Isla Lipana & Co.

September 29, 2021 ITAD BIR RULING NO. 041-21 Article 13 of the Philippines-Japan Tax Treaty, as amended Isla Lipana & Co. 29th Floor, Philamlife Tower 8767 Paseo de Roxas 1226 Makati City Attention: ___________________ Partner, Tax Gentlemen : This refers to your tax treaty relief application that was filed on February 28, 2014 requesting confirmation that the capital gains derived by Mitsubishi Heavy Industries, Ltd. (MHI) from the transfer of its shares in MHI Technical Services Corporation (MTSC) to Mitsubishi Hitachi Power Systems, Ltd. (MHPS) 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 (PH-Japan Tax Treaty), as amended. 1 FACTS MHI 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 of Japan on December 6, 2013. MHPS is also a foreign corporation organized and existing under the laws of Japan based on its company registry. On the other hand, MTSC is a domestic corporation engaged in rendering specialty and technical services to foreign corporations. MHI is the immediate and ultimate parent of MTSC. Based on the records, MHI holds 1,000,000 common shares of MTSC, inclusive of sixty-nine (69) shares held by nominee shareholders (MTSC shares), or 100% of the latter's capital stock. The said shares have a par value of Php_______ per share or a total par value of Php______________, and were subscribed by MHI from December 9, 1992 to April 10, 2007. On July 31, 2013, MHI and MHPS entered into an Absorption-Type Company Split Agreement whereby MHI, the splitting company, transferred to MHPS, the succeeding or absorbing company, the following businesses (businesses subject to company split) operated by MHI: 1. thermal power generation system business; 2. geothermal power system business; 3. environmental equipment business (nitric oxide removal equipment, desulfurization equipment); 4. fuel cells business; 5. thermal power control system business; 6. electric power selling business (limited to electric power selling in connection to the gas turbine combined cycle power generation plant demonstration facilities at Takasago Machinery Works of MHI); 7. product development function incidental to the business described in item 6; and CAIHTE 8. engineering function incidental to the business described in items 1 to 6. As a result, MHPS succeeded to any and all rights and obligations or assets and liabilities that belong to MHI's businesses subject to company split. These assets consist of shares held by MHI in thirty-one (31) subsidiaries and affiliates worldwide including MTSC, among others. In exchange for the aforesaid assets and liabilities, MHPS issued 682 common shares (MHPS shares) to MHI. The Company Split Agreement took effect on February 1, 2014. Also, on the same date, MHI and MHPS entered into a Deed of Assignment of Shares to formalize the transfer of the MTSC shares. RULING Income tax The MTSC shares were transferred by MHI in exchange for the MHPS shares. Not being a cash transaction, Section 7 (c.1.3) of Revenue Regulations (RR) No. 6-2008 states that the consideration or selling price must be equivalent to the fair market value (FMV) of the property received or the MHPS shares. 2 Based on the Schedule of Assets and Liabilities (SAL) of MHPS as of February 1, 2014, the FMV of the MHPS shares and the resulting capital gains are computed as follows: Stockholders' Equity of MHPS as of February 1, 2014 (in JPY/) _____________ Divide by: Outstanding Shares 1,000 Fair market value (FMV) per share _____________ Multiply by: MHPS Shares issued to MHI 682 Total FMV of MHPS shares issued to MHI in exchange for the rights and obligations transferred to MHPS __________ Multiply by: Foreign exchange rate as of January 30, 2014 (1 = P.4418) FMV of shares issued to MHI in exchange for its rights and obligations transferred to MHPS P____________ Multiply by: Percentage of MTSC shares over the net assets transferred by MHI to MHPS* 0.0015792 FMV of MPHS shares received in exchange for the MTSC shares as of February 1, 2014 P_______________ FMV of MTSC shares based on its Balance Sheet as of January 31, 2014 (in PHP) P ______________ Divide by: Exchange rate as of January 31, 2014 0.4418 FMV of MTSC shares (in JPY) ______________ Divide by: Assets and liabilities (net assets) transferred by MHI to MHPS per SAL ______________ *Percentage of MTSC shares over the net assets transferred by MHI to MHPS 0.0015792 Fair market value of the MPHS shares P________ Less: Cost of the MTSC shares ______________ Net capital gains P______________ On the taxability of the aforesaid capital gains, Section 28 (B) (5) (c), in relation to Section 32 (A) (3) and (B) (5), of the National Internal Revenue Code of 1997 (Tax Code), as amended, provides that the net capital gains realized 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, are subject to capital gains tax (CGT), except when such income is exempt under any treaty obligation binding on the Government of the Philippines. The pertinent provisions are quoted hereunder: SEC. 28. Rates of Income Tax on Foreign Corporations . xxx xxx xxx (B) Tax on Nonresident Foreign Corporation. xxx xxx xxx (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% 3 xxx xxx xxx SEC. 32. Gross Income . (A) General Definition . Except when otherwise provided in this Title, gross income means all income derived from whatever source, including (but not limited to) the following items: HEITAD xxx xxx xxx (3) Gains derived from dealings in property; 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." MHI based its claim for tax exemption on Article 13 (4) of the PH-Japan Tax Treaty, which states: Article 13 xxx xxx xxx 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. xxx xxx xxx The above provision allows the Philippines to tax the gains derived by a resident of Japan from the disposition of its shares in a domestic corporation if the latter's assets consist principally of immovable property or real property interests situated in the Philippines. To determine whether the assets of the domestic corporation consist principally of immovable assets, reference may be made to Section 2 (b) of RR No. 4-86, which defines the term "principally" as more than fifty percent (50%) of the entire assets in terms of value, to wit: 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;" xxx xxx xxx As to the valuation of the assets, Section 4 thereof provides that the value of all the assets of the subject corporation both real and personal as appearing in its financial statement on the date of sale of the share or interest in such corporation, as verified by the BIR, shall be used as the basis for determining the composition of its assets. Based on MTSC's Balance Sheet as of January 31, 2014, the percentage of its real property interest over its total assets was only 29.84% , as computed below: Property and equipment and computer hardware, software and network P _____________ Divide by: Total assets ______________ Real property interest 29.84% Since MTSC's assets do not consist principally of immovable property, the gains realized by MHI from the sale of its shares in MTSC to MHPS shall only be taxable in Japan pursuant to Article 13 (4) of the PH-Japan Tax Treaty. Hence, said gains are exempt from Philippine income tax. ATICcS Donor's tax Under Section 100 of the Tax Code, where property (other than real property located in the Philippines and classified as capital assets) is transferred for less than an adequate and full consideration in money or money's worth, the amount by which the FMV of the property exceeded the value of the consideration shall be deemed a gift subject to the donor's tax imposed under Section 99 of the Tax Code, to wit: 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. 4 Section 99. Rates of Tax Payable by Donor . xxx xxx xxx (B) Tax Payable by Donor if Donee is a Stranger . When the donee or beneficiary is stranger, the tax payable by the donor shall be thirty percent (30%) of the net gifts. For the purpose of this tax, a 'stranger,' is a person who is not a: (1) Brother, sister (whether by whole or half-blood), spouse, ancestor and lineal descendant; or (2) Relative by consanguinity in the collateral line within the fourth degree of relationship. xxx xxx xxx The aforequoted provision was implemented by RR No. 2-2003, 5 particularly Section 10 (B) thereof, which states that donation made between business organizations shall be considered as donation made to a stranger and shall, therefore, be subject to 30% 6 donor's tax, 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. In regard to the computation of the FMV of the MTSC shares, Section 7 (c.2.2) of RR No. 6-2008 clarified that the FMV of shares not listed and traded in a local stock exchange stock is equivalent to the book value of such shares as shown in the issuing domestic corporation's audited financial statements nearest to the date of sale of such shares. The book value is computed by dividing the total stockholders' equity of the corporation or net assets by the number of its outstanding shares. 7 Based on this formula, the FMV of the common shares in MTSC, the amount of deemed gift and the corresponding donor's tax are computed below: Shareholders' Equity of MTSC based on its Audited Financial Statements as of January 31, 2014 _____________ Divide by: Outstanding shares _____________ FMV per share _____________ Multiply by: Alienated MTSC shares _____________ FMV of the MTSC shares as of January 31, 2014 _____________ Less: FMV of the MHPS shares received in exchange for the MTSC shares __________ Deemed gift __________ Multiply by: Donor's tax rate 30% Donor's tax due __________ MHI asserted that the transfer of the MTSC shares was made for a legitimate purpose with no intention to donate and should not be subjected to donor's tax. TIADCc This issue has long been settled in the case of The Philippine American Life and General Insurance Company vs. The Secretary of Finance and the Commissioner of Internal Revenue , 8 where the Supreme Court upheld the imposition of donor's tax even in the absence of donative intent on the part of the seller of the shares, to wit: The price difference is subject to donor's tax. Petitioner's substantive arguments are unavailing. The absence of donative intent, if that be the case, does not exempt the sales of stock transaction from donor's tax since Sec. 100 of the NIRC categorically states that the amount by which the fair market value of the property exceeded the value of the consideration shall be deemed a gift. Thus, even if there is no actual donation, the difference in price is considered a donation by fiction of law . (Emphasis ours) But even under the present provision of Section 100 of the Tax Code, as amended by Republic Act No. 10963, otherwise known as the Tax Reform for Acceleration and Inclusion (TRAIN Law), it is required that the transaction be at arm's length. This is a question of fact, and it behooves upon the party seeking to apply the exception to prove that indeed the sale involves no irregularity between unrelated and independent parties. 9 In this case, no proof has been submitted to show that the subject transaction was made under comparable condition and circumstances as a transaction with an independent party. Documentary stamp tax Finally, pursuant to Section 175 of the Tax Code, the transfer of the _______ shares in MTSC is subject to documentary stamp tax equivalent to Php0.75 for every Php200.00 (or a fraction thereof) of the par value of the shares, to wit: 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. 10 The total par value of the MTSC shares is P______________. Therefore, the documentary stamp tax due on the transaction is P______________. AIDSTE This ruling is issued on the basis of the facts as represented. However, if it will be disclosed upon investigation 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. The Consolidated Regulations Prescribing the Rules on the Taxation of Sale, Barter, Exchange, or other Disposition of Shares of Stock Held as Capital Assets. 3. Republic Act No. 11534, otherwise known as the Corporate Recovery and Tax Incentives for Enterprises Act or "CREATE," increased the capital gains tax to 15% effective January 1, 2021. 4. By virtue of Republic Act No. 10963, otherwise known as the Tax Reform for Acceleration and Inclusion (TRAIN Law), 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, free from any donative intent), will be considered as made for an adequate and full consideration in money or money's worth. 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, as amended by Revenue Regulations No. 12-2018. 6. Decreased to 6% upon the effectivity of the TRAIN Law. 7. Section 2 (v) of RR No. 6-2008. 8. G.R. No. 210987, November 24, 2014. 9. Revenue Memorandum Circular No. 30-2019. 10. Pursuant to the TRAIN Law, the documentary stamp tax was increased to One peso and fifty centavos (P1.50) per Two hundred pesos (P200) or fractional part thereof, of the par value of such stock, effective January 1, 2018.