ITAD BIR Ruling No. 058-11

February 22, 2011 ITAD BIR RULING NO. 058-11 Article 10 (2) (a), Philippines-Japan tax treaty, as amended; BIR Ruling No. 007-10; BIR Ruling No. ITAD-069-10; BIR Ruling No. ITAD-057-10; BIR Ruling No. ITAD-051-10 Agan & Montenegro Law Offices Unit J-3, 7th Floor, Electra House Building 115-117 Esteban Street Legaspi Village, Makati City Attention: J. Carlito M. Montenegro Gentlemen : This refers to your letter dated March 25, 2010, on behalf of Isuzu Philippines Corporation (hereinafter referred to as "IPC"), requesting confirmation that cash dividends paid by IPC to Mitsubishi Corporation (hereinafter referred to as "Mitsubishi" ) are subject to the preferential tax rate of 10 percent based on Article 10 (2) (a) of 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 (hereinafter referred to as the "Philippines-Japan tax treaty" ), as amended by a Protocol 1 effective January 1, 2009. HIESTA It is represented that Mitsubishi is a foreign corporation organized and existing under the laws of Japan, with head office address at 3-1, Marunouchi 2-chome, Chiyoda-Ku, Tokyo, Japan, per Certificate dated November 10, 2009 issued by the Tokyo Legal Affairs Bureau in Japan; that Mitsubishi is licensed to do business in the Philippines since March 20, 1967, as shown in the Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission on May 12, 2010; and that, on the other hand, IPC is a domestic corporation, with office address located at 114 Technology Avenue, Laguna Technopark, Bian, Laguna, Philippines. It is further represented that the Board of Directors of IPC, at its meeting on March 26, 2009, approved a resolution declaring cash dividends of PHP100,000,000.00 in favor of IPC's stockholders of record as of December 31, 2008, payable immediately, based on the Certificate issued by the Assistant Corporate Secretary of IPC on March 23, 2010; and that since 1996 and at present, Mitsubishi is the legal and beneficial owner of 350,000 voting stocks of IPC (all fully paid), equivalent to 35 percent of the total outstanding capital stock of IPC. It is further represented that the branch office of Mitsubishi in the Philippines (hereinafter referred to as "Mitsubishi Manila Branch" ) 2 has no investments nor owns shares of stock in IPC, based on the Affidavit issued by the Treasurer of Mitsubishi Manila Branch on May 17, 2010; that Mitsubishi Manila Branch does not use or hold for use in the conduct of its trade or business any shares of stock in IPC; that such shares were acquired directly by the head office of Mitsubishi in Japan without the participation of Mitsubishi Manila Branch ; that, consequently, all gains that arise from these shares inure to the sole benefit of the head office and that these gains are not received by Mitsubishi Manila Branch ; and that Mitsubishi Manila Branch is not a material factor in the realization of such gains received by the head office. It is finally represented that the dividend payment subject of the request for ruling application is not subject of investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Certificate dated August 17, 2010 issued by the Assistant Corporate Secretary of IPC. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code of 1997 (hereinafter referred to as "Tax Code of 1997"), as amended, provides that such dividends received by Mitsubishi are taxable as follows: "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 . . . dividends, rents, royalties . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, Section 32 (B) (5) of the Tax Code of 1997, as amended, provides that the dividends may be exempt or partially exempt (if subject to a reduced rate only) to the extent required by any treaty obligation binding upon the Philippine Government, 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" In relation thereto, you invoke Article 10 of the Philippines-Japan tax treaty, as amended, to wit: "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 10 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; cDIaAS b) 15 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. xxx xxx xxx 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 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." Under paragraphs 2 and 3, Article 10 of the Philippines-Japan tax treaty, as amended, 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, beginning January 1, 2009, (a) 10 percent of the gross amount of the dividends if the beneficial owner is a company which holds directly at least 10 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 domestic company registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines; and (c) 15 percent of the gross amount of the dividends in all other cases. Accordingly, inasmuch as Mitsubishi holds directly 35 percent of the outstanding capital stock of IPC (which in fact exceeds the minimum percentage of holding of 10 percent), and since Mitsubishi maintains this holding since 1996 to present, and, in effect, during the period of six months immediately preceding the date of payment of the dividends, such dividends paid by IPC to Mitsubishi 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. (BIR Ruling No. ITAD 59-10 dated November 3, 2010; BIR Ruling No. ITAD 57-10 dated October 22, 2010) However, under paragraph 5, Article 10 of the Philippines-Japan tax treaty, as amended, the reduced rates on dividends under paragraphs 2 and 3 of Article 10 will not apply to such dividends paid to Mitsubishi if they are effectively connected with a permanent establishment which Mitsubishi has in the Philippines. Under paragraph 2 (b), Article 5 of the tax treaty, Mitsubishi Manila Branch , being a branch office of Mitsubishi in the Philippines, is considered a permanent establishment of Mitsubishi in the Philippines, 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. EIDaAH 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." 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 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 added) (Pages 156-157) Similarly, based on the Supreme Court ruling in Marubeni Corporation vs. Commissioner of Internal Revenue and the Court of Tax Appeals (G.R. No. 76573 dated September 14, 1989), dividends paid to the head office of a foreign corporation which has a branch office in the Philippines are effectively connected to the branch office if the business transactions that give rise to the dividends are conducted through the branch office, 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." Applying the OECD commentaries and the Supreme Court ruling, such dividends paid by IPC to Mitsubishi cannot be considered as effectively connected with Mitsubishi Manila Branch since, as represented, Mitsubishi Manila Branch has no investments nor owns shares of stock in IPC; Mitsubishi Manila Branch does not use or hold for use in the conduct of its trade or business any shares of stock in IPC; and those shares in IPC were acquired directly by the head office of Mitsubishi in Japan without the participation of Mitsubishi Manila Branch . Consequently, all gains (dividends) that arise from these shares inure to the sole benefit of the head office and are not received by Mitsubishi Manila Branch , and Mitsubishi Branch Office is not a material factor in the realization of such gains (dividends) received by the head office. This being the case, we reiterate that such dividends paid by IPC to Mitsubishi 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. (BIR Ruling No. ITAD 51-10 dated October 13, 2010) 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. aDSIHc 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. 2. Situated at the 14th Floor, L.V. Locsin Building, 6752 Ayala Avenue corner Makati Avenue, Makati City, Philippines.