ITAD BIR Ruling No. 005-17

February 10, 2017 ITAD BIR RULING NO. 005-17 Articles 5, 13 and 22, Philippines-Japan tax treaty, as amended Araneta & Faustino Law Offices Corner H.V. Dela Costa and Tordesillas Streets Salcedo Village Makati City Attention: AAA Gentlemen : This refers to your tax treaty relief application filed on January 31, 2013 requesting confirmation that income derived by Seiko Epson Corporation (" Seiko Epson ") from the sale of its assets to Hoya Lens Manufacturing Philippines, Inc. (" Hoya Philippines ") is exempt from income tax pursuant to 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 (" Philippines-Japan tax treaty "), as amended. 1 FACTS Seiko Epson is a foreign corporation organized and existing under the laws of Japan and a resident thereof based on its amended Certificate of All Current Record issued by the Nagano District Legal Affair Bureau and Certification by The Tax Authorities of the Country of Residence issued by the Shinjuku Tax Office. Seiko Epson is engaged in the manufacture and sale of electric machinery and apparatuses, telecommunications machinery and apparatuses and applied electronic machinery and their parts and accessories. It is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission. On the other hand, Hoya Philippines is a domestic corporation organized and existing under Philippine laws. HTcADC On February 1, 2013, Hoya Philippines and Seiko Epson entered into an Asset Transfer Agreement (" Agreement ") where Seiko Epson sold and transferred to Hoya Philippines certain assets, debts, liabilities and contracts as described in Annex 1 (Transferred Assets) of the Agreement for a consideration amounting to _______________. The assets consist of the following intangible properties: a) Patent rights and rights to obtain patent rights; b) Trademark rights, utility model rights and design rights; c) Copyrights; d) Other intangible assets like know-how, design, drawing, computer system, software programs, machine specifications and drawings, and other documents and electronic data related to eyewear lenses; and e) Contractual claims and rights. Patents and rights to obtain a patent are registered in the Philippines (two patent rights and two rights to obtain a patent), in foreign countries (Australia, Austria, Belgium, Canada, China, France, Germany, Hong Kong, India, Italy, Japan, Korea, Netherlands, Singapore, Slovenia, Spain, Sweden, Taiwan, Thailand, United Kingdom of Great Britain and Northern Ireland and United States of America), and with the European Patent Office and the World Intellectual Property Organization. Based on a sworn statement issued by Hoya Philippines , the income subject of this ruling is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceeding, or judicial appeal. RULING In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997, as amended (" Tax Code "), income derived by a foreign corporation not engaged in trade or business in the Philippines is subject to income tax at the rate of 30 percent of the gross amount thereof, to wit: " SEC. 28. Rates of Income Tax on Foreign Corporations. xxx xxx xxx (B) Tax on Nonresident Foreign Corporation. (1) In General. Except as otherwise provided in this Code, a foreign corporation not engaged in trade or business in the Philippines shall pay a tax equal to thirty-five percent (35%) of the gross income received during each taxable year from all sources within the Philippines, such as interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and capital gains, except capital gains subject to tax under subparagraph 5(c) and (d) above: n Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." However, under Section 32 (B) (5) of the Tax Code, such income is exempt to the extent required by any treaty obligation on the Philippines, thus: aScITE " SEC. 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." Relative thereto, Article 13 of the Philippines-Japan tax treaty, as amended, provides as follows: " Article 13 1. Gains derived by a resident of a Contracting State from the alienation of immovable property as defined in paragraph 2 of Article 6 and situated in the other Contracting State may be taxed in that other Contracting State. 2. Gains from the alienation of any property, other than immovable property, forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or of any property, other than immovable property, pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or together with the whole enterprise) or of such a fixed base, may be taxed in that other Contracting State. 3. Gains derived by a resident of a Contracting State from the alienation of ships or aircraft operated in international traffic and any property, other than immovable property, pertaining to the operation of such ships or aircraft shall be taxable only in that Contracting State. 4. Gains from the alienation of shares of a company, a partnership or a trust the property of which consists principally of immovable property situated in a Contracting State, may be taxed in that Contracting State. 5. Gains from the alienation of any property other than those referred to in paragraphs 1, 2, 3 and 4 shall be taxable only in the Contracting State of which the alienator is a resident." Under paragraph 1 , gains from the alienation of immovable property situated in a Contracting State may be taxed in that State. Under paragraph 2 , gains from the alienation of movable property situated in a Contracting State and forming part of the business property or capital assets of a permanent establishment (in the case of an enterprise) or a fixed base (in the case of an individual performing independent personal services) may be taxed in that State. Under paragraph 4 , gains from the alienation of shares of a company, partnership, or trust the property of which consists of immovable property situated in a Contracting State may be taxed in that State. On the other hand, under paragraph 3 , gains from the alienation of ships or aircraft operated in international traffic and any movable property pertaining thereto are taxable only in the Contracting State where the enterprise operating such ships or aircraft is a resident. Under paragraph 5 , gains from the alienation of property other than those referred to in the foregoing paragraphs are taxable only in the Contracting State where the alienator is a resident. Accordingly, Article 13 limits the nature of property, the alienation of which is taxable in the Contracting State where it is situated to: immovable or real property; movable or personal property forming part of the business property or capital assets of a permanent establishment or fixed base; movable or personal property in the form of shares of a company, partnership, or trust. Moreover, as regards a permanent establishment, paragraphs 1, 2 and 3, Article 5 of the treaty define it 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. DETACa 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. 3. A building site or construction or installation project constitutes a permanent establishment only if it lasts more than six months." Under Article 5, a permanent establishment means a fixed place of business through which the business of an enterprise is wholly or partly carried on, and includes especially, a store or other sales outlet, a branch, an office, a factory, and a workshop. It includes also a building site or construction or installation project which lasts more than six months. Since Seiko Epson is not engaged in trade or business in the Philippines to which a branch, an office, or other fixed place of business is necessary, it is not deemed to have a permanent establishment in the Philippines under Article 5 of the treaty. With respect to the two patents and two rights to patent registered in the Philippines which are subject of the Agreement, these are considered movable or personal property situated in the Philippines. Hence, capital gains derived by Seiko Epson from the transfer of these assets to Hoya Philippines are exempt from income tax pursuant to paragraph 5, Article 13 of the Philippines-Japan tax treaty, as amended. On the other hand, with respect to the other patents, rights to patent and the other assets described in the Agreement, which are not registered in the Philippines, they cannot be deemed as movable or personal property situated in the Philippines. Accordingly, the relief under paragraph 5, Article 13 of the treaty does not apply to capital gains arising from the alienation of these properties. Instead of Article 13, the following Article 22 of the Philippines-Japan tax treaty, as amended, applies to such gains: " Article 22 1. Items of income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that Contracting State. 2. The provisions of the preceding paragraph shall not apply to income, other than income from immovable property as defined in paragraph 2 of Article 6, if the recipient of such income, being a resident of a Contracting State, carries on business in the other Contracting State through a permanent establishment situated therein, or performs in that other Contracting State independent personal services from a fixed base situated therein, and the right or property in respect of which the income 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." Under Article 22, items of income of a resident of a Contracting State, wherever arising , not dealt with in the foregoing articles of the treaty are taxable only in the residence State. However, if the income is effectively connected with a permanent establishment or fixed base situated in a Contracting State, such income may be taxed in that State. The relevant commentaries of the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (Conversed Version July 2010) describes the purpose of this article, to wit: "1. This Article provides a general rule relating to income not dealt with in the foregoing Articles of the Convention. The income concerned is not only income of a class not expressly dealt with but also income from sources not expressly mentioned. The scope of the Article is not confined to income arising in a Contracting State; it extends also to income from third States . . ." (Page 299) Under the commentaries, Article 22 applies to items of income not expressly dealt with in a tax treaty, which is generally known as other income . Other income is of two types: first , income which arises in a Contracting State and derived by a resident of the other Contracting State but which falls outside the technical definition of income dealt with in the relevant articles of the treaty, namely, income from real immovable property; business profits; income from the operation of ships and aircraft in international traffic; dividends; interest; royalties; capital gains; income from independent or dependent personal services; director's fees; income of artists and athletes; pensions; income from government service; income of students and teachers. The second concerns income which falls within the definition of any of those articles but which arises in a third State or States. Capital gains derived by Seiko Epson from the transfer of its other assets are considered other income of the second type. While the assets involved form part of the business property or capital assets of Seiko Epson and not its inventory, they are not situated in the Philippines but in third States. Accordingly, since Seiko Epson does not have a permanent establishment in the Philippines, gains derived by Seiko Epson from the transfer of its other patents and rights to patent registered outside the Philippines as well as other assets described in the Agreement are exempt from income tax in the Philippines pursuant to Article 22 of the Philippines-Japan tax treaty, as amended. aDSIHc 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.) CAESAR R. DULAY Commissioner of Internal Revenue Footnotes 1. By the 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 effective January 1, 2009 . n Note from the Publisher: Copied verbatim from the official document.