Punongbayan and Araullo

July 7, 2021 ITAD BIR RULING NO. 034-21 Articles 5 and 7; Philippines-Japan tax treaty, as amended Punongbayan and Araullo 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue 1200 Makati City Attention: ___________________ Head, Tax Advisory and Compliance Gentlemen : This refers to your tax treaty relief applications that were filed on March 21 and November 4, 2014 requesting confirmation that substitution fees paid by Nickel Asia Corporation (NAC) to Sumitomo Metal Mining Company Ltd. (SMM) 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) , as amended. 1 FACTS SMM is a foreign corporation organized and existing under the laws of Japan and a resident thereof based on its Articles of Incorporation and Certificate of Residence issued by the Shiba Tax Office in Japan. It is engaged in mining and collection of gravel and sand, smelting and refining, metal processing, manufacturing electronic materials, and financing business. It is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission. On the other hand, NAC is a domestic corporation that is engaged in mining of nickel, production of ferronickel and nickel pig iron for the production of stainless steel, and renewable energy development. 2 On September 15, 2010, SMM and NAC entered into a Stockholders Agreement (SA) whereby the parties agreed to reorganize and operate Taganito HPAL Nickel Corporation (THPAL) and to make loans to or guarantee the repayment by THPAL of the loans obtained for the completion of the plant in proportion to their shareholding ratio. THPAL is a domestic corporation whose shares are partly owned by SMM (62.50%) and NAC (22.50%). When THPAL needed financial assistance to complete the plant, SMM and NAC agreed to provide additional funding. After the modification of the SA on November 20, 2012, SMM and THPAL entered into a new loan agreement on January 31, 2013 whereby SMM assumed the funding obligation of NAC to THPAL under the SA. To formalize the substitution, SMM and NAC entered into a Substitution Agreement of Loan/Guarantee for THPAL under the Stockholders Agreement (the first Substitution Agreement) on December 3, 2013. The effectivity of the first Substitution Agreement was, by its terms, made retroactive to January 31, 2013. ICHDca In order to raise the bank of its tailings dam located in its plant site, THPAL and SMM again entered into a new loan agreement on December 3, 2013, and SMM assumed once more the funding obligations of NAC to THPAL under the SA. SMM and NAC then entered into another Substitution Agreement of Loan/Guarantee for THPAL under the Stockholders Agreement (the second Substitution Agreement) on December 18, 2013 to set out their respective obligations. The effectivity of the second Substitution Agreement was made retroactive to December 3, 2013. Under the Substitution Agreements, SMM shall substitute for NAC to make loans to, or guarantee the repayment by, THPAL pursuant to the SA so long as the shareholding ratio of SMM in THPAL exceeds 50%. In consideration of the loans or guarantee made by SMM, NAC shall pay SMM every 21st day of March and September a substitution fee of one percent (1%) per annum based on the average of the unpaid principal balance of the loans or guarantee assumed by SMM in substitution for NAC. The first payment of substitution fees under the first and second Substitution Agreements were made on March 21, 2013 and September 21, 2014, respectively. The Substitution Agreements were both notarized in the Philippines on March 11, 2014. RULING In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997 (Tax Code), as amended, income derived by a nonresident foreign corporation is subject to income tax at the rate of 30%, thus: " 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, 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) and (d) above: n Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." However, under Section 32 (B) (5) of the Tax Code, such income is exempt to the extent required by any treaty obligation on the Philippine government, to wit: " 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." For this purpose, paragraph 1, Article 7 and paragraphs 1 and 2, Article 5 of the Philippines-Japan tax treaty provide as follows: " Article 7 1. The profits of an enterprise of a Contracting State shall be taxable only in that Contracting State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in that other Contracting State but only so much of them as is attributable to that permanent establishment." " 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. 2. The term 'permanent establishment' includes especially: a) a store or other sales outlet; TCAScE 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." Under Article 7, the profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as such, the profits may be taxed in the other State but only so much of them as are attributable to the permanent establishment. Under Article 5, the term permanent establishment means a fixed place of business through which the business of an enterprise is wholly or partly carried on, and includes especially, a store or other sales outlet, a branch, an office, a factory, and a workshop. The assignment by NAC to SMM of its obligation to make loans to, and guarantee for THPAL requires the latter to finance the completion and operation of THPAL's plant on behalf of the former. Pursuant to its Articles of Incorporation, SMM is allowed to engage in financing business; hence, any income derived therefrom is treated as business profit under the tax treaty. Since SMM is not engaged in trade or business, and does not have a branch, an office, or other fixed place of business in the Philippines, it is deemed not to have a permanent establishment under paragraphs 1 and 2, Article 5 of the Philippines-Japan tax treaty. Consequently, the substitution fees paid by NAC to SMM are exempt from income tax pursuant to paragraph 1, Article 7 of the tax treaty. However, the substitution fees are subject to VAT under Section 108 (A) of the Tax Code, which provides: " SEC. 108. Value-Added Tax on Sale of Services and Use or Lease of Properties . (A) Rate and Base of Tax . There shall be levied, assessed and collected, a value-added tax equivalent to ten percent (10%) of gross receipts derived from the sale or exchange of services, including the use or lease of properties selling price or gross value in money of the goods or properties sold, bartered or exchanged, such tax to be paid by the seller or transferor: Provided, that the President, upon the recommendation of the Secretary of Finance, shall, effective January 1, 2006, raise the rate of value-added tax to twelve percent (12%) . . . The phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration . . . " In this case, SMM assumed NAC's funding obligations to THPAL or accepted the substitution as the new creditor of THPAL in the Philippines as evidenced by the Substitution Agreements signed and notarized in the Philippines. Considering that the sale by SMM of its services to NAC, i.e. , the provision of loan to THPAL on behalf of NAC, was done in the Philippines, the substitution fees are, therefore, subject to VAT under Section 108 (A) of the Tax Code. cTDaEH 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. 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. https://nickelasia.com/about-us . n Note from the Publisher: Copied verbatim from the official document. The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.