The procedure for registration of a subsidiary and a branch are generally the same, although documentation is different.
Moreover, in the case of a branch, Section 126 of the Corporation Code imposes an additional requirement in the form of a security deposit, which is often treated with less importance, or even overlooked. This may partly be attributed to the ambiguous provisions of Section 126 and its implementing guidelines, i.e., SEC 1982 Security Deposit Guidelines. Under Section 126, foreign corporations who have been granted a license to do business in the Philippines are required to make an initial deposit with the SEC of acceptable securities in an amount not less than P100,000 within 60 days from the date of the issuance of their SEC license. Thereafter, additional securities shall be deposited within six months from the end of each fiscal year if the branch’s gross income exceeds PHP5 million in an amount equivalent to 2% by which said gross income exceeds P5 million.
The security deposit requirement under Section 126 is equally important as the other registration requirements mainly because this is mandatory and non-compliance therewith is a ground for cancellation of the SEC license to do business.
In addition, the amount of security deposit is an additional investment of the foreign company which may affect its operations in the country.
The security deposit requirement embodied under Section 126 of the Corporation Code is intended to protect present and future creditors of the branch with the securities constituting as a trust fund in case the foreign branches become unable to settle its debts.
Most branches normally comply with the initial P100,000 security deposit as this is straightforward and not costly. However, compliance with the additional securities in the succeeding years has posed certain problems, mainly because of ambiguity in its proper computation, which sometimes may be burdensome especially for companies with annual gross earnings already running into millions of pesos. It may be noted that such securities although earning interest, would still entail additional expenses on the part of the branch as a substantial amount will still be shelled out for its purchase.
The ambiguity lies specifically in the definition of what constitutes "gross income" as basis of the 2% additional security deposit. Gross income for purposes of the additional security deposit is not defined under the law or the implementing guidelines of the SEC. Thus, several foreign branches individually have asked SEC for clarification on the definition of gross income.
Various rulings have been issued by the SEC which defined "gross income" as synonymous to the term "gross revenue" which covers gain, income, profits and returns of a branch without any deductions made on the entire amount. Disallowance of any kind of deduction from gross income made it difficult for some foreign branches to comply with the additional security deposit since a significant portion of their earnings had to be placed in investments, which may impact their present and future business plans.
Other foreign branches have likewise asked SEC for a reduction in the 2% additional security deposit by excluding certain items of income from the definition of gross income. The SEC granted such requests on a case to case basis. Others even went as far as requesting for a waiver of the additional security deposit which were disapproved by the commission.
To address ambiguities in the implementation of Section 126 of the Corporation Code, the SEC recently issued SEC Memorandum Circular No. 2 (SEC Memo 2) which took effect on May 30, 2012, superseding the original 1982 Security Deposit Guidelines. A significant amendment introduced in SEC Memo 2 is the definition of gross income for purposes calculating the 2% additional security deposit. SEC Memo 2 adopted the same definition of gross income pronounced in the various rulings of the SEC, i.e., gross income is synonymous to gross revenue which covers gain, income, profits and returns of a branch, but allowed certain deductions consisting of: cost of sales incurred with foreign suppliers; direct costs attributable to related party transactions located outside of the Philippines; direct costs incurred which are attributable to foreign non-related suppliers; and amount of merchandise returned by a customer and/or allowances granted to a customer in the event of defective or improperly shipped merchandise.
These deductions may be deducted from gross income provided the branch submits to the SEC an audited special or annual income statement showing distinctly the amounts of direct costs and expenses actually incurred with foreign entities and foreign related parties.
It will be noted that most of the deductions exclude debts incurred from foreign sources on the premise that only local creditors are protected by the security deposit requirement.
SEC Memo 2 also includes the following features:
• Types of acceptable securities -- Some of the outdated acceptable securities enumerated in the 1982 Securities Deposit Guidelines were replaced by a wide array of choices which include government bonds or any evidence of indebtedness of the Government of the Philippines, including government-owned and -controlled corporations; shares of stock in registered enterprises defined under the Omnibus Investments Code; shares of stock in domestic corporations registered in the stock exchange; shares of stock in domestic corporations under the supervision and regulation of the Insurance Commission and shares of stock in banks licensed by the Bangko Sentral Ng Pilipinas.
• Return of securities -- The release of securities shall follow the same procedures and requirements provided under the original 1982 Securities Deposit Guidelines, i.e., securities shall be released at the time of closure of the branch upon submission of a written application supported by a Board Resolution authorizing the closure. In addition SEC Memo 2 also allows the release of securities if the branch’s gross income for a given year decreases by 10%.
• Monitoring fee -- A monitoring fee shall be paid to the SEC upon filing of the application of compliance. The fixed SEC monitoring fee of P1,000 has been increased to one-tenth of one percent of the amount of securities to be deposited, which will not be less than P5,000 but not more than P50,000 in a given year.
SEC Memo 2 is indeed welcome news to foreign branches. It aims to achieve a healthy compromise between protecting local creditors of foreign branches, at the same time making it less burdensome on the part of the foreign branches to comply with their obligation.
Nevertheless, for companies earning billions of revenue annually, the 2% additional security deposit may still be quite onerous.
I believe certain flexibility may still be applied in respect to the allowable deductions from gross income.
I hope the SEC would take a second look at direct costs attributable to locally-based affiliates which may not strictly be classified among the local creditors intended to be protected by the law, in view of their relationship with the debtor.
The author is a Senior Manager at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of PricewaterhouseCoopers global network. Readers may send inquiries or feedback to her via e-mail at susan.m.aquino@ph.pwc.com.
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