ITAD BIR Ruling No. 065-11

February 25, 2011 ITAD BIR RULING NO. 065-11 Article 10 Philippines-Japan tax treaty, as amended; Section 28 (B) (1) in relation to Section 32(B) (5) of the Tax Code of 1997, as amended; BIR Ruling No. 008-10; BIR Ruling No. 007-10; BIR Ruling No. DA ITAD 068-08; BIR Ruling No. ITAD 053-05 n Sycip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: Antonette Tionko Partner Gentlemen : This refers to your letter dated July 12, 2010, on behalf of your clients, SUMITOMO ELECTRIC INDUSTRIES, LTD. ("SEI") and SUMITOMO WIRING SYSTEMS, LTD. ("SWS"), requesting confirmation that dividends to be paid by INTERNATIONAL ELECTRIC WIRES PHILS. CORP. ("IEWPC") are subject to the preferential tax rate of 10 percent pursuant to 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 ("Philippines-Japan tax treaty"), as amended. HSTAcI Facts It is represented that SEI is a foreign corporation organized and existing under the laws of Japan and is a resident thereof per Residence Certificate dated March 18, 2010, signed by Masayuki Kimoto, District Director of Higashi Tax Office and certified by Japan's Ministry of Foreign Affairs; that SEI is situated in 5-33, Kitahama 4-chome, Chuo-ku, Osaka, 541-0041, Japan; that SEI is engaged primarily in the development, manufacture, processing, and sales of electric wires and cables; that based on Securities and Exchange Commission ("SEC") License No. A199810992, SEI was allowed to establish a branch office in the Philippines ("SEI-Philippine branch") , which is to engage in the design, supervision, material procurement, and management of construction project in the Philippines. It is also represented that SWS is a corporation organized and existing under the laws of Japan and is a resident thereof per Residence Certificate dated March 19, 2010, signed by Ryouji Matsumoto, District Director of Yokkaichi Tax Office, and certified by Japan's Ministry of Foreign Affairs; that SWS is situated in 1-14 Nishisuehiro-cho, Yokkaichi, Mie, 510-8503, Japan; that SWS is engaged in the manufacture, processing, and sales of wiring harness, wires, cables and metal wires; that SWS is not registered as a corporation or as a partnership in the Philippines as evidenced by the Certification of Non-Registration issued by the Securities and Exchange Commission dated March 8, 2010; and that, IEWPC is a domestic corporation registered with the Philippine Economic Zone Authority as an ecozone export enterprise , under Certificate of Registration No. 95-123 dated November 20, 1995, with principal office address at Luisita Industrial Park, Special Export Processing Zone, San Miguel, Tarlac City. It is further represented that SEI and SWS are holders of IEWPC shares; that SEI holds 13,500,000 common shares with a par value of P10.00 per share, representing 54% of the total issued and outstanding capital stock of IEWPC as of October 5, 1995, while SWS holds 9,000,000 common shares with a par value of P10.00 per share, representing 36% of the total issued and outstanding capital stock of IEWPC as of October 5, 1995, per IEWPC's Secretary's Certificate dated April 14, 2010; that at the meeting of the Board of Directors of IEWPC held on April 26, 2010, it was resolved that a cash dividend amounting to US$2,832,202.00 equivalent to 70% of the 2009 and 1st quarter of 2010 Audited Net Income of IEWPC be paid on or before May 2010 to all stockholders of record, in proportion to their respective capital contribution. It is finally represented, based on the certification of Ryosuke Tsujimoto, Chief Representative Officer of SEI-Philippine Branch, dated September 29, 2010, that the dividends to be paid by IEWPC in favor of SEI are not effectively connected with SEI Philippine branch; and that, the dividends subject of the application for tax treaty relief are 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 Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended, applies in general to dividends derived in the Philippines by a nonresident foreign corporation. It provides: "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, . . .: 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: "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: CDTSEI 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 this particular case, the treaty involved is the Philippines-Japan tax treaty, as amended, which, in its Article 10, provides: "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; (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. 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. xxx xxx xxx" It is provided under paragraph 2 (a), Article 10 of the Philippines-Japan tax treaty, as amended, that dividends paid by a Philippine corporation to a resident of Japan may be taxed at a rate not exceeding 10 per cent of the gross amount of dividends if the recipient is a company which holds directly at least 10 per cent of the 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. In all other cases, the 15 percent preferential tax rate shall apply. TASCEc However, under paragraph 5, Article 10 of the same treaty, the taxation of dividends at a reduced rate under paragraph 2 (a) of the Philippines-Japan tax treaty, as amended, shall not apply if the dividends are effectively connected with a permanent establishment which an enterprise of Japan has in the Philippines, or with a fixed base for the purpose of performing independent personal services by an individual resident of Japan. On the matter of dividends being effectively with a permanent establishment, the following commentaries of the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention on Income and on Capital (Condensed Version, July 17, 2008) has made clear that: "31. 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 6 of Article 11 of the Philippines-Japan tax treaty, as amended) 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 interest arising 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 it is 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 6 of Article 11 of the Philippines-Japan tax treaty, as amended) relieves the State of source of the dividends from any limitation under the Article. The foregoing explanations accord with those in the Commentary on Article 7 (on Business Profits) ." (Emphasis supplied) (Page 156) Further, in the case of Marubeni vs. Commissioner of Internal Revenue (G.R. No. 76573 dated September 14, 1989), it is provided 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 that 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 of the branch. Consequently, the taxpayer is 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." In view of the foregoing, since SEI and SWS own more than 10 percent of the outstanding shares of the voting stock of IEWPC, the paying corporation, during the period of six months immediately preceding the date of payment of the dividends, and considering that as represented, the dividends to be paid by IEWPC in favor of SEI are not effectively connected with SEI-Philippine branch, this Office is of the opinion and so holds that the cash dividends to be remitted by IEWPC to SEI and SWS are subject to the preferential rate of 10 percent withholding tax pursuant to Article 10 (2) (a) of the Philippines-Japan tax treaty, as amended. (BIR Ruling No. ITAD-007-10 dated May 20, 2010; BIR Ruling No. ITAD-008-10 dated June 3, 2010; BIR Ruling No. DA ITAD 068-08 dated October 24, 2008; and, BIR Ruling No. ITAD 053-05 dated June 15, 2005) 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. EHTCAa Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue n Note from the Publisher: Written as "BIR Ruling No. ITAD 053-10" in the original document.