Isla Lipana & Co.

October 22, 2018 ITAD BIR RULING NO. 097-18 Article 10 Philippines-Japan tax treaty, as amended Isla Lipana & Co. 29th Floor, Philamlife Tower 8767 Paseo de Roxas 1226 Makati City Attention: AAA _______________ BBB _______________ CCC _______________ DDD _______________ Gentlemen : This refers to your tax treaty relief application filed on April 4, 2017 requesting confirmation that gains derived by Muramoto Industry Company Ltd. ("MIC") from the repurchase/buyback of a portion of its shares of stock in Muramoto Audio-Visual Philippines, Inc. ("MAPLE") are in the nature of capital gains and 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") , as amended. aTEAHc FACTS MIC is a foreign corporation organized and existing under the laws of Japan and a resident thereof based on its Articles of Association and Residence Certificate issued by the Suma Tax Office in Japan. The objects of MIC are to design, manufacture, and sell molds, and to process metal and resins. MIC is not registered as a corporation or partnership in the Philippines based on the Certificate of Non-Registration of Company issued by the Securities and Exchange Commission. On the other hand, MAPLE is a domestic corporation engaged in the manufacture and assembly of car stereos, video tape recorders and related audio-visual equipment, and their components and parts. Based on MAPLE 's Audited Financial Statements as of September 30, 2016 and General Information Sheet as of February 17, 2017, MIC is the immediate and ultimate parent company of MAPLE . MIC holds 775,273 common shares of the company, each share with a par value of P__________, and accounting for 99.99% capital ownership of the company. MAPLE was incorporated and registered with the Securities and Exchange Commission on March 19, 1990. On March 28, 2017, MAPLE (as seller) and MIC (as purchaser) entered into a Sale Purchase Agreement where MIC sold, assigned, transferred and conveyed to MAPLE its 159,152 common shares, which account for 20.53% of the capital stock of MAPLE . The purchase price of the shares is the estimated fair market value ("FMV") of the shares paid in cash. Among others, MIC shall cause the transfer of those shares in the stock and transfer book of MAPLE upon receipt of a tax clearance. Based on MAPLE 's Audited Financial Statements, the estimated fair market value ("FMV") of its total common shares as of September 30, 2016 is $ _______________ (P _______________ ). 1 The estimated FMV of the 159,152 common shares subject of repurchase/buyback is $ _______________ (P _______________ ), which is the purchase price for those shares. Based on Corporate Secretary's Certificate dated March 30, 2017 issued by MAPLE , the shares were acquired by MIC as stock dividends on July 29, 2004 (25,000), April 30, 1999 (70,000) and March 10, 2001 (64,152). Based on a sworn statement issued by MAPLE , 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, for tax treaty purposes, gains from the alienation of shares by a shareholder in connection with the liquidation of the issuing company, or the redemption of shares of the company, or the reduction of the paid-up capital of that company, are characterized as dividends to the extent that the domestic law of that State treats the income as income from shares (dividends) . The following commentaries of the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (July 15, 2014) mention: "31. If shares are alienated by a shareholder in connection with the liquidation of the issuing company or the redemption of shares or reduction of paid-up capital of that company, the difference between the proceeds obtained by the shareholder and the par value of the shares may be treated in the State of which the company is a resident as a distribution of accumulated profits and not as a capital gain. The Article does not prevent the State of residence of the company from taxing such distributions at the rates provided for in Article 10: such taxation is permitted because such difference is covered by the definition of the term 'dividends' contained in paragraph 3 of Article 10 and interpreted in paragraph 28 of the Commentary relating thereto, to the extent that the domestic law of that State treats that difference as income from shares. . ." (Page 252) Under Philippine law, gains from the alienation of shares by a shareholder described above are generally in the nature of capital gains (or capital loss as the case may be) under Section 8 of Revenue Regulations No. 6-2008 2 below: " SEC. 8. TAXATION OF SURRENDER OF SHARES BY THE INVESTOR UPON DISSOLUTION OF THE CORPORATION AND LIQUIDATION OF ASSETS AND LIABILITIES OF SAID CORPORATION . Upon surrender by the investor of the shares in exchange for cash and property distributed by the issuing corporation upon its dissolution and liquidation of all assets and liabilities, the investor shall recognize either capital gain or capital loss upon such surrender of shares computed by comparing the cash and fair market value of property received against the cost of the investment in shares. The difference between the sum of the cash and the fair market value of property received and the cost of the investment in shares shall represent the capital gain or capital loss from the investment, whichever is applicable. If the investor is an individual, the rule on holding period shall apply and the percentage of taxable capital gain or deductible capital loss shall depend on the number of months or years the shares are held by the investor. Section 39 of the Tax C od e, as amended, shall herein apply in all possible situations. The capital gain or loss derived therefrom shall be subject to the regular income tax rates imposed under the Tax C od e, as amended, on individual taxpayers or to the corporate income tax rate, in case of corporations." This characterization is held in two Supreme Court rulings: Commissioner of Internal Revenue v. Goodyear Philippines, Inc. , G.R. No. 216130 dated August 03, 2016, and Wise & Co., Inc., et al. v. Bibiano L. Meer, Collector of Internal Revenue , G.R. No. 48231 dated June 30, 1947. CcSEIH However, under Section 73 (B) of the National Internal Revenue Code of 1997, as amended ("Tax Code") below, if the shares being alienated were acquired as stock dividends , the resulting income is not capital gains but taxable dividends , thus: " Sec. 73. Distribution of dividends or assets by corporations. xxx xxx xxx (B) Stock dividends A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent it represents a distribution of earnings or profits accumulated after March first, nineteen hundred and thirteen ." (Emphasis ours) Section 73 (B) is clear that if a corporation cancels or redeems shares of stock acquired as stock dividends, the resulting income is essentially equivalent to the distribution of taxable dividends. This is because stock dividends, same with ordinary dividends, are taken out of the retained earnings of a corporation which reduce such earnings. When ordinary dividends are paid, the amount reduced in the corporation's earnings (equity) is the same amount reduced in the corporation's assets. However, when stock dividends are declared, the reduction in the corporation's earnings (equity) does not trigger a reduction in the corporation's assets, but an increase in the corporation's share capital (equity). This is the reason why income tax on stock dividends is deferred until they are redeemed or cancelled which, same with ordinary dividends, ultimately reduce the corporation's earnings (equity) and assets. In the instant case, the Sale Purchase Agreement between MIC (shareholder) and MAPLE (issuing corporation) does not speak of redemption but of sale, assignment, transfer and conveyance of shares by MIC to MAPLE . Nonetheless, the fact that this transfer will be reflected in the stock and transfer book of MAPLE necessitates the cancellation of the shares issued to MIC . Since these shares are in the nature of stock dividends, the purchase price paid therefor as a result of the cancellation are considered dividends under Section 73 (B) of the Tax Code. As dividends, the purchase price is subject to a lower income tax under paragraphs 1 and 2, Article 10 of the Philippines-Japan tax treaty, which 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: 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." Under Article 10, 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% if the company, which is the recipient and beneficial of the dividends, holds directly at least 10% 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, and (b) 15% in all other cases. Accordingly, since MIC holds directly at least 10% of the total shares of MAPLE for a period of six months immediately preceding the date of payment the purchase price deemed as dividends, where it holds 99.99% of these shares since March 19, 1990, the purchase price paid for the sale, assignment, transfer and conveyance of the 159,152 common shares to MAPLE are subject to income tax at the rate of 10% pursuant to under paragraph 2 (a), Article 10 of the Philippines-Japan tax treaty. THIcCA 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. http://wwww.bsp.gov.ph/dbank_reports/ExchangeRates_2.asp . 2. Consolidated Regulations Prescribing the Rules on the Taxation of Sale, Barter, Exchange or other Disposition of Shares of Stock Held as Capital Assets .