Currency swaps

ANY gain realized on any net swap payments shall be subject to the ordinary income tax of 30 percent on net taxable income. However, any loss incurred on the net swap payments shall be deductible from the ordinary income for purposes of computing the 30 percent income tax.

A currency swap is an agreement between two parties to exchange two payment streams in different currencies over a certain period of time. In a currency swap, each party agrees to pay the other, amounts calculated based on a reference amount in another currency. This allows the parties to fix their respective foreign exchange risks or hedge currency exposure arising in the normal course of business and effectively reduce their total borrowing costs.

In BIR Ruling No. 137-97, dated Dec. 11, 1997, Smart obtained three US dollar loans. In order to hedge on foreign exchange exposure, Smart entered into currency swaps with a Philippine counterparty, which is a Philippine branch of a foreign bank with Philippine Peso loan obligations.

By entering into currency swaps, Smart and its counterparty will agree to exchange cash flows by making periodic payments to each other. And that the periodic payment consists of the principal and interest of each other’s loans.

Smart agreed to pay the counterparty in Philippine currency an amount equivalent to the counterparty’s obligations and vice versa. The Counterparty agreed to pay Smart an amount in US dollars corresponding to Smart’s obligations.

On each specified swap payment date, Smart will be exchanging its Philippine pesos for US dollars. As a result of the swap, it can either realize a loss or gain on the transaction on swap payment date. The BIR ruled in this:

Any foreign exchange loss incurred in the net swap payments made by Smart from its transactions with the counterparty are deductible expenses under Section 29 of the Tax Code for income purposes. On the other hand, any foreign exchange gain realized in the net swap payments by Smart from its transactions with the Counterparty are subject to the 35 percent corporate income tax under Section 24(a) of the Tax Code.

In its ruling, the BIR observed that the foreign exchange loss would result should Smart pay more pesos to the counterparty compared to the peso equivalent of its dollar obligations. And conversely, a foreign exchange gain if the peso equivalent of Smart’s dollar obligation is more than the actual peso payment it makes to the counterparty.

Applying the above ruling, any appreciation/depreciation on the currencies on the swap payment date resulting to loss or gain on foreign exchange can be reported as a deductible expense, in case of foreign exchange loss, or as an income in case of foreign exchange gain. Such income is subject to the 30 percent corporate income tax or the 2 percent minimum corporate income tax, whichever is

applicable.

In ITAD Ruling No. 159-03, dated Oct. 20, 2003, AAB Manila enters into a swap arrangement with a counterparty/customer. The customer/counterparty in the Philippines enters into a suitable derivatives agreement directly with AAB London. AAB Manila, where involved, acts as a marketer between the customer/counterparty and AAB London.

The BIR ruled that: “income derived by AAB Manila from interest rate swaps and currency swaps is subject to 32 percent corporate income tax. The income is subject to 10 percent if it pertains to AAB Manila’s foreign currency transactions (interest income, bank charges, commissions, service fees, and net foreign exchange transaction gains), and to 32 percent in all other cases.”

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