Mark Dennis Y.C. Joven

June 22, 2020 ITAD BIR RULING NO. 046-20 Section 32 (B) (7) (a) of the National Internal Revenue Code of 1997, as amended and Articles 11 (Interest) and 22 (Other Income) of the Philippines-France tax treaty, as amended Mark Dennis Y.C. Joven Undersecretary International Finance Group Department of Finance Roxas Boulevard corner Pablo Ocampo Sr. Street 1004 Manila Dear Undersecretary Joven : This refers to your letter dated June 11, 2020 requesting confirmation that interest income payments, including but not limited to regular interest, late payment interest, default interest and commitment fees, to be made by the Government of the Philippines (GPH) to Agence Franaise de Dveloppement ("AFD") are exempt from income tax in the Philippines and consequently, from withholding taxes. FACTS AFD is a French public entity governed by French law, with registered office at 5, Rue Roland Barthes, 75598 Paris Cedex 12, France. It is registered with the Trade and Companies Register of Paris under 775 665 599. Based on its Articles of Association, AFD is a public industrial and commercial State institution in France whose mission is to carry out financial transactions of any type with a view to (a) contributing to the implementation of the state's foreign development; (b) contributing to the development of the French overseas departments and collectivities including New Caledonia. For this purpose, it shall finance development operations, respecting the environment, and it may perform other activities and services related to its mission. AFD's endowment is EUR_______________, which may be increased by allocation of public funds in accordance with the applicable statutes and regulations in France. Currently, its Board of Directors is made up of seventeen members: six representatives of the State, five qualified individuals appointed for their knowledge of economic and financial problems, or of ecology and sustainable development, four parliamentarians, and two members elected by the staff. A Government Commissioner also holds a seat on the Board. 1 On June 9, 2020, the GPH, through the Department of Finance ("DOF"), represented by its Secretary, and AFD, represented by its Country Director, entered into two (2) Credit Facility Agreements for the provision of a loan amounting to EUR_______________ (the first credit facility) and EUR_______________ (the second credit facility), respectively, or a total of EUR_______________. DcHSEa The first credit facility will be used by the GPH to accelerate infrastructure investment by increasing private participation through strengthened government financial support for public-private partnerships ("PPPs"); (b) expanded and efficiently implemented pipeline of PPP projects, and (c) strengthened legal and regulatory framework for PPPs. On the other hand, the second credit facility will be used by the GPH to implement a Program aimed to contribute to the inclusive growth and sustainable development of the Philippines, by supporting the development of financial inclusion. The Program more specifically aims to consolidate the institutional and regulatory environment, improve financial infrastructures and build the capacity of financial services providers, the supervisors and the regulator. Both credit facilities will be made available in a single drawdown for the maximum amount of EUR_______________ and EUR_______________, respectively. In consideration, the GPH will pay the following to AFD: 1. a regular interest , which may either be based on the selected floating interest rate or a fixed interest rate as specified in the drawdown request; 2. a default interest on overdue payments computed at the interest rate applicable to the current interest period; 3. late payment interest of two percent (2.0%) in addition to the default interest; 4. a commitment fee of zero point fifteen percent (0.15%) per annum computed based on the amount of the available credit prorated for the actual number of days elapsed and increased by the amount of the drawdown to be made available by AFD in accordance with a pending drawdown request; and 5. an appraisal fee of zero point twenty-five percent (0.25%) based on the maximum amount of the facility. The floating interest rate is equal to the applicable six-month Euro Interbank Offered Rate (EURIBOR) plus a margin of zero point forty-three percent (0.43%) per annum. The fixed interest rate is equal to the fixed reference rate of zero point fifty-two percent (0.52%) per annum increased or decreased by fluctuation of daily index rates from the signing date of the Agreement to the relevant rate setting date. The credit facilities shall be paid in twenty-eight (28) semi-annual installments starting September 30, 2026, after the lapse of the grace period of 72 months from the signing date of the Agreement, until March 31, 2040. RULING In reply, please be informed that under Section 32 (B) (7) (a) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, income derived from investments in the Philippines in loans, stocks, bonds or other domestic securities, or from interest on deposits in banks in the Philippines by (i) foreign governments, (ii) financing institutions owned, controlled, or enjoying refinancing from foreign governments, and (iii) international or regional financial institutions established by foreign governments, are not included from the taxpayer's gross income and are exempt from income tax, 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: SCaITA xxx xxx xxx (7) Miscellaneous Items. (a) Income Derived by Foreign Government. Income derived from investments in the Philippines in loans, stocks, bonds or other domestic securities, or from interest on deposits in banks in the Philippines by (i) foreign governments, (ii) financing institutions owned, controlled, or enjoying refinancing from foreign governments, and (iii) international or regional financial institutions established by foreign governments. xxx xxx xxx Considering that AFD is a financing institution owned and/or controlled by, or is enjoying refinancing from, the French government, income payments made to it by the GPH, including but not limited to regular interest, default interest, late payment interest, commitment fee, appraisal fee and other incidental income, are, therefore, exempt from income tax in the Philippines. The phrase income derived from investments in the Philippines in loans under the above provision includes not only the regular interest but all other types of income arising from the said investment. A similar exemption is likewise provided under the Convention between the Government of the Republic of the Philippines and the Government of the French Republic for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-France tax treaty") . 2 Paragraph 3 (a), Article 11 thereof provides: Article 11 INTEREST 1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. 2. However, such interest may be taxed in the Contracting State in which it arises, and according to the law of that State, but if the recipient is the beneficial owner of the interest, the tax so charged shall not exceed 15 per cent of the amount of the interest. 3. Notwithstanding the provisions of paragraph 2, a) Interest arising in a Contracting State and paid to a resident of the other Contracting State in respect of a bond, debenture or other similar obligation of the government of the first-mentioned Contracting State or a political subdivision or local authority thereof shall, provided that the interest is beneficially owned by a resident of the other Contracting State, be taxable only in that other Contracting State; xxx xxx xxx (Emphasis supplied) Under Article 11 (3) (a) of the Philippines-France tax treaty, interest arising in a Contracting State and paid to a resident of the other Contracting State in respect of a bond, debenture or other similar obligation of the government of the first-mentioned Contracting State (source State) or a political subdivision or local authority thereof shall be taxable only in the other Contracting State (residence State of the income recipient). This provision is an exception to the general rule that interest is subject to shared taxing rights between the source and residence states. Accordingly, since the interest arising in the Philippines is in respect of a loan obligation of the GPH and is paid to AFD, a resident of France by reason of its establishment therein as a public industrial and commercial State institution, interest payments made by the GPH to AFD are, therefore, exempt from income tax in the Philippines. The term interest as defined under Article 11 (4) of the treaty is, however, limited to the regular interest under the facility agreements, thus: aTHCSE 4. The term "interest" as used in this Article means income from debt claims of every kind, whether or not secured by mortgage, and whether or not carrying a right to participate in the debtor's profits, and in particular, income from government securities and income from bonds or debentures, including premiums and prizes attaching to bonds or debentures. Penalty charges for late payment shall not be regarded as interest for the purpose of this Article . (Emphasis supplied) Penalty charges for late payment are explicitly stated not to be "interest" for the purposes of the treaty. For the other types of income arising from the credit facilities such as the default interest, late payment interest, commitment fee, appraisal fee and other incidental income, paragraph 1 of Article 22 (Other Income) of the Philippines-France tax treaty shall govern: Article 22 OTHER INCOME 1. Items of income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that Contracting State. However, if such income is derived from sources within the other Contracting State, it may also be taxed in accordance with the law of that other State. Under this provision, other income of a resident of a contracting state not dealt with in other income articles of the Philippines-France tax treaty, irrespective of the source, shall be taxable only in the residence state. An exception is, however, provided under the second sentence which allows the taxation of such income based on the domestic law of the source state. Hence, the other types of income of AFD arising from the credit facilities extended to the GPH may likewise be subject to tax in the Philippines if its law so provides. Section 32 (B) (7) (a) of the Tax Code, the applicable provision in this case, however, exempts such other types of income from tax based on the previous discussion. In view of the foregoing, this Office is of the opinion and hereby holds that income payments made by the GPH to AFD under the Credit Facility Agreements, in the form of regular interest, default interest, late payment interest, commitment fee and appraisal fee and other incidental income, are exempt from income tax in the Philippines under Section 32 (B) (7) (a) of the Tax Code, paragraph 3 (a), Article 11 (Interest) and paragraph 1, Article 22 (Other Income) of the Philippines-France tax treaty, and consequently, from final withholding tax. This ruling shall apply to similar and subsequent credit facility or loan agreements to be entered into between GPH and AFD, provided that there are no material and substantial changes in the applicable Tax Code and treaty provisions, and provided further that AFD remains a public industrial and commercial State institution in France that is owned and/or controlled by, or is enjoying refinancing from, the French government. This ruling is issued on the basis of the foregoing facts as represented. However, if it shall be disclosed upon investigation that the actual facts are different, then this ruling shall be considered without force and effect insofar as the herein parties are concerned. IDSEAH Very truly yours, (SGD.) CAESAR R. DULAY Commissioner of Internal Revenue Footnotes 1. https://www.afd.fr/en/governance 2. As amended by a first protocol on June 26, 1995 and a second protocol on November 25, 2011.