Nakashima Philippines Corporation

August 3, 2020 ITAD BIR RULING NO. 060-20 Article 13 Philippines-Japan tax treaty, as amended Nakashima Philippines Corporation 2nd Street North Drive Cavite Economic Zone 4106 Rosario, Cavite Attention: AAA _______________ Gentlemen : This refers to your tax treaty relief application filed on January 31, 2019 requesting confirmation that capital gains derived by Nakashima Propeller Co., Ltd. ("NPCL") from the transfer of its shares of stock in Nakashima Philippines Corporation ("NPC") to Unilox Industrial Corporation ("UIC") are exempt from income tax 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) , as amended. 1 FACTS NPCL is a foreign corporation organized and existing under the laws of Japan and a resident thereof based on its Articles of Incorporation and Certificate of Residence issued by the Saidaiji Tax Office in Japan. NPCL develops, designs, manufactures, sells, mediates, repairs, maintains, licenses and provides consulting for marine equipment. It is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission. On the other hand, UIC is a domestic corporation organized and existing under the laws of the Philippines and operates in the nonferrous metal (except aluminum) production and processing industry. 2 NPC is also a domestic corporation engaged in the manufacture of marine propellers and parts, and copper and aluminum castings. Based on its Audited Financial Statements ("AFS") as of November 30, 2018, NPC is a wholly-owned subsidiary of NPCL and its ultimate parent is Nakashima Holdings Co., Ltd. of Japan. On April 2, 2019, NPCL and UIC entered into a Deed of Transfer of Shares where NPCL transferred its 110,000 shares in NPC to UIC for $ __________ . These shares amount to 10% ownership in NPC . Finally, based on the sworn statement issued by NPC , 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 proceeding, or judicial appeal. cDHAES RULING A. Income Tax In reply, please be informed that under Section 28 (B) (5) (c) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, capital gains derived by a foreign corporation not engaged in trade or business from the disposition of unlisted shares in a domestic corporation are subject to income tax at the rate of 5% to 10%, to wit: " Sec. 28. Rates of Income Tax on Foreign Corporations. xxx xxx xxx (B) Tax on Nonresident Foreign Corporation. (5) Tax on Certain Incomes Received by a Nonresident Foreign Corporation. xxx xxx xxx (c) Capital Gains from Sale of Shares of Stock not Traded in the Stock Exchange. A final tax at the rates prescribed below is hereby imposed upon the net capital gains realized during the taxable year from the sale, barter, exchange or other disposition of shares of stock in a domestic corporation, except shares sold, or disposed of through the stock exchange: Not over P100,000 3% On any amount in excess of P100,000 10%" However, under Section 32 (B) (5) of the Tax Code, such gains are exempt to the extent required by any treaty obligation binding upon the Philippine government, 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: 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." Relative thereto, paragraph 4, Article 13 of the Philippines-Japan tax treaty provides relief as follows: " Article 13 4. Gains from the alienation of shares of a company, a partnership or a trust the property of which consists principally of immovable property situated in a Contracting State, may be taxed in that Contracting State." Applying the foregoing provision in this case, capital gains derived by NPCL from the transfer of NPC shares to UIC may be taxed in the Philippines if the assets of NPC consist principally of immovable property situated in the Philippines. Whether or not the assets of NPC consist principally of immovable or real property, Section 2 (b) of Revenue Regulations No. 4-86 4 requires that the company's real property interest should be more than 50% of its entire assets in terms of value, thus: " Section 2. Definitions. For purposes of these regulations, the following terms and phrases shall be understood to mean xxx xxx xxx b) 'Principally,' 'wholly or principally,' 'directly or principally' or 'attributable' more than fifty percent of the entire assets in terms of value;" ASEcHI Based on NPC 's AFS as of November 30, 2018, its real property interest as of this date and prior to the transfer of its shares to UIC is 47.50%, as computed below: November 30, 2018 Building $____________ Machinery and Equipment ____________ Furniture and Fixtures ____________ Leasehold Improvements ____________ Construction In-progress ____________ Total Real Property ____________ Real Property Interest = ____________ (Total real property) ____________ (Total assets) = 47.50% Accordingly, since NPC 's real property interest as of the effectivity date of the transfer is 47.50% only and not more than 50%, capital gains derived by NPCL from the transfer of its 110,000 shares in NPC to UIC are exempt from income tax pursuant to paragraph 4, Article 13 of the Philippines-Japan tax treaty. B. Donor's Tax Under Section 100 of the Tax Code, as amended by Republic Act No. 10963, otherwise known as the Tax Reform for Acceleration and Inclusion Act (TRAIN), where property, other than real property subject to capital gains tax under Section 24 (D), is transferred for less than an adequate and full consideration in money or money's worth, the excess between the higher fair market value ("FMV") of the property and the lower consideration received by the transferor for the property is deemed a gift subject to donor's tax, except if the sale, exchange, or transfer of the property is made by the transferor in the ordinary course of his business, thus: " SEC. 100. Transfer for Less Than Adequate and Full Consideration. Where property, other than real property referred to in Section 24(D), is transferred for less than an adequate and full consideration in money or money's worth, then the amount by which the fair market value of the property exceeded the value of the consideration shall, for the purpose of the tax imposed by this Chapter, be deemed a gift, and shall be included in computing the amount of gifts made during the calendar year: Provided, however, That a sale, exchange, or other transfer of property made in the ordinary course of business (a transaction which is a bona fide, at arm's length, and free from any donative intent), will be considered as made for an adequate and full consideration in money or money's worth." Based on the foregoing provision, the sale, exchange or other transfer of property made in the ordinary course of business and is, thus, considered as made for an adequate and full consideration in money or money's worth, is exempt from donor's tax. A transaction is made in the ordinary course of business if (a) the transaction is bona fide , (b) the transaction is arm's length, and (c) the transaction is free from any donative intent. While the first and third conditions may easily be presumed, the second condition that the transaction is at arm's length needs a convincing proof. To show that a transaction was made at arm's length, a comparability analysis should be made that should NPCL offer to sell the 110,000 NPC shares to other independent and interested parties , the proposed consideration for the property would be equal to or almost equal to the amount of consideration offered by, and received from, UIC even if below the shares' fair market value. This provision has been clarified by the Bureau through the issuance of Revenue Memorandum Circular No. 30-2019, to wit: "Thus, starting January 1, 2018, when shares of stock not traded in stock exchange are sold for less than its fair market value, the excess of the fair market value over the selling price shall be treated as gift subject to donor's tax imposed by Section 100 of the 1997 NIRC, as amended, except when it is sold at arm's length, free from any donative intent (in the ordinary course of business). The determination of whether the sale of shares of stock not listed and traded is at arm's length is a question of fact and not of law. Since an arm's length transaction is a question of fact, it therefore behooves upon the party seeking to apply the exception to prove that indeed the sale involves no irregularity between unrelated and independent parties. This would require presentation and reception of reasonable evidence sufficient enough to convince that the sale of the shares of stock for less than its FMV without intent to evade tax and defraud the government (of the tax due therein). The evidence that should be presented should be viewed in accordance with its relation and relevance to the transaction on a case to case basis." ITAaHc In other words, the burden of proof rests upon NPCL to show, by way of comparative analysis, that the consideration received for the NPC shares is equal to or at least approximate to the amount of consideration had these shares been sold to other interested parties, even if below the shares' fair market value. In this case, the fair market value of the shares sold, as computed below: Total Equity USD__________ Percentage of shares sold 10% Fair market value of shares sold USD__________ ============= is less than the amount of consideration received by NPCL for the said shares. Considering that NPC failed to establish that the NPC shares were sold at arm's length, the excess ($ __________ ) of the fair market value ($ __________ ) over the consideration ($ __________ ) is, therefore, considered gift subject to donor's tax. C. Documentary Stamp Tax Finally, under Section 175 of the Tax Code, the transfer of shares in NPC is subject to documentary stamp tax equivalent to P1.50 on every P200.00, or fractional part thereof, of the par value of the shares, 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 One peso and fifty centavos (P1.50) on each Two hundred pesos (P200), or fractional part thereof, of the par value of such stock. . ." 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. 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, effective January 1, 2009. 2. https://www.emis.com/php/company-profile/PH/Unilox_Industrial_Corporation_en_1675192.html 3. Note from the Publisher: Copied verbatim from the official document. Missing Footnote Text and Footnote Reference. 4. Determination of Whether the Assets of a Corporation Consist Principally of Real Property Interest under the Philippine Tax Treaties.