ITAD BIR Ruling No. 022-10

August 25, 2010 ITAD BIR RULING NO. 022-10 Article 11, Philippines-Japan tax treaty; BIR Ruling No. DA-ITAD-140-06; BIR Ruling No. ITAD-164-05 L&K Industries Philippines, Inc. Lot C-2 & D, CPIP, M.A. Roxas Highway, CSEZ Clarkfield, Pampanga Attention: Ms. Ma. Gemma A. Tapang Chief Operating Officer Gentlemen : This refers to your letter dated March 5, 2007, requesting the confirmation of the exemption of the interest due for the loans made by L&K Industries Philippines, Inc. (L&K Philippines) to Lite-on Japan, Ltd. (Lite-on Japan) under Article 11 (4) of the Philippines-Japan tax treaty. It is represented that Lite-on Japan is a corporation organized and existing under the laws of Japan with principal address at 4-2-1 Kudan Kita, Chiyoda-ku, Tokyo, Japan; that it is not registered either as a corporation or as a partnership in the Philippines per certification issued by the Securities and Exchange Commission dated March 5, 2007; that L&K Philippines is a corporation organized and existing under the laws of the Philippines with principal address at Phase I Lot C-2 & D, CPIP, M.A. Roxas Highway, CSEZ, Clarkfield, Pampanga. It is further represented that on July 20, 2006, two (2) Loan Agreements were entered into by and between Lite-on Japan and L&K Philippines in the principal amounts of 1) Two Hundred Eighty Million Yen (280,000,000) , with interest on the outstanding balance of the principal amounts at the rate of 2 percent per annum payable on the day of the end of every quarter commencing on September 30, 2006 and continuing until the full sum of the principal amount will have been repaid to Lite-on Japan; and, 2) One Hundred Twenty Million Yen (120,000,000) with an interest at the rate of Lite-on Japan's cost plus 1 percent per annum payable on the day of the end of every quarter commencing on September 30, 2006 and continuing until the full sum of the principal amount will have been repaid to Lite-on Japan; that on August 18, 2006, a separate loan agreement was entered into by Lite-on Japan and Japan Bank for International Cooperation (JBIC) (JBIC loan) for a maximum principal amount limited to 280,000,000.00 the proceeds of which will be used for the purpose of funding the loan agreement between Lite-on Japan and L&K Philippines; that the interest of the said JBIC loan is 16 percent per annum; and that the issue or transaction subject of this request for ruling is not under investigation, on-going audit, administrative protest, claims for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal. HCITAS In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, applies in general to interest received by a nonresident foreign corporation which provides: "Section 28. Rates of Income Tax on Foreign Corporations. (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 interest, 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): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). However, Section 32 (B) (5) of the Tax Code of 1997, as amended provides: "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: (5) Income Exempt under Treaty. Income of any kind, to the extent required by any obligation binding upon the Government of the Philippines." Thus, the provisions of Article 11 of the Philippines-Japan tax treaty, which you invoke, may apply to the instant case. It provides "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 the 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; DHITcS 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 incentive 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 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: ASHICc (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 Government of the two Contracting States. 5. The term 'interest' as used in this Article means income derived from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right in the debtor's profits, and in particular, income from Government securities and income from bonds and debentures, including premiums and prizes attaching to such securities, bonds or debentures." Based on the above provisions, interest derived in the Philippines by the Government of Japan including its political subdivisions, local authorities and financial institutions; or from debt-claims guaranteed or indirectly financed by a financial institution wholly owned by the Japanese government, shall not be subject to Philippine income tax. In the instant case, however, it should be noted that the Loan Agreement in the amount of 280,000,000, from which the subject interest is derived is solely by and between Lite-on Japan and L&K Philippines, and, there is nothing therein which, as represented, provides that JBIC guarantees or shall finance indirectly, the said loan of L&K Philippines. While it is true that the amount 280,000,000 which Lite-on Japan lent to L&K Philippines came from JBIC, still, such amount was obtained by Lite-on Japan through another loan agreement it executed with JBIC on August 18, 2006. Therefore, it cannot be said that the subject interest is derived from a loan which was indirectly financed/guaranteed by the JBIC. The second loan agreement between Lite-on Japan and JBIC is a separate and distinct loan agreement from that executed between Lite-on Japan and L&K Philippines. This is so, notwithstanding a certification from JBIC that the amount of 280,000,000 borrowed by Lite-on Japan shall be used by the latter to finance a loan made by L&K Philippines. In view of all the foregoing, this Office is of the opinion and so holds that the interest derived from the Loan Agreement amounting to 280,000,000 is subject to the preferential tax rate of 15% of its gross amount. (BIR Ruling No. DA-ITAD-140-06 dated November 8, 2006; BIR Ruling No. ITAD-164-05 dated December 22, 2005) Likewise, as to the 120,000,000 loan amount, the same shall be subject to tax at a preferential rate of 15% pursuant also to Article 11 (2) (b) of the same treaty. Nevertheless, as to the payments of the subject interest beginning January 1, 2009, the same shall be subject to a preferential tax rate of 10% of its gross amount, pursuant to Article IV of the new protocol of the Philippines-Japan tax treaty, which provides: IEaATD "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." Finally, the Loan Agreements between L&K Philippines and Lite-on Japan shall be subject to documentary stamp tax imposed under Section 173 of the Tax Code of 1997. This ruling is issued on the basis of the foregoing 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