Whether Interest Payments of San Pascual Cogeneration Corp. are Exempt from Tax Pursuant to the RP-Japan Tax Treaty

September 10, 1998 BIR RULING NO. 131-98 R.P. Japan Tax Treaty-000-00-131-98 Sycip, Gorres, Velayo & Co. 6760 Ayala Avenue Makati City Attention: Atty . E . C . Alcantara Tax Division Gentlemen : This refers to your letter dated May 28, 1998, requesting on behalf of your client, The Industrial Bank of Japan. Ltd. (IBJ), for our opinion that interest payments to be made by San Pascual Cogeneration Corporation (SPCC) for loans obtained from Japanese commercial banks and guaranteed by the Ministry of International Trade and Industry of the Government of Japan (MITI) are exempt from tax pursuant to Article 11 (4) of the RP-Japan Tax Treaty. It is represented that IBJ is the financial advisor of SPCC, a joint venture among Mission Energy and Texaco, Inc. (both US companies) and Caltex Philippines; that SPCC entered into a Power Purchase Agreement (PPA) with the National Power Corporation (NPC); that to fulfill its obligations under the PPA, SPCC will obtain a loan from Japanese commercial banks; that under the PPA, SPCC shall construct a cogeneration power plant and thereafter, sell electricity to NPC; that the obligations of NPC under the PPA are guaranteed by the Philippine government; that MITI, a Japanese government agency, is providing political and convertibility risk insurance to the effect that if the Philippine government fails to meet its guarantee obligations, MITI undertakes to pay the loan secured by SPCC from the Japanese banks to the extent of 95% thereof. In reply, please be informed that Article 11 (4) of the RP-Japan Tax Treaty provides, viz: "4. Notwithstanding the provisions of paragraph 2 and 3, interest arising in a Contracting State and derived by the Government of the other Contracting State including political subdivisions and local authorities thereof, the Central Bank of that other Contracting State or any financial institution wholly owned by that Government, or by any resident of the other Contracting State with respect to debt-claims guaranteed or indirectly financed by the Government of that other Contracting State including political subdivisions and local authorities thereof, the Central Bank of that other Contracting State or any financial institution wholly owned by that Government shall be exempt from tax in the first-mentioned Contracting State. cdll For the purpose of this paragraph, the term "financial institution wholly owned by the Government" means: (a) In the case of Japan, the Export-Import of Japan, the Overseas Economic Cooperation Fund and the Japan International Cooperation Agency; (b) In the case of the Philippines, the Development Bank of the Philippines; (c) Any such financial institution the capital of which is wholly owned by the Government of either Contracting State, other than those referred to in sub-paragraphs (a) and (b) above, as may be agreed from time to time between the Government of the two Contracting States." Thus, interest arising in a Contracting State and derived by a resident of the other Contracting State with respect to debt-claims guaranteed by the Government of that other Contracting State shall be exempt from tax in the first-mentioned Contracting State. Under Article 11(7) of the said Tax Treaty, interest shall be deemed to arise in a Contracting State when the payor is a resident of that Contracting State. In view thereof, since the interest payments of SPCC are deemed to arise in the Philippines, the payor being a Philippine resident, and inasmuch as the loans secured by SPCC from Japanese commercial banks are guaranteed by MITI, a Japanese government agency, to the extent of 95% thereof, the interest payments to be remitted to the Japanese banks, with respect to 95% of the loans guaranteed by MITI are taxable only in Japan. Accordingly, such interest payments are exempt from Philippine income tax pursuant to Article 11 (4) of the RP-Japan Tax Treaty. However, interest payments of SPCC with respect to 5% of the loans, which portion is not covered by those guaranteed by MITI, shall be subject to Philippine income tax. 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. Very truly yours, (SGD.) BEETHOVEN L. RUALO Commissioner of Internal Revenue