ITAD BIR Ruling No. 051-10

October 13, 2010 ITAD BIR RULING NO. 051-10 Articles 5 and 10 Philippines-Japan tax treaty; BIR Ruling No. ITAD 9-09; BIR Ruling No. DA-ITAD 69-10 Rencor Management Consultancy 23 Sampaguita Street, Lakeview Muntinlupa City Attention: Ms. Corazon V. Abarca Management and Tax Consultant Gentlemen : This refers to your application for tax treaty relief dated October 14, 2009 involving the taxation of dividends to be paid by First Sumiden Realty, Inc. ("First Sumiden") to Sumitomo Electric Industries, Ltd. ("Sumitomo Electric") 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 HcaDIA Basic Facts It is represented that Sumitomo Electric is a foreign corporation organized and existing under the laws of Japan based on its Articles of Incorporation, as amended; that the primary purpose of Sumitomo Electric is to develop, manufacture, process, and sell electric wires and cables, optical fiber cables, products and equipment for electric power transmission and distribution and for communication, steel bars, wire rods, metal wires, alloy wires, composite metal and other metal products, hard alloy machine tools, machine parts, electrical contacts and other powder alloy products, among others; that Sumitomo Electric is situated at 4-5-33, Kitahama, Chuo-ku, Osaka, 541-0041, Japan, per Residence Certificate dated June 12, 2009 issued by the District Director of Higashi Tax Office in Japan; that based on the certification issued by the Securities and Exchange Commission ("SEC") dated November 26, 1999, the SEC duly approved the request of Sumitomo Electric to amend its purpose to allow it to enter into contracts for construction works and to engage in the design, supervision, procurement of materials, and management of construction projects, pursuant to a duly approved Board Resolution by Sumitomo Electric on July 18, 1999; that as mentioned in that Resolution, Sumitomo Electric has a branch office in the Philippines and is registered with the SEC under License No. A1998810992; that the original purpose of the branch office is to engage in the design, supervision, procurement of materials, and management of projects involving civil engineering, construction and formation of electrical systems, and construction of telecommunication systems; that based on the letter of Sumitomo Electric Industries, Ltd. Manila Branch Office ("Sumitomo Electric Philippine Branch") to the SEC dated January 13, 2009, Sumitomo Electric Philippine Branch requested the SEC to formally terminate its business and withdraw its license to transact business in the Philippines, pursuant to a duly approved Board Resolution by Sumitomo Electric on February 26, 2008; that the request was brought about by the completion by Sumitomo Electric Philippine Branch of its contractual obligation to the National Power Corporation to furnish and deliver transmission line materials and to construct the "Ilijan Cut in Point 500 KV Transmission Line" on a turn-key basis, where the latter had already issued the necessary Certificate of Final Acceptance to Sumitomo Electric Philippine Branch in July 2006; that Sumitomo Electric Philippine Branch is situated at the 5th Floor, King's Court I Building, 2129 Pasong Tamo Street, Makati City, Philippines; that, on the other hand, First Sumiden is a domestic corporation situated at Ampere Street corner Main Avenue, Light Industry and Science Park, Barrio Diezmo, Cabuyao, Laguna, Philippines; and that First Sumiden is registered with the Philippine Economic Zone Authority ("PEZA") as an "ecozone facilities enterprise" under Certificate of Registration No. 96-07 dated May 30, 1996. It is also represented based on the notarized certificate by the Assistant Corporate Secretary of First Sumiden , Mr. Esmeraldo C. Amistad, dated July 17, 2009, that: 1. In a special meeting by the Board of Directors of First Sumiden on March 5, 2008, the Board approved the declaration and payment of cash dividends to the stockholders on record of the Corporation as of December 31, 2007, amounting to US$960,000.00 (or its equivalent in Philippine pesos as of the date of payment of the dividends) and payable on or before March 14, 2008; and 2. As of the date of declaration and of payment of the dividends, and since April 12, 1996, Sumitomo Electric holds 139,998 common shares of stock of First Sumiden or equivalent to 40 percent, each share with a par value of PHP100.00. It is further represented based on the notarized certification by the Chief Representative of Sumitomo Electric Philippine Branch , Mr. Ryosuke Tsujimoto, dated July 5, 2010, that: 1. Sumitomo Electric Philippine Branch was not a material factor in the realization of such dividends paid by First Sumiden to Sumitomo Electric in Japan; that the dividends were not realized in the ordinary course of business of Sumitomo Electric Philippine Branch ; and that the subject shares in First Sumiden out of which the dividends were paid were not used, nor held for use, in the conduct of business of Sumitomo Electric Philippine Branch ; and 2. Although Sumitomo Electric has a branch office in the Philippines in the person of Sumitomo Electric Philippine Branch , the latter had no participation in the investments which were made directly by Sumitomo Electric in Japan and without using the funds of Sumitomo Electric Philippine Branch. It is finally represented based on the notarized certification by the President of First Sumiden , Mr. Danilo C. Lachica, dated July 17, 2009, that the dividends subject of the application for tax treaty relief are not subject of an investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal. Ruling In reply, please be informed that a foreign corporation like Sumitomo Electric , whether or not engaged in trade or business in the Philippines, is subject to income tax in the Philippines only with respect to income derived in the Philippines. Section 23 (F) of the National Internal Revenue Code of 1997 ("Tax Code of 1997") , as amended, provides: "SEC. 23. General Principles of Income Taxation in the Philippines. Except when otherwise provided in this Code: xxx xxx xxx (F) A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines." However, any income derived by a foreign corporation may be exempt (or partially exempt if subject to a reduced rate only) if the same is so exempt (or partially exempt) to the extent required by any treaty obligation binding upon the Philippine Government. Section 32 (B) (5) of the Tax Code of 1997, as amended, provides: aEDCSI "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: (5) Income Exempt under Treaty. Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines." With respect to a treaty, what is invoked for this purpose is the Philippines-Japan tax treaty . 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 per cent of the gross amount of the dividends if the beneficial owner is a company which holds directly at least 25 per cent 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) 25 per cent 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. xxx xxx xxx" Under paragraphs 2 and 3, Article 10 of the Philippines-Japan tax treaty, dividends arising in the Philippines and paid to a resident of Japan may be taxed in the Philippines, but the rate of income tax that may be imposed thereon 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 25 percent 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) 10 percent of the gross amount of the dividends if the dividends are 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; and (c) 25 percent in all other cases. Accordingly, inasmuch as Sumitomo Electric holds directly at least 25 percent of the total common shares of stock of First Sumiden during the period of six months immediately preceding the date of payment of the dividends declared by First Sumiden on March 5, 2008, and paid on or before March 14, 2008, such dividends shall be subject to income tax in the Philippines at the rate of 10 percent based on the gross amount thereof. However, since Sumitomo Electric has a permanent establishment in the Philippines in the person of Sumitomo Electric Philippine Branch , paragraph 6, Article 10 of the Philippines-Japan tax treaty provides that the reduced rates on dividends in paragraphs 2 and 3 of Article 10 will not apply to such dividends paid to Sumitomo Electric if they are effectively connected with Sumitomo Electric Philippine Branch , thus: "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." On the definition of a permanent establishment , paragraphs 1 and 2 of the Philippines-Japan tax treaty defines a permanent establishment as a fixed place of business through which the business of an enterprise is wholly or partly carried on, and includes, for example, a store or other sales outlet, a branch , an office, a factory, a workshop, and a warehouse, thus: TAIDHa "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. 3. A building site or construction or installation project constitutes a permanent establishment only if it lasts more than six months. xxx xxx xxx" On the question of dividends being effectively connected with a permanent establishment, the relevant commentaries of the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention on Income and on Capital (Condensed Version, July 17, 2008) mention: "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) A similar understanding is reached by 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) where the Court held that: "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." Following the above commentaries and jurisprudence, such dividends paid by First Sumiden to Sumitomo Electric in Japan are not effectively connected with Sumitomo Electric Philippine Branch since, based on the notarized certification by Sumitomo Electric Philippine Branch dated July 5, 2010: 1. Sumitomo Electric Philippine Branch was not a material factor in the realization of such dividends paid by First Sumiden to Sumitomo Electric in Japan; the dividends were not realized in the ordinary course of business of Sumitomo Electric Philippine Branch ; and the subject shares in First Sumiden out of which the dividends were paid were not used, nor held for use, in the conduct of business of Sumitomo Electric Philippine Branch ; and 2. Sumitomo Electric Philippine Branch had no participation in the investments which were made directly by Sumitomo Electric in Japan and without using the funds of Sumitomo Electric Philippine Branch. This being the case, we reiterate that the dividends to be paid by First Sumiden to Sumitomo Electric in Japan are subject to income tax at the rate of 10 percent based on the gross amount thereof. (BIR Ruling No. ITAD 9-09 dated April 1, 2009 and BIR Ruling No. DA-ITAD 69-10 dated April 1, 2009) 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. ETISAc Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Signed on February 13, 1980, and effective January 1, 1981.