ITAD BIR Ruling No. 107-14

July 21, 2014 ITAD BIR RULING NO. 107-14 Articles 5 (Permanent Establishment) and 12 (Interest), Philippines-United States tax treaty Angara Abello Concepcion Regala and Cruz Law Offices 22nd Floor, ACCRALAW Tower 2nd Avenue corner 30th Street Crescent Park West, Bonifacio Global City, Taguig Attention: Atty. Ruby Rose J. Yusi Atty. Katherine L. Soto Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on July 12, 2011 requesting confirmation that interest paid by Allegro Microsystems Philippines, Inc. ("Allegro Philippines") to Allegro Microsystems, Inc. ("Allegro") is subject to income tax at the rate of 15 percent pursuant to the Convention between the Government of the Republic of the Philippines and the Government of the United States of America with Respect to Taxes on Income ("Philippines-United States tax treaty"). Facts Allegro is a foreign corporation and a resident of the United States based on its Amended and Restated Certificate of Incorporation filed at the State of Delaware in the United States on July 19, 2007, and its Certificate of Residence issued by the Internal Revenue Service of the United States on April 11, 2011. Allegro is located at 115 Northeast Cutoff Worcester, Massachusetts, United States. Based on the Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission on June 16, 2011, Allegro is licensed to establish a regional or area headquarters in the Philippines on July 15, 1998 under Registration No. F199800011 and to date no petition is filed to withdraw or cancel such license. On the other hand, Allegro Philippines is a domestic corporation located at Sampaguita Street, Marimar Village, Barangay La Huerta, Paraaque City, Philippines. CAHaST On August 3, 2010 , Allegro and Allegro Philippines entered into a Loan Agreement where Allegro granted loans to Allegro Philippines totaling $11,000,000.00 to finance Allegro Philippines' expansion of its place of business. The loans will be drawn on August 3, 2010 ($4,000,000.00), November 3, 2010 ($4,000,000.00), and February 3, 2011 ($3,000,000.00). Based on the Certification issued by Banco de Oro Unibank, Inc. 1 on June 30, 2011, the loans were remitted on those dates under the following transaction numbers: FSA704068162EXD, FSA704073068EXD and FSA704077788EXD. Each loan bears a fixed rate of interest of 4.30 percent per annum payable annually. The loans will be repaid as follows: First loan amounting $4,000,000.00 dated August 3, 2010 Date of Payment Amount of Amount of Outstanding Principal Repaid Interest Paid Balance (in US Dollars) (in US Dollars) (in US Dollars) August 3, 2010 - - 4,000,000.00 3-Aug-11 195,352.00 172,000.00 3,804,648.00 3-Aug-12 203,752.00 163,600.00 3,600,896.00 August 3, 2013 212,513.00 154,839.00 3,388,383.00 August 3, 2014 221,652.00 145,700.00 3,166,731.00 August 3, 2015 231,183.00 136,169.00 2,935,548.00 August 3, 2016 241,123.00 126,229.00 2,694,425.00 August 3, 2017 251,492.00 115,860.00 2,442,933.00 August 3, 2018 262,306.00 105,046.00 2,180,627.00 August 3, 2019 273,585.00 93,767.00 1,907,042.00 August 3, 2020 285,349.00 82,003.00 1,621,693.00 August 3, 2021 297,619.00 69,733.00 1,324,074.00 August 3, 2022 310,417.00 56,935.00 1,013,657.00 August 3, 2023 323,765,00 43,587.00 689,892.00 August 3, 2024 337,687.00 29,665.00 352,206.00 August 3, 2025 352,206.00 15,146.00 - Total 4,000,001.00 1,510,279.00 ========== ========== Second loan amounting $4,000,000.00 dated November 3, 2010 Date of Payment Amount of Amount of Outstanding Principal Repaid Interest Paid Balance (in US Dollars) (in US Dollars) (in US Dollars) November 3, 2010 - - 4,000,000.00 November 3, 2011 195,352.00 172,000.00 3,804,648.00 November 3, 2012 203,752.00 163,600.00 3,600,896.00 November 3, 2013 212,513.00 154,839.00 3,388,383.00 November 3, 2014 221,652.00 145,700.00 3,166,731.00 November 3, 2015 231,183.00 136,169.00 2,935,548.00 November 3, 2016 241,123.00 126,229.00 2,694,425.00 November 3, 2017 251,492.00 115,860.00 2,442,933.00 November 3, 2018 262,306.00 105,046.00 2,180,627.00 November 3, 2019 273,585.00 93,767.00 1,907,042.00 November 3, 2020 285,349.00 82,003.00 1,621,693.00 November 3, 2021 297,619.00 69,733.00 1,324,074.00 November 3, 2022 310,417.00 56,935.00 1,013,657.00 November 3, 2023 323,765.00 43,587.00 689,892.00 November 3, 2024 337,687.00 29,665.00 352,206.00 November 3, 2025 352,206.00 15,146.00 - Total 4,000,001.00 1,510,279.00 ========== ========== Third loan amounting $3,000,000.00 dated February 3, 2011 Date of Payment Amount of Amount of Outstanding Principal Repaid Interest Paid Balance (in US Dollars) (in US Dollars) (in US Dollars) February 3, 2011 - - 3,000,000.00 February 3, 2012 146,514.00 129,000.00 2,853,486.00 February 3, 2013 152,814.00 122,700.00 2,700,672.00 February 3, 2014 159,385.00 116,129.00 2,541,287.00 February 3, 2015 166,239.00 109,275.00 2,375,048.00 February 3, 2016 173,387.00 102,127.00 2,201,661.00 February 3, 2017 180,843.00 94,671.00 2,020,818.00 February 3, 2018 188,619.00 86,895.00 1,832,199.00 February 3, 2019 196,729.00 78,785.00 1,635,470.00 February 3, 2020 205,189.00 70,325.00 1,430,281.00 February 3, 2021 214,012.00 61,502.00 1,216,269.00 February 3, 2022 223,214.00 52,300.00 993,055.00 February 3, 2023 232,813.00 42,701.00 760,242.00 February 3, 2024 242,824.00 32,690.00 517,418.00 February 3, 2025 253,265.00 22,249.00 264,155.00 February 3, 2026 264,155.00 11,359.00 - Total 3,000,002.00 1,132,708.00 ========== ========== All payments will be made in US dollars and remitted to Allegro 's account at Bank of America in the United States. Based on the Sworn Statement issued by the Regional Office of Allegro in the Philippines (" Allegro Regional Office ") on March 31, 2012, the transaction between Allegro and Allegro Philippines under the Loan Agreement is not connected to Allegro Regional Office. Allegro Regional Office is located at Suite 2500, 25th Floor, 88 Corporate Center, 141 Valero corner Sedeo Streets, Salcedo Village, Makati City, Philippines. Ruling In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code of 1997 (" Tax Code "), as amended, provides: "SEC. 28. Rates of Income Tax on Foreign Corporations. EIcTAD (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 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: n Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." However, such royalties may be exempt or subject to a reduced rate to the extent required by any treaty obligation on the Philippines. Section 32 (B) (5) of the Code provides: "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: (5) Income Exempt under Treaty. Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines." Relative thereto, Article 12 of the Philippines-United States tax treaty provides: "Article 12 Interest 1. Interest derived by a resident of one of the Contracting States from sources within the other Contracting State may be taxed by both Contracting States. DIEAHc 2. Interest derived by a resident of one of the Contracting States from sources within the other Contracting State shall not be taxed by the other Contracting State at a rate in excess of 15 percent of the gross amount of such interest. 3. Interest derived by a resident of one of the Contracting States from sources within the other Contracting State with respect to public issues of bonded indebtedness shall not be taxed by the other Contracting State at a rate in excess of 10 percent of the gross amount of such interest. xxx xxx xxx 5. Paragraphs 2, 3, and 4 shall not apply if the recipient of interest from sources within one of the Contracting States, being a resident of the other Contracting State, carries on business in the first-mentioned Contracting State through a permanent establishment situated therein or performs in that other 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 a case, the provisions of Article 8 (Business Profits) or Article 15 (Independent Personal Services), as the case may be, shall apply." Under Article 12, interest arising in the Philippines and paid to a resident of the United States may be taxed in the Philippines at a rate not to exceed (a) 10 percent if the interest is paid in respect of public issues of bonded indebtedness in the Philippines, and (b) 15 percent in all other cases. However, the reduction of tax will not apply if the interest is effectively connected with a permanent establishment (if the recipient is an enterprise) or a fixed base (if the recipient is an individual performing independent personal services) which the recipient has in the Philippines. Accordingly, since the interest subject of the Loan Agreement is not paid in respect of public issues of bonded indebtedness in the Philippines, such interest paid by Allegro Philippines to Allegro shall be subject to income tax at the rate of 15 percent pursuant to paragraph 2, Article 12 of the Philippines-United States tax treaty. HCTAEc On the question of permanent establishment, the fact that Allegro has an office in the Philippines in Allegro Regional Office makes the latter a permanent establishment of Allegro in the Philippines, under paragraph 2 (c), Article 5 of the treaty, to wit: " Article 5 PERMANENT ESTABLISHMENT 1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which a resident of one of the Contracting States engages in a trade or business. 2. The term 'fixed place of business' includes but is not limited to: a) A seat of management; b) A branch; c) An office ;" (Emphasis ours) On the question of income being effectively connected with a permanent establishment, 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), ruled that the taxation of income derived by a foreign corporation which has a branch office in the Philippines will be taxed as income of the branch office only if the business transaction that gives rise to the income has been conducted by the foreign corporation through the branch office , to wit: "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." cIHSTC Accordingly, since the Loan Agreement that gives rise to the interest is solely between Allegro Philippines and Allegro and it does not involve Allegro Regional Office , such interest is not and cannot be made effectively connected with Allegro Regional Office . This is buttressed by the fact that the amount of the loans were remitted directly by Allegro to Allegro Philippines at the latter's bank Account in Banco de Oro Unibank in the Philippines, and that the principal and interest of the loan will be remitted directly by Allegro Philippines to Allegro at the latter's bank Account in Bank of America in the United States. This being the case, such interest paid by Allegro Philippines to Allegro shall be subject to a reduced rate of tax of 15 percent pursuant to paragraph 2, Article 12 of the Philippines-United States tax treaty, as earlier ruled. Finally, under Section 179 of the National Internal Revenue Code of 1997, as amended, the Loan Agreement are subject to documentary stamp tax equivalent to P1.00 for every P200.00 (or a fraction thereof) of the amount of each loan (the Philippine peso equivalent of the total loans of $11,000,000.00), to wit: "SEC. 179. Stamp Tax on All Debt Instruments. On every original issue of debt instruments, there shall be collected a documentary stamp tax of One peso (P1.00) on each Two hundred pesos (P200), or fractional part thereof, of the issue price of any such debt instrument: Provided, That for such debt instruments with terms of less than one (1) year, the documentary stamp tax to be collected shall be of a proportional amount in accordance with the ratio of its terms in number of days to three hundred sixty-five (365) days: Provided, further, That only one documentary stamp tax shall be imposed on either loan agreement, or promissory notes issued to secure such loan." 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. TCcDaE Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Located at BDO Corporate Center, 7899 Makati Avenue, Makati City, Philippines. n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.