ITAD BIR Ruling No. 140-12

March 28, 2012 ITAD BIR RULING NO. 140-12 Articles 5 and 10, Philippines-Japan tax treaty, as amended Sycip Gorres Velayo & Co. 6760 Ayala Avenue Makati City 1226 Attention: Wilfredo U. Villanueva Principal, Tax Services Gentlemen : This refers to your application for tax treaty relief dated June 9, 2011 requesting confirmation that dividends paid by First Philippine Industrial Park, Inc. ("First Philippine") to Sumitomo Corporation ("Sumitomo") are subject to income tax at the 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 ("Philippines-Japan tax treaty"). 1 Facts It is represented that Sumitomo is a corporation organized and existing under the laws of Japan and is a resident thereof based on its Articles of Incorporation, as amended, and on the Residence Certificate issued by the Kyobashi Taxation Office in Japan on June 1, 2011; that Sumitomo is situated at 1-8-11, Harumi, Chuo-ku, Tokyo, Japan; that based on the Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission ("SEC") on June 6, 2011, Sumitomo is licensed by SEC to engage in trade or business in the Philippines under SEC Registration No. F000000492 issued on March 20, 1967; that to date, it has not filed a petition to cancel or withdraw such license; and that, on the other hand, First Philippine is a domestic corporation situated at Barangay Santa Anastacia, Santo Tomas, Batangas, Philippines. It is further represented based on the Certificates issued by the Corporate Secretary of First Philippine on June 1 and 10, 2011 and on the General Information Sheet of Sumitomo in 2010, that First Philippine (through its Board of Directors which held a meeting on May 12, 2011) declared cash dividends of P60,000,000.00 in favor of Sumitomo, payable on or before June 15, 2011; and that since October 13, 1998 up to present, Sumitomo owns 3,471,427 (P347,142,700.00) of the 1,157,143,000 shares of stock of First Philippine equivalent to 29.99 percent of the total shares. ITCHSa It is further represented based on the Affidavit issued by the Treasurer of Sumitomo Corporation Manila Branch ("Sumitomo Philippine Branch") on June 8, 2011, that Sumitomo is the legal and beneficial owner of 3,471,430 shares of stock of First Philippine; that 347,143 of these shares are recorded in the books of Sumitomo Philippine Branch but such recording is merely based on an internal arrangement between Sumitomo and Sumitomo Philippine Branch; that Sumitomo Philippine Branch does not use or hold for use in the conduct of its trade or business any shares of stock of First Philippine; that all gains arising from these shares inure solely to the benefit of Sumitomo and that Sumitomo Philippine Branch is not a material factor in the realization of such gains; and that Sumitomo Philippine Branch is situated at 35th Floor, Philamlife Tower, Paseo de Roxas, Makati City, Philippines. It is finally represented that the dividends subject of this ruling are not subject of investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Sworn Statement issued by the Assistant Vice President for Finance of First Philippine on June 1, 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, dividends paid to Sumitomo are 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-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: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)". ATcEDS However, under Section 32 (B) (5) of the Tax Code, 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: "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, 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 10 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; ESCacI 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." Under paragraphs 2 and 3 of Article 10, 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 10 percent of the voting shares or the total shares of the company paying the dividends during the 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 investment incentives laws of the Philippines; and (c) 15 percent in all other cases. However, under paragraph 5, Article 10 of the tax treaty, the reduced rates of income tax will not apply if the shares in respect of which the dividends are paid are effectively connected with Sumitomo Philippine Branch, a permanent establishment of Sumitomo in the Philippines, thus: "5. The provisions of paragraphs 1, 2 and 3 shall not apply if the beneficial owner of the dividends, being a resident of a Contracting State, carries on business in the other Contracting State of which the company paying the dividends is a resident, through a permanent establishment situated therein, or performs in that other Contracting State independent personal services from a fixed base situated therein, and the holding in respect of which the dividends are 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." Under paragraphs 1 and 2, Article 5 of the tax treaty, a fixed place of business like an office or a branch is considered a permanent establishment, thus: cCSDTI "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 ; xxx xxx xxx" On the question of dividends being effectively connected with a permanent establishment, the following commentaries of the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (Condensed Version, July 2010) 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: "Paragraph 4 31. 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 source and in the State of the beneficiary's residence when the beneficiary has a permanent establishment in the former State. Paragraph 4 is not based on such a 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 of 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 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. (Page 193)" Similarly, in Marubeni Corporation vs. Commissioner of Internal Revenue and the Court of Tax Appeals (G.R. No. 76573 dated September 14, 1989), the Supreme Court mentioned that dividends derived by a foreign corporation which has a branch office in the Philippines are effectively connected with the branch office if the business activities that give rise to such dividends are conducted through the branch office following a principal-agent relationship theory between the foreign corporation and the branch office, 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." cDICaS Accordingly, since 10 percent (347,143 of 3,471,430) of the shares of stock of Sumitomo in First Philippine is recorded in the books of Sumitomo Philippine Branch thereby forming part of the latter's assets in the Philippines, dividends arising from the portion of these shares are effectively connected with Sumitomo Philippine Branch. On the other hand, the other 90 percent of the shares held by Sumitomo are not effectively connected with Sumitomo Philippine Branch provided dividends arising therefrom are remitted directly to Sumitomo. As to dividends not effectively connected with Sumitomo Philippine Branch, these dividends paid by First Philippine to Sumitomo are subject to income tax at the rate of 10 percent of the gross amount thereof, pursuant to paragraph 2 (a), Article 10 of the Philippines-Japan tax treaty. On the other hand, as to dividends effectively connected with Sumitomo Philippine Branch, these dividends paid by First Philippine to Sumitomo or Sumitomo Philippine Branch are included in the taxable income 2 of Sumitomo Philippine Branch and subject to income tax at the rate of 30 percent under Section 28 (A) of the Tax Code, thus: "SEC. 28. Rates of Income Tax on Foreign Corporations. (A) Tax on Resident Foreign Corporation. (1) In General. Except as otherwise provided in this Code, a foreign corporation organized, authorized, or existing under the laws of any foreign country, engaged in trade or business within the Philippines, shall be subject to an income tax equivalent to thirty-five percent (35%) of the taxable income derived in the preceding taxable year from all sources within the Philippines: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." 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. aDSAEI Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. As amended by the 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. "SEC. 31. Taxable Income Defined. The term 'taxable income' means the pertinent items of gross income specified in this Code, less the deductions and/or personal and additional exemptions, if any, authorized for such types of income by this Code or other special laws."