ITAD BIR Ruling No. 026-17

September 25, 2017 ITAD BIR RULING NO. 026-17 Article 13 Philippines-Japan tax treaty, as amended ______________________________ ______________________________ ______________________________ ______________________________ Attention: ____________________ Gentlemen : This refers to your tax treaty relief application filed on April 7, 2014 requesting confirmation that capital gains derived by Corporation 1 (" Corp1 ") from the transfer of its shares of stock in Corporation 2 (" Corp2 ") to Corporation 3 (" Corp3 ") are 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 "). 1 FACTS Corp1 is a foreign corporation organized and existing under the laws of Japan and a resident thereof based on its amended Articles of Incorporation and Certificate of Residence issued by the Kojimachi Tax Office of Japan. Corp1 is engaged primarily in the manufacture and sale of all types of electrical machinery and appliances, information equipment and appliances, industrial machinery and appliances, household electrical machinery and appliances, lighting machinery and appliances, rolling stock machinery and appliances, ship machinery and appliances, aircraft machinery and appliances, guided rockets, satellites, communications equipment and appliances, machining equipment and instruments, atomic power machinery and equipment, gas instruments, building and residence-related products, semiconductors, integrated circuits and other general machinery and equipment and parts. Based on the Certification of Corporate Filing/Information issued by the Securities and Exchange Commission, Corp1 is licensed to establish a representative office in the Philippines and to date no petition for withdrawal of such license has been filed with the Commission. Corp3 is a foreign corporation organized and existing under the laws of Singapore. HTcADC On the other hand, Corp2 is a domestic corporation organized and existing under the laws of the Philippines. It is engaged primarily in manufacturing, buying and selling, leasing, servicing and repairing machinery, equipment, elevator and escalator, motors and articles of every kind and description. Based on its General Information Sheet for 2014 and Secretary's Certificate, it has 300,000,000 outstanding and subscribed common shares with a par value of P1.00 each. Corp1 holds 179,999,997 of these shares representing 60 percent ownership in the company. On March 26, 2014, pursuant to a Deed of Sale, Corp1 transferred 30,000,000 of those shares in Corp2 to Corp3 . In exchange, Corp3 will issue 1,432,000 shares to Corp1 with a par value of 114,546,000 (P50,480,422). 2 Based on Corp2 's Audited Financial Statements as of March 31, 2013 and Interim Financial Statements as of March 31, 2014, the ratio of the company's real property over its total assets is 2.55% and 0.95%, respectively. As of March 31, 2013, Corp2 's shares have a presumed fair market value ("FMV") of P826,285,682. The 30,000,000 shares transferred to Corp3 have an FMV of P82,628,568, which is greater than the consideration received by Corp1 from Corp3 . RULING A. Income tax In reply, please be informed that under Section 28 (B) (5) (c) of the National Internal Revenue Code of 1997, as amended (" Tax Code "), capital gains from the disposition of shares in a domestic corporation derived by a foreign corporation not engaged in trade or business in the Philippines are subject to income tax at the rate of 5 or 10 percent, to wit: " SEC 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. xxx xxx xxx (c) Capital Gains from Sale of Shares of Stock not Traded in the Stock Exchange. A final tax at the rates prescribed below is hereby imposed upon the net capital gains realized during the taxable year from the sale, barter, exchange or other disposition of shares of stock in a domestic corporation, except shares sold, or disposed of through the stock exchange: Not Over P100,000 5% On any amount in excess of P100,000 10%" However, under Section 32 (B) (5) of the Tax Code, such gains are exempt if required under any treaty obligation on the Philippines, thus: " 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, paragraphs 4 and 5, Article 13 of the Philippines-Japan tax treaty provides: "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 4, gains from the alienation of shares of a domestic company, the property of which consists principally of immovable property situated in the Philippines, may be taxed in the Philippines. Under paragraph 5, gains from the alienation of property other than that referred to in paragraph 4 shall be taxable only in the Contracting State of which the alienator is a resident. Relative thereto, under Section 2 (b) of Revenue Regulations No. 4-86, 3 the term consisting principally of real or immovable property means that the ratio of real or immovable property over the total assets (" real property interest " or " RPI ") of the corporation is more than 50% , to wit: aScITE " SECTION 2. Definitions . For purposes of these regulations, the following terms and phrases shall be understood to mean b) 'Principally,' 'wholly or principally,' 'directly principally' or 'attributable' more than fifty percent of the entire assets in terms of value" ; (Emphasis ours) Accordingly, since Corp2 's RPI as of March 31, 2013 and March 31, 2014 is 2.55% and 0.95%, respectively, and not more than 50%, any gains derived by Corp1 from the transfer of a portion of its shares in Corp2 to Corp3 are exempt from income tax pursuant to paragraphs 4 and 5, Article 13 of the Philippines-Japan tax treaty. B. Donor's tax As mentioned above, the presumed FMV of the 30,000,000 shares of Corp2 subject of transfer is greater than the consideration received for those shares. Under Section 100 of the Tax Code, the excess between the higher FMV and the lower consideration is a deemed gift subject to donor's tax , to wit: " SEC. 100. Transfer for Less Than Adequate and Full Consideration. Where property, other than real property referred to in Section 24(D), is transferred for less than an adequate and full consideration in money or money's worth, then the amount by which the fair market value of the property exceeded the value of the consideration shall, for the purpose of the tax imposed by this Chapter, be deemed a gift, and shall be included in computing the amount of gifts made during the calendar year." Moreover, Section 7 (c.1.4) of Revenue Regulations No. 6-2008, 4 as amended by Revenue Regulations No. 6-2013, in implementing Section 100 of the Tax Code, provides: " SEC. 7. SALE, BARTER OR EXCHANGE OF SHARES OF STOCK NOT TRADED THROUGH A LOCAL STOCK EXCHANGE PURSUANT TO SECS. 24(C), 25(A)(3), 25(B), 27(D)(2), 28(A)(7)(c), 28(B)(5)(c) OF THE TAX CODE, AS AMENDED . xxx xxx xxx (c) Determination of Amount and Recognition of Gain or Loss. (c.1) Determination of Selling Price. In determining the selling price, the following rules shall apply: xxx xxx xxx (c.1.4) In case the fair market value of the shares of stock sold, bartered, or exchanged is greater than the amount of money and/or fair market value of the property received, the excess of the fair market value of the shares of stock sold, bartered or exchanged over the amount of money and the fair market value of the property, if any, received as consideration shall be deemed a gift subject to the donor's tax under Sec. 100 of the Tax Code, as amended." (c.2) Definition of 'fair market value' of the Shares of Stock. For purposes of this Section, 'fair market value' of the shares of stock sold shall be: xxx xxx xxx (c.2.2) In the case of shares of stock not listed and traded in the local stock exchanges, the value of the shares of stock at the time of sale shall be the fair market value. In determining the value of the shares, the Adjusted Net Asset Method shall be used whereby all assets and liabilities are adjusted to fair market values. The net of adjusted asset minus the liability values is the indicated value of the equity." As to the rate of donor's tax, under Section 10 (B) of Revenue Regulations No. 2-2003, 5 donation made between business organizations is considered donation made to a stranger subject to donor's tax of 30%, to wit: " SEC. 10. RATES OF DONOR'S TAX. xxx xxx xxx (B) Tax payable by the donor if donee is a stranger. When the donee or beneficiary is a stranger, the tax payable by the donor shall be thirty per cent (30%) of the net gifts. HEITAD xxx xxx xxx Donation made between business organizations and those made between an individual and a business organization shall be considered as donation made to a stranger." C. Documentary stamp tax Finally, under Section 175 of the Tax Code, the transfer of the said Corp2 shares is subject to documentary stamp tax as follows: " SEC. 175. Stamp Tax on Sales, Agreements to Sell, Memoranda of Sales, Deliveries or Transfer of Shares or Certificates of Stock. On all sales, or agreements to sell, or memoranda of sales, or deliveries, or transfer of shares or certificates of stock in any association, company, or corporation, or transfer of such securities by assignment in blank, or by delivery, or by any paper or agreement, or memorandum or other evidences of transfer or sale whether entitling the holder in any manner to the benefit of such stock, or to secure the future payment of money, or for the future transfer of any stock, there shall be collected a documentary stamp tax of Seventy-five-centavos (P0.75) on each Two hundred pesos (P200), or fractional part thereof, of the par value of such stock: Provided, That only one tax shall be collected on each sale or transfer of stock from one person to another, regardless of whether or not a certificate of stock is issued, indorsed, or delivered in pursuance of such sale or transfer: and Provided, further, That in the case of stock without par value the amount of the documentary stamp tax herein prescribed shall be equivalent to twenty-five percent (25%) of the documentary stamp tax paid upon the original issue of said stock." 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. As amended 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 . 2. Note from the Publisher: Copied verbatim from the official copy. Missing footnote text. 3. Determination of Whether the Assets of a Corporation Consist Principally of Real Property Interest under the Philippine Tax Treaties. 4. Consolidated Regulations Prescribing the Rules on the Taxation of Sale, Barter, Exchange or Other Disposition of Shares of Stock Held as Capital Assets. 5. Consolidated Revenue Regulations on Estate Tax and Donor's Tax Incorporating the Amendments Introduced by Republic Act No. 8424, the Tax Reform Act of 1997.