ITAD BIR Ruling No. 119-13

April 24, 2013 ITAD BIR RULING NO. 119-13 Article 10, Philippines-Japan tax treaty Maximus Management Holdings, Inc. 36th Floor, GT Tower International 6815 Ayala Avenue 1200 Makati City Attention: Takeshi Arai Vice President Gentlemen : This refers to your tax treaty relief application filed on July 27, 2012 requesting for confirmation that dividends paid by Maximus Management Holdings, Inc. ("Maximus") to Mitsui & Co., Ltd. ("Mitsui Japan") are subject to a preferential tax rate of 10 percent pursuant to 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 as amended by a Protocol 1 ("Philippines-Japan tax treaty") . It is represented that Mitsui Japan is a foreign corporation organized and existing under the laws of Japan with its principal office address at 1-2-1 Ohtemachi, Chiyoda-ku, Tokyo, Japan based on its Residence Certificate issued by the District Director of Kojimachi Tax Office on July 22, 2011; that Mitsui Japan is registered and licensed to engage in business in the Philippines based on the Certification issued by the Securities and Exchange Commission on July 2012; and that on the other hand, Maximus is a domestic corporation situated at the 36th Floor GT Tower International, 6815 Ayala Avenue, Makati City. It is further represented that during the Special Meeting of the Board of Directors of Maximus held on July 2, 2012, Maximus declared cash dividends in the amount of PhP195,878,516.54 in favor of its Class B Stockholders to be paid not later than September 30, 2012 based on the Certificate issued by the Corporate Secretary of Maximus on July 23, 2012; that Mitsui Japan owns Sixty Thousand Three Hundred Forty-Two (60,342) shares of stock or 40% of the entire stockholdings of Maximus with a total par value of Six Hundred Sixty-Three Million Seven Hundred Sixty-Two Thousand Pesos (PhP663,762,000.00) computed at Eleven Thousand Pesos (PhP11,000.00) per share, the breakdown of which is as follows: Date Acquired Number of Amount Mode of Acquisition Common Shares August 25, 1999 15,497 170,467,000.00 Initial Capital 1 11,000.00 Acquired share from Mr. Hosoya September 16, 1999 35,792 393,712,000.00 Increase in Subscribed Capital October 19, 1999 9,052 99,572,000.00 Increase in Subscribed Capital based on the Certification issued by the Corporate Secretary of Maximus on July 23, 2012; and that although Mitsui Japan has a branch here in the Philippines, the investment of Mitsui Japan in Maximus was acquired using Mitsui Japan 's funds from Japan and without the participation of Mitsui-Phil branch, based on the Certification issued by the General Manager of Mitsui & Co. Ltd. Manila Branch on March 6, 2013. It is further represented that first payment was made on August 15, 2012 based on the computer print-out certified by the Metropolitan Bank and Trust Company on even date. It is finally represented that the dividends subject of this ruling are 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 same Corporate Secretary of Maximus on July 23, 2012. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, provides that dividends paid to Mitsui Japan, being a foreign corporation not engaged in trade or business in the Philippines, are subject to income tax at the rate 30 percent, thus: "Section 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-five percent (35%) of the gross income received during each taxable year from all sources within the Philippines, such as . . ., dividends, . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, Section 32 (B) (5) of the Code provides that such dividends may be exempt from income tax or subject to a reduced rate to the extent required by any treaty obligation on the Philippines, thus: "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. xxx xxx xxx" In this particular case, you invoke the Philippines-Japan tax treaty. Paragraphs 1, 2 and 3, Article 10 thereof provide: "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) 15 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. xxx xxx xxx" Based on the aforequoted provisions, dividends arising in the Philippines and paid to a resident of Japan may be taxed in the Philippines at a rate not to exceed: (a) 10 percent if the company recipient of the dividends holds directly at least 25 percent of the voting shares or the total shares of the company paying the dividends for a period of six months immediately preceding the date of payment of the dividends; (b) 10 percent if the dividends are paid by a domestic company registered with the Board of Investments and engaged in preferred pioneer areas of investment under the incentive laws of the Philippines; and (c) 15 percent in all other cases. However, under paragraph 5 of Article 10, the Philippines, being the source of the dividends, is not obliged to limit the tax rates on dividends under paragraphs 2 and 3 of the article if the holding in respect of which the dividends are paid is effectively connected with a permanent establishment which Mitsui has in the Philippines. Under paragraph 2 (b), Article 5 of the tax treaty, Mitsui-Phil branch, being the branch office in the Philippines of Mitsui, is considered a permanent establishment of Mitsui, 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. 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." On the question of whether dividends are 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 17, 2008) mention that such dividends are effectively connected if they are 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)." (Emphasis supplied) (Pages 156-157) 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), 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 dividends 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." (Emphasis supplied) Accordingly, the holdings in respect of the dividends paid by Maximus to Mitsui Japan are not effectively connected with Mitsui-Phil branch since they are not paid in respect of holdings forming part of the assets of Mitsui-Phil branch or otherwise effectively connected therewith, and since the business activities that give rise to such dividends are not conducted through Mitsui-Phil branch. This is because, based on the pertinent Certification issued by Mitsui-Phil branch, Mitsui-Phil branch has no investments nor owns shares of stock in Maximus; does not use or hold for use in the conduct of its trade or business any shares of stock in Maximus; the head office of Mitsui in Japan acquired such shares in Maximus directly and without the participation of Mitsui-Phil branch; dividends arise from these shares inure to the sole benefit of Mitsui and Mitsui-Phil branch did not receive any of these dividends; and Mitsui-Phil branch is not a material factor in the realization of dividends received by the Mitsui. This being the case, and considering that Mitsui Japan holds 40 percent of the total shares of Maximus during a period of six months immediately preceding the date of payment of the dividends, this Office is of the opinion and so holds that such dividends paid by Maximus to Mitsui Japan are subject to income tax at a preferential rate of 10 percent based on the gross amount thereof, pursuant to paragraph 2 (a), Article 10 of the Philippines-Japan tax treaty. (BIR Ruling No. ITAD-204-11 dated August 3, 2011) 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.) 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.