Legal guide to doing business in the Philippines

This legal guide provides Japanese investors with a practical overview of doing business in the Philippines.

Philippines’ foreign equity restrictions

As an initial step, a foreign investor must determine whether the proposed business is subject to foreign equity restrictions. In this non-exhaustive list of activities, foreign equity is prohibited or capped.

1. 1. Government-funded infrastructure projects and provision of consulting services: capped at 40%, but may be increased to 75% where the structure to be built requires techniques or technologies not adequately possessed by an entity which is 40% foreign-owned;
   2. Public utilities (distribution of electricity, transmission of electricity, petroleum products pipeline transmission systems, water pipeline distribution systems, seaports and public utility vehicles): capped at 40%;
   3. Public services declared by the president of the Philippines as “critical structures”, namely public services that own, use or operate systems and assets, whether physical or virtual, so vital to the Philippines that the incapacity or destruction of such systems or assets would have a detrimental impact on national security: capped at 50%;
   4. Ownership of private lands: cappedat 40%;
   5. Retail trade enterprises with a paid-up capital of less than PHP25 million (USD405,700): capped at 40%;
   6. Practice of a profession (such as engineering): no foreign equity allowed.

Foreign investors should provide a detailed description of their proposed operations in the Philippines to their legal advisers, who can then assess whether any intended activities face equity restrictions and, if necessary, structure the entity to ensure full legal compliance.

If the foreign investor must partner with a Philippine national due to foreign ownership caps, it may adopt minority protection mechanisms at board and shareholder levels, such as:

1. 1. Enhanced quorum and notice requirements; and
   2. Consent rights over major actions (e.g. amendments to constitutional documents, share issuances and material borrowings).

The foreign investor may also negotiate for anti-dilution protections, transfer restrictions and tag-along rights, among other protection mechanisms. But any such mechanism must neither vest the foreign investor control over the company nor constitute a nominee or “dummy” arrangement, as these are prohibited under the Philippine Anti-Dummy Law.

Choosing subsidiary or branch presence

A foreign entity wishing to do business in the Philippines must set up a local presence. While it may be organised as a sole proprietorship or partnership, the most common and practical vehicle is a corporation.

Domestic corporation. Subject to foreign equity restrictions, a foreign investor may establish a wholly or partially owned domestic corporation. A corporation has its own separate and independent legal personality to conduct business in the Philippines.

The parent is not liable for the subsidiary’s obligations absent grounds that justify the piercing of the corporate veil, and a subsidiary is generally taxed on Philippine and foreign-sourced income.

Branch. If the proposed activities are not subject to foreign equity restrictions, the foreign investor may establish a Philippine branch to undertake them. A branch has no legal personality separate from its head office, its liabilities are ultimately liabilities of the head office, and it is generally taxed only on Philippine-sourced income.

SEC registration and operational licences

The above-mentioned corporate vehicles must be registered with the Philippine Securities and Exchange Commission (SEC).

After SEC registration and before commencing operations, other basic registrations and licences must be obtained, including:

1. 1. A business permit from each local government unit where the business will operate;
   2. Tax registrations; and
   3. Employment-related registrations.

If the entity will engage in a specially regulated activity (e.g. financial services, power generation, construction, or the importation or distribution of food or drugs), it must generally obtain all relevant permits and approvals before doing so.

If the entity is qualified and intends to avail of tax and other fiscal incentives, it must also register with the relevant administering agency (e.g. the Philippine Economic Zone Authority or the Board of Investments) before commencing operations.

Required registrations, licences and timelines vary by activity/project and location, and should be considered in planning Philippine operations. As a practical matter, it is prudent to adopt a conservative timeline that accounts for potential administrative delays.

Land ownership limits and leasing

As noted, a foreign investor can own only up to 40% of a company that owns land, although there is no such restriction on ownership of buildings and other structures standing on land owned by another person.

However, a foreign investor can lease land for investment purposes under the Investors Lease Act for an aggregate period of not more than 99 years. The leased premises must be used solely for the purpose of the government-approved and registered investment, and must comprise such area as may reasonably be required for the purpose of such investment.

Land is a major component of the operations of certain businesses, such as manufacturing, logistics and energy projects. Whether the land will be owned by the operating company itself or leased by the operating company from another person, it is important that such ownership or lease be in place to synchronise with the timeline for the construction of the facility/project. Legal due diligence on the land must be completed prior to entering into an acquisition or lease agreement.

Also, some projects require consent from the local government unit where the project will be built. Specific steps and estimated duration for securing this consent must be factored into the overall project timeline.

Entry by share or asset

A foreign investor may enter the Philippine market by acquiring shares in an existing Philippine company, avoiding the need to establish a separate entity. As a shareholder, the foreign investor is liable for the target company’s liabilities only to the extent of its shareholdings.

Subject to any restrictions in the target company’s contracts and government registrations/licences, a share acquisition allows the foreign investor to acquire the target company, together with the target company’s government registrations/licences, contracts, employees, assets and liabilities.

Alternatively, the foreign investor can acquire all or some of the assets of an existing company in the Philippines. In such asset acquisition, the foreign investor must set up an entity in the Philippines that will acquire the assets. The acquiring entity and the target company will then agree on which assets, contracts and liabilities will be acquired, subject to any third-party consent requirement.

As government registrations/licences are generally non-transferable, the acquiring entity will need to apply for its own government registrations/licences. Specific third-party consents and government registrations/licences that need to be obtained should be identified with the timeline determined.

These issues should be factored when setting out the parties’ pre-closing, closing and post-closing obligations under the asset acquisition agreement.

Taxes on share acquisition also differ from those on an asset acquisition. Taxes in asset acquisition depend on the assets acquired (e.g. equipment, inventory, real property, contracts, intellectual property and goodwill). The foreign investor should seek advice on the most tax-efficient way to undertake an acquisition.

Competition filing and due diligence

The foreign investor should also seek legal advice on whether the acquisition is subject to compulsory merger notification under the Philippine Competition Act.

Acquisitions that meet the applicable thresholds – such as the “size of party” and the “size of transaction” thresholds – must be immediately notified to the Philippine Competition Commission.

Size of party refers to the aggregate value of transaction parties’ assets in the Philippines and revenues from sales in, into or from the Philippines. Size of transaction refers to the value of assets being acquired and/or the gross revenues generated by them, or depending on the type of transaction, the value of the acquired entity and the entities it controls.

This means that, even if the acquisition is the foreign investor’s first investment in the Philippines, its acquisition may still be subject to the notification requirement on account of the circumstances of its ultimate parent and affiliates, and the target company’s ultimate parent and affiliates.

Additionally, financial, tax, operational and legal due diligence should be conducted before an acquisition.

Among the challenges of doing due diligence in the Philippines, especially on small or family-owned companies, are incomplete or inaccurate records and unfamiliarity of the target with the due diligence process. It is therefore important that the purpose of legal due diligence is explained to the target.

Finally, foreign investors should note that this guide is general and not exhaustive. Professional legal advice should always be sought.

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