ITAD BIR Ruling No. 115-12

March 8, 2012 ITAD BIR RULING NO. 115-12 Article 11, Philippines-Japan Tax Treaty, as amended; BIR Ruling No. ITAD-115-11 JSResources Philippines, Inc. 17th Floor, 6788 Ayala Avenue cor. Oledan Square Makati City 1229 Attention: Takeo Inoue President Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on June 28, 2011, requesting confirmation that the interests paid to JFE Shoji Trade Corporation ("JFE-Japan") by JSResources Philippines, Inc. ("JSResources") are subject to final withholding tax at a rate of 10 percent preferential tax rate, pursuant to Article 11 of the amended 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"). It is represented that JFE-Japan, with address at 1-6-20 Doujima, Kita-ku, Osaka, Japan, is a corporation organized and existing under the laws of Japan, and is a resident of Japan per the Residence Certificate issued by the District Director of KITA Tax Office dated May 12, 2011; that it has a branch office in the Philippines ("JFE-Manila Branch") per certification issued by the Securities and Exchange Commission dated May 18, 2011; and that, on the other hand, JSResources is a corporation organized and existing under the laws of the Philippines with principal address at 17th Floor, 6788 Ayala Avenue corner Oledan Square, Makati City; that per the Corporate Secretary's Certificate issued by JSResources dated June 2, 2011, JFE-Japan is a stockholder of record of 29,999,995 shares representing 99.99% of the outstanding and common shares of JSResources. It is further represented that on December 1, 2010, a Revolving Loan Facility Agreement ("Agreement") was executed by and between JFE-Japan and JSResources whereby the former agrees to provide the latter with a credit facility for a maximum amount of Three Million Two Hundred Seventy Thousand United States Dollars (USD3,270,000.00), as working capital and capital investment of JSResources; that the loan has an interest rate of 1.475% per year and shall mature on November 30, 2011; that the said Agreement was amended on March 28, 2011, increasing the principal amount to Four Million Four Hundred Seventy Thousand United States Dollars (US$4,470,000.00); that per the Corporate Secretary's Certificate issued on September 28, 2011 by JFE-Manila Branch, although JFE-Japan has a branch here in the Philippines, said branch office is neither a material factor in the realization of interest paid by JSResources to JFE-Japan, and that the subject interest will neither be used in, nor be held for use in, the conduct of the trade or business of JFE-Manila Branch. ASDTEa It is finally represented, based on the Sworn Certification issued by JSResources on June 16, 2011, that the transaction subject of the request for 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 of the taxpayer/s involved. In reply, please be informed that interest income derived by a nonresident foreign corporation is generally taxable under Section 28 (B) (5) (a) of the National Internal Revenue Code of 1997 (NIRC of 1997), as amended. It provides: "Section 28. Rates of Income Tax on Foreign Corporations. (B) Tax on Nonresident Foreign Corporation. xxx xxx xxx (5) Tax on Certain Incomes Received by a Nonresident Foreign Corporation. (a) Interest on Foreign Loans. A final withholding tax at the rate of twenty percent (20%) is hereby imposed on the amount of interest on foreign loans contracted on or after August 1, 1986; However, said income may be exempt from income tax or partially exempt pursuant to a treaty obligation to which the Philippine government is bound. Thus, Section 32 (B) (5) of the NIRC of 1997, as amended, provides: "Section 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." Thus, Article 11 of the Philippines-Japan tax treaty, as amended, which you invoke, may apply to the instant case. It states: EHSADc "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 5. 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." Based on the above provisions, interest derived by a corporation which is a resident of Japan may qualify for a preferential rate of 10 percent of the gross amount thereof, under the Philippines-Japan tax treaty, as amended, if the recipient of such interest is also the beneficial owner thereof. However, the 10 percent 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. However, under paragraph 5 of Article 11, the Philippines, being the source of the interest, is not obliged to limit the tax rates on interest under paragraphs 2 and 3 of the article if the holding in respect of which the interest is paid is effectively connected with a permanent establishment which JFE-Japan has in the Philippines. Under paragraph 2 (b), Article 5 of the tax treaty, JFE-Manila Branch, being the branch office in the Philippines of JFE-Japan, is considered a permanent establishment of JFE-Japan, thus: "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. CcAITa 1. 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." On the question of whether the interest is effectively connected with a permanent establishment, the following commentaries of the Organisation for Economic Co-operation and Development ("OECD") Model Tax Convention on Income and on Capital (Condensed Version, July 21, 2010) mention that such interest is effectively connected if it is paid in respect of holdings forming part of the assets of the permanent establishment or otherwise effectively connected with that establishment, thus: "24. Certain States consider that dividends, interest and royalties arising from sources in their territory and payable to individuals or legal persons who are residents of other States fall outside the scope of the arrangement made to prevent them from being taxed both in the State of the beneficiary's residence when the beneficiary has a permanent establishment in the former State. Paragraph 4 (paragraph 5 of Article 10 of the Philippines-Japan tax treaty) is not based on such conception which is sometimes referred to as 'the force of attraction of the permanent establishment.' It does not stipulate that dividends flowing to a resident of a Contracting State from a source situated in the other State must, by a kind of legal presumption, or fiction even, be related to a permanent establishment which that resident may have in the latter State, so that the said State would not be obliged to limit its taxation in such a case. The paragraph merely provides that in the State of source the dividends are taxable as part of the profits of the permanent establishment there owned by the beneficiary which is a resident in the other State, if they are paid in respect of holdings forming part of the assets of the permanent establishment or otherwise effectively connected with that establishment . In that case, paragraph 4 (paragraph 5 of Article 10 of the Philippines-Japan tax treaty) relieves the State of source of the dividends from any limitations under the Article. The foregoing explanations accord with those in the Commentary on Article 7 (on Business Profits)." (Underscoring supplied) cSaATC Similarly, following 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), income (in this case, dividends) derived by a foreign corporation can become effectively connected with its branch office in the Philippines if the business activities that give rise to such income are conducted through the branch office, following the principal-agent relationship theory, thus: " 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." (Underscoring supplied) Accordingly, the interests paid by JSResources to JFE-Japan are not effectively connected with JFE-Manila Branch since they are not paid in respect of holdings forming part of the assets of JFE-Manila Branch, and since the business activities that give rise to such interest are not conducted through JFE-Manila Branch. This is because the Loan Agreement was executed between JFE-Japan and JSResources directly and without the participation of JFE-Manila Branch; interests arising from the loan inure to the sole benefit of JFE-Japan and JFE-Manila Branch did not receive any of these interests; and, therefore, JFE-Manila Branch is not a material factor in the realization of interest received by JFE-Japan. In view of the foregoing, and considering that interest paid to JFE-Japan is not effectively connected to its branch office, this office is of the opinion and so holds that the interest derived by JFE-Japan from JSResources under the Agreement, paid starting from the date of the filing of this TTRA on June 28, 2011, are subject to Philippine income tax at the rate of 10 percent of the gross amount thereof pursuant to Article 11 (2) of the Philippines-Japan tax treaty, as amended. (BIR Ruling No. ITAD-115-11 dated April 11, 2011) Moreover, the drawdown Notice under the Agreement is subject to documentary stamp tax imposed under Section 179 of the Tax Code of 1997, as amended, at the rate of One Peso (P1.00) on each Two Hundred Pesos (P200) or fractional part thereof. HCEISc This ruling is issued on the basis of the foregoing 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.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue