ITAD BIR Ruling No. 141-11

May 2, 2011 ITAD BIR RULING NO. 141-11 Articles 5 and 10, Philippines-Japan tax treaty, as amended; BIR Ruling No. ITAD-007-10; BIR Ruling No. ITAD-073-11 Isla Lipana & Co. 29th Floor, Philamlife Tower 8767 Paseo de Roxas 1226 Makati City Attention: Malou P. Lim Partner, Tax Services Gentlemen : This refers to your letter dated April 5, 2010, on behalf of your client, NTT Communications Corporation ("NTT Communications") , requesting confirmation that dividends paid by the Philippine Long Distance Telephone Company ("PLDT") to NTT Communications are subject to a reduced rate of income tax of 15 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 effective January 1, 2009 ("Philippines-Japan tax treaty, as amended"). It is represented that NTT Communications is a corporation organized and existing under the laws of Japan and is a resident thereof based on the Certificate of Residence issued by the Koji-Machi Tax Office in Japan on March 12, 2010; that NTT Communications is situated at 1-1-6 Uchisaiwai-cho, Chiyoda-ku, Tokyo, Japan; that NTT Communications is licensed to establish a branch office in the Philippines on January 28, 2000, and that to date, it has not filed a petition to withdraw or cancel such license, based on the Certificate of Filing/Information issued by the Securities and Exchange Commission on May 12, 2010; and that, on the other hand, PLDT is a domestic corporation situated at Ramon Cojuangco Building, Makati City, Philippines. It is further represented that on March 2, 2010, the Board of Directors of PLDT, at its meeting, declared regular cash dividends of Seventy-Six pesos (PhP76.00) per outstanding common share of stock and special cash dividends of Sixty-Five pesos (PhP65.00) per outstanding common share of stock, in favor of the stockholders of record of PLDT as of March 17, 2010, based on the Certificate issued by the Corporate Secretary of PLDT on March 12, 2010; that the dividends are payable on April 20, 2010, and will be taken out of the unaudited and unrestricted retained earnings of PLDT as of December 31, 2009; and that as of March 6, 2006 to present, NTT Communications holds 12,633,487 common shares of stock of PLDT amounting to PhP32,594,396,460.00, which represents 6.73 percent ownership in PLDT, based on the Certifications issued by the Assistant Manager for Stock Transfer of the Hongkong and Shanghai Banking Corporation Ltd 2 on March 30, 2010. It is further represented that NTT Communications Corporation-Philippine Branch ("NTT Communications Branch Office") , being the branch office of NTT Communications in the Philippines, situated at 9th Floor, MGO Building, Legaspi Street corner Dela Rosa Street, Makati City, Philippines, is not a material factor in the realization of dividends paid by PLDT to the head office of NTT Communications in Japan, based on the Sworn Certification issued by the General Manager of NTT Communication Branch Office on April 30, 2010; that the dividends are not realized in the ordinary course of trade or business of NTT Communications Branch Office; and that the shares of stock in PLDT that give rise to the dividends are not used in, or held for use in, the conduct of trade or business of NTT Communications Branch Office. ETDHSa 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 Sworn Statement issued by the Assistant Vice President of PLDT on March 17, 2010. 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 NTT Communications are subject to income tax at the rate of 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 interest, 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): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." However, Section 32 (B) (5) of the same Code provides that such dividends may be exempt from 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" Relative thereto, you invoke the Philippines-Japan tax treaty, as amended. Paragraphs 1, 2, 3 and 5, 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: aCcEHS 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; b) 15 per cent of the gross amount of the dividends in all other cases. 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 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. xxx xxx xxx." Based on the aforequoted provisions, dividends arising in the Philippines and derived by 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 issued by 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, the limitation of tax on dividends under paragraphs 2 and 3 of Article 10 does not apply if the dividends are effectively connected with a permanent establishment which the company recipient of the dividends has in the Philippines. Relative thereto, since NTT Communications has a branch in the Philippines, namely, NTT Communications Branch Office, it is deemed to have a permanent establishment in the Philippines under paragraphs 1 and 2, Article 5 of the Philippines-Japan tax treaty, as amended, 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: CIHTac 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." (emphasis supplied) According to the following commentaries of the Organisation for Economic Cooperation and Development (OECD) Model Tax Convention on Income and on Capital (Condensed Version, July 17, 2008) , dividends are effectively connected with a permanent establishment 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, according to the following pronouncement of 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 which has a branch office in the Philippines are effectively connected with the branch office if the business activities that give rise to the dividends are conducted through the branch office following a principal-agent relationship 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. " (Emphasis ours) Accordingly, since NTT Communications Branch Office is not a material factor in the realization of dividends paid by PLDT to the head office of NTT Communications in Japan, inasmuch as the dividends are not realized in the ordinary course of trade or business of NTT Communications Branch Office, and the shares of stock in PLDT that give rise to the dividends are not used in, or held for use in, the conduct of trade of business of NTT Communications Branch Office, this Office is of the opinion and so holds that dividends paid by PLDT to NTT Communications are not effectively connected with NTT Communications Branch Office. Such being the case and considering that NTT Communications does not hold directly at least 10 percent of the common (voting) shares of stock or the total shares of stock of PLDT (in fact, it merely holds 6.73 percent of the total shares of PLDT), and considering further that PLDT is not registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines, the dividends paid by PLDT to NTT Communications are subject to income tax at the rate of 15 percent of the gross amount thereof, pursuant to paragraph 2 (b), Article 10 of the Philippines-Japan tax treaty, as amended (BIR Ruling No. ITAD 073-11 dated March 2, 2011; BIR Ruling No. ITAD 007-10 dated May 20, 2010) aEHIDT 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 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. 2. Situated at HSBC Centre, Fifth Avenue West, Bonifacio Global City, Taguig City, Philippines.