Sycip Gorres Velayo and Co.

June 7, 2018 ITAD BIR RULING NO. 072-18 Article 13 Philippines-Japan tax treaty, as amended Sycip Gorres Velayo and Co. 6760 Ayala Avenue Makati City Attention: AAA __________ Gentlemen : This refers to your tax treaty relief application filed on October 30, 2014 requesting confirmation that capital gains derived by Babcock-Hitachi Kabushiki Kaisha (" Babcock-Hitachi ") from the transfer of its shares of stock in Babcock-Hitachi (Philippines), Inc. (" Babcock-Hitachi Philippines ") to Mitsubishi Hitachi Power Systems Ltd. (" Mitsubishi Hitachi Power ") 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 "). 1 HTcADC FACTS Babcock-Hitachi is a corporation organized and existing under the laws of Japan and a resident thereof based on its amended Articles of Incorporation, the Transcript of Register issued by the Yokohama Legal Affairs Bureau, and the Certificate of Residence issued by the Yokohama Tax Office in Japan. Babcock-Hitachi is engaged in the manufacture, sale and repair of steam generators, nuclear power equipment, environmental protection equipment, chemical plants, measuring equipment, and other general industrial machinery. 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. Mitsubishi Hitachi Power is also a corporation organized and existing under the laws of Japan based on its amended Articles of Incorporation and Transcript of Register issued by the Yokohama Legal Affairs Bureau in Japan. Mitsubishi Hitachi Power is engaged in research and the development, design, procurement, manufacture, sale, installation and maintenance of thermal power systems such as boilers, steam turbines, gas turbines, heat exchangers generators, and related equipment such as environmental equipment and control system. On the other hand, Babcock-Hitachi Philippines is a domestic corporation engaged in manufacturing, processing, exporting, distributing, trading, and dealing in boiler and boiler components for use in utility, industrial and cogeneration applications and generation of heat recovery steam. Babcock-Hitachi Philippines is a wholly-owned subsidiary of Babcock-Hitachi , based on the former's Audited Financial Statements as of March 31, 2014, General Information Sheet as of August 27, 2014, and Corporate Secretary's Certificates. Babcock-Hitachi owns 3,379,996 common shares of Babcock-Hitachi Philippines which accounts for 96.57% ownership in Babcock-Hitachi Philippines . Each share has a par value of P_____ or total value of P__________. On July 29, 2014, Babcock-Hitachi and Mitsubishi Hitachi Power entered into a Merger Agreement where both parties agreed to merge with Babcock-Hitachi as the dissolving company and Mitsubishi Hitachi Power as the surviving company. Because Mitsubishi Hitachi Power owns all shares of Babcock-Hitachi , the former will not grant any consideration for the merger such as shares or monetary payment. Also, Mitsubishi Hitachi Power will not change the amount of its capital, capital reserve, and retained earnings reserve after the merger. The merger would take effect on October 1, 2014. Mitsubishi Hitachi Power shall succeed to all employees, assets, liabilities, rights, and obligations of Babcock-Hitachi on the effectivity date of the merger. On October 1, 2014, as a consequence of the merger, Babcock-Hitachi and Mitsubishi Hitachi Power entered into a Deed of Transfer where Babcock-Hitachi , the dissolving company, confirms that, on the effectivity date of the merger, all its rights, title and interest in and to the 3,379,996 common shares in Babcock-Hitachi Philippines shares shall be deemed automatically transferred by operation of law to Mitsubishi Hitachi Power , the surviving company. Based on Babcock-Hitachi Philippines ' Interim Financial Statements as of September 30, 2014, the company's real property interest as of that date is 31.45%. 2 Under Section 2 (b) of Revenue Regulations No. 4-86, 3 real property interest is the percentage of the taxpayer's real or immovable property over its total assets. The taxpayer's assets are considered to be principally of, wholly or principally of, directly principally of, or attributable to real or immovable property if the taxpayer's real property interest is more than 50%, 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 principally' or 'attributable' more than fifty percent of the entire assets in terms of value;" Based on Babcock-Hitachi Philippines ' Audited Financial Statements as of March 31, 2014, the fair market value of the 3,379,996 transferred shares is P__________. 4 Based on a sworn statement issued by Babcock-Hitachi , 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 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 nonresident foreign corporation from the disposition of shares in a domestic corporation not traded in a stock exchange are subject to capital gains 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 5% 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, thus: aScITE " 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 that gains from the alienation of shares of a domestic company in the Philippines, the property of which consists principally of immovable property situated in the Philippines, may be taxed therein, thus: "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." Accordingly, since Babcock-Hitachi Philippines ' real property interest as of the effectivity date of the merger on October 1, 2014 is 29.32%, which is not more than 50%, the company's assets do not consist principally of immovable property under Section 2 (b) of Revenue Regulations No. 4-86. This being the case, capital gains, if any, derived by Babcock-Hitachi from the transfer of all its shares in Babcock-Hitachi Philippines to Mitsubishi Hitachi Power 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, where property (other than real property) is transferred for less than an adequate and full consideration in money or money's worth, the excess between the higher fair market value of the property and the lower consideration received by the transferor is deemed a gift subject to donor's tax, 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." As of the effectivity date of the merger, the fair market value of the shares in Babcock-Hitachi Philippines transferred by Babcock-Hitachi to Mitsubishi Hitachi Power was P__________, and Babcock-Hitachi (the transferor) did not receive any consideration for such shares from Mitsubishi Hitachi Power (the transferee). The lack of consideration, or the presence thereof but less than the shares' fair market value, does not give rise to donor's tax because the transfer was a result of a merger and not for Babcock-Hitachi (or its ultimate parent) to relinquish ownership of the shares. The use of the term fair market value in Section 100 presupposes a transfer of property between a knowledgeable, willing, and unpressured buyer and a knowledgeable, willing, and unpressured seller in an open market, where the transfer would result in the seller relinquishing his ownership over the property. Hence, if the consideration received or demanded by the seller is below the fair market value of the sold property, the deficit would be characterized a gift subject to donor's tax under Section 100. However, this is not the case of the subject merger. Under the merger, Mitsubishi Hitachi Power will not grant any consideration to Babcock-Hitachi because the former owns all shares of Babcock-Hitachi , the transferor and dissolving company. Thus, before the merger, and after the merger, Mitsubishi Hitachi Power owns and will continue to own all assets of Babcock-Hitachi including those shares in Babcock-Hitachi Philippines . Moreover, in Republic of the Philippines vs. David Rey Guzman and the Register of Deeds of Bulacan, Meycauayan Branch, G.R. No. 132964, February 18, 2000 , the Supreme Court held that for a donation to be valid, the following three requisites are necessary: (1) reduction in the property of the donor, (2) increase in the property of the donee, and (3) intent on the part of the donor to do an act of liberality (donative intent). In the case of the subject merger, the transfer by Babcock-Hitachi of its assets to Mitsubishi Hitachi Power was carried out for purely business reasons and not motivated by any donative intent on the part Babcock-Hitachi . HEITAD In light of recent developments introduced under Republic Act No. 10963 , otherwise known as the Tax Reform for Acceleration and Inclusion (hereinafter referred to as the TRAIN Law ), which took effect on January 1, 2018 , Section 100 was amended to exempt from the imposition of donor's tax the transfer of property for less than adequate and full consideration, where such transfer is a bona fide transfer, at arm's length, and free from any donative intent , 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 . " (Underscoring supplied) C. Documentary stamp tax Finally, under Section 175 of the Tax Code, the transfer of shares in Babcock-Hitachi Philippines is subject to documentary stamp tax equivalent to P0.75 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 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." Beginning January 1, 2018, the documentary stamp tax imposed on transfer of shares or certificate of stock shall now be P1.50 on every P200.00, or fractional part thereof, of the par value of the shares, pursuant to Section 52 of the TRAIN Law. Section 175 of the Tax Code now reads as follows: " 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. As amended by the 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. Total assets = P __________ Total real property = P __________ (property, plant and equipment) + P __________ (investment in a real estate company) = P __________ Real property interest = P __________ 0 (total real property) P __________ (total assets) x 100% = 31.45% 3. Entitled Determination of Whether the Assets of a Corporation Consist Principally of Real Property Interest under the Philippine Tax Treaties. 4. Total assets = P __________ Total liabilities = P __________ Fair market value of all shares = P __________ (total assets) P __________ (total liabilities) = P __________ Percentage of the transferred shares = 96.57% Fair market of the transferred shares = P __________ (fair market value of all shares) x 96.57% = P __________