ITAD BIR Ruling No. 046-12

February 10, 2012 ITAD BIR RULING NO. 046-12 Article 10, Philippines-Japan tax treaty, as amended; BIR Ruling No. ITAD 204-11 JFE Shoji Trade Philippines, Inc. 17th Floor, 6788 Ayala Avenue Oledan Square Makati City 1229 Attention: Takeo Inoue President Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on June 7, 2011, requesting confirmation that the cash dividends paid to JFE Shoji Trade Corporation ("JFE-Japan") by JFE Shoji Trade Philippines, Inc. ("JSTP") are subject to final withholding tax at a rate of 10 percent preferential tax rate, pursuant to Article 10 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 JFE-Japan, with principal address at 1-6-20 Doujima, Kita-Ku, Osaka, Japan, is a resident of Japan per the Certificate of Residence issued by the District Director of KITA Tax Office on May 12, 2011; that it was licensed to establish a branch in the Philippines per Certificate issued by the Securities and Exchange Commission dated May 18, 2011; that pursuant to the grant of license, JFE-Japan put up a branch in the Philippines ("JFE-Phil branch"); and that, on the other hand, JSTP is a corporation organized and existing under the laws of the Philippines with principal address at 17/F 6788 Ayala Avenue, corner Oledan Square, Makati City 1226. It is further represented that on April 7, 2011, JSTP declared cash dividend to JFE-Japan amounting to P15,046,000.00, payable on June 30, 2011; that per the Corporate Secretary's Certificate issued on May 30, 2011 by JSTP, as of the date of record, JFE-Japan owns 211,835 shares with a par value of Php100.00 per share or an aggregate par value of Php21,183,500.00, constituting 99.997% of JSTP 's outstanding capital stock; that although JFE-Japan has a branch here in the Philippines, its investments or shares of stock in JSTP were directly acquired by JFE-Japan without the participation of its Philippine branch, based on the notarized Certification issued by JFE-Phil branch on September 2, 2011; and that the subject shares were acquired by JFE-Japan from JSTP through direct subscription and payment in cash on August 7, 1995 and December 14, 1999. CSHEca It is finally represented, per the Sworn Statement issued on June 16, 2011 issued by JSTP, that the issue or transaction subject of this request for ruling is not under investigation, on-going audit, administrative protest, claims 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 interest, 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%). . . ." However, Section 32 (B) (5) of the Tax Code of 1997, as amended, provides: "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: DTcHaA 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 relation thereto, Article 10 of the Philippines-Japan tax treaty, as amended, which you invoke, may apply to the instant 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 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; 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 per cent of the gross amount of the dividends. SaITHC 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." Based on the aforequoted provisions, the Philippines may tax the dividends paid by resident thereof to a company which is a resident of Japan at a rate not exceeding 10 percent if the latter company 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 6 months immediately preceding the date of payment of the dividends; otherwise, said dividends may be taxed at a rate not exceeding 15 percent of the gross amount in all other cases. 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 JFE-Japan has in the Philippines. Under paragraph 2 (b), Article 5 of the tax treaty, JFE-Phil branch, is considered a permanent establishment of JFE-Japan, 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. 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. . . ." (Emphasis ours) TEDaAc 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 (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 supplied) 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." (Emphasis supplied) ECAaTS Accordingly, the holdings in respect of the dividends paid by JSTP to JFE-Japan are not effectively connected with JFE-Phil branch since they are paid not in respect of holdings forming part of the assets of JFE-Phil branch or otherwise effectively connected therewith, and since the business activities that give rise to such dividends are not conducted through JFE-Phil branch. This is because JFE-Phil branch has neither investments nor owns shares of stock in JSTP; does not use or hold for use in the conduct of its trade or business any shares of stock in JSTP; JFE-Japan acquired such shares in JSTP directly and without the participation of JFE-Phil branch; and, dividends arising from these shares inure solely to the benefit of JFE-Japan and JFE-Phil branch did not receive any of these dividends. Hence, JFE-Phil branch is not a material factor in the realization of dividends received by the JFE-Japan. In view thereof and considering that JFE-Japan holds directly 99.997% of the outstanding capital stock JSTP or more than the required minimum shareholdings of 10 percent, for a period of 6 months immediately preceding the date of payment, said dividends paid by JSTP to JFE-Japan are subject to 10 percent preferential tax rate, pursuant to Article 10 (2) (a) of Philippines-Japan tax treaty, as amended. (BIR Ruling No. ITAD-204-11 dated August 3, 2011) This ruling is issued on the basis of the foregoing 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