ITAD BIR Ruling No. 045-12

February 10, 2012 ITAD BIR RULING NO. 045-12 Article 10, Philippines-Japan tax treaty, as amended; BIR Ruling No. ITAD 59-10; BIR Ruling No. ITAD 51-10; BIR Ruling No. ITAD 37-10 SGV & Co. 6760 Ayala Avenue Makati City Attention: Atty. Carolina A. Racelis Principal, Tax Services Gentlemen : This refers to your tax treaty relief application filed on August 18, 2011, requesting confirmation that dividends paid to Metal One Corporation ("Metal One") by MM Steel Service Center Corporation ("MM Steel") are subject to a preferential tax rate of 10 percent 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 by a Protocol 1 effective January 1, 2009. It is represented that Metal One is a foreign corporation organized and existing under the laws of Japan and is a resident of Japan based on the Certificate issued by Shiba Tax Office on July 15, 2011; that Metal One is situated at 23-1, Shiba 3-chome, Minato-ku, Tokyo, Japan; that Metal One is licensed to engage in business in the Philippines since January 7, 2004, under Securities and Exchange Commission (SEC) No. A200300108 and, to date, Metal One has not filed a petition to withdraw or cancel such license, based on the Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission ("SEC") on December 28, 2011; and that, on the other hand, MM Steel is a domestic corporation registered with Philippine Economic Zone Authority (PEZA) as Ecozone Export Enterprise under Certificate of Registration No. 09-48 and is situated at People's Technology Complex, Special Economic Zone, Barangay Cabilang Baybay, Carmona, Cavite, Philippines. It is further represented, that on May 30, 2011, the Board of Directors of MM Steel, at its meeting, declared cash dividends amounting to US$502,800.00 in favor of the stockholders of record of MM Steel as of December 11, 2010, to be paid on August 31, 2011; that Metal One is the legal and beneficial owner of 345,148 Class A shares and 1,022,935 Class B constituting 40 percent of the entire stockholdings of MM Steel, which were acquired on September 3, 2010. TcHCIS It is further represented based on the Certification issued by the General Manager of Metal One Corporation-Manila Branch (Metal One Branch Office), being the branch office in the Philippines of Metal One and situated at the 14th Floor, L.V. Locsin Building, 6752 Ayala Avenue corner Makati Avenue, Makati City, Philippines, that Metal One Branch Office has no investments nor owns shares of stock in MM Steel; that Metal One Branch Office does not use or hold for use in the conduct of its trade or business any shares of stock of MM Steel; that the head office of Metal One in Japan acquired such shares in MM Steel directly and without the participation of Metal One Branch Office; that, consequently, all gains that arise from these shares inure to the sole benefit of Metal One and that Metal One Branch Office did not receive any such gains; and that Metal One Branch Office is not a material factor in the realization of such gains received by Metal One. It is finally represented that the dividends subject of this ruling are not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Certification issued by the President and CEO of MM Steel on June 9, 2011. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code"), as amended, provides that dividends paid to Metal One, being a foreign corporation not engaged in trade or business in the Philippines, are subject to income tax at the rate of 30 percent, thus: "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 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): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). TCAHES xxx xxx xxx" However, Section 32 (B) (5) of the Code provides that such dividends may be exempt from income tax or subject to a reduced rate to the extent required by any treaty obligation on the Philippines, thus: "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" With respect to a tax treaty, you invoke the Philippines-Japan tax treaty, as amended. Paragraphs 1, 2, and 3, Article 10 thereof provide: "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 percent of the gross amount of the dividends if the beneficial owner is a company which holds directly at least 10 percent 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; cACEHI b) 15 percent 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. 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 percent of the gross amount of the dividends. xxx xxx xxx" Based on the aforequoted provisions, dividends arising in the Philippines paid to a resident of Japan may be taxed in the Philippines at a rate not to exceed: (a) beginning, January 1, 2009, 10 percent of the gross amount of dividends if the company recipient of the dividends holds directly at least 10 percent of the voting shares or the total shares of the company paying the dividends during the period of six months immediately preceding the date of payment of the dividends; (b) 10 percent of the gross amount of the dividends if the domestic company paying the dividends is registered with the Board of Investments and engaged in preferred areas of activities under the investment incentives laws of the Philippines; and (c) 15 percent of the gross amount of the dividends in all other cases. Accordingly, considering that Metal One holds directly at least 10 percent of the total shares of stock of MM Steel during the period of six months immediately preceding the date of payment of the dividends which is not later than August 31, 2011, such dividends paid by MM Steel to Metal One are subject to income tax at the reduced rate of 10 percent of the gross amount thereof, pursuant to paragraph 2 (a), Article 10 of the Philippines-Japan tax treaty, as amended. (BIR Ruling No. ITAD 59-10 dated November 3, 2010; BIR Ruling No. ITAD 51-10 dated October 13, 2010; BIR Ruling No. ITAD 37-10 dated September 16, 2010) 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 Metal One has in the Philippines. Under paragraph 2 (b),Article 5 of the tax treaty, Metal One Branch Office, being the branch office in the Philippines of Metal One, is considered a permanent establishment thereof, 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. IDaCcS 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." According to the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (Condensed Version, July 17, 2008), such dividends are effectively connected with the permanent establishment 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 (paragraph 5 of Article 10 of the Philippines-Japan tax treaty) 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)." (Emphasis added) (Pages 156-157) acHETI Similarly, according to 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." (Emphasis added) Accordingly, the holdings in respect of the dividends paid by MM Steel to Metal One are not effectively connected with Metal One Branch Office since they are not paid in respect of holdings forming part of the assets of Metal One Branch Office or otherwise effectively connected therewith, and since the business activities that give rise to such dividends are not conducted through Metal One Branch Office. This is because Metal One Branch Office has no investments nor owns shares of stock of MM Steel; does not use or hold for use in the conduct of its trade or business any shares of stock of MM Steel; the head office of Metal One in Japan acquired such shares in MM Steel directly and without the participation of Metal One Branch Office; dividends arise from these shares inure to the sole benefit of Metal One Branch Office and Metal One Branch Office did not receive any of these dividends; and Metal One Branch Office is not a material factor in the realization of dividends received by Metal One. Thus, to reiterate, such dividends paid by MM Steel to Metal One are subject to income tax at the rate of 10 percent of the gross amount thereof, pursuant to paragraph 2 (a), Article 10 of the Philippines-Japan tax treaty, as amended. (BIR Ruling No. ITAD 59-10 dated November 3, 2010; BIR Ruling No. ITAD 51-10 dated October 13, 2010; BIR Ruling No. ITAD 37-10 dated September 16, 2010) ADaSET 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 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.