ITAD BIR Ruling No. 084-13

April 4, 2013 ITAD BIR RULING NO. 084-13 Articles 5 and 11, Philippines-Japan tax treaty; BIR Ruling No. ITAD 145-12 Punongbayan and Araullo 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue Makati City Attention: Eleanor L. Roque Head Tax Advisory and Compliance Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on September 22, 2011 requesting confirmation that interest paid by Taganito HPAL Nickel Corporation ("Taganito") to Mitsui and Company Ltd. ("Mitsui") is subject to income tax at the rate of 10 percent 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 by a Protocol 1 effective January 1, 2009. DAETHc Facts Mitsui is a foreign corporation and a resident of Japan based on its Articles of Incorporation and the Certificate of Residence issued by the Kojimachi Tax Office in Japan on August 26, 2011. Mitsui is located at 1-2-1, Ohtemachi, Chiyoda-ku, Tokyo, Japan. Based on the Certification issued by the Securities and Exchange Commission ("SEC") on October 11, 2011, Mitsui is engaged in trade or business in the Philippines through a branch office, Mitsui and Company Ltd. Manila Branch ("Mitsui Philippine Branch") , under SEC Registration No. F-000000490. On the other hand, Taganito is a domestic corporation located at 24th Floor, Pacific Star Building, Makati Avenue corner Sen. Gil Puyat Avenue, Makati City, Philippines. On June 10, 2011, Taganito and Mitsui entered into a Term Loan Agreement where Mitsui granted Taganito a loan of US$48,200,000.00 to be utilized for its operating and capital expenditures. The loan bears interest at the rate of 3.495 percent per annum and computed based on the outstanding principal of the loan. Interest is computed from the date the loan is given up to each payment date on March 25 and September 25 of the year. The loan is subject to default interest (penalty for late payment) equivalent to the regular interest rate plus 2 percent per annum. The loan will be paid as follows: Date of Payment Amount of Principal Amount of Outstanding Repaid (in US Dollars) Principal Subject to Interest (in US Dollars) September 25, 2011 2 - 48,200,000.00 March 25, 2012 - 48,200,000.00 September 25, 2012 - 48,200,000.00 March 25, 2013 - 48,200,000.00 September 25, 2013 - 48,200,000.00 March 25, 2014 6,025,000.00 48,200,000.00 September 25, 2014 6,025,000.00 42,175,000.00 March 25, 2015 6,025,000.00 36,150,000.00 September 25, 2015 6,025,000.00 30,125,000.00 March 25, 2016 6,025,000.00 24,100,000.00 September 25, 2016 6,025,000.00 18,075,000.00 March 25, 2017 6,025,000.00 12,050,000.00 September 25, 2017 6,025,000.00 6,025,000.00 Total 48,200,000.00 - ============ =========== All payments will be remitted by wire transfer to Mitsui 's account at Sumitomo Mitsui Banking Corporation (Head Office) located at 1-2, Yurakucho 1-chome, Chiyoda-ku, Tokyo, Japan. aTCAcI Based on the Certifications issued by Metropolitan Bank and Trust Company on August 18, 2011 and the Certificate of Inward Remittance issued by Bank of Tokyo-Mitsubishi UFJ Manila Branch on August 22, 2011, Taganito received the following amounts from Mitsui (through Sumitomo Mitsui Banking Corporation): Date of Remittance Amount (in US Dollars) June 20, 2011 22,900,000.00 June 27, 2011 7,000,000.00 July 26, 2011 18,300,000.00 Total 48,200,000.00 =========== Based on the Certification issued by the General Manager of Mitsui Philippine Branch on September 15, 2011, Mitsui Philippine Branch has no direct or indirect participation in the Term Loan Agreement between Taganito and Mitsui and that interest arising therefrom and derived by Mitsui is not attributable to Mitsui Philippine Branch nor paid or coursed through it. Mitsui Philippine Branch is located at 36th Floor, GT Tower International, 6815 Ayala Avenue, Makati City, Philippines. Ruling In reply, please be informed that paragraphs 1, 2, 4 and 5, Article 11 of the Philippines-Japan tax treaty, as amended, provide: "Article 11 1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State. 2. However, such interest may also be taxed in the Contracting State in which it arises, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the interest the tax so charged shall not exceed 10 per cent of the gross amount of the interest." xxx xxx xxx 4. The term 'interest' as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and in particular, income from Government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. AcISTE 5. The provisions of paragraphs 1 and 2 above shall not apply if the beneficial owner of the interest, being a resident of a Contracting State, carries on business in the other Contracting State in which the interest arises, through a permanent establishment situated therein, or performs in that other Contracting State independent personal services from a fixed base situated therein, and the debt-claim in respect of which the interest is 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." Under Article 11, interest arising in the Philippines and paid to a resident of Japan, beginning January 1, 2009, may be taxed in the Philippines at a rate not to exceed 10 percent. However, this reduced rate does not apply if the interest is effectively connected with a permanent establishment (if the recipient is an enterprise) or a fixed base (if the recipient is an individual performing independent and professional services) which the recipient has in the Philippines. The term interest generally includes income from debt-claims or the loan of money. On the question of permanent establishment, Mitsui Philippine Branch , being a branch office in the Philippines of Mitsui , constitutes the latter's permanent establishment under paragraphs 1 and 2, Article 5 of the Philippines-Japan tax treaty, to wit: "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 ;" On whether interest paid to Mitsui is effectively connected with Mitsui Philippine Branch , such interest is not effectively connected since Mitsui Philippine Branch has no direct or indirect participation in the Term Loan Agreement between Taganito and Mitsui, and the interest is paid and will be paid directly to Mitsui at its account in Sumitomo Mitsui Banking Corporation in Japan and not to or through Mitsui Philippine Branch . caADIC This conclusion is consistent with the rule laid down by the Supreme Court in Marubeni Corporation vs. Commissioner of Internal Revenue and the Court of Tax Appeals (G.R. No. 76573 dated September 14, 1989) where it ruled that the taxation of income derived by a foreign corporation which has a branch office in the Philippines will be taxed as income of the branch office only if the business transaction that gives rise to the income has been conducted by the foreign corporation through the branch office , to wit: "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." On the question of default interest (penalty for late payment) , this is likewise considered interest within the scope of Article 11 of the Philippines-Japan tax treaty since it partakes of an income arising from debt-claims or the loan of money, and since this article does not contain an additional sentence for the purpose of excluding this kind of income. The following commentaries of the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (Condensed Version, July 22, 2010) explain as follows: "22. The second sentence 3 of paragraph 3 excludes from the definition of interest penalty charges for late payment but Contracting States are free to omit this sentence and treat penalty charges as interest in their bilateral conventions . Penalty charges, which may be payable under the contract, or by customs or by virtue of a judgement, consist either of payments calculated pro rata temporis or else of fixed sums; in certain cases they may combine both forms of payment. Even if they are determined pro rata temporis they constitute not so much income from capital as a special form of compensation for the loss suffered by the creditor through the debtor's delay in meeting his obligations. Moreover, considerations of legal security and practical convenience make it advisable to place all penalty charges of this kind, in whatever form they be paid, on the same footing for the purposes of their taxation treatment. . ." (Page 213) From the viewpoint of the OECD Model Convention and some tax treaties, the reason default interest (penalty for late payment) is excluded from the scope of Article 11 is that this does not constitute so much income for the creditor since it is not paid regularly but incidentally, and it is more of a special compensation for the loss suffered by the creditor through the borrower's default or delay in fulfilling its obligations to the creditor. However, this view is not adopted in the Philippines-Japan tax treaty which means that default interest (penalty for late payment) constitutes a taxable income under the treaty. Accordingly, since the interest paid by Taganito to Mitsui under the Agreement is not effectively connected with Mitsui Philippine Branch , such interest, including any default interest (penalty for late payment) that might be paid in the future, shall be subject to income tax at the rate of 10 percent pursuant to paragraph 2, Article 11 of the Philippines-Japan tax treaty. ( BIR Ruling No. ITAD 145-12 dated March 30, 2012 ) Finally, under Section 179 of the National Internal Revenue Code of 1997, as amended, the Term Loan Agreement, being a debt-instrument, is subject to documentary stamp tax of P1.00 for every P200.00 (or a fraction thereof) of the amount of the loan, to wit: "SEC. 179. Stamp Tax on All Debt Instruments . On every original issue of debt instruments, there shall be collected a documentary stamp tax of One peso (P1.00) on each Two hundred pesos (P200), or fractional part thereof, of the issue price of any such debt instrument: Provided, That for such debt instruments with terms of less than one (1) year, the documentary stamp tax to be collected shall be of a proportional amount in accordance with the ratio of its terms in number of days to three hundred sixty-five (365) days: Provided, further, That only one documentary stamp tax shall be imposed on either loan agreement, or promissory notes issued to secure such loan." 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. HSCAIT Very truly yours, (SGD.) KIM S. JACINTO-HENARES 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 . 2. Since the subject TTRA was filed on September 22, 2011 , the first payment of interest on September 25, 2011 is subject to relief (exemption from income tax or reduction of tax) pursuant to Section 14 of Revenue Memorandum Order No. 72-2010 (Guidelines on the Processing of Tax Treaty Relief Applications (TTRA) Pursuant to Existing Philippine Tax Treaties) ("RMO 72-2010") , to wit: "SEC. 14. When and Where to File the TTRA . All tax treaty relief applications (updated BIR Forms No. 0901-D, 0901-I, 0901-R, 0901-P, 0901-S, 0901-T, 0901-O and 0901-C) relative to the implementation and interpretation of the provisions of Philippine tax treaties shall only be submitted to and received by the International Tax Affairs Division (ITAD). If the forms or any necessary documents are submitted to any other BIR Office, the application shall be considered as improperly filed. Filing should always be made BEFORE the transaction. Transaction for purposes of filing the TTRA shall mean before the occurrence of the first taxable event." 3. Paragraph 3 of the OECD Model Convention provides: "3. The term 'interest' as used in this article means income from debt claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and in particular, income from government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. Penalty charges for late payment shall not be regarded as interest for the purpose of this article ."