Salvador Llanillo and Bernardo Attorneys-at-Law

March 11, 2020 ITAD BIR RULING NO. 031-20 Article 14 (Capital Gains) Philippines-United States of America tax treaty Salvador Llanillo and Bernardo Attorneys-at-Law 8th Floor, Tower One and Exchange Plaza Ayala Triangle, Ayala Avenue 1226 Makati City Attention: AAA _______________ Gentlemen : This refers to your tax treaty relief application filed on May 17, 2011 requesting confirmation that gains derived by The Interpublic Group of Companies, Inc. ("Interpublic") from the transfer of its shares of stock in Treyna Holdings, Inc. ("Treyna'') to IPG Nederland B.V. ("IPG Nederland") are exempt from income tax pursuant to the Convention between the Government of the Republic of the Philippines and the Government of the United States of America with Respect to Taxes on Income ("Philippines-United States tax treaty") . FACTS Interpublic is a foreign corporation organized and existing under the laws of the United States based on its Restated Certificate of Incorporation filed with the Government of the State of Delaware in the United States and Certificate of Residence issued by the Internal Revenue Service of the United States. The object of Interpublic is to conduct a general advertising agency, public relations, sales promotion, product development, marketing counsel and market research business; and to conduct research in and act as consultant and advisor in respect of matters pertaining to advertising, marketing, merchandising and distribution of services, products and merchandise. IPG Nederland is also a foreign corporation organized and existing under the laws of the Netherlands, engaged in the management of funds, trusts and foundations organized for purposes other than religious, educational, charitable, or nonprofit research. On the other hand, Treyna is a domestic corporation engaged in general advertising business, primarily as an agent, including the preparation and management of advertisements and manufacture and construction of advertising devices and novelties, based on its Audited Financial Statements ("AFS") as of December 31, 2009 and General Information Sheet as of April 15, 2011. Based on the latter documents and Corporate Secretary's Certificates, Interpublic owns 490,200 shares, which represent 40% of the outstanding and fully subscribed common shares of Treyna . Each share has a par value of P______ or total value of P __________ held by Interpublic . AHCETa On February 5, 2009, Interpublic and IPG Nederland entered into a Deed of Assignment where Interpublic transferred its 490,200 common shares in Treyna to IPG Nederland . Consequently, Interpublic relinquished all its rights, title, interests and privileges over the shares in favor of IPG Nederland , such as the right to receive dividends, right to inspect corporate books, and voting rights. The transfer was made pursuant to an earlier unilateral resolution of Interpublic , being the sole shareholder of IPG Nederland , to transfer to the latter its beneficial ownership of the subject shares as its informal capital contribution. Instead of shares, IPG Nederland will recognize this contribution as share premium in its books. Based on its AFS, as of December 31, 2008, Treyna 's real property interest is 8.46%, as computed below: Real property interest = P __________ P __________ = 8.46%. 1 Under Section 2 (b) of Revenue Regulations No. 4-86, 2 real property interest is the percentage of the taxpayer's real or immovable property over its total assets. The taxpayer's assets are considered to be principally of, wholly or principally of, directly principally of, or attributable to real or immovable property if the taxpayer's real property interest is more than 50%, thus: " SECTION 2. Definitions. For purposes of these regulations, the following terms and phrases shall be understood to mean xxx xxx xxx b) 'Principally,' 'wholly or principally,' 'directly principally' or 'attributable' more than fifty percent of the entire assets in terms of value;" On the other hand, the fair market value of the 490,200 transferred shares is P __________ , computed as follows: Fair market value = Percentage of transferred shares (40%) x [Total assets (P __________ Total liabilities (P __________ )] = P __________ . Based on a certification issued by Treyna , 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 proceedings, or judicial appeal. RULING A. Income tax In reply, please be informed that under Section 28 (B) (5) (c) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, capital gains derived by a nonresident foreign corporation from the disposition of shares in a domestic corporation not traded in a stock exchange are subject to capital gains tax at the rate of 5% to 10%, to wit: ScHADI " 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 to the extent required by any treaty obligation binding upon the Philippine government, 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, Item 1 of the United States Senate's reservation to Article 14 (Capital Gains) of the Philippines-United States tax treaty provides that gains from the alienation of an interest in a domestic corporation in the Philippines may be taxed therein if the assets of the corporation consist principally of immovable property situated in the Philippines, thus: "TEXT OF THE RESOLUTION OF RATIFICATION Resolved (two-thirds of the Senators present concurring therein), That the Senate advise and consent to the ratification of the Convention signed at Manila on October 1, 1976, between the Government of the United States of America and the Government of the Republic of the Philippines with Respect to Taxes on Income, and an Exchange of Notes done at Washington on November 24, 1976, subject to the following: aICcHA (1) reservation that, notwithstanding the provisions of Article 14 relating to capital gains, both the United States and the Philippines may tax gain from the disposition of an interest in a corporation if its assets consist principally of a real property interest located in that country. Likewise, both countries may tax gain from the disposition of an interest in a partnership, trust or estate to the extent the gain is attributable to a real property interest in one of the countries. The term 'real property interest' is to have the meaning it has under the law of the country in which the underlying real property is located;" Accordingly, since Treyna 's real property interest as of December 31, 2008, prior to the transfer of shares on February 5, 2009, is 8.46%, which is not more than 50%, the company's assets do not consist principally of immovable property under Section 2 (b) of Revenue Regulations No. 4-86. This being the case, capital gains, if any, derived by Interpublic from the transfer of all its shares in Treyna to IPG Nederland are exempt from income tax pursuant to Item 1 of the United States Senate's reservation to Article 14 of the Philippines-United States tax treaty. B. Donor's tax Under Section 100 of the Tax Code, where property (other than real property) is transferred for less than an adequate and full consideration in money or money's worth, the excess between the higher fair market value of the property and the lower consideration received by the transferor is deemed a gift subject to donor's tax, thus: " 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." Prior to the transfer, the fair market value of Treyna shares transferred by Interpublic to IPG Nederland is P ___________ , and Interpublic (the transferor) did not receive any consideration for such shares from IPG Nederland (the transferee). The lack of consideration, or the presence thereof but less than the shares' fair market value, does not give rise to donor's tax because the transfer was a result of a business reorganization and not for Interpublic to technically relinquish ownership of the shares. The use of the term fair market value in Section 100 presupposes a transfer of property between a knowledgeable, willing, and unpressured buyer and a knowledgeable, willing, and unpressured seller in an open market, where the transfer would result in the seller relinquishing his ownership over the property. Hence, if the consideration received or demanded by the seller is below the fair market value of the sold property, the deficit would be characterized as a gift subject to donor's tax under Section 100. However, this is not the case of the subject business reorganization. Under the reorganization, Interpublic , as sole shareholder of IPG Nederland , resolved not to compensate itself for the shares in Treyna it transferred to IPG Nederland . The transfer of shares in Treyna by Interpublic to IPG Nederland was treated as capital contribution by Interpublic to IPG Nederland based on the unilateral resolution issued and approved by Interpublic on May 19, 2008. Since Interpublic is the sole shareholder of IPG Nederland , it remains to be the sole owner of all assets of IPG Nederland including those shares in Treyna . Moreover, in Republic of the Philippines vs. David Rey Guzman and the Register of Deeds of Bulacan, Meycauayan Branch, G.R. No. 132964, February 18, 2000 , the Supreme Court held that for a donation to be valid, the following three requisites are necessary: (1) reduction in the property of the donor, (2) increase in the property of the donee, and (3) intent on the part of the donor to do an act of liberality (donative intent). In the case of the subject business reorganization, the transfer by Interpublic of its shares in Treyna to IPG Nederland was carried out for purely business reasons and not motivated by any donative intent on the part of Interpublic . EHaASD In light of recent developments introduced under Republic Act No. 10963 , otherwise known as the Tax Reform for Acceleration and Inclusion (hereinafter referred to as the TRAIN Law ), which took effect on January 1, 2018 , Section 100 was amended to exempt from the imposition of donor's tax the transfer of property for less than adequate and full consideration, where such transfer is a bona fide transfer, at arm's length, and free from any donative intent , thus: " 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: Provided, however, That a sale, exchange, or other transfer of property made in the ordinary course of business (a transaction which is a bona fide, at arm's length, and free from any donative intent), will be considered as made for an adequate and full consideration in money or money's worth ." (Underscoring supplied) C. Documentary stamp tax Finally, under Section 175 of the Tax Code, the transfer of shares in Treyna is subject to documentary stamp tax equivalent to P0.75 on every P200.00, or fractional part thereof, of the par value of the shares, to wit: IDTSEH " 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." Beginning January 1, 2018, the documentary stamp tax imposed on transfer of shares or certificate of stock shall now be P1.50 on every P200.00, or fractional part thereof, of the par value of the shares, pursuant to Section 52 of the TRAIN Law. Section 175 of the Tax Code now reads 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 One peso and fifty centavos (P1.50) on each Two hundred pesos (P200), or fractional part thereof, of the par value of such 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. Real property interest = Real property Total assets Real property consists of property and equipment (P __________ ); rental deposit as non-current asset (P __________ ); and prepaid rent as current asset (P __________ ). 2. Entitled Determination of Whether the Assets of a Corporation Consist Principally of Real Property Interest under the Philippine Tax Treaties.