Buan and Temprosa Law Offices

August 23, 2018 ITAD BIR RULING NO. 077-18 Articles 5 and 7 Philippines- Japan tax treaty Buan and Temprosa Law Offices Units 1005 and 1006, Cityland Condominium 10, Tower 1 156 H.V. dela Costa Street, Ayala North 1226 Makati City Attention: AAA BBB Gentlemen : This refers to your tax treaty relief application filed on March 10, 2014 requesting confirmation that guarantee fees paid by Makati Sky Plaza, Inc. (" Makati Sky ") to Itochu Corporation (" Itochu ") 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 , as amended (" Philippines Japan tax treaty "). aScITE FACTS Itochu is a foreign corporation organized and existing under the laws of Japan and a resident thereof based on its amended Articles of Incorporation and Certificate of Status of Taxable Person issued by the Kita Taxation Office in Japan. Itochu is engaged in the business of export, import, sale, purchase, brokerage, agency, manufacturing and processing of commodities of various kinds. It is also engaged in financial business, including the lending of money, exchange transactions, guarantee of payment of obligations and the sale and purchase of credits, as well as holding management, and disposition of real estates and movables subject of security interest such as mortgage or pledge. Itochu is engaged in business in the Philippines through a branch, namely, Itochu Corporation Manila Branch (" Itochu Manila Branch "). Based on Itochu Manila Branch 's amended License to Transact Business issued by the Securities and Exchange Commission and its Audited Financial Statements as of March 31, 2017, Itochu Manila Branch is engaged in export, import, sale, purchase, brokerage, agency, manufacturing and processing of commodities. It is also engaged in the wholesale trading and logistics transaction processing services such as preparing invoices, certificates of origin and packing lists for clients; reviewing and checking the contents of the letters of credits of clients; encoding the details of the sales contracts and letters of credit in the clients' online contract book; and filing the shipping documents in soft copy in the online image filing system of clients. On the other hand, Makati Sky is a domestic corporation engaged in leasing activities. Based on its General Information Sheet as of July 10, 2013, Makati Sky is a wholly-owned subsidiary of Itochu , where the latter holds 99.99% of the outstanding capital of Makati Sky . On April 15, 2013, Makati Sky and Itochu entered into a Guaranty Agreement where Itochu agreed to guarantee the performance of Makati Sky 's obligations to Mirole Development Corporation (" Mirole ") under the amended Lease Agreement between Makati Sky and Mirole dated June 4, 1997. In consideration, Makati Sky will pay guarantee fees to Itochu at the rate of 0.10% per annum based on the accumulated unpaid balance of the rent payable by Makati Sky to Mirole from 2013 to 2029. The land lease has a beginning balance of P__________ in 2013 and an ending balance of P__________ in 2029. Under the amended Lease Agreement, Mirole , as lessor, is the owner of two parcels of land situated at 6788 Ayala Avenue in Makati City. The land has a total area of 2,400 square meters. Makati Sky , as lessee, desires to lease the land for the purpose of developing an office building thereon. The lease shall be for a period of thirty years commencing on the date of delivery of possession of the land by Makati Sky from Mirole . Makati Sky shall complete the building within 24 months from the date of delivery, and shall pay rent to Mirole as follows: a) P__________ for the first two years of construction; and b) After construction, P__________ for the first year of the operation of the building subject to increase of 2.00% per annum for each succeeding year of operation. The building will be called Oledan Square situated at the above address. Based on a certification issued by Itochu Manila Branch , it has no participation in the Guarantee Agreement between Makati Sky and Itochu , and that Itochu Manila Branch does not receive guarantee fees from Makati Sky . Moreover, based on Itochu Manila Branch 's Audited Financial Statements, the act of providing guarantee whether by itself or for others is not among those business activities which it can engage in the Philippines; Itochu Manila Branch 's assets (particularly, receivables) do not include guarantee fee receivables from Makati Sky ; and Itochu Manila Branch 's revenues and other sources of income are not derived from providing guarantee to Makati Sky . Based on a certification issued by Makati Sky , 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 In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997, as amended (" Tax Code "), income derived by a foreign corporation not engaged in trade or business in the Philippines is subject to income tax at the rate of 30%, to wit: " 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%)" However, under Section 32 (B) (5) of the Tax Code, such income is exempt to the extent required by any treaty obligation on 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 1, Article 7 and paragraphs 1 and 2, Article 5 of the Philippines-Japan tax treaty provide as follows: HEITAD " Article 7 1. The profits of an enterprise of a Contracting State shall be taxable only in that Contracting State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in that other Contracting State but only so much of them as is attributable to that permanent establishment." " 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. 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." Under Article 7, profits derived by an enterprise of a Contracting State in the other Contracting State may be taxed in the other State, but only so much of the profits as are attributable to a permanent establishment situated in that State. Under Article 5, a permanent establishment means a fixed place of business through which the business of an enterprise is wholly or partly carried on, and includes especially, a store or other sales outlet, a branch, an office, a factory, and a workshop. In the instant case, Itochu has a permanent establishment in the form of a branch ( Itochu Manila Branch ) under paragraph 2 (b), Article 5 of the Philippines-Japan tax treaty. On whether guarantee fees paid by Manila Sky to Itochu are attributable to Itochu Manila Branch , this is not the case based on the following reasons: 1. The Guaranty Agreement between Manila Sky and Itochu does not involve Itochu Manila Branch ; 2. The act of providing guarantee is not among those activities which Itochu Manila Branch can exercise in the Philippines; 3. Itochu Manila Branch 's assets (particularly, receivables) do not include guarantee fee receivables from Makati Sky ; and 4. Itochu Manila Branch 's revenues and other sources of income are not derived from providing guarantee to Makati Sky . This means that in the event of default by Makati Sky on its obligation to pay rent to Mirole under the amended Lease Agreement, the risk of default will be borne solely by Itochu and not Itochu Manila Branch . In Marubeni Corporation vs. Commissioner of Internal Revenue and the Court of Tax Appeals (G.R. No. 76573 dated September 14, 1989), the Supreme Court ruled that income derived by a foreign corporation directly and independently of its branch office in the Philippines cannot be attributed to 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." (Emphasis ours) This being the case, since the guarantee fees paid by Manila Sky to Itochu are not attributable to Itochu Manila Branch or any form of permanent establishment which Itochu might have in the Philippines, such fees are exempt from income tax pursuant to paragraph 1, Article 7 of the Philippines-Japan tax treaty. ATICcS 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 n Note from the Publisher: Copied verbatim from the official document.