Puyat Jacinto and Santos Law Office

April 3, 2018 ITAD BIR RULING NO. 061-18 Article 13 (Gains from the Alienation of Property) Philippines- Netherlands tax treaty Puyat Jacinto and Santos Law Office 12th Floor, VGP Center (formerly Manila Bank Building) 6772 Ayala Avenue 1226 Makati City Attention: AAA BBB CCC Gentlemen : This refers to your tax treaty relief application filed on September 5, 2012 requesting confirmation that gains from liquidating dividends derived by C-Cubed B.V. (" C-Cubed ") from the surrender of its shares of stock in Customer Contact Center (" Customer Contact ") are exempt from capital gains tax pursuant to the Convention between the Kingdom of the Netherlands and the Republic of the Philippines for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (" Philippines-Netherlands tax treaty "). FACTS C-Cubed is a foreign corporation organized and existing under the laws of the Netherlands and a resident thereof based on its Articles of Association and Declaration of Residence issued by the Tax and Customs Administration of the Netherlands. Its primary purpose is to administer, invest in, manage, acquire and dispose of shares in other companies, registered property of all kinds or capital assets, on its own behalf and others; to accept joint and several liabilities for third party debts; and to provide personal or collateral security for company debts as well as third party debts. C-Cubed is not registered as a corporation or partnership in the Philippines based on a Certification of Non-Registration of Company issued by the Securities and Exchange Commission. HTcADC Customer Contact is a domestic corporation organized and existing under the laws of the Philippines. Based on its Articles of Incorporation, General Information Sheet (" GIS ") for 2011 and Audited Financial Statements (" AFS ") as of March 31, 2011, Customer Contact 's primary purpose is to engage in customer contact services business (" call centers ") to satisfy relationship requirements of clients through various multimedia and personal access services. It also designs and develops information databases and provides consultancy, advisory, management and staffing services to its clients. In 2006, as a result of corporate restructuring, its primary purpose was changed to investing in call center ventures and in purchasing and leasing of real and personal properties. C-Cubed owns 9,999,995 common shares of stock Customer Contact with a par value of P_____ each or a total of P__________, which represents 99.99% of the capital stock of Customer Contact . The remaining five common shares amounting to P_____ are held by five nominee individuals. Based on Corporate Secretary's Certificate issued by Customer Contact , on August 13, 2012, the Board of Directors of Customer Contact approved a resolution authorizing the declaration and payment of liquidating dividends to C-Cubed and the nominee shareholders. The dividends will be paid as follows: 1. The amount consisting of all remaining assets of Customer Contact minus the amount of P__________ will be paid to the shareholders on November 30, 2012. The latter amount is the company's allowance its remaining contingent liabilities. 2. The whole amount of P__________ (or net of this amount after deducting any contingent claims) will be paid to the shareholders upon final resolution of any court of competent jurisdiction on such claims against Customer Contact , if any. Based on Customer Contact 's AFS interim financial statements as of November 30, 2012, it has net assets (assets minus liabilities) amounting P__________ consisting significantly of receivables from affiliates amounting __________. In terms of equity, which is equal to net assets, the company's share capital is P__________ and retained earnings of P__________. As additional information, based on Customer Contact 's AFS, on July 30, 2005, Hinduja TMT Ltd. (" HTMT ") of India completed its 100% acquisition of Customer Contact after it became the sole shareholder of C-Cubed thereby making the latter the immediate parent of Customer Contact , and HTMT the ultimate parent of Customer Contact . In September 2005, HTMT established a branch office in the Philippines (" HTMT Branch "). With the entry of the HTMT Branch, HTMT has interest in three different entities: HTMT Branch, Source One Communications Asia, Inc. (" SOCA ") and Customer Contact . HTMT has developed a restructuring plan to simplify its business structure in the Philippines under one brand and to provide a more direct income stream to HTMT . As part of the plan, the Board of Directors of Customer Contact approved the following initiatives: 1. Transfer Customer Contact 's call center business to HTMT Branch effective October 1, 2005; 2. Consolidate and realign the operations of HTMT Branch, Source One Communications Asia, Inc. (" SOCA ") and Customer Contact by entering into service and facilities agreement with HTMT Branch effective October 1, 2005 which was pre-terminated due to the sale of Customer Contact 's assets to HTMT Branch effective January 1, 2007; and 3. Approval of the articles and plan of merger between SOCA and Customer Contact , with the latter as the surviving corporation. On July 30, 2008, the Board of Directors of Customer Contact approved the dissolution of the company effective August 1, 2008. On March 18, 2010, the company received the tax clearance from the Bureau of Internal Revenue. The company is in the process of completing the necessary documents relating to its application for a certificate of dissolution with the Securities and Exchange Commission. Effective October 1, 2006, Hinduja Global Solutions Ltd. (" HGSL "), also of India, took over the business of HTMT following the latter's demerger. The entire business of HTMT Branch is transferred to HGSL Branch effective August 1, 2008. As of March 31, 2011 and 2010, Customer Contact has no regular employees and its administrative functions are handled by HTMT Branch . As of those dates, the company's operations focused mainly on administrative matters to effect the eventual dissolution of the company. RULING A. Income tax In reply, please be informed that liquidating dividends paid by Customer Contact to its shareholders consist of two parts: P__________ as return of capital and P__________ as gains from liquidating dividends. On the characterization of such gains for tax treaty purposes, the following commentaries of the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (July 15, 2014) mention: aScITE "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) Based on the commentaries, when shares are alienated by a shareholder in connection with the liquidation of the issuing company, or the redemption of its shares, or reduction of its paid-up capital, the difference between the proceeds obtained by the shareholder and the par value of the shares may be treated in the residence State of the company as a distribution of accumulated profits ( i.e. , dividends) and not as a capital gain to the extent that the domestic law of that State treats the difference as such. As dividends, the difference is subject to tax in that State at a reduced rate, while as capital gains, the difference is exempt under specific conditions. However, in the Philippines, such difference is not regarded as dividends but capital gains (or capital loss , as the case may be) subject to regular income tax rate as provided under Section 8 of Revenue Regulations No. 6-2008 , 1 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." (Underscoring ours) The same characterization is reached by the courts 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 "). In the Goodyear case, Goodyear Philippines, Inc. (" Goodyear Philippines ") redeemed its preferred shares issued to its parent in the United States, Goodyear Tire and Rubber Company (" Goodyear "). The court ruled that the redemption price paid by Goodyear Philippines to Goodyear , computed by deducting the aggregate par value of those shares from the consideration, were not ordinary dividends nor accumulated dividends in arrears , especially in the absence of any retained earnings on the part of Goodyear Philippines during the taxable years in question, to wit: "In light of the foregoing, the Court therefore holds that the redemption price representing the amount of P97,732,314.000 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 respondents 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 97,732,314.00 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 28 (B) (5) (b) of the Tax Code." (Emphasis ours) Moreover, in the Wise case, Wise and Company, Inc. (" Wise "), a domestic corporation, received liquidating dividends as a result of the dissolution of its subsidiary in Hong Kong, Manila Wine Merchants, Ltd. (" Manila Wine "). Manila Wine 's assets were sold to The Manila Wine Merchants, Inc. (" Manila Wine Philippines "), the newly formed domestic corporation which succeeded Manila Wine . The court ruled that those liquidating dividends were not ordinary dividends even if the parties notionally termed the distribution as dividends , and the payments sourced from Manila Wine 's earnings and profits as augmented by consideration received from the sale of those assets to Manila Wine Philippines , thus: HEITAD "More than with the distribution of June 8, 1937, is this true with those declared on July 22, 1937, and paid on August 4 and October 28, 1937, respectively (Stipulation of Facts, par. 5, Record on Appeal, p. 21). 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.). In both Schedules B and B-1 of the Stipulation of Facts (Record on appeal, pp. 16-18), being minutes of directors' meetings of the Hongkong Co., where authorization and instruction were given to declare and pay in the form of 'dividends' to the shareholders the amounts in question, it was specifically provided that the surplus to be so distributed be that resulting after providing for return of capital and necessary or various expenses, as shown in the balance sheet prepared as of June 1, 1937, and in the reconstructed balance sheet of the same date presented by the company's auditors, it having been resolved in Schedule B-1 that 'any balance remaining to be distributed when final liquidator's account has been rendered and paid' (Record on Appeal, p. 18; emphasis supplied). 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. The distinction between a distribution in liquidation and an ordinary dividend is factual; the result in each case depending on the particular circumstances of the case and the intent of the parties. If the distribution is in the nature of a recurring return on stock it is an ordinary dividend. However, if the corporation is really winding up its business or recapitalizing and narrowing its activities, the distribution may properly be treated as in complete or partial liquidation and as payment by the corporation to the stockholder for his stock. The corporation is, in the latter instances, wiping out all parts of the stockholders' interest in the company. . . (Montgomery, Federal Income Tax Handbook [1938-1939], 258; (Emphasis ours) Not being dividends, gains from the alienation of shares of a company are taxed in accordance with paragraph 4, Article 13 of the Philippines-Netherlands tax treaty, to wit: " Article 13 GAINS FROM THE ALIENATION OF PROPERTY 1. Gains from the alienation of immovable property, as defined in paragraph 2 of Article 6, may be taxed in the State in which such property is situated. 2. Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of one of the States has in the other State, or of movable property pertaining to a fixed base available to a resident of one of the States in the other State for the purpose of performing professional services, including such gains from the alienation of such permanent establishment (alone or together with the whole enterprise) or of such a fixed base, may be taxed in the other State. 3. Notwithstanding the provisions of paragraph 2, gains derived by an enterprise of one of the States from the alienation of ships and aircraft operated in international traffic pertaining to the operation of such ships or aircraft, shall be taxable only in that State. 4. Gains from the alienation of any property, other than those mentioned in paragraphs 1, 2, and 3 shall be taxable only in the Contracting State of which the alienator is a resident." Under paragraph 4, gains from the alienation of property other than that referred to in paragraphs 1 (immovable property), 2 (movable property of a permanent establishment or fixed base) and 3 (ships and aircraft in international traffic) shall be taxable only in the contracting State of which the alienator is a resident. Accordingly, pursuant to paragraph 4, Article 13 of the Philippines-Netherlands tax treaty since C-Cubed is a resident of the Netherlands, gains from liquidating dividends derived by C-Cubed from the redemption of its preferred shares in Customer Contact are exempt from income tax imposed under Section 28 (B) (1) of the National Internal Revenue Code of 1997 (" Tax Code "), as amended, which reads: ATICcS " SEC. 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 interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and capital gains, except capital gains subject to tax under subparagraph 5 (c) and (d) above: n Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." B. Improperly accumulated earnings tax While gains from the alienation of shares in connection with the liquidation of a domestic corporation, or the redemption of its shares, or reduction of its paid-up capital, are treated as capital gains and exempt from income tax under tax treaties under specific conditions, this does not, however, prevent this Bureau from imposing the 10% improperly accumulated earnings tax (" IAET ") on the retained earnings of the corporation when the whole or part of those earnings constitute improperly accumulated taxable income. The IAET is imposed under Section 29 (A) of the Tax Code and implemented by Revenue Regulations No. 2-2001 , 2 to wit: " SEC. 29. Imposition of Improperly Accumulated Earnings Tax. (A) In General. In addition to other taxes imposed by this Title, there is hereby imposed for each taxable year on the improperly accumulated taxable income of each corporation described in Subsection B hereof, an improperly accumulated earnings tax equal to ten percent (10%) of the improperly accumulated taxable income." " SEC. 2. Concept of Improperly Accumulated Earnings Tax (IAET). Pursuant to Section 29 of the Code, there is imposed for each taxable year, in addition to other taxes imposed under Title II of the Tax Code of 1997, a tax equal to 10% of the improperly accumulated taxable income of corporations formed or availed of for the purpose of avoiding the income tax with respect to its shareholders or the shareholders of any other corporation, by permitting the earnings and profits of the corporation to accumulate instead of dividing them among or distributing them to the shareholders. The rationale is that if the earnings and profits were distributed, the shareholders would then be liable to income tax thereon, whereas if the distribution were not made to them, they would incur no tax in respect to the undistributed earnings and profits of the corporation. Thus, a tax is being imposed in the nature of a penalty to the corporation for the improper accumulation of its earnings, and as a form of deterrent to the avoidance of tax upon shareholders who are supposed to pay dividends tax on the earnings distributed to them by the corporation. The touchstone of the liability is the purpose behind the accumulation of the income and not the consequences of the accumulation. Thus, if the failure to pay dividends is due to some other causes, such as the use of undistributed earnings and profits for the reasonable needs of the business, such purpose would not generally make the accumulated or undistributed earnings subject to the tax. However, if there is a determination that a corporation has accumulated income beyond the reasonable needs of the business, the 10% improperly accumulated earnings tax shall be imposed." Under Section 2 of the Regulations, the IAET is a penalty tax imposed on the domestic corporation and not on the shareholders of that corporation which makes the IAET beyond the scope of relief of tax treaties. C. Documentary stamp tax Section 175 of the Tax Code generally imposes documentary stamp tax (" DST ") on deliveries and transfer of shares or certificates of stock, to wit: TIADCc " 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, Section 4 of Revenue Regulations No. 13-2004 3 provides guidelines on the imposition of DST, 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 endorsement 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. . ." Under Section 4 of the Regulations, 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. In the case at hand, the Board of Directors of Customer Contact approved the dissolution of the company. As a result, all common shares issued to and held by C-Cubed and the nominee shareholders were surrendered to and retired by Customer Contact . These shares were not retained and converted to treasury shares. Where Customer Contact did not take title to those shares, there is no actual or constructive transfer of beneficial ownership of those shares to Customer Contact . This being so, the surrender and retirement of those shares of Customer Contact is not subject to DST. 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. Implementing the Provision on Improperly Accumulated Earnings Tax Under Section 29 of the Tax Code of 1997. 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. n Note from the Publisher: Copied verbatim from the official document.