ITAD BIR Ruling No. 004-16

February 2, 2016 ITAD BIR RULING NO. 004-16 Article 11, Philippines-Japan tax treaty, as amended Pilipinas Hino Incorporated Industrial Park Road Canlubang Industrial Estate Canlubang, Calamba City, Laguna Attention: Ms. Visitacion A. Mejia Accounting Manager Gentlemen : This refers to your tax treaty relief application filed on October 17, 2013, requesting confirmation that interest to be paid by PILIPINAS HINO INCORPORATED ("PILIPINAS HINO") to MARUBENI CORPORATION ("MARUBENI") is subject to preferential tax of 10 percent rate pursuant to the Convention between the Republic of the Philippines and Japan for the Avoidance and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Japan tax treaty") , as amended by a Protocol 1 effective January 1, 2009. It is represented that MARUBENI is a corporation organized and existing under the laws of Japan and is a resident thereof based on the Certificate of Residence issued by Kojimachi Tax Office in Japan on August 2, 2013; that MARUBENI is licensed to do business in the Philippines since March 20, 1967, per Securities and Exchange Commission (SEC) Certification and, to date, MARUBENI has not filed a petition to withdraw or cancel such license, based on the Certificate of Corporate Filing/Information issued by the SEC on September 11, 2013; and that, on the other hand, PILIPINAS HINO is a corporation organized and existing under the laws of the Philippines. It is further represented that on August 14, 2013, MARUBENI and PILIPINAS HINO entered into a Finance Facility Agreement ("Agreement"). Under the Agreement, MARUBENI agrees to extend a finance facility to PILIPINAS HINO solely for the purpose for the sales of products 2 in accordance with the Confirmation of Sales Contract to be entered into between MARUBENI ("Seller") and PILIPINAS HINO ("Buyer"). The Facility shall be made available by the MARUBENI to PILIPINAS HINO in accordance with the terms of the Confirmation of Sales Contract and this Agreement, provided that in any event, the sum of the outstanding and unpaid principal amount of the Facility at any time shall not exceed JPY750,000,000.00. PILIPINAS HINO shall pay interest accrued on each shipment amount from B/L date to 270 days after B/L date (hereinafter called "Maturity Date") and including the date until the day immediately preceding the date on which the invoice amount is fully paid. The interest rate applicable to each shipment be Nine (9)-Month TIBOR Rate quoted by Japanese Bankers Association (JBA) plus 3 percent per annum, 10 days prior to each B/L date. The Facility shall be valid until March 31, 2015 unless this Agreement is earlier terminated. It is further represented based on the Certification dated July 25, 2013 issued by the General Manager of MARUBENI CORPORATION, MANILA BRANCH, being the branch office in the Philippines of MARUBENI; that MARUBENI CORPORATION, MANILA BRANCH has no participation, directly or indirectly, in the granting of loan between MARUBENI and PILIPINAS HINO, and that the interest income derived by MARUBENI from said transaction is neither attributable to MARUBENI CORPORATION, MANILA BRANCH nor paid or coursed through it because any interest income derived from said loan is directly recorded in the books of MARUBENI. TAIaHE It is finally represented that the interest subject of this ruling is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Sworn Statement issued by the Accounting Manager of PILIPINAS HINO on October 7, 2013. In reply, please be informed that Section 28 (B) (5) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, provides that interest to be paid to MARUBENI, being a foreign corporation not engaged in trade or business in the Philippines, is subject to income tax at the rate of 20 percent, thus: "Section 28. Rates of Income Tax on Foreign Corporations. xxx xxx xxx (B) Tax on Nonresident Foreign Corporation. (5) Tax on Certain Incomes Received by a Nonresident Foreign Corporation. (a) Interest on Foreign Loans. A final withholding tax at the rate of twenty percent (20%) is hereby imposed on the amount of interest on foreign loans contracted on or after August 1, 1986; xxx xxx xxx" However, Section 32 (B) (5) of the Code provides that such interests may be exempt from tax or subject to a reduced rate to the extent required by any treaty obligation on the Philippines, thus: "Section 32. Gross Income. xxx xxx xxx (B) Exclusions from Gross Income. The following items shall not be included in gross income and shall be exempt from taxation under this Title: xxx xxx xxx (5) Income Exempt under Treaty. Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines. xxx xxx xxx" Relative thereto, you invoke the Philippines-Japan tax treaty, as amended. Paragraphs 1, 2, and 3, Article 11 thereof provide: "Article 11 1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State. 2. However, such interest may also be taxed in the Contracting State in which it arises, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the interest the tax so charged shall not exceed 10 per cent of the gross amount of the interest. 3. Notwithstanding the provisions of paragraph 2, the amount of tax imposed by the Philippines on the interest paid by a company, being a resident of the Philippines, registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines to a resident of Japan, who is the beneficial owner of the interest, shall not exceed 10 per cent of the gross amount of the interest. 4. Notwithstanding the provisions of paragraphs 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. cDHAES For the purposes of this paragraph, the term 'financial institution wholly owned by the Government' means: a) In the case of Japan, the Export-Import Bank 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; and 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 Governments of the two Contracting States. 5. The term 'interest' as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and in particular, income from Government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. 6. The provisions of paragraphs 1, 2 and 3 above shall not apply if the beneficial owner of the interest, being a resident of a Contracting State, carries on business in the other Contracting State in which the interest arises, through a permanent establishment situated therein, or performs in that other Contracting State independent personal services from a fixed base situated therein, and the debt-claim in respect of which the interest is paid is effectively connected with such permanent establishment or fixed base. In such case the provisions of Article 7 or Article 14, as the case may be, shall apply. xxx xxx xxx" Based on the above provisions, interests on foreign loans are generally taxable in the Philippines at the rate of 20 percent. However, interests derived by a corporation which is a resident of Japan may qualify for a preferential rate of 10 percent of the gross amount thereof, under the Philippines-Japan tax treaty, as amended, if the recipient of such interest is also the beneficial owner thereof. However, the 10 percent tax rate shall not apply if the Japanese corporation has a permanent establishment in the Philippines and the subject interest income is effectively connected to the said permanent establishment. As to the definition of permanent establishment, Article 5 of the Philippines-Japan tax treaty, as amended, provides, as follows: "Article 5 1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which the business of an enterprise is wholly or partly carried on. 2. The term 'permanent establishment' includes especially. a) a store or other sales outlet; b) a branch ; c) an office; d) a factory; e) a workshop; f) a warehouse; g) a mine, an oil or gas well, a quarry or other place of extraction of natural resources." Based on the foregoing, the reduced rate on interest under paragraphs 2 and 3, Article 10 of the Philippines-Japan tax treaty may not apply to the interests paid by PILIPINAS HINO to MARUBENI if such are effectively connected with a permanent establishment which the latter may have in the Philippines, such as MARUBENI CORPORATION, MANILA BRANCH. ASEcHI On the question of interest being effectively connected with a permanent establishment, the relevant commentaries of the Organisation for Economic Cooperation and Development ("OECD") Model Tax Convention on Income and on Capital (Condensed Version, July 17, 2008) mention that interests are effectively connected if they are paid in respect of holdings forming part of the assets of the permanent establishment or otherwise effectively connected with that establishment, thus: "24. Certain States consider that dividends, interest and royalties arising from sources in their territory and payable to individuals or legal persons who are residents of other States fall outside the scope of the arrangement made to prevent them from being taxed both in the State of the beneficiary's residence when the beneficiary has a permanent establishment in the former State. Paragraph 4 (paragraph 5 of Article 10 of the Philippines-Japan tax treaty) is not based on such conception which is sometimes referred to as 'the force of attraction of the permanent establishment'. It does not stipulate that dividends flowing to a resident of a Contracting State from a source situated in the other State must, by a kind of legal presumption, or fiction even, be related to a permanent establishment which that resident may have in the latter State, so that the said State would not be obliged to limit its taxation in such a case. The paragraph merely provides that in the State of source the dividends are taxable as part of the profits of the permanent establishment there owned by the beneficiary which is a resident in the other State, if they are paid in respect of holdings forming part of the assets of the permanent establishment or otherwise effectively connected with that establishment. In that case, paragraph 4 (paragraph 5 of Article 10 of the Philippines-Japan tax treaty) relieves the State of source of the dividends from any limitations under the Article. The foregoing explanations accord with those in the Commentary on Article 7 (on Business Profits)." (Emphasis added) (Pages 156-157) Similarly, the pronouncement of the Supreme Court in Marubeni Corporation vs. Commissioner of Internal Revenue and Court of Tax Appeals (G.R. No. 76573 dated September 14, 1989) may also apply to the herein case notwithstanding that the income included in the Marubeni case is dividends. In the said case, the Supreme Court said that dividends paid to the head office of a foreign corporation which has a branch office in the Philippines are effectively connected to the branch office if the business transactions that give rise to the dividends are conducted through the branch office, thus: "The general rule that a foreign corporation is the same juridical entity as its branch office in the Philippines cannot apply here. This rule is based on the premise that the business of the foreign corporation is conducted through its branch office, following the principal-agent relationship theory. It is understood the branch becomes its agent here. So that when the foreign corporation transacts business in the Philippines independently of its branch, the principal-agent relationship is set aside. The transaction becomes one of the foreign corporation, not the branch. Consequently, the taxpayer is the foreign corporation, not the branch or the resident foreign corporation. Corollarily, if the business transaction is conducted through the branch office, the latter becomes the taxpayer, and not the foreign corporation." Applying the OECD commentaries and the principle enumerated in the Supreme Court ruling, such interest paid by PILIPINAS HINO to MARUBENI cannot be considered as effectively connected with MARUBENI CORPORATION, MANILA BRANCH since, as represented, it does not have any participation whatsoever with regard to the loan between PILIPINAS HINO and MARUBENI. Moreover, MARUBENI does not use or hold for use in the conduct of its trade or business any shares of stock in PILIPINAS HINO, and all interest gains of MARUBENI that arise inure to its sole benefit and are not received by MARUBENI CORPORATION, MANILA BRANCH. And, finally, MARUBENI CORPORATION, MANILA BRANCH is not a material factor in the realization of such interest income received by the head office. In view of all of the foregoing, and considering that MARUBENI's interest income is not effectively connected to its representative office in the Philippines, MARUBENI CORPORATION, MANILA BRANCH, this Office is of the opinion and so holds that the interests derived by SMBC from IEWPC are subject tax at the preferential rate of 10 percent of the gross amount of the interests , pursuant to Article 11 (2) of the Philippines-Japan tax treaty, as amended. Finally, Section 179 of the Tax Code, as amended, provides that the Financial Facility Agreement, being debt instrument, is subject to documentary stamp tax of P1.00 for every P200.00 (or a fraction thereof) of the amount of the loans subject of these instruments, thus: ITAaHc "SEC. 179. Stamp Tax on All Debt Instruments . On every original issue of debt instruments, there shall be collected a documentary stamp tax of One peso (P1.00) on each Two hundred pesos (P200), or fractional part thereof, of the issue price of any such debt instrument: Provided, That for such debt instruments with terms of less than one (1) year, the documentary stamp tax to be collected shall be of a proportional amount in accordance with the ratio of its terms in number of days to three hundred sixty-five (365) days: Provided, further, That only one documentary stamp tax shall be imposed on either loan agreement, or promissory notes issued to secure such loan. For purposes of this section, the term debt instrument shall mean instruments representing borrowing and lending transactions including but not limited to debentures, certificates of indebtedness, due bills, bonds, loan agreements, including those signed abroad wherein the object of the contract is located or is used in the Philippines, instruments and securities issued by the government or any of its instrumentalities, deposit substitute debt instruments, certificates or other evidences of deposits that are either drawing interest significantly higher than the regular savings deposit taking into consideration the size of the deposit and the risks involved or drawing interest and having a specific maturity date, orders for payment of any sum of money otherwise than at sight or on demand, promissory notes, whether negotiable or non-negotiable, except bank notes issued for circulation." This ruling is issued on the basis of the facts as represented. However, if upon investigation it shall be disclosed that the actual facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Protocol Amending the Convention between the Republic of the Philippines and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income. 2. Products means buses.