ITAD BIR Ruling No. 088-14

June 19, 2014 ITAD BIR RULING NO. 088-14 Article 10, Philippines-Japan tax treaty Isla Lipana & Co. 29th Floor, Philamlife Tower 8767 Paseo de Roxas, 1226 Makati City Attention: Carlos Hilario R. Mateo Gentlemen : This refers to your tax treaty relief application filed on April 10, 2013 requesting for confirmation that dividends paid by Philippine Long Distance Telephone Company ("PLDT") to NTT Docomo, Inc. ("NTT JP") are subject to a preferential tax 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 as amended by a Protocol 1 ("Philippines-Japan tax treaty") . It is represented that NTT JP is a foreign corporation organized and existing under the laws of Japan with its principal office address at 2-11-1, Nagata-cho, Chiyoda-ku, Tokyo, Japan based on its Certificate of Residence issued by the District Director of Kojimachi Tax Office, Japan on March 15, 2013; that NTT JP was issued a license to establish its branch office in the Philippines on May 31, 2006 based on the Certification issued by the Securities and Exchange Commission on May 27, 2013; and that on the other hand, PLDT is a domestic corporation situated at Ramon Cojuangco Building, Makati Avenue, Makati City. It is further represented that on March 5, 2013, PLDT, through its Board of Directors, passed and approved the declaration of final regular dividend of PhP60.00 per outstanding share of common stock and a special dividend of PhP52.00 per outstanding share of common stock payable on April 18, 2013 to the holders of record of said stock at the close of business on March 19, 2013 based on the Certificate issued by the Corporate Secretary of PLDT on April 5, 2013; that based on the Certificate issued by the Corporate Secretary of PLDT on April 5, 2013, NTT JP is the beneficial owner of the following shares of stock of PLDT: SHEIDC Date of Issuance of Number of shares Value of shares % of Ownership Stock Certificate April 3, 2006 12,633,486 33,655,606,704 5.85 April 29, 2008 5,601,335 14,921,956,440 2.59 December 14, 2011 4,562,081 12,153,383,784 2.11 Total 22,796,902 60,730,946,928 10.55 ========= =========== ==== Moreover, it was represented that on April 18, 2013 the dividends were remitted by PLDT to NTT JP based on the Certification issued by the Senior Vice President for Service Delivery of HSBC on April 24, 2013; and that NTT Docomo-Philippine Branch was not a material factor in the realization of the dividends paid by PLDT to NTT JP based on the Sworn Certification issued by the Senior Manager of NTT Docomo-Philippine Branch on November 6, 2013. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, provides that dividends paid to a non-resident foreign corporation not engaged in trade or business in the Philippines, are subject to income tax at the rate 30 percent, thus: "Section 28. Rates of Income Tax on Foreign Corporations . (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%). DASEac xxx xxx xxx" However, Section 32 (B) (5) of the Code provides that such dividends may be exempt from income tax or subject to a reduced rate to the extent required by any treaty obligation on the Philippines, thus: "Section 32. Gross Income . (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. xxx xxx xxx" In this particular case, you invoke the Philippines-Japan tax treaty. Paragraphs 1, 2 and 3, Article 10 thereof provide: "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: SCaITA 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" Based on the aforequoted provisions, dividends arising in the Philippines and paid to a resident of Japan may be taxed in the Philippines at a rate not to exceed: (a) 10 percent if the company recipient of the dividends holds directly at least 25 percent of the voting shares or the total shares of the company paying the dividends for a period of six months immediately preceding the date of payment of the dividends; (b) 10 percent if the dividends are paid by a domestic company registered with the Board of Investments and engaged in preferred pioneer areas of investment under the incentive laws of the Philippines; and (c) 15 percent in all other cases. HSATIC However, under paragraph 5, Article 10 of the same treaty, the Philippines, being the source of the dividends, is not obliged to limit the tax rates on dividends under paragraphs 2 and 3 of the article if the holding in respect of which the dividends are paid is effectively connected with a permanent establishment which NTT JP has in the Philippines. Under paragraph 2 (b), Article 5 of the tax treaty, NTT JP Branch in the Philippines, may be considered a permanent establishment of NTT JP, thus: "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. . . ." (Underscoring ours) On the question of whether dividends are effectively connected 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 22, 2010 p. 193) mention that such dividends are effectively connected if they are paid in respect of holdings forming part of the assets of the permanent establishment or otherwise effectively connected with that establishment, thus: cAHDES "24. 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 5 of Article 10 of the Philippines-Japan tax treaty) 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 dividends flowing 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 they are 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 5 of Article 10 of the Philippines-Japan tax treaty) relieves the State of source of the dividends from any limitations under the Article. The foregoing explanations accord with those in the Commentary on Article 7 (on Business Profits)." Similarly, following 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), dividends derived by a foreign corporation can become effectively connected with its branch office in the Philippines if the business activities that give rise to such dividends are conducted through the branch office, following the principal-agent relationship theory, 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." EHSAaD Accordingly, the holdings in respect of the dividends paid by PLDT to NTT Japan are not effectively connected with NTT Japan Branch since the branch was not a material factor in the realization of the dividends paid by PLDT to NTT Japan based on the Sworn Certification issued by the Senior Manager of NTT Japan Branch on November 6, 2013. In this case, considering that NTT JP holds 10.55 percent of the outstanding capital stock of PLDT during a period of six months immediately preceding the date of payment of the dividends, or since December 14, 2011, this Office is of the opinion and so holds that such dividends to be paid by PLDT to NTT JP are subject to income tax at a preferential rate of 10 percent based on the gross amount thereof, pursuant to paragraph 2 (a), Article 10 of the Philippines-Japan tax treaty. 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.) 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 effective January 1, 2009.