust for the entruster and turn over the same to the

entruster to the extent of the amount owing to the entruster or as appears on the trust receipt; (3) insure the goods for their total value against loss from fire, theft, pilferage or other casualties; (4) keep said goods or proceeds thereof whether in money or whatever form, separate and capable of identification as property of the entruster; (5) return the goods, documents or instruments in the

event of non-sale or upon demand of the entruster; and (6) observe all other terms and conditions of the trust receipt not contrary to the provisions of this Decree. Section 10. Liability of entrustee for loss. The risk of loss shall be borne by the entrustee. Loss of goods, documents or instruments which are the subject of a

trust receipt, pending their disposition, irrespective of whether or not it was due to the fault or negligence of the entrustee, shall not extinguish his obligation to the entruster for the value thereof. Section 11. Rights of purchaser for value and in good faith. Any purchaser of goods from an entrustee with right to sell, or of documents or instruments through their customary form of transfer, who buys the goods, documents, or

instruments for value and in good faith from the entrustee, acquires said goods, documents or instruments free from the entruster's security interest. Section 12. Validity of entruster's security interest as against creditors. The entruster's security interest in goods, documents, or instruments pursuant to the

written terms of a trust receipt shall be valid as against all creditors of the entrustee for the duration of the trust receipt agreement.

Section 13. Penalty clause. The failure of an entrustee to turn over the proceeds of the sale of the goods, documents or instruments covered by a trust receipt to the extent of the amount owing to the entruster or as appears in the trust receipt or to return said goods, documents or instruments if they were not sold or disposed of in accordance with the terms of the trust receipt shall constitute the

crime of estafa, punishable under the provisions of Article Three hundred and fifteen, paragraph one (b) of Act Numbered Three thousand eight hundred and fifteen, as amended, otherwise known as the Revised Penal Code. If the violation

or offense is committed by a corporation, partnership, association or other juridical entities, the penalty provided for in this Decree shall be imposed upon

the directors, officers, employees or other officials or persons therein responsible for the offense, without prejudice to the civil liabilities arising from the criminal offense. Section 14. Cases not covered by this Decree. Cases not provided for in this Decree shall be governed by the applicable provisions of existing laws.

Section 15. Separability clause. If any provision or section of this Decree or the application thereof to any person or circumstance is held invalid, the other

provisions or sections hereof and the application of such provisions or sections to other persons or circumstances shall not be affected thereby. Section 16. Repealing clause. All Acts inconsistent with this Decree are hereby repealed.

Section 17. This Decree shall take effect immediately.

Metrobank v. Jimmy Go, et al

538 SCRA 337 (2007)

2.8. Payment

Civil Code, Arts. 1233, 1236-1238, 1240, 1242-1251

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



consent. But the payment is in any case valid as to the creditor who has accepted it. (n)

Article 1240. Payment shall be made to the person in whose favor the obligation has been constituted, or his successor in interest, or any person authorized to receive it. (1162a) Article 1242. Payment made in good faith to any person in possession of the credit shall release the debtor.

Article 1243. Payment made to the creditor by the debtor after the latter has

been judicially ordered to retain the debt shall not be valid. (1165) Article 1244. The debtor of a thing cannot compel the creditor to receive a different one, although the latter may be of the same value as, or more valuable than that which is due.

In obligations to do or not to do, an act or forbearance cannot be substituted by another act or forbearance against the obligee's will. (1166a) Article 1245. Dation in payment, whereby property is alienated to the creditor in satisfaction of a debt in money, shall be governed by the law of sales. (n)

Article 1246. When the obligation consists in the delivery of an indeterminate or generic thing, whose quality and circumstances have not been stated, the creditor cannot demand a thing of superior quality. Neither can the debtor deliver a thing of inferior quality. The purpose of the obligation and other circumstances shall be taken into consideration. (1167a) Article 1247. Unless it is otherwise stipulated, the extrajudicial expenses

required by the payment shall be for the account of the debtor. With regard to judicial costs, the Rules of Court shall govern. (1168a) Article 1248. Unless there is an express stipulation to that effect, the creditor cannot be compelled partially to receive the prestations in which the obligation

consists. Neither may the debtor be required to make partial payments. However, when the debt is in part liquidated and in part unliquidated, the creditor

may demand and the debtor may effect the payment of the former without waiting for the liquidation of the latter. (1169a) Article 1249. The payment of debts in money shall be made in the currency stipulated, and if it is not possible to deliver such currency, then in the currency which is legal tender in the Philippines.

The delivery of promissory notes payable to order, or bills of exchange or other mercantile documents shall produce the effect of payment only when they have been cashed, or when through the fault of the creditor they have been impaired.

In the meantime, the action derived from the original obligation shall be held in the abeyance. (1170)

Article 1250. In case an extraordinary inflation or deflation of the currency stipulated should supervene, the value of the currency at the time of the establishment of the obligation shall be the basis of payment, unless there is an agreement to the contrary. (n) Article 1251. Payment shall be made in the place designated in the obligation.

There being no express stipulation and if the undertaking is to deliver a determinate thing, the payment shall be made wherever the thing might be at the

moment the obligation was constituted. In any other case the place of payment shall be the domicile of the debtor. If the debtor changes his domicile in bad faith or after he has incurred in delay, the additional expenses shall be borne by him. These provisions are without prejudice to venue under the Rules of Court.

2.9. Application of Payment


Application of Payment

SUBSECTION 1. Application of Payments Article 1252. He who has various debts of the same kind in favor of one and the same creditor, may declare at the time of making the payment, to which of them

the same must be applied. Unless the parties so stipulate, or when the application of payment is made by the party for whose benefit the term has been constituted, application shall not be made as to debts which are not yet due. If the debtor accepts from the creditor a receipt in which an application of the payment is made, the former cannot complain of the same, unless there is a cause for invalidating the contract. (1172a)

Article 1253. If the debt produces interest, payment of the principal shall not be deemed to have been made until the interests have been covered. (1173) Article 1254. When the payment cannot be applied in accordance with the preceding rules, or if application can not be inferred from other circumstances, the debt which is most onerous to the debtor, among those due, shall be deemed

to have been satisfied. If the debts due are of the same nature and burden, the payment shall be applied to all of them proportionately. (1174a)



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)

2.11. Compensation


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 1284. When one or both debts are rescissible or voidable, they may be compensated against each other before they are judicially rescinded or avoided.

Article 1285. The debtor who has consented to the assignment of rights made by a creditor in favor of a third person, cannot set up against the assignee the compensation which would pertain to him against the assignor, unless the assignor was notified by the debtor at the time he gave his consent, that he reserved his right to the compensation. If the creditor communicated the cession to him but the debtor did not consent

thereto, the latter may set up the compensation of debts previous to the cession, but not of subsequent ones.

If the assignment is made without the knowledge of the debtor, he may set up the compensation of all credits prior to the same and also later ones until he had knowledge of the assignment. (1198a) Article 1286. Compensation takes place by operation of law, even though the

debts may be payable at different places, but there shall be an indemnity for expenses of exchange or transportation to the place of payment. (1199a) Article 1287. Compensation shall not be proper when one of the debts arises from a depositum or from the obligations of a depositary or of a bailee in commodatum.

Neither can compensation be set up against a creditor who has a claim for support due by gratuitous title, without prejudice to the provisions of paragraph 2 of article 301. (1200a) Article 1288. Neither shall there be compensation if one of the debts consists in civil liability arising from a penal offense. (n)

Article 1289. If a person should have against him several debts which are susceptible of compensation, the rules on the application of payments shall apply to the order of the compensation. (1201) Article 1290. When all the requisites mentioned in article 1279 are present,

compensation takes effect by operation of law, and extinguishes both debts to the concurrent amount, even though the creditors and debtors are not aware of the

compensation. (1202a)

2.12. Novation

Civil Code, Arts. 1291 Article 1291. Obligations may be modified by:

(1) Changing their object or principal conditions;

(2) Substituting the person of the debtor;



(3) Subrogating a third person in the rights of the creditor. (1203)

3. Economic Attributes of Investment Devices

WILLIAM A. KLEIN & JOHN C. COFFEE, JR., BUSINESS

ORGANIZATION AND FINANCE, 240-251 (2007) 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

deviation—that 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

Yield is the rate of return that will be earned by a lender if the full amount of interest and principal that the borrower has agreed to pay are paid on

schedule When used alone, yield means yield to maturity, or total yield Current Yield the promised interest payment as a percentage of the

initial investment o It is of some significance for tax purposes and for people concerned

with cash flow o It does not reveal total yield, since the

Yield to maturity investor‘s total 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.



A critical axiom of modern investment analysis is that in their major investment decisions, the overwhelming majority of people are risk averse

One corollary is that investors will accept volatility risk only if they are paid to do so (amount paid is sometimes called a risk premium)

Another corollary is that the higher the risk, the higher the return o As between two investments of equal return, people will prefer the one

with the lower risk o As between two investments of equal risk, people will prefer the one

with the higher return Risk-adjusted interest rate the traditional way of accounting for the

difference in risk among investments is to adjust the interest rate upward

(or downward) to rake control of increased (or decreased) risk 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. Debt Instruments and Loan Documentation



GROWTH, 164-218 (2005) Debt Instruments Debt instruments may be categorized into two broad categories: secured

debt or unsecured debt Secured Debt

o A loan extended to a borrower based primarily on the ability of the borrower to repay the loan from the cash flows of its business

operations. o The basic loan transaction is coupled with a grant by the borrower of a

security interest in the assets or cash flows of the borrower. o In the event that the borrower is unable to repay the loan out of the

cash flows of its business, the lender may take title to the assets pledged s security and then sell the assets. The lender may then apply the proceeds of the sale of the pledged

assets to repay the secured debt. If the proceeds of the sale are insufficient to repay the obligation, a

lender then has a claim against the general assets of the borrower o A lender may also proceed to collect any unpaid amounts from a

guarantor or from the proceeds of the sale of any assets that a guarantor may have pledged to support the original loan request

Unsecured Debt

o Made by a lender when the borrower is able to convince the lender that the general credit of the borrower is sufficient to insure repayment of the requested loan

o The borrower is typically well-established and has a history of successfully retiring credit extended by secured and unsecured lenders

o Preference Secured loans are paid first before unsecured ones

o Riskier, has higher interest because of the priority of payments to

secured lenders than to unsecured ones, unsecured loans are generally more risky and therefore carries a higher interest rate than secured loans

4.1. Preliminary Steps to entering into a debt financing 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

borrower‘s 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



o The lender must be presented with a detailed set of assumptions and the basic modules used by the borrower in building its financial model

Fundamental to the success of any loan request is an understanding of the nature and character of loans made by the lending institution o Due diligence by the borrower can reduce or eliminate false starts

related to making loan requests to lenders o Check their websites!

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 lender‘s willingness to extend a loan

With a detailed description of the lender‘s 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 lender‘s 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 borrower‘s 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

o The flexibility to make changes rather than terminate a commitment is beneficial to the borrower and lender

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 lender‘s 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, consultant‘s fees and credit reports

4.2. The Credit Agreement Loan Documentation Loan documentation can be as simple as a lender‘s 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



4.3. Types of Credit Facilities Credit facilities fall into two primary categories of loans: term or revolving

o Term Loans 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

o 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 borrower‘s available loan amount normally

include accounts receivable and inventory o As these assets increase, the borrower‘s 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

o Interest Rate and Pricing Alternatives

4.4. Representation and Warranties

4.5. Borrower’s Organizational Structure

4.6. Borrower’s Financial Statements

4.7. Borrower’s Operations

4.8. Loan Covenants

o Affirmative Covenants

o Negative Covenants

o Prepayment Covenants

o Financial Covenants

4.9. Liquidity Ratios

4.10. Leverage Ratios

4.11. Events of Default

4.12. Remedies Available Upon an Event of Default

4.13. The Promissory Note

4.14. The Security Agreement

4.15. The Collateral Assignment

4.16. The Inter-Creditor Agreement

4.17. Subordination Agreement

4.18. Categories of Debt Instruments

4.19. Secured Loans

4.20. Asset Based Fiancings

4.21. Cash Flow Based Financings

4.22. Junior Secured Loans

4.23. Unsecured Loans

4.24. High Yield Debt

4.25. Mezzanine Financings

4.26. Convertible Debt and Convertible Stock

4.27. Bridge Loans

4.28. Specialized Lending

4.29. Credit Ratings and Reporting Agencies

5. Taxation

5.1. Interest as a Deduction from Gross Income: NIRC

§34 (B)

(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;



Thirty-nine percent (39%) beginning January 1, 1999; and Thirty-eight percent (38%) beginning January 1, 2000;

(2) Exceptions. - No deduction shall be allowed in respect of interest

under the succeeding subparagraphs: (a) If within the taxable year an individual taxpayer reporting income on

the cash basis incurs an indebtedness on which an interest is paid in advance through discount or otherwise: Provided, That such interest shall be allowed a a deduction in the year the indebtedness is paid:

Provided, further, That if the indebtedness is payable in periodic amortizations, the amount of interest which corresponds to the

amount of the principal amortized or paid during the year shall be allowed as deduction in such taxable year;

(b) If both the taxpayer and the person to whom the payment has been made or is to be made are persons specified under Section 36 (B); or

(c) If the indebtedness is incurred to finance petroleum exploration.

(3) Optional Treatment of Interest Expense. - At the option of the taxpayer, interest incurred to acquire property used in trade business or exercise of a profession may be allowed as a deduction or treated as a capital expenditure.

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.

Extent of VAT exemption on interest: NIRC

§109(M), (U); Revenue Regulation No. 16-2005

§4.109-1(B)(1)(m), (u)

*NIRC provision same as that below

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 multi-

purpose 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.

Percentage Taxes; Gross Receipts Tax: NIRC

§121, 122 (As amended by RA No. 9337)

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



and all other items treated as gross income under Section 32 of this Code 7%

(d) On net trading gains within the taxable year on foreign currency, debt securities, derivatives, and other similar financial instruments 7%

Provided, however, That in case the maturity period referred to in paragraph

(a) is shortened thru pre-termination, then the maturity period shall be reckoned to end as of the date of pre-termination for purposes of classifying the transaction

and the correct rate of tax shall be applied accordingly. Provided, finally, That the generally accepted accounting principles as may be

prescribed by the Bangko Sentral ng Pilipinas for the bank or non-bank financial

intermediary performing quasi-banking functions shall likewise be the basis for the calculation of gross receipts.

Nothing in this Code shall preclude the Commissioner from imposing the same tax herein provided on persons performing similar banking activities.

SEC. 122. Tax on Finance Companies. - There shall be collected a tax of five percent (5%) on the gross receipts derived by all finance companies, as well as by other financial intermediaries not performing quasi-banking functions dong business in the Philippines, from interest, discounts and all other items treated as gross income under this Code: Provided, That interests, commissions and

discounts from lending activities, as well as income from financial leasing, shall be

taxed on the basis of the remaining maturities of the instruments from which such receipts are derived, in accordance with the following schedule:

Short-term maturity (non in excess of two (2) years) 5% Medium-term maturity (over two (2) but not exceeding four (4) years)

3%

Long-term maturity o Over four (4) years but not exceeding seven (7) years 1% o Over seven (7) years 0%

Provided, however, That in case the maturity period is shortened thru

pretermination, then the maturity period shall be reckoned to end as of the date

of pretermination for purposes of classifying the transaction as short, medium or

long-term and the correct rate of tax shall be applied accordingly. Nothing in this Code shall preclude the Commissioner from imposing the

same tax herein provided on persons performing similar financing activities.

5.3. Inter-company Loans

Revenue Memorandum Order No. 63-99 (July 19,

1999)

Subject: Determination of Taxable Income on Inter-company Loans or Advances applying Section 50 of the NIRC, as amended

Objectives: To adopt the arm's length bargaining standard as the ultimate test for

determining the correct gross income and deductions between two or more enterprises under common control.

To provide a means of redistributing or reapportioning income and expenses of taxpayers under common control after applying Section 50 of the NIRC,

as amended.

Coverage: Loans or advances of money or other consideration (whether or not

evidence by a written instrument); Indebtedness arising in the ordinary course of business out of sales, leases,

or the rendition of services by or between members of the group, or any

other similar extension; But does not apply to alleged indebtedness which was in fact a contribution

of capital or a distribution by a corporation with respect to its shares. Applying the Arms length Standard on Sec. 50 Section 50. Allocation of income and deductions. - In any case of two

or more organizations, trades, or businesses (whether or not incorporated and whether or not organized in the Philippines) owned or controlled directly or indirectly by the same interests, the Commissioner of Internal Revenue is authorized to distribute, apportion, or allocate gross income or deductions between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the

income of any such organizations, trades or businesses. Section 50 empowers the Commissioner to rectify abnormalities and

distortions in income brought about by common control through the adoption of standards considered fair, reasonable or at arm's length.

This Order adopts the arm's length bargaining standard as the ultimate test

for determining the fairness of related party transactions - i.e., "the standard to be applied in every case is that of an uncontrolled taxpayer

dealing at arm's length with another uncontrolled taxpayer". Determination of Taxable Income on Intercompany Loans and Advances In General

o Where one member of a group of controlled entities makes a loan or advances directly or indirectly, or otherwise becomes a creditor of

another member of such group, and charges no interest, or charges interest at a rate which is not equal to an arm's-length rate as defined (below), the Commissioner may make appropriate allocations to reflect



an arm's length interest rate for the use of such loan or advance. o If payments are made to parties under common control according to a

legally enforceable contract, the contract may still be recognized as valid. However, for purposes of determining the true taxable income of the parties involved, the interest rate charged may be subjected to reallocation.

o Section 50 does not apply only to taxable entities. Reallocation may also apply to tax-exempt organizations.

Arm’s 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.

BIR Ruling No. DA-096-06 (March 8, 2006,

Marubeni Corporation)

Doctrine: No interest income should be imputed on an interest-free loan extended to a corporation by a stockholder if said loan was utilized by the

corporation for the purpose of paying for its operational and capital expenditures. Facts: On September 13, 2005, a Loan Agreement was entered into between

Marubeni Corp, a corporation organized and existing under the laws of Japan, and Lipa Ecozone Properties, Inc. (LEPI), a corporation organized and existing under the laws of the Philippines

LEPI's outstanding capital stock is forty percent (40%) owned by Marubeni while the remaining sixty percent (60%) is owned by Celestial Corporation

(Celestial), a company organized and existing under the laws of the Philippines;

Pursuant to the Loan Agreement, Marubeni lent to LEPI a loan in the aggregate amount not exceeding Fifty Million Japanese Yen, for the purpose of payment of cost and operational and capital expenses incurred for the

day-to-day operation of LEPI Issue: W/N interest income shall be imputed on the interest-free loan extended by Marubeni to LEPI considering that the said loan was extended solely to finance LEPI‘s operation and capex. NO interest income! The loan was made in

order for LEPI to meet its various financial obligations

Ratio: NIRC Sec. 50. ―Allocation of Income and Deductions. - In the case of two

or more organizations, trades or businesses (whether or not incorporated and whether or not organized in the Philippines) owned or controlled directly or indirectly by the same interests, the Commissioner is authorized

to distribute, apportion or allocate gross income or deductions between or among such organization, trade or business, if he determines that such distribution, apportionment or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organization, trade or business."

Corollarily, Revenue Memorandum Order No. 63-99 provides that this

applies to all forms of bona fide indebtedness and includes:

o Loans or advances of money or other consideration (whether or not evidenced by a written instrument);

o Indebtedness arising in the ordinary course of business out of sales, leases, or the rendition of services by or between members of the group, or any other similar extension;

o But does not apply to alleged indebtedness which was in fact a

contribution of capital or a distribution by a corporation with respect to its shares.

In BIR Ruling No. DA004-04 dated January 6, 2004 "inter-corporate

advances are not covered by RMO No. 63-99. Section 2.3 of RMO states



that it does not apply to indebtedness which was in fact a contribution to capital.

o The foregoing inter-corporate advances are analogous to capital contribution since it is based on percentage of stockholdings of the stockholders making the advances.

o The fact that some individual stockholders in some instances are not able to contribute to the fund constituting the advances does not destroy its character as an analogous capital contribution.

o These are emergency loans to help a related company which is short of

capital. o Such inter-corporate loans are clearly transactions, done for tax

avoidance or evasion purposes." The interest-free shareholder's advances/loans in the above-cited ruling are

in the same nature as those lent by Marubeni to LEPI because the said loan shall only be utilized by the latter for operational and capital expenditures and therefore not covered by RMO No. 63-99 as such not

subject to the imputed interest under the aforesaid RMO.

BIR Ruling No. DA-320-07 (May 31, 2007, Epson

Precision Phils.)

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

with intention to practice lending of money to others. As such, any interest derived by EPPI from the transaction shall not be subject to VAT on lending

investors. YES The imputation by EPPI of interest on the inter-company advances based on

bank reference rate shall be considered as at arm's length YES 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.

Revenue Memorandum Circular No. 48-2011

(October 6, 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



are directed to assess deficiency DST, if warranted, on these kinds of transactions.

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 non-negotiable, 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)

5.5. Thin Capitalization Issues

Thin Capitalization Definition in Black’s Dictionary

Thin Capitalization (Wikipedia) A company is said to be thinly capitalized when its capital is made up of a much

greater proportion of debt than equity, i.e. its gearing, or leverage, is too high. This is perceived to create problems for two classes of people: Creditors bear the solvency risk of the company, which has to repay the

bulk of its capital with interest; and Revenue authorities, who are concerned about abuse by excessive interest

deductions

Revenue Audit Memorandum Order No. 1-98 (July

7, 1998) Subject: Audit Guidelines and Procedures in the Examination of Interrelated Group of Companies

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.



Special Audit Procedures. In addition, focus must be made on the following audit issues (detailed audit procedures are laid down in Section 3

of this RAMO ): o Use of tax shelters (such as a foundation or a tax-exempt company) in

order to avail of tax exemptions or of lower tax rates; o Shifting income and/or expenses in favor of a related company with

special tax privileges (e.g. BOI Incentives, Tax Holidays, and etc.); o Transfer pricing in inter-company supply of goods (tangible and

intangible) and services;

o Inter-company loans and advances, and financing arrangements where the interest charged for the use of money is not at arm's length;

o Arbitrary cost-sharing arrangements for common expenses; o Tax avoidance through resale and agency arrangements; and o Thin capitalization and earning stripping.

Use of Section 50 of the NIRC, as amended

o The authority for allocating income and expenses between or among related parties is laid down in Section 50 of the NIRC, as amended. This Section gives the Commissioner of Internal Revenue the authority to make allocation of income and expenses between or among controlled group of companies, if a related taxpayer has not reported its true taxable income.

o The purpose of Section 50 is to ensure that taxpayers clearly reflect income attributable to controlled transactions and to prevent the avoidance of taxes with respect to such transactions. It places a controlled taxpayer in tax parity with an uncontrolled taxpayer by determining the arm's-length price of inter-company transactions.

Determination of Arm's Length Price

o The method to be used in determining the arm's-length price depends on the type of transaction ó whether the transaction involves a transfer of property, services, loans, advances, rentals or other arrangements. Accordingly, proper judgment must be used taking into consideration the peculiarity of the transaction and the presence of available

information that would reliably determine the correct income of a controlled taxpayer.

o The different methods of determining the arm's length price of a controlled transaction under the OECD Rules on transfer pricing may be used as a reference. This includes the use of Comparable Uncontrolled Price Method, Resale Method, Cost-plus Method and Gross Profit Margin Method (these are discussed in detail in the next Section).

o In addition, the following must be considered:

Data and Assumptions - consider the completeness and accuracy of available data and information and the reliability of assumptions that are to be made.

Comparability - consider similar transactions between unrelated parties. Factors of comparability to be considered in the

examination include: Functional analysis - factors such as product design and

engineering, manufacturing, production and process, marketing and distribution, advertising and etc.

Contractual terms - this include sales and purchase agreements, volume, nature of warranties, credit and payment terms and other commercial arrangements.

Risks - market risks including fluctuations in demand, financial risks, collection risk and commercial risks.

Economic conditions - refers to the prevailing conditions in the market.

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



extraordinary market conditions; The Resale Price Method (RPM) - it evaluates arm's length by

reference to the gross profit margin realized in comparable transactions.

The Cost Plus Method (CPM) - it evaluates the arm's-length by adding the appropriate gross profit to the controlled taxpayer's cost of producing the property involved in the controlled transaction and then impose the applicable profit rate.

The Profit Split Method - this is done simply by dividing the profit

between the members involved in the transaction taking into consideration the extent of their participation in the realization of

the transaction. 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.

Performance of Services for Another

o In general - under this scheme, one member of the group performs marketing, managerial, administrative, technical or other services for the benefit of, or on behalf of another member of the group without charge or at a charge which is not arm's-length.

o To determine the arm's length price for the service, the "Benefit Test" may be considered. Under this test, the direct benefit to the member which received the service must be considered. It is necessary to take

into account on some reasonable basis all the costs or deductions which are directly or indirectly related to the service performed.

o Where tangible or intangible property is transferred, sold, assigned, loaned, leased or otherwise made available in any manner by one member of a group to another member of the group and services are rendered by the transferor in connection with such transfer, the services rendered in such transaction, provided it is not ancillary, must be

valued. Sharing of Costs

o In general. A cost sharing arrangement is an agreement under which the parties agree to share the costs in proportion to their respective share of anticipated benefits. This is very common in joint undertaking

and in expenses such as research and development, office and factory spaces, legal and consultancy services and etc.

o In determining the appropriateness of the sharing arrangement, factors such as benefits-received, size of the company, participation in the venture, and etc. should be considered.

Thin Capitalization and Earning Stripping

o 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.

o 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%.

o 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.



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.

Oranbo Realty Corp. v. CIR

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 CIR‘s 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.

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:



1. Item A; Loan from BPI was incurred on July 19, 1989 and the purpose of

the loan was to finance the acquisition by ORANBO (taxpayer) of all outstanding shares of stock of NOMA Devt. Corp. (see Term Loan Agreement dated July 19, 1989 page 116). Financial statements from 1990-1991 however, do not reflect these transactions (purchase of shares of stock and its disposition, the proceeds of disposition, gain/loss from disposition, etc.) This indicates that the loan is not only inexistent but also fictitious or simulated.

The taxpayer should be required to submit proof of the transactions above.

Furthermore, the loans obtained greatly exceeds the stock/equity of ORANBO and should have been treated as investment in stock by the creditor bank. In our jurisdiction we follow the thin incorporation rule, whereby loans obtained in excess of capitalization shall be treated as equity contribution (capital investments on the part of the lender) and not as liabilities.

Item B. Loan from UCPB, for P27,000,000.00, was incurred on August 15, 1990 for working capital requirements. Financial statement for 1990 (Statement of Changes in Financial Position) showed that the taxpayer acquired land in the amount of P25,821,745.00.

Since the proceeds of the loan was used in the purchase of real estate above the correct treatment should be to capitalize the interest expense attributable to the purchase price. It is a settled rule that the cost of money (interest expense) and all other capital assets is a capital expenditure. Rationale behind this rule is that land do not depreciate, save only on some exceptional cases, in fact in most instances it appreciates. It is therefore proper

that the expenses incurred for the acquisition of said property should be capitalized as part of the cost and not charged to operation as current expenses. C. Due to Aris Philippines was series advances way back in 1984. Aris Phil. (ARIS for short) is a 40% stockholder of ORANBO. All of this advances were used

in the purchased land and in meeting working capital requirements. The records show that advances taken are sometimes settled in kind. (dacion en pago) real

estate. ORANBO leases all its land and building to ARIS. (See Notes to 1991 F/S). As can be seen above, financial profile, the company declared a taxable net income of P145,058.00 from gross income of 19,884,420.00 or measly .00729 or seventh of one-percent. The land and building leased is valued at P96,744,856.00. The

records do not show any lease contract between the parties neither is there a way to establish or standards to be used to determine whether the amount of rental being paid by ARIS is based on commercial rates.

ORANBO and ARIS are related taxpayers if not commonly owned by one or group

of stockholder. While the taxpayer admits being 40% owned by ARIS the document however show otherwise. In various loan document entered into by ORANBO with third party (BPI & UCPB), it is being represented by Mr. ROLF H. SCHROEDER as Chairman of ORANBO REALTY CORP. But in ORANBOs transaction with ARIS, this time ORANBO is represented by Mr. BENILDO G. HERNANDEZ as President, while ARIS is represented by Mr. ROLF H. SCHROEDER, as President.

It is a settled rule in this jurisdiction that payment of interest between related taxpayers are not deductible because of (possible) connivance.

Taking all the above circumstances, we are left with no option but to recommend for the disallowance of the entire interest expenses claimed as deduction. pred In view thereof, we most respectfully recommend that all the interest expenses

claimed as deduction be disallowed and assessment based on adjusted taxable income be approved." We shall tackle each item one by one. Item A. Loan with BPI.

Respondent's revenue examiner is of the opinion that the interest expense arising from the loan from BPI is not deductible. The financial statements for the years 1990-1991 do not reflect the purchase of all the outstanding shares of stock of NOMA Development Corporation. Thus, reaching to a conclusion that such loan is fictitious and inexistent.

In an earlier case of Oranbo Realty Corporation vs. CIR, CTA Case No. 4820, January 23, 1995, this Court had the occasion to rule in this wise: Petitioner [ORANBO] is a corporation duly organized and existing under the laws of the Philippines. It wholly owns Noma Development Corporation, a domestic

corporation whose term of existence was shortened to December 31, 1988 by an amendment of the Articles of Incorporation duly approved by the Securities and

exchange Commission on September 28, 1989 (Exh. C). A Deed of Conveyance was executed by Noma Development Corporation (Assignor) and Oranbo Realty Corporation (Assignee) on June 29, 1990 with respect to the transfer of real properties together with its improvements without any consideration but by way of liquidating dividence in pursuance to the

dissolution of Noma Development Corporation (Exh. A). (Emphasis supplied)"



Clearly, the acquisition of shares of stocks of NOMA Development cannot in any way reflect in the financial statements of petitioner for the calendar years 1990-

1991 because NOMA Development Corporation was earlier dissolved on December 31, 1988. As a matter of fact, the shares of stock acquired by petitioner were replaced by real estate of NOMA Development Corporation by way of liquidating dividends due to its dissolution. Item B. Loan with UCPB.

Respondent contends that the interest expense pertaining to the loan from UCPB which was used to purchase land should be capitalized. Her reason behind such

statement was that "land do not depreciate, save only [i]n some exceptional cases, in fact in most instances it appreciates. It is therefore proper that the expenses incurred for the acquisition of said property should be capitalized as part of the cost and not charged to operation as current expenses."

We do not agree. In refutation, We are of the opinion that the case of PAPER INDUSTRIES CORP. OF THE PHILS. (PICOP) vs. COURT OF APPEALS, COMMR. OF INTERNAL REVENUE AND COURT OF TAX APPEALS, G.R. Nos. 106949-50; and COMMR. OF INTERNAL REVENUE vs. PICOP, THE COURT OF APPEALS AND THE COURT OF TAX APPEALS, G.R. Nos. 106984-85, December 1, 1995, decided by the Supreme Court En Banc is applicable to the case at bar. Although it involves

the allowance of interest on loans for the purchase of machinery and equipment as a deduction from gross income, it nevertheless may apply to interest expense paid on loan contracted by herein petitioner from UCPB since it involves the purchase of capital asset out of a loan obtained from a bank. Said the High Court: "(1) Whether Picop is entitled to deduct against current income for the purchase of machinery and equipment.

In 1969, 1972 and 1977, Picop obtained loans from foreign creditors in order to finance the purchase of machinery and equipment needed for its operations. In its 1977 Income Tax Return, Picop claimed interest payments made in 1977, amounting to P42,840,131.00, on these loans as a deduction from its 1977 gross

income.

The CIR disallowed this deduction upon the ground that, because the loans had been incurred for the purchase of machinery and equipment, the interest payments on those loans should have been capitalized instead and claimed as a depreciation deduction taking into account the adjusted basis of the machinery and equipment (original, acquisition cost plus interest charges) over the useful life of such assets.

Both the CTA and the Court of Appeals sustained the position of Picop and held that the interest deduction claimed by Picop was proper and allowable. In the

instant Petition, the CIR insists on its original position. We begin by noting that interest payments on loans incurred by a taxpayer (whether BOI-registered or not) are allowed by the NIRC as deductions against the taxpayer's gross income. Section 30 of the 1977 Tax Code provided as follows:

'Section 30. Deduction from Gross Income. The following may be deducted from gross income:

(a) Expenses: xxx xxx xxx

(b) Interest: (1) In the general. ó 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. ó 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



not incurred or paid) for the purpose of determining the "opportunity cost" of investing funds in a given business. Such "theoretical" or imputed interest does

not arise from a legally demandable interest-bearing obligation incurred by the taxpayer who however wishes to find out, e.g., whether he would have been better off by lending out his funds and earning interest rather than investing such funds in his business. One thing that Section 79 quoted above makes clear is that interest which does constitute a charge arising under an interest-bearing obligation is an allowable deduction from gross income.

It is claimed by the CIR that Section 79 of Revenue Regulations No. 2 was "patterned after" paragraph 1.266-1 (b), entitled "Taxes and Carrying Charges

Chargeable to Capital Account and Treated as Capital Items" of the U.S. Income Tax Regulations, which paragraph read as follows: '(B) Taxes and carrying Charges. ó the items thus chargeable to capital accounts are ó

(11) In the case of real property, whether improved or unimproved and whether productive or nonproductive. (a) Interest on a loan (but not theoretical interest of a taxpayer using his own funds).'

The truncated excerpt of the U.S. Income Tax Regulations quoted by the CIR needs to be related to the relevant provisions of the U.S. Internal Revenue Code, which provisions deal with the general topic of adjusted basis for determining allowable gain or loss on sales or exchange of property and allowable depreciation and depletion of capital assets of the taxpayer:

'Present Rule. The Internal Revenue Code and the Regulations promulgated thereunder provide that "No deduction shall be allowed for amounts paid or accrued for such taxes and carrying charges as, under regulations prescribed by the Secretary or his delegate, are chargeable to capital account with respect to property, if the taxpayer elects, in accordance with such regulations to treat such

taxes or charges as so chargeable."

At the same time, under the adjustment of basis provisions which have just been discussed, it is provided that adjustment shall be made for all expenditures, receipts, losses or other items' properly chargeable to a capital account, thus including taxes and carrying charges, however, an exception exists, in which event such adjustment to the capital account is not made with respect to taxes and carrying charges which the taxpayer has not elected to capitalize but for

which a deductions instead has been taken.' (emphasis supplied)

The 'carrying charges' which may be capitalized under the above quoted provisions of the U.S. Internal Revenue Code include, as the CIR has pointed out,

interest on a loan (but not theoretical interest of a taxpayer using his own funds)'. What the CIR failed to point out is that such 'carrying charges' may, either be (a) capitalized in which case the cost basis of the capital assets, e.g., machinery and equipment, will be adjusted by adding the amount of such interest payments or, alternatively, be (b) deducted from gross income of the taxpayer. Should the taxpayer elect to deduct the interest payments against its gross income, the taxpayer cannot at the same time capitalize the interest payments. In other

words, the taxpayer is not entitled to both the deduction from gross income and the adjusted (increased) basis for determining gain or loss and the allowable

depreciation charge. The U.S. Internal Revenue Code does not prohibit the deduction of interest on a loan obtained for purchasing machinery and equipment against gross income, unless the taxpayer has also or previously capitalized the same interest payments and thereby adjusted the cost basis of such assets.

We have already noted that out 1997 NIRC does not prohibit the deduction of interest on a loan incurred for acquiring machinery and equipment. Neither does our 1997 NIRC compel the capitalization of interest payments on such a loan. The 1977 Tax Code is simply silent on a taxpayer's right to elect one or the other tax treatment of such interest payments. Accordingly, the general rule that interest payments on a legally demandable loan are deductible from gross income must

be applied. The CIR argues finally that to allow Picop to deduct its interest payments against its gross income would be to encourage fraudulent claims to double deductions from gross income: '[t]o allow a deduction of incidental expense/cost incurred in the purchase of fixed

asset in the year it was incurred would invite tax evasion through fraudulent application of double deductions from gross income.' (Emphasis supplied) cdll The Court is not persuaded. So far as the records of the instant cases show, Picop has not claimed to be entitled to double deduction of its 1977 interest payments.

The CIR has neither alleged nor proved that Picop had previously adjusted its cost basis of the machinery and equipment purchased and claim, e.g., increased

deductions for depreciation. We conclude that the CTA and the Court of Appeals did not err in following the deductions of Picop's 1977 interest payments on its loans for capital equipment against its gross income for 1977."

Item C. Due to Aris Philippines.



Respondent alleges that petition and Aris Philippines are related taxpayers. In which, if found true would disallow the deduction of the subject interest expense

pursuant to Section 29 (b) (2) (ii) of the Tax Code, as amended. Section 29 (b) (2) (ii) in relation to Section 30(b) of the Tax Code, as amended, provide as follows: "SEC. 29. Deductions from gross income. ó . . .

(a) Expenses:

xxx xxx xxx (b) Interest: xxx xxx xxx

(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. ó In computing taxable income to deduction shall in any case be allowed in respect of ó xxx xxx xxx

(b) Losses from sales or exchanges of property. ó 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 ó

(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

corporations, with respect to the taxable year of the corporation preceding the date of the sale or exchange was, under the law applicable to such taxable year, a

personal holding company or a foreign personal holding company; (4) Between a grantor and a fiduciary of any trust; (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) Between a fiduciary of a trust and a beneficiary of such trust." (Emphasis ours)

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. 6-

85; 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].



A perusal of the evidence presented by petitioner revealed that it has

satisfactorily proven its claim for refund or tax credit. Petitioner has filed its claim for refund/tax credit within the two-year period with the BIR and with this Court. The letter-claim for refund/tax credit was filed with the BIR on April 28, 1993 (Exh. E of petitioner; p. 101-102, CTA records) and the petition for review was filed on March 28, 1994. The two-year period, in the instant case, commences to run on April 15, 1992, the actual date of filing petitioner's 1991 Annual Income Tax Return which is also the time required by law for a taxpayer to file the final

income tax return (Commissioner of Internal Revenue v. TMX sales, Inc. et al., G.R. No. 837736, January 15, 1992). The certificate of creditable withholding tax

at source (BIR Form 1743.1), offered in evidence by petitioner (Exh. B of petitioner, p. 72, CTA records), sufficiently established the amount of creditable withholding tax for the year 1991. Furthermore, as testified by petitioner's income tax return (TSN, Hearing of October 3, 1994, pp. 8-9). Thus, petitioner has satisfactorily proven its claim for refund or tax credit. Therefore there is no reason

why We should not grant petitioner's prayer. WHEREFORE, in view of 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. LLphil

SO ORDERED. ERNESTO D. ACOSTA Presiding Judge

I CONCUR: RAMON O. DE VEYRA Associate Judge

CA Decision:

TENTH DIVISION [CA-G.R. SP No. 44039. October 10, 2001.] COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. COURT OF TAX APPEALS AND ORANBO REALTY CORPORATION, respondents.

D E C I S I O N

CARPIO MORALES, J p:

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 not deductible for the loan itself greatly exceeded Oranbo's capital stock so that the loan, coupled with its concomitant interests, should have been treated as the

lender's capital investment and not a deductible expense on the part of the borrower Oranbo.



As for the UCPB loan, petitioner argues that interests thereon could not likewise qualify as deductible expense. Oranbo, which is in realty business, having utilized

the loan for the purchase of land, thus amounting to acquisition of capital asset and, therefore, all attendant expenses including interest payments on the incurred loan are deemed capital expenditures and not deductible business expenses. The petition fails. IEaHSD

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

exclusively to the study and consideration of tax problems and has necessarily developed an expertise on the subject, unless there has been an abuse or

improvident exercise of authority (Commissioner of Internal Revenue v. Court of Appeals, 303 SCRA 614, 1999) none of which is present in the case at bench. WHEREFORE, the assailed decision is hereby AFFIRMED.

MODULE 4: EQUITY CONSIDERATIONS

1. Equity, A Vehicle for Financing Corporate Growth



GROWTH, 218-251 (2005).

2. Revisiting the Share of Stock in the Philippine Context

2.1. Shares and their classification: CESAR L. VILLANUEVA,

PHILIPPINE CORPORATE LAW, 591-608 (2013)

2.2. PLDT v. NTC

539 SCRA 365 (2007)

2.3. Shares of Stock - CORPORATION CODE §§6, 7, 8, 9

2.4. Outstanding Capital Stock - CORPORATION CODE §137

2.5. 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



3.1.1. Shares of stock not traded in the stock

exchange:

NIRC §§27(D)(2), §28 (7)(c), 28(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)

3.1.2. Donor’s Tax on Sale of Shares for Inadequate

Consideration:

BIR Ruling No. 557-12 (Sept 6, 2012) –

Pacven Walden Ventures III LP

3.1.3. 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

3.1.4. Procedural Aspects for Shares Not Traded in

the Stock Exchange

Payment of Tax and Filing of Returns:

Revenue Regulation 6-2008 §10(c)

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)

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

Up to 25% 4%

Over 25% to 33 1/3% 2%



Over 33 1/3% 1%

Base gross seling price or gross value in money

RR 6-2008 §2(g), §2(j), §2(k), §2(l),

§2(m), §6, §10(b)

3.1.6. Shares of Stock Traded in the local stock

exchange:

NIRC §127

RR 6-2008 §2(g), §2(n), §5, §10(a)

3.1.7. Dissolution of the Corporation:

RR 6-2008 §8

— 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. Dividend Tax

NIRC §§24(B)(2); §27(D)(4); §28(A)(7)(d);

§28(B)(5)(b), §73

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

NFRC‘s domicle

3.3. Documentary Stamp Tax Rates

NIRC §§174, 175 (see RR 13-2004 in relation to

RA No. 9243)

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

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.



o BIR Ruling No. DA 097-04 (ASE Holding

Electronics Philippines, Inc.)

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.

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)

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)

4.2. 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.



SEC Opinion No. 12-03 dated April 14, 2003 (OFW

International Holdings, Inc.)

4.3. Liability of Directors for Issuance of Watered Stocks


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)

4.5. Stock Subscriptions


AND OTHER BUSINESS ENTERPRISES, “Section 5. Stock

Subscriptions,” 1418-1424 (2009)

5. Property for Share Exchanges

5.1. Determination of Amount and Recognition of Gains

and Loses

NIRC §40

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.)

5.2. Value Added Taxes

RR No. 16-2005 §4.106-8(b)(1) as amended by

RR No. 10-2011 (July 1, 2011)

5.3. Documentary Stamp Taxes

NIRC §199(m), as amended by RA No. 9243)

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



SEC Opinion No. 34-10, addressed to Mr.

Melquiades Malabanan, Dec. 22, 2010

6.2. Tax Angle

Revenue Memorandum Circular No. 35-2011

(March 14, 2011)

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 (June 23, 2005)

(Unocal)

Contribution of Assets:

BIR Ruling No. DA-376-05 (Sept. 1, 2005)

(Rockwell)

Without Issuance of New Stock:

BIR Ruling No. DA-398-06 (June 26, 2006)

(Chevron)

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 25, 2008)

(Maynilad Water Services, Inc.)

Without Issuance of New Stock:

BIR Ruling No. DA-(CA-252) 649-09 (Nov. 4,

2009) (Teletech Holdings, Inc.)

7. Dividends, Surplus Retained Earnings and Improperly

Accumulated Earnings

7.1. Trust Fund Doctrine

CESAR L. VILLANUEVA, PHILIPPINE CORPORATE LAW, 608-

620 (2013)

7.2. Power to Declare Dividends


7.3. Some Concepts

CESAR L. VILLANUEVA, PHILIPPINE CORPORATE LAW, 620-

630 (2013)

7.4. Comparative Views


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)

7.5. Dividend Tax

NIRC §24(B)(2); §27(D)(4); 28(A)(7)(d);

§28(B)(5)(b), §73

7.6. IAET

NIRC §29

RR NO. 2-01 (Feb. 12, 2001)

RMC No. 35-2011 (March 14, 2011)

7.7. Rulings

BIR Ruling No. 093-13 (March 18, 2013) (Cebu Air

Inc.)



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)

7.8. VAT: Distribution to shareholders/investors

RR No. 16-2005 §4.106-7(a)(2)(i)

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