ITAD BIR Ruling No. 101-16

June 22, 2016 ITAD BIR RULING NO. 101-16 Articles 5 & 11, Philippines-Japan Tax Treaty Manabat Sanagustin & Co., CPAs The KPMG Center, 9/F 6787 Ayala Avenue Makati City 1226, Metro Manila Attention: Maria Carmela M. Peralta Principal, Tax Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on 26 September 2011 , requesting confirmation that the interest income of Mizuho Corporate Bank Ltd., Hong Kong Branch ("Mizuho HK") arising from a loan agreement with your client, Energy Development Corporation ("EDC") is subject to preferential tax rate of 10% pursuant to Article 11 of 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. 1 It is represented that Mizuho Corporate Bank Ltd. ("Mizuho") is the head office of Mizuho HK , the former is a corporation organized and existing under the laws of and is a resident of Japan, located at 1-3-3 Marunochi, Chiyoda-Ku, Tokyo, based on the Certificate of Residence issued by the District Director of Kojimachi Tax Office, dated 29 July 2011 as certified by the Consul General of the Republic of the Philippines in and for Tokyo Japan dated 01 August 2011; that Mizuho HK is registered to do business in Hong Kong, as certified in the Business Registration Certificate issued on 05 September 2011; that Mizuho is not registered as a corporation or partnership in the Philippines and the registered company name similar to said entity is Mizuho Corporate Bank Ltd.-Manila Branch, based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission dated 22 September 2011; and that, on the other hand, EDC is a corporation organized and existing under the laws of the Philippines with principal address at Energy Center Merritt Road, Fort Bonifacio, Taguig City. HTcADC It is further represented that on 17 June 2011, EDC entered into a Credit Agreement (Agreement) through Standard Chartered Bank (Hong Kong) Limited ("SCB HK") as facilitating agent, with a number of lenders for a total amount of USD175,000,000.00. One of the lenders is Mizuho HK for an amount of USD13,500,000.00 with a term of three (3) months with interest rate equal to the aggregate of the margin (1.75%) as defined in the Agreement and the London Interbank Offer Rate (LIBOR). It is also represented, as evidenced by a Sworn Certification executed by Ms. Vilma B. Cervantes, Vice President of Mizuho Manila branch ( Mizuho Manila ) dated 13 September 2011, that Mizuho Manila is in its own right a signatory in the Agreement also as a Lender; that Mizuho HK and Mizuho Manila independently book their respective interest income from the loan; that the nature of the rights and obligations of Mizuho Manila and Mizuho HK as lenders under the Agreement are several such that their rights are separate and independent; and that the interest income earned by Mizuho HK is not used or held to be used by Mizuho Manila . It is further represented that on 14 September 2011, SCB HK advised EDC that the amount of USD892,879.17 as interest payment for the whole amount of loan is due to mature; that EDC has a dollar account with the UnionBank of the Philippines ("UnionBank") and on 27 September 2011, EDC requested that its dollar account with UnionBank be debited in the amount of USD892,879.17 and remit the same to SCB HK; and that the transaction was made through SWIFT as certified by the First Vice President, Treasury Operations Group of UnionBank, dated 17 August 2012. It is finally represented that the interest subject of this TTRA is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Certification issued by the Senior Vice President and Chief Financial Officer of EDC dated 19 September 2011. Ruling In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ( "Tax Code" ), as amended, interest paid to Mizuho HK is subject to income tax at the rate of 30 percent, thus: "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 percent (30%) 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." However, under Section 32 (B) (5) of the Tax Code, such interest may be exempt from income tax or subject to a reduced rate to the extent required by any treaty obligation on the Philippines, thus: "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." With respect to a treaty, Mizuho HK invoked the Philippines-Japan tax treaty, as amended, paragraph 2 of Article 11 thereof provides: "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. aScITE (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." Based on the foregoing, interests arising in the Philippines and paid to a resident of Japan shall be subject to a preferential tax rate of 10%. However, the preferential tax rate shall not apply if the Japanese corporation has a permanent establishment in the Philippines and the subject interest income is effectively connected to the said permanent establishment. Article five (5) of the Philippines-Japan tax treaty, as amended, defines "permanent establishment" as: "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. xxx xxx xxx" As culled from the records, Mizuho has a branch here in the Philippines- Mizuho Manila . Whether the interest paid by EDC to Mizuho HK is considered to have been made through a permanent establishment here in the Philippines, the relevant commentaries of the Organisation for Economic Co-operation and Development ("OECD") Model Tax Convention on Income and on Capital 2 provide: ". . . the right to tax of the State where the permanent establishment is situated does not extend to profits that the enterprise may derive from that State but that are not attributable to the permanent establishment. This is a question on which there have historically been differences of view, a few countries having some time ago pursued a principle of general "force of attraction" according to which income such as other business profits, dividends, interest and royalties arising from sources in their territory was fully taxable by them if the beneficiary had a permanent establishment therein even though such income was clearly not attributable to that permanent establishment. Whilst some bilateral tax conventions include a limited anti-avoidance rule based on a restricted force of attraction approach that only applies to business profits derived from activities similar to those carried on by a permanent establishment, the general force of attraction approach described above has now been rejected in international tax treaty practice. The principle that is now generally accepted in double taxation conventions is based on the view that in taxing the profits that a foreign enterprise derives from a particular country, the tax authorities of that country should look at the separate sources of profit that the enterprise derives from their country and should apply to each the permanent establishment test , subject to the possible application of other Articles of Convention. This solution allows simpler and more efficient tax administration and compliance, and is more closely adapted to the way in which business is commonly carried on. . . ." (emphasis ours) In the same vein, the Supreme Court in the case of Marubeni Corporation vs. Commissioner of Internal Revenue and Court of Tax Appeals 3 held that: "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 . Consequently, the taxpayer is 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) Hence, based on the foregoing, the income paid to the head office of a foreign corporation which has a branch office in the Philippines shall not be subject to the preferential tax rate if the income is not effectively connected to the said branch office. However, if the business transactions that give rise to the income came from a separate and independent transaction/source from the branch office here in the Philippines, it shall be subject to the preferential tax rate under the tax treaty. In this case, it was represented that Mizuho Manila's transactions are separate and independent from those engaged by Mizuho HK . Therefore, applying the rules enunciated above, such interest paid by EDC to Mizuho HK cannot be considered as effectively connected with Mizuho Manila . Consequently, this Office is of the opinion and so holds that the interests paid are subject to tax at the preferential rate of 10 percent of the gross amount of the interests , pursuant to Article 11 (2) of the Philippines-Japan tax treaty, as amended. 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. Please be guided accordingly. 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. 2. OECD Model Tax Convention on Income and on Capital, Condensed Version, Eighth Edition, 2010, p. 157. 3. G.R. No. 76573 dated September 14, 1989.