Punongbayan and Araullo

October 22, 2018 ITAD BIR RULING NO. 100-18 Articles 10, 11 and 12 Philippines- Japan tax treaty Punongbayan and Araullo 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue 1200 Makati City Attention: AAA _______________ Gentlemen : This refers to your letter dated May 7, 2012 requesting for a review of BIR Ruling No. ITAD 149-12 dated April 4, 2012 which denied relief of 10% on the following income payments made by Coral Bay Nickel Corporation ("Coral Bay") : 1. Dividends paid by Coral Bay to Mitsui and Company Ltd. ("Mitsui") and Sojitz Corporation ("Sojitz") which were subjected to 25% under paragraph 2 (b), Article 10 of 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 effective January 1, 2009; CacEIS 2. Interest paid by Coral Bay to Sojitz, Sumitomo Metal Mining Company Ltd. ("Sumitomo Metal") and Sumitomo Mitsui Banking Corporation ("Sumitomo Bank") prior to the filing of the relevant tax treaty relief application ("TTRA") on October 26, 2007, which was subjected to 20% under Section 28 (B) (5) (a) of the National Internal Revenue Code of 1997, as amended ("Tax Code") ; and 3. Royalties paid by Coral Bay to Sumitomo Metal and Sumitomo Seika Chemicals Company Ltd. ("Sumitomo Chemicals") prior to the filing of the relevant TTRA on November 10, 2007, which were subjected to 35% under Section 28 (B) (1) of the Tax Code. FACTS Mitsui, Sojitz, Sumitomo Metal, Sumitomo Bank and Sumitomo Chemicals are foreign corporations organized and existing under the laws of Japan and residents thereof. On the other hand, Coral Bay is a domestic corporation engaged in the production of mixed sulphides of nickel and cobalt. Coral Bay is registered with the Board of Investments ("BOI") as a pioneer enterprise since June 27, 2002. Based on a certification issued by BOI on October 23, 2017, the BOI approved the cancellation of Coral Bay 's Certificate of Registration as new producer of mixed sulfide of nickel and cobalt on July 10, 2017. Coral Bay is also registered with the Philippine Economic Zone Authority ("PEZA") as an ecozone export enterprise since December 27, 2002. Dividends On May 18, 2007, Coral Bay declared cash dividends amounting to US$ _______________ in favor of its stockholders of record as of December 31, 2006. As of May 31, 2007, Mitsui and Sojitz each hold ____% of the capital ownership of the company. Interest On October 22, 2002, Coral Bay and Sojitz entered into a Loan Agreement where Sojitz granted Coral Bay a loan amounting to $__________ to finance the construction of its production facility for nickel and cobalt mixed sulphides. The loan bears a floating interest rate equal to the six-month London Interbank Offer Rate ("LIBOR") for the US dollar plus a margin of ____% per annum. Principal and interest are payable every six months beginning February 21, 2006 up to August 21, 2010. On November 10, 2003, Coral Bay and Sumitomo Metal entered into a Term Loan Agreement where Sumitomo Metal granted Coral Bay a loan amounting to $ _______________ to finance its operating and capital expenditures. The loan bears a floating interest rate equal to the six-month LIBOR for the US dollar plus a margin of ___% per annum. Principal and interest are payable every six months beginning February 21, 2006 up to February 21, 2008. On September 9, 2004, March 17 and August 23, 2005 and June 21, 2006, Sumitomo Bank issued Facility Letters to Coral Bay where Sumitomo Bank granted Coral Bay a revolving credit facility amounting to US$ ___________ , US$ __________ , US$ __________ , US$ __________ and US$ __________ , to finance its general working capital requirements. Coral Bay may draw an amount from each facility (which constitutes an advance) by making a drawdown notice to Sumitomo Bank not later than one business day before the date of the advance. An advance will be repaid in full on its repayment date and any amounts repaid may be redrawn before the cancellation or termination of the facility. Each advance bears interest on its repayment date at a rate to be agreed upon by the parties. Royalties On October 1, 2002, Sumitomo Metal and Coral Bay entered into a Technical Assistance and License Agreement where Sumitomo Metal granted Coral Bay a non-exclusive and non-transferable right to use the high pressure acid leaching process developed by Sumitomo Metal , and to apply any technical information and improvements to enable Coral Bay and its contractors to design, engineer, construct, enhance, maintain and operate its plant and to produce products. In consideration, Coral Bay will pay Sumitomo Metal an instalment fee of __________ , payable every six months for a period of ten years, and a running royalty of ___% every six months based on the total sales of the products. On October 1, 2002, Sumitomo Chemicals, Sumitomo Metal and Coral Bay entered into an Assignment and Assumption Agreement where Coral Bay was named as the joint venture referred to in the License Agreement between Sumitomo Chemicals and Sumitomo Metal dated December 10, 2001. As a result, Sumitomo Metal transferred its contractual rights and obligations to Coral Bay , and Coral Bay agreed to pay __________ to Sumitomo Metal to reimburse the amount advanced by Sumitomo Metal in connection with and pursuant to the Assignment and Assumption Agreement. Under the License Agreement, Sumitomo Chemicals granted Sumitomo Metal a non-exclusive license to install the facilities and to produce and use hydrogen sulphide in a nickel mixed sulphide production plant in Rio Tuba, Palawan in the Philippines. Sumitomo Chemicals will furnish technical assistance to Sumitomo Metal on the construction of the facilities. In consideration, Sumitomo Metal will pay Sumitomo Chemicals a compensation of __________ for the grant of the license and another compensation for the provision of technical information required for the operation of the facilities. HaTDAE On March 11, 2015, the Office of the President, through the Executive Secretary, remanded the request for review to the Bureau of Internal Revenue ("BIR") in the light of the Supreme Court ruling in Deutsche Bank AG Manila Branch vs. Commissioner of Internal Revenue, G.R. No. 188550, August 19, 2013 ("Deutsche Bank case") . Here, the Court took cognizance of Revenue Memorandum Order No. 1-00 (Procedures for Processing Tax Treaty Relief Application) ("RMO 1-2000") , which requires taxpayers to file the TTRA with the International Tax Affairs Division of the BIR at least fifteen days before the intended transaction or payment of income, thus: "III. Policies: In order to achieve the above-mentioned objectives, the following policies shall be observed: xxx xxx xxx 2. Any availment of the tax treaty relief shall be preceded by an application by filing BIR Form No. 0901 (Application for Relief from Double Taxation) with ITAD at least 15 days before the transaction i.e., payment of dividends, royalties, etc., accompanied by supporting documents justifying the relief. . ." The BIR cited RMO 1-2000 as legal basis in denying relief of 10% to interest paid by Coral Bay to Sojitz, Sumitomo Metal and Sumitomo Bank , and royalties paid by Coral Bay to Sumitomo Metal and Sumitomo Chemicals , prior to the filing of the relevant TTRAs and subjecting them to the regular rates of 20% and 35% under the Tax Code. On dividends paid by Coral Bay to Mitsui and Sojitz , the BIR noted that Mitsui and Sojitz respectively held 17.99% of the capital ownership of Coral Bay , which was below the 25% threshold under paragraph 2 (a), Article 10 of the Philippines-Japan tax treaty that qualifies any stockholder to the lower rate of 10%, thus: " 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 25 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) 25 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." While paragraph 3 of Article 10 provides the same lower rate of 10% to domestic corporations like Coral Bay registered with BOI and engaged in preferred pioneer areas of investment, the BIR argued that Coral Bay , upon its later registration with PEZA, should now be governed by the provisions of Republic Act No. 7916 (An Act Providing for the Legal Framework and Mechanism for the Creation, Operation, Administration, and Coordination of Special Economic Zones in the Philippines, Creating for This Purpose, The Philippine Economic Zone Authority (PEZA), and for Other Purposes) ("RA 7916") . As such, fiscal and non-fiscal incentives given to Coral Bay should be limited to incentives under RA 7916. Aside from Article 10, the lower rate of 10% to interest and royalties paid by domestic corporations registered with BOI and engaged in preferred pioneer areas of investment are contained in Articles 11 and 12 of the Philippines-Japan tax treaty, thus: " Article 11 xxx xxx xxx 3. Notwithstanding the provisions of paragraph 2, the amount of tax imposed by the Philippines on the interest 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 interest, shall not exceed 10 per cent of the gross amount of the interest." " Article 12 xxx xxx xxx 3. Notwithstanding the provisions of paragraph 2, the amount of tax imposed by the Philippines on the royalties 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 royalties, shall not exceed 10 per cent of the gross amount of the royalties." In BIR Ruling No. ITAD 149-12, the BIR made the same argument that Coral Bay , upon its later registration with PEZA, should now be governed by the provisions of RA 7916, and as such, fiscal and non-fiscal incentives given to Coral Bay should be limited to incentives under RA 7916. RULING In reply, please be informed that in the Deutsche Bank case, the Supreme Court emphasized the observance of the principle of pacta sunt servanda where the BIR is reminded to ensure that reliefs granted under tax treaties are accorded to the parties entitled thereto, and that the BIR must not impose additional requirements that would negate the availment of these reliefs especially when such requirements are not provided for in tax treaties, thus: "'A state that has contracted valid international obligations is bound to make in its legislations those modifications that may be necessary to ensure the fulfillment of the obligations undertaken.' Thus, laws and issuances must ensure that the relief granted under tax treaties are accorded to the parties entitled thereto. The BIR must not impose additional requirements that would negate the availment of the reliefs provided for under international agreements. More so, when the RP-Germany Tax Treaty does not provide for any pre-requisite for the availment of the benefits under said agreement ." (Underscoring supplied) Accordingly, since the requirement of prior filing of TTRA is not present in the Philippines-Japan tax treaty, this Office reconsiders the denied relief of 10% to interest paid by Coral Bay to Sojitz, Sumitomo Metal and Sumitomo Bank prior to the filing of the relevant TTRA on October 26, 2007, and royalties paid by Coral Bay to Sumitomo Metal and Sumitomo Chemicals prior to the filing of the relevant TTRA on November 10, 2007, which were subjected to regular income tax rates under the Tax Code. caSEAH Moreover, following the observance of the pacta sunt servanda principle in the Deutsche Bank case, this Office reconsiders the denied relief of 10% to dividends paid by Coral Bay to Mitsui and Sojitz which were subjected to 25% under paragraph 2 (b), Article 10 of Philippines-Japan tax treaty; interest paid by Coral Bay to Sojitz, Sumitomo Metal and Sumitomo Bank after the filing of the relevant TTRA on October 26, 2007 and before the effectivity of the amending protocol to the tax treaty on January 1, 2009, which was subjected to 15% under paragraph 2, Article 11 of the tax treaty prior to its amendment; and royalties paid by Coral Bay to Sumitomo Metal and Sumitomo Chemicals after the filing of the relevant TTRA on November 10, 2007 and before the effectivity of the amending protocol on January 1, 2009, which were subjected to 25% under paragraph 2 (b), Article 12 of the tax treaty prior to its amendment. At all those times, Coral Bay is registered with BOI and engaged in preferred pioneer areas of investment until the cancellation of its certificate by BOI on July 10, 2017. To deny relief to dividends, interest and royalties paid by Coral Bay to those nonresident entities when it complies with the specific requirement of the treaty also goes against the pacta sunt servanda principle laid down in the Deutsche Bank case. In fine, this Office rules as follows: 1. Dividends paid by Coral Bay to Mitsui and Sojitz are subject to income tax of 10% under paragraph 3, Article 10 of Philippines-Japan tax treaty; 2. Interest paid by Coral Bay to Sojitz, Sumitomo Metal and Sumitomo Bank prior to the amendment of the Philippines-Japan tax treaty on January 1, 2009 is subject to income tax of 10% under paragraph 3, Article 11 of tax treaty prior to its amendment; and 3. Royalties paid by Coral Bay to Sumitomo Metal and Sumitomo Chemicals prior to the amendment of the Philippines-Japan tax treaty on January 1, 2009 are subject to income tax of 10% under paragraph 3, Article 12 of 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.) CAESAR R. DULAY Commissioner of Internal Revenue