ITAD BIR Ruling No. 032-10

August 27, 2010 ITAD BIR RULING NO. 032-10 Article 11, Philippines-Japan tax treaty, as amended; Section 179, NIRC of 1997, as amended MG Exeo Network, Inc. 7th Floor DPC Place 2322 Pasong Tamo Extension 1231 Makati City, Philippines Attention: Ms. Connie R. Pangilinan Manager, Finance and Administrative Department Gentlemen : This refers to your letter dated March 16, 2009 applying for relief from double taxation to avail of the 10 percent tax treaty rate on the interest payments of your peso denominated loan from Kyowa Exeo Corporation (hereinafter referred to as " Kyowa "), 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 (hereinafter referred to as the "Philippines-Japan tax treaty" ), as amended by Article IV of the Protocol Amending the Philippines-Japan tax treaty (hereinafter referred to as the "Protocol" ). DaEATc It is represented that Kyowa, with head office at 29-20, Shibuya 3-chome, Shibuya-ku, Tokyo, is a corporation duly organized and existing under the laws of Japan as evidenced by a duly authenticated notarized Certified Copy of the Corporate Register dated February 16, 2009; that it is not registered either as a corporation or as a partnership in the Philippines per Certification of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission dated January 23, 2009; that, on the other hand, MG Exeo Network, Inc. (hereinafter referred to as "MG Exeo" ) is a corporation duly organized and existing under and by virtue of the laws of the Philippines, with business address at 7th Floor DPC Place Bldg., 2322 Chino Roces Ave., Makati City; that as of January 31, 2009, Kyowa holds 262,495 shares in MG Exeo which is 35% of the total outstanding shares of the latter. It is further represented that on May 07, 2007, a Loan Agreement (hereinafter referred to as the "2007 Agreement" ) was executed by and between MG Exeo and Kyowa whereby the latter agrees to extend to the former a loan in an amount not exceeding ONE HUNDRED FIFTY MILLION PESOS (P150,000,000.00), the principal amount of the loan of which shall be available to MG Exeo anytime in May 2007, and for which MG Exeo agrees to pay Kyowa a fixed interest at the rate of 2% per annum upon maturity on the loan from the date of initial drawdown up to its maturity on May, 2008; that, moreover, the said loan was rolled over on May of 2008, hence on May 05, 2008, another Loan Agreement (hereinafter referred to as the "2008 Agreement" ) was executed by and between MG Exeo and Kyowa whereby the outstanding balance of ONE HUNDRED FORTY-TWO MILLION PESOS (P142,000,000.00) was made available to MG Exeo for roll over by May, 2008, and for which MG Exeo agrees to pay Kyowa a fixed interest at the rate of 2% per annum upon maturity on the loan from the date of initial drawdown up to its maturity on May, 2009; that the proceeds of both loans are to be used to finance the company's various projects with Globe Telecom, Digitel Mobile Phil., Inc. (as subcontractor to Ericsson Telecommunications, Inc. and Huawei Technology Philippines) and new projects with Innove Communications, Inc. and Eastern Telecommunication Philippines, Inc.; and that MG Exeo was served Letters of Authority for the years 2006 and 2007 for the examination of all internal revenue taxes, the books of accounts and other accounting records, but that there is neither any issue nor assessment on the subject of the herein request for ruling, per the sworn Affidavit executed by the Finance and Administrative Manager of MG Exeo dated March 6, 2009. In reply, please be informed that interest income derived by a nonresident foreign corporation is generally taxable under Section 28, paragraph B, sub-paragraphs 1 and 5 (a) of the National Internal Revenue Code of 1997 (NIRC of 1997), as amended. It provides: "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, . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." xxx xxx xxx (5) Tax on Certain Incomes Received by a Nonresident Foreign Corporation. (a) Interest on Foreign Loans. A final withholding tax at the rate of twenty percent (20%) is hereby imposed on the amount of interest on foreign loans contracted on or after August 1, 1986; aDECHI However, said interest income may be exempt or partially exempt pursuant to a treaty obligation to which the Philippine government is bound. Thus, Section 32 (B) (5) of the NIRC of 1997, as amended, provides, viz.: "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: 1 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." Accordingly, the Philippines-Japan tax treaty, which you have invoked, may apply to the interest payments of MG Exeo to Kyowa . Its Article 11 provides, viz.: "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. cCTaSH 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 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. HAaDcS xxx xxx xxx" Based on the above provisions, interest on foreign loans are generally taxable in the Philippines at the rate of 20 percent. However, interests derived by a corporation which is a resident of Japan may qualify for a preferential rate of 15 percent of the gross amount thereof, under the Philippines-Japan tax treaty, if the recipient of such interest is also the beneficial owner thereof. However, the 15 percent tax rate shall not apply if the Japanese corporation has a permanent establishment in the Philippines and the subject interest income is effectively connected to the said permanent establishment. In relation thereto, there is the Protocol amending the Philippines-Japan tax treaty (Protocol) which took effect on January 1, 2009 which Article IV provides, viz.: "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. xxx xxx xxx" Under the Protocol, the 10 percent and 15 percent preferential tax rates on interest were replaced by a single 10 percent rate. Accordingly, effective January 09, 2009, and for as long as the recipient of the interest is the beneficial owner thereof, the 10 percent preferential tax rate may be availed for all interests derived regardless of whether or not the interest is paid in respect of Government securities, or bonds or debentures. In view of all of the foregoing, and considering that Kyowa , as represented, has no permanent establishment in the Philippines to which the subject interests are effectively connected to, this Office is of the opinion and so holds that the interests derived by Kyowa from MG Exeo under the 2007 and 2008 Agreements are subject to the preferential tax rate of 15 percent of the gross amount of the interests; whereas, interests from the 2008 Agreement which will accrue and/or are payable after the effectivity of the Protocol on January 1, 2009, are subject tax at the preferential rate of 10 percent of the gross amount of the interests, pursuant to Article 11 (2) of the Philippines-Japan tax treaty, as amended. HSIDTE Moreover, the herein Loan Agreements entered into between Kyowa and MG Exeo are both subject to documentary stamp tax imposed under Section 179 of the Tax Code of 1997, as amended, at the rate of One Peso (P1.00) on each Two Hundred Pesos (P200) or fractional part thereof, of the issue price of any such loan agreement. 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 Footnotes 1. TITLE II TAX ON INCOME.