The passage of Republic Act (RA) No. 11659 which amends the Public Service Act of 1935 widens the investment opportunities for foreign investors in the country as it narrows the list of public utilities subject to foreign equity restrictions. Corollary to this, businesses, domestic and foreign alike, also need to raise capital to venture into these liberalized industries. As such, the issuance of Philippine Depositary Receipts (PDRs), as a form of raising capital, is quite an uncommon but effective source of funds. Moreover, PDRs are preferred by non-resident foreign corporations in light of the tax-sparing rule on dividends received from a domestic corporation.
However, a PDR proved to be the opposite of a simple form of investment when it comes to the tax implications of receiving distributions from a foreign PDR holder. In fact, a PDR is not defined by the Tax Code nor by the Securities Regulation Code (SRC). However, it is classified as a security that grants the holder the right to the delivery of the sale of the underlying shares according to the Philippine Stock Exchange Academy (PSEA). On separate occasions, the Bureau of Internal Revenue (BIR) and the Court of Tax Appeals (CTA) have comprehensively analyzed the nature of PDRs and the tax impacts of distributions to foreign holders of PDRs.
On the matter of the request for confirmation of the proper income tax rates applicable to cash distributions paid by ABS-CBN Corporation (ABS-CBN) to Mercury Media Holdings Finance I, Ltd. (Mercury Media), the International Tax Affairs Division of the BIR (ITAD-BIR) ruled that such cash distributions received by Mercury Media which is a non-resident foreign corporation (NRFC) holder of PDRs issued by ABS-CBN, a domestic corporation engaged in mass media, are not considered cash dividends subject to 15% under Section 28 B)(5)(b) of the Tax Code but are interest subject to 30% under Section 28(B) thereof.
In this ruling, the ITAD-BIR took a closer look at the definition of a shareholder under Section 22(M) of the Tax Code, read it together with the definition of dividends provided in Section 73(A) thereof, and applied them considering the circumstances peculiar to this case. As the term shareholders include those who are holders of option/s to purchase shares of stock of a corporation, PDR holders may be considered as shareholders if they have the legal right to exercise the option without violating the provisions of the Constitution and special laws. Considering that the issuing corporation is engaged in an industry whose ownership is reserved by the Constitution fully to Filipino citizens, Mercury Media may not be considered a shareholder of ABS-CBN as it is prohibited from legally exercising the option to purchase shares of stocks of the latter. Ultimately, the cash distributions received by Mercury Media from holding PDRs issued by ABS-CBN have not considered dividends but are taxable as interest income.
The CTA conducted a similar analysis on the nature of PDRs in the case of Rappler Holdings Corp. (Rappler), ruling that the issuance of PDRs by Rappler were investment transactions that did not involve the sale of the underlying shares of stocks of Rappler Inc. After carefully dissecting the provisions of the PDR instruments and PDR subscription agreements, the CTA found that the PDR holder only retains an option to purchase the underlying shares of Rappler Inc. subject to the condition that there is no law restricting foreign ownership in the business of the operating entity. Absent the valid exercise of the option to legally purchase shares of stocks by the foreign PDR holders, they are not considered shareholders of the mass media operating entity.
The above rulings are consistent with the provisions of Revenue Memorandum Order (RMO) No. 46-2020 which prescribes the guidelines and procedures for the availment of the reduced rate of 15% on intercompany dividends paid by a domestic corporation to a NRFC pursuant to the Tax Code. Section 5 of RMO No. 46-2020 recognizes that a holder of a PDR is entitled to the dividends accruing to the underlying shares. However, the nature of the PDRs will determine whether these dividends are entitled to the reduced rate. In order to be entitled to the reduced rate, it is necessary that the PDR is coupled with a right to purchase the underlying shares and the said right can be legally exercised.
As illustrated in the above cases involving the underlying shares of corporations engaged in operations reserved for Philippine nationals, foreign PDR holders cannot legally exercise the right to purchase said shares, preventing them from becoming shareholders who are entitled to receive dividends from the Philippine company, such that any cash or asset distributions to the former will not be treated as dividends for tax purposes.
Interestingly, the Securities and Exchange Commission (SEC) En Banc stood in the opposite direction when it ruled in 2018 that the issuance by Rappler of PDRs to foreign investors equated to the violation of the constitutional and statutory foreign equity restrictions for mass media. The SEC focused on the essence of control as being the influence over corporate policy and not limited to ownership of stock.
Thus, considering the most recent ITAD-BIR ruling, the discussion on the nature, as well as the legal and tax implications of PDRs will become more interesting as more companies that have PDRs interact more with the government and the laws and regulations that it implements.
Maria Regina C. Gameng
KPMG in the Philippines