ITAD BIR Ruling No. 033-12

February 8, 2012 ITAD BIR RULING NO. 033-12 Article 10, Philippines-Japan tax treaty, as amended; BIR Ruling No. ITAD 7-10; BIR Ruling No. ITAD 8-10; BIR Ruling No. ITAD 11-10; BIR Ruling No. ITAD 35-10 Isla Lipana & Co. 29th Floor, Philamlife Tower 8767 Paseo de Roxas, Makati Attention: Malou P. Lim Partner Gentlemen : This refers to your Tax Treaty Relief Application filed on April 5, 2010, on behalf of your client, NTT DOCOMO INC. ("NTT"), requesting confirmation that dividends to be paid to NTT by PHILIPPINE LONG DISTANCE TELEPHONE COMPANY ("PLDT") are subject to the preferential tax rate of 10 percent pursuant to Article 10 (2) (a) of the amended 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, as amended"). It is represented that NTT, with office address at 2-11-1, Nagata-cho, Chiyoda-ku Tokyo, 100-6150, Japan, is a resident of Japan within the meaning of Article 4 of the Philippines-Japan tax treaty, as evidenced by the Certificate of Residence issued by the District Director of Koujimachi Tax Office dated March 16, 2010; that on May 31, 2006, NTT was granted a license by the Securities and Exchange Commission ("SEC") under SEC No. FS200608460 to establish a branch office in the Philippines per Certificate of Corporate Filing/Information dated May 12, 2010; that pursuant to said license, NTT established a branch office in the Philippines, hereinafter referred to as NTT-Phil. branch; and that, on the other hand, PLDT is a corporation organized and existing under and by virtue of the laws of the Philippines with office address at 9th Floor MGO Building, Legaspi corner Dela Rosa Streets, Makati City. It is further represented that, as certified by PLDT's Corporate Secretary on March 31, 2010 based on a certification issued by the Assistant Manager Stock Transfer Unit of HSBC Securities Services and certified further by the Vice President of the Securities and Funds Services of Citibank on March 25, 2010, NTT is the registered/beneficial owner of the following PLDT shares of common stock as of March 17, 2010: IAaCST Date of Issuance Number of shares Percentage of ownership April 3, 2006 12,633,486 6.763% April 29, 2008 5,601,335 2.999% February 12, 2008 8,533,253 4.57% Total 26,768,074 14.33% ========= ========= That at the meeting of the PLDT Board of Directors held on March 2, 2010, the following cash dividends were declared out of PLDT's unaudited unrestricted retained earnings as of December 31, 2009: a. Regular dividend of P76.00 per outstanding share of the PLDT's common stock payable on April 20, 2010 to the stockholders of record on March 17, 2010; b. Special dividend of P65.00 per outstanding share of PLDT's common stock, payable on April 20, 2010 to the stockholders of record on March 17, 2010. that NTT Philippine branch is not a material factor in the realization of dividends paid by PLDT to NTT, and such dividends are not realized in the ordinary course of trade or business of the branch office per the Sworn Statement of NTT-Phil. branch's General Manager dated April 27, 2010; and finally, that the dividends subject of the application for tax treaty relief are not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended, applies, in general, to dividends derived in the Philippines by a nonresident foreign corporation. It provides: "Section 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 . . ., dividends, . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, Section 32 (B) (5) of the Tax Code of 1997, as amended, provides: TcEAIH "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: 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. xxx xxx xxx" In this particular case, Article 10 of the Philippines-Japan tax treaty, as amended, which you invoked, may apply to the herein case. It provides: "Article 10 1. Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other Contracting State. 2. However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the dividends the tax so charged shall not exceed: (a) 10 per cent of the gross amount of the dividends if the beneficial owner is a company which holds directly at least 10 per cent either of the voting shares of the company paying the dividends or of the total shares issued by that company during the period of six months immediately preceding the date of payment of the dividends; (b) 15 per cent of the gross amount of the dividends in all other cases. The provisions of this paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid. EcaDCI 3. Notwithstanding the provisions of paragraph 2, the amount of tax imposed by the Philippines on the dividends 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 dividends, shall not exceed 10 per cent of the gross amount of the dividends. 4. The term 'dividends' as used in this Article means income from shares or other rights, not being debt-claims, participating in profits, as well as income from other corporate rights assimilated to income from shares by the taxation laws of the Contracting State of which the company making the distribution is a resident. 5. The provisions of paragraphs 1, 2 and 3 shall not apply if the beneficial owner of the dividends, being a resident of a Contracting State, carries on business in the other Contracting State of which the company paying the dividends is a resident, through a permanent establishment situated therein, or performs in that other Contracting State independent personal services from a fixed base situated therein, and the holding in respect of which the dividends are 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. . . ." It is provided under paragraph 2 (a), Article 10 of the Philippines-Japan tax treaty, as amended, that dividends paid by a Philippine corporation to a resident of Japan may be taxed at a rate not exceeding 10 percent of the gross amount of dividends if the recipient is a company which holds directly at least 10 percent of either of the voting shares of the company paying the dividends or of the total shares issued by that company during the period of six months immediately preceding the date of payment of the dividends. In all other cases, the 15 percent preferential tax rate shall apply. However, under paragraph 5 of Article 10, the Philippines, being the source of the dividends, is not obliged to limit the tax rates on dividends under paragraphs 2 and 3 of the article if the holding in respect of which the dividends are paid is effectively connected with a permanent establishment which NTT has in the Philippines. Under paragraph 2 (b), Article 5 of the tax treaty, NTT-Phil. branch, being the branch office in the Philippines of NTT, is considered a permanent establishment of NTT, thus: "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. DaTICc 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; f) a warehouse; g) a mine, an oil or gas well, a quarry or other place of extraction of natural resources." On the question of whether dividends are 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 22, 2010, P. 193) mention that such dividends are effectively connected if they are paid in respect of holdings forming part of the assets of the permanent establishment or otherwise effectively connected with that establishment, thus: "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 5 of Article 10 of the Philippines-Japan tax treaty) 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 dividends flowing 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 dividends are taxable as part of the profits of the permanent establishment there owned by the beneficiary which is a resident in the other State, if they are paid in respect of holdings forming part of the assets of the permanent establishment or otherwise effectively connected with that establishment. In that case, paragraph 4 relieves the State of source of the dividends from any limitations under the Article. The foregoing explanations accord with those in the Commentary on Article 7 (on Business Profits)." AEIHCS Similarly, following the Supreme Court in Marubeni Corporation vs. Commissioner of Internal Revenue and the Court of Tax Appeals (G.R. No. 76573 dated September 14, 1989), dividends derived by a foreign corporation can become effectively connected with its branch office in the Philippines if the business activities that give rise to such dividends are conducted through the branch office, following the principal-agent relationship theory, thus: "The general rule that a foreign corporation is the same juridical entity as its branch office in the Philippines cannot apply here. This rule is based on the premise that the business of the foreign corporation is conducted through its branch office, following the principal-agent relationship theory. It is understood the branch becomes its agent here. So that when the foreign corporation transacts business in the Philippines independently of its branch, the principal-agent relationship is set aside. The transaction becomes one of the foreign corporation, not the branch or the resident foreign corporation. Corollarily, if the business transaction is conducted through the branch office, the latter becomes the taxpayer, and not the foreign corporation." Accordingly, the holdings in respect of the dividends paid by PLDT to NTT are not effectively connected with NTT-Phil. branch since they are not paid in respect of holdings forming part of the assets of NTT-Phil. branch or otherwise effectively connected therewith, and since the business activities that give rise to such dividends are not conducted through NTT-Phil. branch. This is because NTT-Phil. branch has no investments nor owns shares of stock in PLDT; does not use or hold for use in the conduct of its trade or business any shares of stock in PLDT; the head office of NTT-Phil. branch in Japan acquired such shares in PLDT directly and without the participation of NTT-Phil. branch; dividends arise from these shares inure to the sole benefit of NTT and NTT-Phil. branch did not receive any of these dividends; and NTT-Phil. branch is not a material factor in the realization of dividends received by the NTT. In view of the foregoing, since NTT owns more than 10 percent common shares of stocks in PLDT, the paying corporation, during the period of six months immediately preceding the date of payment of the dividends, this Office is of the opinion and so holds that the cash dividends to be paid by PLDT to NTT are subject to the preferential tax rate of 10 percent tax pursuant to Article 10 (2) (a) of the Philippines-Japan tax treaty, as amended. (BIR Ruling No. ITAD-007-10 dated May 20, 2010; BIR Ruling No. ITAD-008-10 dated June 3, 2010; BIR Ruling No. ITAD 11-10 dated June 16, 2010; and, BIR Ruling No. ITAD 35-10 dated September 14, 2010) ADCEcI 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.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue