ITAD BIR Ruling No. 039-17

November 9, 2017 ITAD BIR RULING NO. 039-17 Article 13 Philippines-Japan tax treaty, as amended ______________________________ ______________________________ ______________________________ ______________________________ ______________________________ Attention: ____________________ ____________________ Gentlemen : This refers to your tax treaty relief application filed on February 29, 2016 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 capital gains 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 cHECAS FACTS Corp1 is a foreign corporation organized and existing under the laws of Japan and a resident thereof based on its amended Articles of Association and Certificate of Residence issued by the __________ Tax Office in Japan. Corp1 is engaged in the development, manufacturing, sales, rental, import and export, and after-sales service to users of various weighing equipment, equipment for office and general use, wrapping and packing equipment, electric equipment for general use, electronic equipment, electronic calculator and its accompaniment, and specially-controlled medical devices, among others. 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. Corp3 is also a foreign corporation organized and existing under the laws of Singapore. Corp3 's line of business includes manufacturing scales and balances, except laboratory. 2 On the other hand, Corp2 is a domestic corporation organized and existing under the laws of the Philippines. It is engaged in the development, manufacturing and export of software programs of computers and other related electronic products and related services such as installation, modification and training. On December 29, 2015, Corp1 and Corp3 entered into a Deed of Assignment of Shares of Stock (" Deed ") where Corp1 transferred all its 640,000 common shares of stock in Corporation 2 (" Corp2 ") to Corp3 , each share with a par value of P1. Based on Corp2 's General Information Sheet as of December 15, 2015 and Corporate Secretary's Certificate and Audited Financial Statements as of December 31, 2014, those transferred shares represent 43.01% ownership in Corp2 . As consideration, Corp3 will issue 1,467 shares to Corp1 with a total par value of P1,641,115. As of December 31, 2014, the ratio of Corp2 real property over its total assets is 8.50%. As of that date, the fair market value (" FMV ") of all outstanding and subscribed Corp2 common shares is P12,227,913. The FMV of shares transferred to Corp3 is P5,259,225, which is greater than the consideration of P1,641,115 received by Corp1 for those shares. RULING A. Income tax In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997, as amended (" Tax Code "), capital gains derived by a foreign corporation not engaged in trade or business in the Philippines from the disposition of shares in a domestic corporation 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, paragraph 4, 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." 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. Relative thereto, under Section 2 (b) of Revenue Regulations No. 4-86, 3 the term consisting principally of immovable property means that the ratio of real property over the total assets (" real property interest ") of the corporation is more than 50% , to wit: cAaDHT " 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 real property interest as of December 31, 2014 is 8.50%, which is not more than 50%, its assets do not constitute principally of immovable property. As such, gains derived by Corp1 from the transfer of all its shares in Corp2 to Corp3 are exempt from capital gains tax pursuant to paragraph 4, Article 13 of the Philippines-Japan tax treaty. B. Donor's tax As mentioned above, the FMV of the transferred Corp2 shares is greater than the consideration for those shares. Under Section 100 of the Tax Code, as implemented by Section 7 (c.1.4) of Revenue Regulations No. 6-2008, 4 the excess between the higher FMV and the lower consideration 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." " SEC. 7. SALE, BARTER OR EXCHANGE OF SHARES OF STOCK NOT TRADED THROUGH A LOCAL STOCK EXCHANGE PURSUANT TO SEC. 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." Under Section 10 (B) of Revenue Regulations No. 2-2003, 5 the applicable rate on donation made between business organizations is 30%, where such transaction is considered donation made to a stranger, thus: " 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. 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: HCaDIS " 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. https://www.bloomberg.com/profiles/companies/7732888ZSP-Corp3 . 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.