Punongbayan and Araullo

March 28, 2018 ITAD BIR RULING NO. 057-18 Reservation to Article 14 (Capital Gains) Philippines- United States of America tax treaty Punongbayan and Araullo 19th and 20th Floors, Tower 1 The Enterprise Center 6766 Ayala Avenue 1200 Makati City Attention: AAA __________ Gentlemen : This refers to your tax treaty relief application filed on December 13, 2010 requesting confirmation that capital gains derived by Goodyear Tire and Rubber Company (" Goodyear ") from the redemption of its shares of stock in Goodyear Philippines, Inc. (" Goodyear Philippines ") are exempt from income tax pursuant to the Convention between the Government of the Republic of the Philippines and the Government of the United States of America with Respect to Taxes on Income (" Philippines-United States tax treaty "). TAcSaC FACTS Goodyear is a corporation organized and existing under the laws of the United States and a resident thereof based on its amended Articles of Incorporation and Certificate of Residence issued by the Internal Revenue Service of the United States. The primary objects of Goodyear are to produce, manufacture, purchase, import, acquire, own, process, operate, develop, use, sell, lease, exchange, export, dispose of, turn to account, and to generally deal in, and to render services in respect of rubber, rubber compounds, rubber substitutes, and similar substances to rubber, and articles produced from rubber. Goodyear is not registered as a corporation or partnership in the Philippines based on the Certificate of Non-Registration of Company issued by the Securities and Exchange Commission. On the other hand, Goodyear Philippines is a domestic corporation engaged in manufacturing tires until the closures of its manufacturing plant on September 30, 2009. Following closure, Goodyear Philippines continues to do business by importing and distributing tires. Based on Goodyear Philippines ' Audited Financial Statements as of December 31, 2009, and General Information Sheet as of November 26, 2010, and Corporate Secretary's Certificates dated March 9, 2011, February 2, 2011 and December 2, 2010, Goodyear Philippines ' immediate and ultimate parent company is Goodyear , which holds 13,318,630 preferred and 2,664,991 common shares of the company, each share with a par value of P_____, and accounting for 97.26% capital ownership of Goodyear Philippines . On November 19, 2010, the Board of Directors of Goodyear Philippines authorized the redemption of the company's 1,731,422 preferred shares held by Goodyear . The redemption, at a redemption price of P__________. Upon redemption, the redeemed shares will be reclassified as treasury shares until retired formally. Those shares were acquired by Goodyear by original subscription on May 27, 2010. The shares were not acquired as stock dividends because Goodyear Philippines has no retained earnings as of December 31, 2009 and 2008. As of December 31, 2009, the ratio of Goodyear Philippines ' real property over total assets is 7.20%. Based on a certification issued by Goodyear Philippines , the income subject of this ruling is not under 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, for tax treaty purposes, gains from the redemption of shares are characterized as dividends based on the following commentaries of the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (July 15, 2014), thus: "31. If shares are alienated by a shareholder in connection with the liquidation of the issuing company or the redemption of shares or reduction of paid-up capital of that company, the difference between the proceeds obtained by the shareholder and the par value of the shares may be treated in the State of which the company is a resident as a distribution of accumulated profits and not as a capital gain. The Article does not prevent the State of residence of the company from taxing such distributions at the rates provided for in Article 10: such taxation is permitted because such difference is covered by the definition of the term 'dividends' contained in paragraph 3 of Article 10 and interpreted in paragraph 28 of the Commentary relating thereto, to the extent that the domestic law of that State treats that difference as income from shares . . ." (Page 252) However, based on those commentaries, such characterization is permitted to the extent that the domestic law of the Contracting State taxing such gains that treats the gains as income from shares or dividends. Under Section 73 (b) of the National Internal Revenue Code of 1997, as amended (" Tax Code "), gains from redemption of shares are taxable dividends if those shares are originally stock dividends issued previously by the redeeming company, thus: LexLib " Sec. 73. Distribution of dividends or assets by corporations. (b) Stock dividends A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent it represents a distribution of earnings or profits accumulated after March first, nineteen hundred and thirteen. " (Emphasis ours) Otherwise, under Section 8 of Revenue Regulations No. 6-2008, 1 gains from redemption of shares are capital gains (or capital loss as the case may be) subject to regular income tax rate, thus: " SEC. 8. TAXATION OF SURRENDER OF SHARES BY THE INVESTOR UPON DISSOLUTION OF THE CORPORATION AND LIQUIDATION OF ASSETS AND LIABILITIES OF SAID CORPORATION. Upon surrender by the investor of the shares in exchange for cash and property distributed by the issuing corporation upon its dissolution and liquidation of all assets and liabilities, the investor shall recognize either capital gain or capital loss upon such surrender of shares computed by comparing the cash and fair market value of property received against the cost of the investment in shares. The difference between the sum of the cash and the fair market value of property received and the cost of the investment in shares shall represent the capital gain or capital loss from the investment, whichever is applicable. If the investor is an individual, the rule on holding period shall apply and the percentage of taxable capital gain or deductible capital loss shall depend on the number of months or years the shares are held by the investor. Section 39 of the Tax Code, as amended, shall herein apply in all possible situations. The capital gain or loss derived therefrom shall be subject to the regular income tax rates imposed under the Tax Code, as amended, on individual taxpayers or to the corporate income tax rate, in case of corporations." (Emphasis ours) This treatment as capital gains and not ordinary dividends is held by the Supreme Court in Commissioner of Internal Revenue v. Goodyear Philippines, Inc. , G.R. No. 216130 dated August 03, 2016 (" Goodyear case ") and Wise & Co., Inc., et al. v. Bibiano L. Meer, Collector of Internal Revenue , G.R. No. 48231 dated June 30, 1947 (" Wise case "), thus: Goodyear case: "In light of the foregoing, the Court therefore holds that the redemption price representing the amount of P97,732,314.00 received by GTRC could not be treated as accumulated dividends in arrears that could be subjected to 15% FWT . Verily, respondent's AFS covering the years 2003 to 2009 show that it did not have unrestricted retained earnings, and in fact, operated from a position of deficit. Thus, absent the availability of unrestricted retained earnings, the board of directors of respondent had no power to issue dividends . . . It is also worth mentioning that one of the primary features of an ordinary dividend is that the distribution should be in the nature of a recurring return on stock 46 which, however, does not obtain in this case. As aptly pointed out by the CTA En Banc, the amount of P97,732,314.00 received by GTRC did not represent a periodic distribution of dividend, but rather a payment by respondent for the redemption 47 of GTRC's 3,729,216 preferred shares . . . All told, the amount of P97,732,314.00 received by GTRC from respondent for the redemption of its 3,729,216 preferred shares were not accumulated dividends in arrears . Contrary to petitioner's claims, it is therefore not subject to 15% FWT on dividends in accordance with Section 28 (B) (5) (b) of the Tax Code." (Emphasis ours) Wise case: ". . . The distributions thus declared on July 22, 1937, and paid on August 4 and October 28, 1937, were from the surplus of the Hongkong Company resulting from the active conduct of its business and amounting to P74,182.12, which surplus was augmented to a total of P270,116.59 as a result of the sale of its business and assets to the Manila Company (ibid.) . . . It thus becomes more evident that those distributions were to be made in the course or as a result of the Hongkong Company's liquidation and that said liquidation was to be complete and final. And although the various resolutions above-mentioned speak of distributions of dividends when referring to those already alluded to, 'a distribution does not necessarily become a dividend by reason of the fact that it is called a dividend by the distributing corporation . (Holmes Federal Taxes, 6th edition, 774.) The ordinary connotation of liquidating dividend involves the distribution of assets by a corporation to its stockholders upon dissolution. (Klein, Federal Income Taxation, 253-254.) xxx xxx xxx The amounts thus distributed among the plaintiffs were not in the nature of a recurring return on stock in fact, they surrendered and relinquished their stock in return for said distributions, thus ceasing to be stockholders of the Hongkong Company, which in turn ceased to exist in its own right as a going concern during its more or less brief administration of the business as trustee for the Manila Company, and finally disappeared even as such trustee. " (Emphasis ours) aSIHcT In the case at hand, since the preferred shares subject of redemption were not acquired as stock dividends, capital gains arising therefrom are not ordinary dividends but capital gains . Under Item 1 of the United States Senate's Reservation to Article 14 (Capital Gains) of the Philippines-United States tax treaty, such gains may be taxed in the Philippines if the domestic corporation's assets consist principally of real property located in the Philippines, thus: " TEXT OF THE RESOLUTION OF RATIFICATION Resolved (two-thirds of the Senators present concurring therein), That the Senate advise and consent to the ratification of the Convention signed at Manila on October 1, 1976, between the Government of the United States of America and the Government of the Republic of the Philippines with Respect to Taxes on Income, and an Exchange of Notes done at Washington on November 24, 1976, subject to the following: (1) reservation that, notwithstanding the provisions of Article 14 relating to capital gains, both the United States and the Philippines may tax gain from the disposition of an interest in a corporation if its assets consist principally of a real property interest located in that country. Likewise, both countries may tax gain from the disposition of an interest in a partnership, trust or estate to the extent the gain is attributable to a real property interest in one of the countries. The term "real property interest" is to have the meaning it has under the law of the country in which the underlying real property is located;" Under Section 2 (b) of Revenue Regulations No. 4-86 (" RR 4-86 "), 2 the term consisting principally of real property as used in tax treaties means that the ratio of the domestic corporation's real property over its total assets is more than 50%, to wit: " SECTION 2. Definitions. For purposes of these regulations, the following terms and phrases shall be understood to mean b) 'Principally,' 'wholly or principally,' 'directly principally' or 'attributable' more than fifty percent of the entire assets in terms of value;" Accordingly, since the ratio of Goodyear Philippines ' real property over total assets prior to redemption is 7.20%, and not more than 50%, its assets do not constitute principally of immovable property under Section 2 (b) of RR 4-86. This being so, capital gains derived by Goodyear from the redemption of its preferred shares in Goodyear Philippines are exempt from income tax pursuant to the Reservation to Article 14 of the Philippines-United States tax treaty. Finally, on documentary stamp tax (" DST "), under Section 175 of the Tax Code, this tax is imposed on the delivery or transfer of shares or certificates of stock, 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." However, under Section 4 of Revenue Regulations No. 13-2004 (" RR 13-2004 "), 3 it clarifies that for a sale or exchange to be subject to DST, there must be an actual or constructive transfer of beneficial ownership over the shares from one person to another, thus: " SECTION 4. New Rate of DST on Sales, Agreements to Sell, Memoranda of Sales, and Subsequent Transfer of Shares of Stocks xxx xxx xxx All transfer of shares of stock of a domestic corporation are subject to the DST upon execution of the deed transferring ownership or rights thereto, or upon delivery, assignment or indorsement of such shares in favor of another. No transfer of shares of stock shall be recorded unless DST thereon has been duly paid for in accordance with section 201 of the Code. For a sale or exchange to be taxable, there must be an actual or constructive transfer of beneficial ownership of the shares of stock from one person to another. Such transfer may be manifested by the clear exercise of attributes of ownership over such stocks by the transferee, or by an actual entry of a change in the name appearing in the certificate of stock or in the Stock and Transfer Book of the issuing corporation or by any entry indicating transfer of beneficial ownership in any form of registry including those of a duly scripless registry, such as those maintained for or by the Philippine Stock Exchange. . ." In the case of redemption, there is no actual or constructive transfer of beneficial ownership. This is because, upon redemption, the preferred shares will be surrendered by Goodyear to Goodyear Philippines and the shares will not be assigned or transferred to another person. Instead, these shares will be reclassified as treasury shares until formally retired. This being so, the redemption of shares of Goodyear Philippines is exempt from DST under Section 4 of RR 13-2004. CSEHcT 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.) CAESAR R. DULAY Commissioner of Internal Revenue Footnotes 1. Consolidated Regulations Prescribing the Rules on the Taxation of Sale, Barter, Exchange or other Disposition of Shares of Stock Held as Capital Assets. 2. Determination of Whether the Assets of a Corporation Consist Principally of Real Property Interest under the Philippine Tax Treaties. 3. Implementing the Provisions of Republic Act No. 9243, An Act Rationalizing the Provisions on the Documentary Stamp Tax of the National Internal Revenue Code of 1997, as Amended, and for Other Purposes.