ITAD BIR Ruling No. 014-10

July 1, 2010 ITAD BIR RULING NO. 014-10 Article 11 Philippines-Japan tax treaty Buag & Uy Law Offices Suites A and B, 10th Floor, Strata 100 Building F. Ortigas, Jr. Road (formerly Emerald Avenue) Ortigas Center, Pasig City Attention: Atty. Jose Mario C. Buag Gentlemen : This refers to the application for tax treaty relief dated June 4, 2008 1 involving interest derived by Artnature, Inc. (Artnature) from its deposit accounts at the branch office of Mizuho Corporate Bank, Ltd. in the Philippines (Mizuho Bank Branch Office) . cDCIHT Basic Facts It is represented that Artnature is a foreign corporation organized and existing under the laws of Japan and is a resident of Japan based on its Articles of Incorporation; that Artnature is situated at 40-7, Yoyogi 3-chome, Shibuya-ku, Tokyo, Japan; that Artnature is engaged primarily in the manufacture and sale of hair products, in providing guidance on hair fostering, beauty culture and hairdressing business, and in the manufacture, sale, export and import of cosmetic and pharmaceutical items and medical appliances; that based on its License to Transact Business in the Philippines issued by the Securities and Exchange Commission (SEC) dated October 10, 2006, Artnature is licensed under Company Registration No. FS200615974 to establish a representative office in the Philippines to deal directly with its relevant parties in the Philippines, including activities such as but not limited to, information gathering, information dissemination, assistance to its subsidiaries in the Philippines and promotion of the company's products ; that the representative office ( Artnature Representative Office ) is situated at Kilometer 32, Barangay Nueva, National Highway, San Pedro, Laguna, Philippines; and that, on the other hand, Mizuho Bank Branch Office is situated at the 26th Floor, Citibank Tower, Valero corner Villar Streets, Salcedo Village, Makati City, Philippines. It is also represented based on the Certificate of Deposit Existence (CER-000082-08) dated May 19, 2008 issued by Mizuho Bank Philippine Branch that Artnature maintains the following deposit accounts at the bank: Account Type Account No. Opening Date Philippine Peso Current Account H10-767-153075 May 31, 2006 United States Dollar Savings Account F15-789-153266 May 31, 2006 Japanese Yen Savings Account F15-789-153274 May 31, 2006 It is further represented based on the notarized certification by the Chief Representative of Artnature Representative Office , Mr. Hiroshi Kazama, dated March 31, 2010, that: 1. interest derived by the head office of Artnature in Japan from its deposit accounts at Mizuho Bank Philippine Branch is not effectively connected with Artnature Representative Office ; and 2. the deposit accounts in question and the accruing interest thereon do not form part of the assets of Artnature Representative Office . It is finally represented based on the notarized Certification by the Assistant Vice President and Senior Assistant Manager for Operations of Mizuho Bank Philippine Branch , Ms. Eileen R. Madino, that the interest subject of the application for tax treaty relief is not subject of investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal. Ruling In reply, please be informed that a foreign corporation like Artnature , whether or not engaged in trade or business in the Philippines, is subject to income tax in the Philippines only with respect to income derived in the Philippines. Section 23 (F) of the National Internal Revenue Code of 1997 (Tax Code of 1997), as amended, provides: "SEC. 23. General Principles of Income Taxation in the Philippines . Except when otherwise provided in this Code: cEAHSC xxx xxx xxx (F) A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines." However, any income derived by a foreign corporation may be exempt (or partially exempt if subject to a reduced rate only) if the same is so exempt (or partially exempt) to the extent required by any treaty obligation binding upon the Philippine Government. Section 32 (B) (5) of the Tax Code of 1997, as amended, provides: "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: (5) Income Exempt under Treaty . Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines." With respect to a treaty, what is being invoked for the purpose of the Philippine peso deposit account of Artnature is 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) , signed on February 13, 1980, and effective January 1, 1981. Article 11 thereof provides as follows: "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: a) 10 per cent of the gross amount of the interest if the interest is paid in respect of Government securities, or bonds or debentures; b) 15 per cent of the gross amount of the interest in all other cases. 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. 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 aESICD 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. 7. Interest shall be deemed to arise in a Contracting State when the payer is that Contracting State itself, a political subdivision or a local authority thereof or a resident of that Contracting State. Where, however, the person paying the interest, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base in connection with which the indebtedness on which the interest is paid was incurred, and such interest is borne by such permanent establishment or fixed base, then such interest shall be deemed to arise in the Contracting State in which the permanent establishment or fixed base is situated. 8. Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the interest, having regard to the debt-claim for which it is paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case, the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this Convention." 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 (Amending Protocol), signed on December 9, 2006, and effective January 1, 2009, amends Article 11 of the Philippines-Japan tax treaty as follows: " Article IV Paragraphs 2, 3, 4, 5, 6, 7 and 8 of Article 11 of the Convention shall be deleted and replaced by the following : '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. IEHaSc 3. Notwithstanding the provisions of paragraph 2, 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, insured 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. For the purposes of this paragraph, the term 'financial institution wholly owned by the Government' means: a) In the case of Japan, the Japan Bank for International Cooperation and the Nippon Export and Investment Insurance; b) In the case of the Philippines, the Development Bank of the Philippines and the Land 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. 4. 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. 5. The provisions of paragraphs 1 and 2 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. 6. Interest shall be deemed to arise in a Contracting State when the payer is that Contracting State itself, a political subdivision or a local authority thereof or a resident of that Contracting State. Where, however, the person paying the interest, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base in connection with which the indebtedness on which the interest is paid was incurred, and such interest is borne by such permanent establishment or fixed base, then such interest shall be deemed to arise in the Contracting State in which the permanent establishment or fixed base is situated. 7. Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the interest, having regard to the debt-claim for which it is paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case, the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this Convention.'" ISHaTA Under paragraphs 2 and 3, Article 11 of the Philippines-Japan tax treaty, as amended, interest arising in the Philippines and paid to a resident of Japan may be taxed in the Philippines, but the rate of income tax that may be imposed on interest paid or received before January 1, 2009, shall not exceed (a) 10 percent of the gross amount of the interest if it is paid in respect of government securities, bonds or debentures, or if the interest is 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; and (b) 15 percent of the gross amount of the interest in all other cases. In the case of interest paid or received on January 1, 2009, and thereafter, the rate of income tax is simplified to 10 percent. Under paragraph 3, Article 11 of the tax treaty, as amended, interest arising in the Philippines may be exempt if it is derived by the Government of Japan, a political subdivision or a local authority of Japan, the Central Bank of Japan, a financial institution wholly owned by the government of Japan, or by a resident of Japan under certain conditions. However, under paragraph 6, Article 11 of the Philippines-Japan tax treaty, as amended, the taxation of interest at a reduced rate or rates under paragraphs 2 and 3 of Article 11 shall not apply if the interest is effectively connected with a permanent establishment which an enterprise of Japan has in the Philippines, or with a fixed base for the purpose of performing independent personal services by an individual resident of Japan. The concept of permanent establishment Paragraphs 1 and 2 of the Philippines-Japan tax treaty, as amended, defines a permanent establishment 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; j) 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." Artnature has a permanent establishment in the Philippines Since a permanent establishment means a fixed place of business through which the business of an enterprise is wholly or partly carried on, and includes, in particular, an office , it follows that Artnature Representative Office , being an office of Artnature and situated currently at Kilometer 32, Barangay Nueva, National Highway, San Pedro, Laguna, Philippines, constitutes a permanent establishment of Artnature . The concept of interest being effectively connected with a permanent establishment On the question when interest is effectively connected with a permanent establishment, the following commentaries of the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention on Income and on Capital (Condensed Version, July 17, 2008) mention: "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 6 of Article 11 of the Philippines-Japan tax treaty, as amended) 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 interest arising 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 interest is taxable as part of the profits of the permanent establishment there owned by the beneficiary which is a resident in the other State, if it is paid in respect of debt-claims forming part of the assets of the permanent establishment or otherwise effectively connected with that establishment . In that case, paragraph 4 (paragraph 6 of Article 11 of the Philippines-Japan tax treaty, as amended) relieves the State of source of the interest from any limitation under the Article. The foregoing explanations accord with those in the Commentary on Article 7 (on Business Profits)." (Emphasis added) (Page 177) Interest is not effectively connected with Artnature Representative Office Based on the notarized certification submitted by Mr. Hiroshi Kazama, Chief Representative of Artnature Representative Office , dated March 31, 2010: EDHTAI 1. interest derived by the head office of Artnature in Japan from its deposit accounts at Mizuho Bank Philippine Branch is not effectively connected with Artnature Representative Office ; and 2. the deposit accounts in question and the accruing interest thereon do not form part of the assets of Artnature Representative Office . Definition of "interest" as income from debt-claims includes interest from deposits Paragraph 5, Article 11 of the Philippines-Japan tax treaty, as amended, defines interest as follows: "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." Relative thereto, it is noteworthy that the concept of interest as income from debt-claims includes interest from deposits, as mentioned in the following commentaries of the OECD Model Convention, thus: "18. Paragraph 3 (paragraph 5 of Article 11 of the Philippines-Japan tax treaty, as amended) specifies the meaning to be attached to the term 'interest' for the application of the taxation treatment defined by the Article. The term designates, in general, income from debt claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in profits. The term 'debt claims of every kind' obviously embraces cash deposits and security in the form of money , as well as government securities, and bonds and debentures, although the three latter are specially mentioned because of their importance and of certain peculiarities that they may present . . ." (emphasis added) (Page 175) Accordingly, inasmuch as the interest derived by Artnature from its Philippine peso deposit account at Mizuho Bank Philippine Branch is not effectively connected with Artnature Representative Office , such interest shall be subject to income tax in the Philippines at the rate of 15 percent based on the gross amount of the interest for interest derived before January 1, 2009, and at the rate of 10 percent based on the gross amount of the interest for interest derived on January 1, 2009, and thereafter. Finally, requests for ruling invoking the provisions of the Tax Code of 1997, as amended, should be filed at the Law Division of this Bureau and not at the International Tax Affairs Division. Thus, your request for exemption from income tax of interest derived by Artnature from its Japanese yen and United States dollar deposit accounts at Mizuho Bank Philippine Branch pursuant to Section 28 (A) (7) (b) of the Tax Code of 1997, as amended, will be resolved by the Law Division. 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.) JOEL L. TAN-TORRES Commissioner of Internal Revenue Footnotes 1. Originally filed by the law firm of Romulo Mabanta Buenaventura Sayoc & de los Angeles under authorization dated May 14, 2008 from Artnature , and as superseded by a new authorization dated March 31, 2010 to the law firm of Buag & Uy .