BUSINESS ENTITIES AND FORMATION

Types of business enterprises

Philippine law recognizes a variety of business forms, including the

corporation, the branch office, the general and limited partnership, the

representative office, the regional headquarters and the sole proprietorship. All of

these forms are available to a foreign investor, especially if working with a

Filipino citizen may be necessary before a foreigner will be permitted to establish

an entity or engage in a particular line of business in the country because the

nation’s law still places limits on foreign equity holding in some sectors of the

economy. Apart from legal restrictions on ownership, an investor’s choice of

entity will hinge on numerous factors and circumstances, such as desired degree

of control over the business, acceptable amount of government supervision,

anticipated duration of an investment, acceptable degree of exposure to liability,

and preferred tax treatment.

Restrictions on the foreign ownership of business in the Philippines are

largely the remnant of the years of insularity during prior regimes. They are

disappearing slowly as the current government moves to the country toward

greater openness in the economy. The law currently allows foreign investors to

own up to 100 percent of an entity’s capital, as long as the entity’s activity is not

included among those designated on the Negative List adopted as part of the

Foreign Investments Act of 1991.

 The Negative list is both highly detailed and broad in coverage. It limits

foreign equity in businesses ranging from cockfighting to any operations that

could potentially compete with existing businesses funded with Filipino capital.

Other specific businesses areas on the Negative list include mass media, retail

trade, some agricultural industries, and professional activities such as medicine,

law, accounting, and engineering. A specific percentage of minority foreign

investment is allowed in a few areas-for example, up to 30 percent in advertising

businesses and up to 40 percent in businesses engage in exploiting Philippine

natural resources, owning Philippine land, operating or managing public utilities,

or those endowed with paid-up equity capital of less than US$500,000. Any

foreign investor considering a particular operating in the Philippines would be

wise to review the Negative List with care.

In general, the government of the Philippines prefers that foreigners own

no more than 60 percent of a Philippine business entity; however, it relaxes this

limit if the business is expected to bring substantial amounts of capital or

employment into the country, materially stimulate exports from the Philippines, or

further the growth of government-designated pioneer industries. For business

falling into any of these three categories, the government will sometimes offer

extra incentives, provided that the business qualifies under rules established by

the country’s Board of Investments (BOI) or the Philippine Economic Zone

Authority (PEZA).

A foreign investor who is interested in ownership in a Filipino entity should

bear in mind that ownership limits established by the Negative List do not
necessary preclude actual foreign control over such an entity. Even if foreign

ownership of a business venture is limited by law to a minority stake, the foreign

investor can structure participation in the venture to ensure effective

management control. Techniques commonly used to retain such control include

the creation of an entity in which the majority Philippine ownership is spread

among so many unconnected domestic investors that the foreign investor is in de

facto control of the organization through plurality ownership. Other common

arrangements include an express management contract between an entity and a

foreign investor; a licensing agreement by which a foreign investor licenses

intellectual property rights to the enterprise; voting trust agreement that confers

shareholders’ voting rights on a foreign investor acting as a trustee; pledge of

shares and voting rights to foreign lenders that loan funds to the domestic

enterprise; and simple voting arrangements between shareholders that delegate

voting control to the foreign investors.

The most common business form used by foreign investors in the

Philippines is the corporation, typically the 60/40 corporation in which Filipino

investors own 60 percent of the corporation and foreign investors own 40

percent. While many foreign companies open branch offices in the Philippines,

the operation of a branch leaves the foreign firm open to greater potential liability

than does the incorporation of a separate Philippine subsidiary. Franchise

agreements have become more popular in the Philippines in recent years, and

many foreign companies choose to conduct their Philippine operations through

simple agent or distributor contracts with resident Filipino agents. Other business
forms, including partnerships and sole proprietorships, are usually undesirable

for foreign investors because they offer neither favorable tax treatment nor limits

on potential liability. Nor would these forms generally be considered appropriate

vehicles for serious foreign operations in the Philippines.

Corporations

The most salient feature of a Philippine corporation, governed by the New

corporation code, is limitation of liability. Once a corporation is properly

organized, it is deemed by law to have an existence separate from its investors,

and those investors are not liable for the obligations of the business beyond the

amounts they have invested.

The limited liability factor is a major consideration behind the preference of

foreign companies for the incorporation of a subsidiary rather than the

establishments of a branch office. Use of the corporate from can limit the

company’s liability to assets located in the Philippines. In contrast, a branch

office is regarded as an extension of the parent corporation, and therefore the

parent’s assets potentially become exposed to general liability, regardless of

where they are located. In choosing between Philippine corporation and a branch

office, investors should also review the tax treatment accorded to these two types

of entities in the Philippines. (Refer to the “Taxation” Chapter, beginning on page,

for a discussion of tax treatment.)

Articles of incorporation the corporation’s basic charter must specify the

corporate name, place of business, purpose, and term of existence; identify the
incorporators and directors; describe amounts and kinds of capital stocks;

enumerate shareholders’ rights and obligations; and set forth rules of corporate

governance. During the incorporation process, the articles are filed with the

Philippine Securities and Exchange Commission (SEC), the chief agency

supervising corporations.

Capital. The corporate ownership interests of investors are represented

by certificates designating shares of stock. At least five shareholders are needed

to form a corporation, and a maximum of 15 founding shareholders are

permitted. The majority of a corporation’s founding shareholders must be

Philippine residents. Once a formation is complete, a corporation can have any

number of shareholders, unless it is a “close corporation,” which by law may

have no more than 20 shareholders.

No minimum amount of authorized capital is required to start a

corporation, but at least 25 percent of a corporation‘s authorized capital must be

subscribed, and at least 25 percent of that amount must be paid into the

corporation at the time of incorporation. During its existence, a corporation can

increase or decrease its authorized capital with the approval of the corporation’s

board of directors and two-thirds of the corporation’s shares or shareholders.

In addition to the capital contributions of shareholders, Philippine corporations

can obtain funds through the capitalization of retained earnings or the sale of

bonds, commercial paper, and other forms of debt obligations.

 Share characteristics. Philippine law allows a corporation to provide for

different classes of stock, the characteristics of which are defined in the

corporation’s articles. Shares may have par value or no par value. Regardless of

par value, investor must pay a fair value for shares, either in cash or in kind, and

shares cannot be issued for a value of less than five pesos.

In most corporations, owners of common stock are entitled to equal

distributions of profits without any preference over stockholders, while owners of

preferred stock typically have first rights to fixed dividends and distribution of the

principal upon liquidation. While owners of common stocks are typically entitled

to cast votes in shareholder meetings, with the weight of their votes depending

on the extent of their stock ownership, owners of preferred shares usually have

no voting rights, except in some unique situation detailed in the New Corporation

Code. In corporations capitalized in part through foreign equity, common stock is

often divided into “A” and “B” shares, with A shares being held solely by Filipinos

and B shares by foreigners. Philippine law also authorizes the issuance of

convertible stock, which owners can transform from one class to another at

designated times and prices.

Shares of stock are generally transferable, although Philippine law

restricts any transfers that would unfairly affect the right of a corporation’s

creditors. For businesses in which foreign investment is restricted, the ownership

of shares is limited to a certain percentage, and the transfer of shares is also

restricted if the result would raise foreign equity holdings above permissible level.

In a “close” corporation, articles of incorporation can provide additional

restrictions on share transfers, as long as these restrictions are written into the

articles of incorporation and are stated on the certificates.

Directors. corporate directors generally have broad powers to manage

Philippine corporations, at least to the extent authorized by the corporate articles

and bylaws. However, before taking actions that would fundamentally alter the

corporations such as dissolving or merging it, changing its line of business, or

disposing of most of its assets directors must first secure the approval of

shareholders. Each director must own at least must own at least one share of the

corporation’s stock, and the majority of the directors must be Philippines resident.

The shareholders elect the directors for the term of office specified in the

corporate articles or bylaws. Once elected, the directors must hold their own

election to select a president from among themselves. They must also choose a

treasurer, who need not be a director, secretary, who must be a Philippine citizen

and resident; and any other officers required by the corporate articles or bylaws.

A single director can hold any two of these positions at the same time. Under

SEC rules, foreigners cannot serve as corporate officers.

Key Regulators and Registries

The Security and Exchange Commission (SEC) the chief agency

overseeing business entities, is responsible for registering different forms of

business and accepting annual filings.

 The Board of Investments (BOI) determines whether corporations quality

for government incentives to do business under the Omnibus Investments Act of

1991. This Boards releases annual list of desirable business operations that will

be entitled to receive incentives.

The Philippine Economic Zone Authority (PEZA) is generally charge

with promoting foreign trade. It registers export-oriented enterprises located

inside the boundaries of designated EPZs and determines whether these

enterprises quality for government incentives.

The Central Bank (Bangko Sentral ng Pilipinas) manages monetary

policy and exchange controls and registers all foreign investments in the

Philippines. Unless an investment is registered with the Central Bank, foreign

investor can neither repatriate investment capital nor remit earnings to the

investor’s home country.

The Department of Trade and Industry (DTI) oversees many aspects of

economic and industrial policy. Its bureaus handle the registration of several

business forms, including sole proprietorships.

The Technology Transfer Board (TTB), a division within the DTI, is a policy

board responsible for regulating technology transfers and approving royalty rates

for licensing agreements.

The National Economic and Development Authority (NEDA) is a

central planning body responsible for devising and implementing general social
and economic development policy in the Philippines. NEDA also supervises

commissions related to the oil industry and price and wage controls.

The Environmental Management Bureau (EMB), policies industries to

ensure compliance with environmental standards.