Villaraza and Angangco Law

October 22, 2018 ITAD BIR RULING NO. 103-18 Article 13 (Capital Gains) Philippines- Korea tax treaty Villaraza and Angangco Law CVC Law Center 11th Avenue corner 39th Street Bonifacio Triangle Bonifacio Global City 1634 Taguig City Attention: AAA BBB CCC Gentlemen : This refers to your tax treaty relief application filed on August 8, 2014 requesting confirmation that liquidating dividends paid by EWP Philippine Holdings Corporation ("EWP Philippines") to Korea East-West Power Company Ltd. ("Korea Power") are exempt from income tax pursuant to the Convention between the Republic of the Philippines and the Republic of Korea for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Korea tax treaty") . HTcADC FACTS Korea Power is a foreign corporation organized and existing under the laws of Korea and a resident thereof based on its amended Articles of Incorporation and Certificate of Residence issued by the Samseong District Tax Office in Korea. The primary purpose of Korea Power is to develop electric power resources, to generate electricity by operating power plants, and to engage in other necessary or related activities. It is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission. On the other hand, EWP Philippines is a domestic corporation based on its General Information Sheet and Audited Financial Statements ("AFS") .The primary purpose of EWP Philippines is to acquire, hold, sell, exchange, deal and invest in stocks, bonds or securities of any public or private corporation and in real property, excluding land, and personal property of all kinds. Based on Corporate Secretary's Certificate, on June 25, 2014, the Board of Directors of EWP Philippines approved a resolution authorizing the declaration of liquidating dividends to the stockholders of the company as of December 31, 2013, in proportion to their respective shareholdings. As of that date, Korea Power holds 917,997 common shares of EWP Philippines representing 99.99% ownership in the company. Each share has a par value of P_____ or total value of P__________. Korea Power is entitled to receive liquidating dividends amounting to P__________, which were remitted to it on October 27, 2014 through telegraphic transfer. Based on its AFS, EWP Philippines has no retained earnings and those liquidating dividends will be sourced from its capital and additional paid-in capital amounting to P__________. Also, EWP Philippines has no real property; its assets consist only of cash and input value-added tax. RULING Income tax In reply, please be informed that for tax treaty characterization purposes, income from the surrender of shares in connection with the liquidation of a company or the reduction of its paid-up capital is regarded as dividends as mentioned in the following commentaries of the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (July 15, 2014),thus: "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) (Emphasis ours) However, as pointed out in the commentaries, that characterization will apply only to the extent that the domestic law of the State treats the income as income from shares (i.e.,dividends) . In the Philippines, the difference between the liquidation value or redemption value and the par value of the shares is not deemed as dividends but capital gains (or capital loss , as the case may be) subject to regular income tax rate, as provided under Section 8 of Revenue Regulations No. 6-2008, 1 thus: " 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 Code, 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 Code, as amended, on individual taxpayers or to the corporate income tax rate, in case of corporations." (Underscoring ours) The same conclusion is reached in Commissioner of Internal Revenue v. Goodyear Philippines, Inc. ,G.R. No. 216130 dated August 3, 2016 ("Goodyear case") and Wise & Co., Inc., et al. v. Bibiano L. Meer, Collector of Internal Revenue ,G.R. No. 48231 dated June 30, 1947 ("Wise case") . In the Goodyear case, the court ruled that the redemption price paid by a domestic corporation (Goodyear Philippines, Inc.) to its foreign parent (Goodyear Tire and Rubber Company Goodyear) is not ordinary dividends nor accumulated dividends in arrears, to wit: aScITE "In light of the foregoing, the Court therefore holds that the redemption price representing the amount of P97,732,314.00 received by GTRC could not be treated as accumulated dividends in arrears that could be subjected to 15% FWT .Verily, respondent's AFS covering the years 2003 to 2009 show that it did not have unrestricted retained earnings, and in fact, operated from a position of deficit. Thus, absent the availability of unrestricted retained earnings, the board of directors of respondent had no power to issue dividends ... It is also worth mentioning that one of the primary features of an ordinary dividend is that the distribution should be in the nature of a recurring return on stock 46 which, however, does not obtain in this case .As aptly pointed out by the CTA En Banc, the amount of P97,732,314.00 received by GTRC did not represent a periodic distribution of dividend, but rather a payment by respondent for the redemption 47 of GTRC's 3,729,216 preferred shares. ... All told, the amount of P97,732,314.00 received by GTRC from respondent for the redemption of its 3,729,216 preferred shares were not accumulated dividends in arrears . Contrary to petitioner's claims, it is therefore not subject to 15% FWT on dividends in accordance with Section 28 (B) (5) (b) of the Tax Code." (Emphasis ours) In the Wise case, the court ruled that liquidating dividends paid by a foreign subsidiary (Manila Wine Merchants, Ltd.) to its domestic parent (Wise and Company, Inc.) are not ordinary dividends even if they are called 'dividends,' thus: "More than with the distribution of June 8, 1937, is this true with those declared on July 22, 1937, and paid on August 4 and October 28, 1937, respectively (Stipulation of Facts, par. 5, Record on Appeal, p. 21). The distributions thus declared on July 22, 1937, and paid on August 4 and October 28, 1937, were from the surplus of the Hongkong Company resulting from the active conduct of its business and amounting to P74,182.12, which surplus was augmented to a total of P270,116.59 as a result of the sale of its business and assets to the Manila Company (ibid.) .In both Schedules B and B-1 of the Stipulation of Facts (Record on appeal, pp. 16-18),being minutes of directors' meetings of the Hongkong Co.,where authorization and instruction were given to declare and pay in the form of 'dividends' to the shareholders the amounts in question, it was specifically provided that the surplus to be so distributed be that resulting after providing for return of capital and necessary or various expenses, as shown in the balance sheet prepared as of June 1, 1937, and in the reconstructed balance sheet of the same date presented by the company's auditors, it having been resolved in Schedule B-1 that 'any balance remaining to be distributed when final liquidator's account has been rendered and paid" (Record on Appeal, p. 18; emphasis supplied).It thus becomes more evident that those distributions were to be made in the course or as a result of the Hongkong Company's liquidation and that said liquidation was to be complete and final. And although the various resolutions above-mentioned speak of distributions of dividends when referring to those already alluded to, 'a distribution does not necessarily become a dividend by reason of the fact that it is called a dividend by the distributing corporation .' (Holmes Federal Taxes, 6th edition, 774.) The ordinary connotation of liquidating dividend involves the distribution of assets by a corporation to its stockholders upon dissolution. (Klein, Federal Income Taxation, 253-254.) xxx xxx xxx The amounts thus distributed among the plaintiffs were not in the nature of a recurring return on stock in fact, they surrendered and relinquished their stock in return for said distributions, thus ceasing to be stockholders of the Hongkong Company, which in turn ceased to exist in its own right as a going concern during its more or less brief administration of the business as trustee for the Manila Company, and finally disappeared even as such trustee . The distinction between a distribution in liquidation and an ordinary dividend is factual; the result in each case depending on the particular circumstances of the case and the intent of the parties. If the distribution is in the nature of a recurring return on stock it is an ordinary dividend. However, if the corporation is really winding up its business or recapitalizing and narrowing its activities, the distribution may properly be treated as in complete or partial liquidation and as payment by the corporation to the stockholder for his stock. The corporation is, in the latter instances, wiping out all parts of the stockholders' interest in the company. ...(Montgomery, Federal Income Tax Handbook [1938-1939],258) ;(Emphasis ours) Not being dividends but capital gains, paragraph 4, Article 13 (Capital Gains) of the Philippines-Korea tax treaty provides relief as follows: "4. Gains from the alienation of shares of a company, the property of which consists principally of immovable property situated in a Contracting State, may be taxed in that State. Gains from the alienation of interest in a partnership or a trust, the property of which consists principally of immovable property situated in a Contracting State, may be taxed in that State." Under paragraph 4, gains from the alienation of shares of a company, the property of which consists principally of immovable property situated in a Contracting State, may be taxed in that State. Relative thereto, Section 2 (b) of Revenue Regulations No. 4-86 2 defines the term principally of immovable property (as used in tax treaties) to mean that more than 50% of the entire assets of the company in terms of value are immovable property, thus: HEITAD " SECTION 2. Definitions. For purposes of these regulations, the following terms and phrases shall be understood to mean b) 'Principally,' 'wholly or principally,' 'directly principally' or 'attributable' more than fifty percent of the entire assets in terms of value"; Accordingly, since EWP Philippines ,as of December 31, 2013 and immediately prior to the declaration of liquidating dividends, has no immovable property to speak of, its property does not consist principally of immovable property. This being the case, liquidating dividends paid by EWP Philippines to Korea Power ,being in the nature of capital gains, are exempt from income tax pursuant to paragraph 4, Article 13 of the Philippines-Korea tax treaty. Documentary stamp tax Generally, Section 175 of the Tax Code imposes a documentary stamp tax ("DST") on the delivery and transfer of shares or certificates of stock, to wit: " SEC. 175. Stamp Tax on Sales, Agreements to Sell, Memoranda of Sales, Deliveries or Transfer of Shares or Certificates of Stock . On all sales, or agreements to sell, or memoranda of sales, or deliveries, or transfer of shares or certificates of stock in any association, company, or corporation, or transfer of such securities by assignment in blank, or by delivery, or by any paper or agreement, or memorandum or other evidences of transfer or sale whether entitling the holder in any manner to the benefit of such stock, or to secure the future payment of money, or for the future transfer of any stock, there shall be collected a documentary stamp tax of Seventy-five-centavos (P0.75) on each Two hundred pesos (P200),or fractional part thereof, of the par value of such stock: Provided, That only one tax shall be collected on each sale or transfer of stock from one person to another, regardless of whether or not a certificate of stock is issued, indorsed, or delivered in pursuance of such sale or transfer: and Provided, further, That in the case of stock without par value the amount of the documentary stamp tax herein prescribed shall be equivalent to twenty-five percent (25%) of the documentary stamp tax paid upon the original issue of said stock." However, Section 4 of Revenue Regulations No. 13-2004 3 clarifies that the DST is imposed only when there is actual or constructive transfer of beneficial ownership of shares from one person to another ,thus: " SECTION 4. New Rate of DST on Sales, Agreements to Sell, Memoranda of Sales, and Subsequent Transfer of Shares of Stocks. xxx xxx xxx All transfer of shares of stock of a domestic corporation are subject to the DST upon execution of the deed transferring ownership or rights thereto, or upon delivery, assignment or indorsement of such shares in favor of another. No transfer of shares of stock shall be recorded unless DST thereon has been duly paid for in accordance with Section 201 of the Code. For a sale or exchange to be taxable, there must be an actual or constructive transfer of beneficial ownership of the shares of stock from one person to another. Such transfer may be manifested by the clear exercise of attributes of ownership over such stocks by the transferee, or by an actual entry of a change in the name appearing in the certificate of stock or in the Stock and Transfer Book of the issuing corporation or by any entry indicating transfer of beneficial ownership in any form of registry including those of a duly scripless registry, such as those maintained for or by the Philippine Stock Exchange. .." In the case of the dissolution of EWP Philippines ,it is clear that there is no actual or constructive transfer of beneficial ownership of shares from Korea Power (the stockholder) to another person. This is because in the dissolution, those shares will be surrendered to EWP Philippines (the issuer);in turn, EWP Philippines will retire those shares and not retain them; and EWP Philippines will not convert the surrendered shares to treasury shares for the purpose of reissuing them to third parties in the future. This being so, the surrender by Korea Power of its shares in EWP Philippines is not subject to DST. 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. ATICcS Very truly yours, (SGD.) CAESAR R. DULAY Commissioner of Internal Revenue Footnotes 1. Consolidated Regulations Prescribing the Rules on the Taxation of Sale, Barter, Exchange or other Disposition of Shares of Stock Held as Capital Assets. 2. Determination of Whether the Assets of a Corporation Consist Principally of Real Property Interest under the Philippine Tax Treaties. 3. Implementing the Provisions of Republic Act No. 9243, An Act Rationalizing the Provisions on the Documentary Stamp Tax of the National Internal Revenue Code of 1997, as Amended, and for Other Purposes.