November 24, 2008

BIR RULING [DA-(TAR-004) 458-08]

34 (D); RR 6-06; DA-398-05;
DA-359-03
SGV & Co.
6760 Ayala Avenue
Makati City
Attention: Atty. Romulo S. Danao, Jr.
Partner, Tax Services
Gentlemen :
This refers to your letter dated July 22, 2008 requesting confirmation that the
current practice of your client, CBK Power Company Limited ("CBK Power" for
brevity), relating to the use of functional currency, conforms to the provisions of
Revenue Regulations RR No. 06-06 dated March 16, 2006 on the use of functional
currency other than Philippine Peso in Financial Statements that will be submitted and
in the Books of Accounts that will be maintained for internal revenue tax purposes.
DHCSTa

It is represented that CBK Power is a partnership duly organized and existing

under and by virtue of Philippine laws, with office address at 29th Floor, LKG Tower,
Ayala Avenue, Makati City; that it was organized primarily to engage in the
rehabilitation, construction, and subsequent operation and maintenance of a
hydroelectric power plant complex located in Caliraya, Botocan and Kalayaan in
Laguna, known as the CBK Complex; that it currently uses the US dollar as its
functional currency in its financial statements as the US dollar is the currency of the
primary economic environment in which it operates; that for income tax reporting
purposes, CBK Power translates its functional currency income and expense accounts
to Philippine pesos on a monthly basis using the average exchange rate during the
month (under the Philippine Dealing System or PDS) for purposes of computing its
income tax liability; that the total translated amounts per month are added to arrive at
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the income and expenses in Philippine pesos for the quarter/year, which shall be the
basis for computing CBK Power's quarterly/annual income tax liability; that CBK
Power also reconciles at the end of the year, certain income and expenses in the
Income Tax Return with the equivalent peso figures of such income and expenses in
the subsidiary ledgers maintained to serve as the source of the figures reflected in
other tax returns (VAT, EWT, etc.); that the reconciling items are then reflected in the
Annual Income Tax Return. The reconciliation is due to the fact that, for purposes of
reporting other taxes (VAT, EWT, etc.) in the other tax returns (VAT, EWT, etc.),
CBK Power uses the historical amount or actual conversion/prevailing rate on
transaction day, whichever is applicable, to convert the said income and expense
accounts from functional currency into peso; that with respect to its balance sheet
accounts where the original currency is the same as its functional currency, such as its
US dollar-denominated loans, CBK Power no longer translates such accounts to
Philippine pesos for both financial accounting and income tax purposes, hence, CBK
Power does not recognize unrealized foreign exchange gains or losses from such
accounts in its functional currency books nor realized foreign exchange gains or losses
for income tax purposes; that on the other hand, CBK Power recognizes
unrealized/realized gains or losses on balance sheet accounts where the original
currency is not the same as its functional currency, such as in the case of
peso-denominated receivables/payables, for financial accounting and income tax
purposes.
In reply, please be informed that with regard to the use of the monthly average
exchange rate in translating income and expense accounts for income tax reporting
purposes, paragraph 2 of Section 7 of RR No. 06-06 provides viz.:
"For purposes of translating the functional currency income and
expenses to Philippine Pesos, the translation shall be done on a monthly basis
using the average exchange rate during the month (under the Philippine
Dealing System or PDS). The total translated amounts per month shall be added
to arrive at the income and expenses in Philippine pesos for the quarter/year,
which shall be the basis in computing the taxpayer's income tax liability. The
total figures in the ITR for the year should be reconciled with the total of the
equivalent peso figures as converted from the functional currency figures in the
subsidiary ledgers maintained to serve as the source of the figures reflected in
tax returns other than income tax. The reconciliation of the figures shall be done
at the end of the year and the reconciling items shall be reflected in the annual or
final adjustment income tax return." (Emphasis supplied)
HAISEa

Thus, the current practice of CBK Power in converting its dollar income and
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expense accounts into peso using the average exchange rate during the month for the
purpose of computing its income tax liability is consistent with the provisions of RR
No. 06-06. CBK Power also conforms to the provisions of the regulations when it
reconciles certain income and expenses with the equivalent peso figures (as converted
from the US dollar) of such income and expenses in its subsidiary ledgers and as
reflected in the other tax returns (VAT, EWT, etc.), with the reconciling items being
reflected in the annual income tax return of CBK Power.
In addition, Section 8 of RR No. 06-06 provides as follows:
"Currency to be Used in the Filing of Tax Returns Other than Income
Tax. All tax returns other than ITR shall likewise be filed in Philippine peso
currency using historical peso amount or actual conversion/prevailing PDS rate
on transaction day, whichever is applicable." (Emphasis supplied)

Consistent with the above provision, CBK Power correctly maintains

subsidiary ledgers with equivalent peso figures for transactions subject to other taxes
(except income tax) and uses the historical amount or actual conversion/prevailing
rate on transaction day, whichever is applicable, in recording the income and expense
accounts in such tax returns.
With regard to balance sheet accounts where the original currency is in US
dollars, such as in the case of US-dollar denominated loans, this Office believes that
CBK Power should no longer translate such accounts to Philippine peso for both
financial accounting and tax purposes and, therefor, does not have to recognize
unrealized/realized foreign exchange gains or losses from the transaction. This
practice of CBK Power is more in keeping with the underlying intent and purpose of
the functional currency regulations, which seeks to do away with artificial foreign
exchange gains or losses that distort the real financial condition of the companies.
In connection therewith, this Office has ruled in BIR Ruling No. DA-398-05
dated September 26, 2005, as follows:
"Finally, the use of foreign currency for companies whose functional
currency is a foreign currency will more clearly reflect income considering that
the use of Philippine pesos results in artificial foreign exchange losses which
distort the real financial condition of these companies. The use of foreign
currency is also revenue neutral." (Emphasis supplied)

Moreover, Section 11 (a) of RR 6-06 provides that:

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"Functional currency amounts (for both balance sheet and income

statement items, including capital accounts) should be specifically identified
and carried over to the functional currency financial statements in their original
functional currency amounts, i.e., not translated amounts. For example,
assuming the determined functional currency is the U.S. dollars (USD), all
accounts denominated in USD amounts should be carried over to the functional
currency financial statements." (Emphasis supplied)
aDATHC

With respect, however, to balance sheet accounts where the original currency is
not the same as its functional currency, such as peso-denominated loans, this Office
believes that CBK Power should recognize unrealized foreign exchange gains or
losses for accounting purposes and, if realized, should report the gains or losses as
income or expenses, respectively, for income tax purposes. Thus, this Office in BIR
Ruling No. DA-359-03 dated October 10, 2003 has ruled that realized foreign
exchange gains or losses should be recognized as income or expense, respectively, for
income tax purposes Pertinent portions of said ruling state as follows:
"There is an actual foreign exchange gain or loss realized by DPI
depending on the appreciation/depreciation of the Philippine Peso to the US
dollar between the time income/expense or the asset/liability is recorded in its
books and the time the same is collected/paid.
What DPI has reflected in its books as a liability or expense (i.e.,
accounts payables, advance payments from contractees, purchase of construction
materials) was the amount before the foreign exchange fluctuated, thus, since
the payment of said liability was done when the peso depreciated, it suffered a
foreign exchange loss when it used more pesos to pay its foreign currency
obligations (The Coca-cola Export Corporation vs. Commissioner of Internal
Revenue, C.T.A. Case No. 5238, December 19, 1997.) Alternatively, if DPI has
reflected in its books as an asset or income (i.e., accounts receivables, advance
payments to sub-contractors, construction income) an amount before the foreign
exchange fluctuated, it will realize a gain when the peso depreciated at the time
of collection.
Section 34(D) of the 1997 Tax Code provides that losses actually
sustained during the taxable year and not compensated by insurance or other
forms of indemnity shall be allowed as deductions from gross income. Thus,
foreign exchange losses may be allowed as a deduction if the losses have
actually been incurred in the course of trade or business during the taxable
year." (Underscoring supplied)

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Particular to the above-mentioned ruling, the Bureau laid down the instances
when foreign exchange fluctuations may be considered as taxable gains and/or
deductible expenses, such as
"1. Exchange rate at the time of receipt of advance payments on
contracts is different from the rate at the time income is earned and debited
against advance payments.
2.
Exchange rate at the time of recording/recognizing accounts
receivables is different from the rate at the time of actual collection of the
account receivables.
3.
Exchange rate at the time advance payments are made to
subcontractors is different from the rate at the time expenses on the sub-contract
are incurred/recorded.
AECacT

4.
Exchange rate at the time of recording/recognizing accounts
payables is different from the rate at the time accounts payables are paid.
5.
Exchange rate at the time down payments for construction
materials are made is different from the rate at the time of full
payment/settlement of the balance on the purchase price of these materials."

While the above ruling speaks of gains or losses from the conversion of the
Philippine peso to the US dollar, this Office believes that the same principle can be
applied by analogy to the instant case where the functional currency is the US dollar,
and the US dollar has to be converted into Philippine peso upon payment of CBK
Power's peso-denominated liability. The exchange rate at the time of recording or
recognizing the peso-denominated loan (from peso to US dollar) can differ from the
rate at the time the loan is paid and thus, realized gain or loss can be recognized or
sustained, respectively on the part of CBK Power. Accordingly, CBK Power is
justified in recognizing realized foreign exchange gains or losses as income or
expense, respectively, for income tax purposes, where the original currency of the
account is not the same as its functional currency, such as peso-denominated loans.
In light of the foregoing discussions, this Office hereby confirms that the
current practice of CBK Power as represented and described above conforms to the
provisions of RR No. 06-06 on the use of functional currency other than Philippine
Peso in Financial Statements that will be submitted and in the Books of Accounts that
will be maintained for internal revenue tax purposes.
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This ruling is being issued on the basis of the foregoing facts as represented.
However, if upon investigation, it will be disclosed that the facts are different, then
this ruling shall be considered null and void.
DACcIH

Very truly yours,

Commissioner of Internal Revenue
By:

(SGD.) JAMES H. ROLDAN

Assistant Commissioner
Legal Service

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