ITAD BIR Ruling No. 155-14

August 18, 2014 ITAD BIR RULING NO. 155-14 Article 10, Philippines-Japan tax treaty, as amended Castillo Laman Tan Pantaleon & San Jose Law Firm The Valero Tower, 122 Valero Street Salcedo Village, 1227 Makati City Attention: Maria Victoria D. Sarmiento Gentlemen : This refers to your tax treaty relief application filed on March 27, 2014 requesting confirmation that dividends paid by Davao Central Chemical Corporation ("Davao Central") to Mitsubishi Corporation ("Mitsubishi") 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, as amended") . It is represented that Mitsubishi is a foreign corporation organized and existing under the laws of Japan and a resident thereof based on its amended Articles of Incorporation and Residence Certificate issued by the Kojimachi Tax Office in Japan on February 21, 2014; that Mitsubishi is located at 3-1, Marunouchi 2-chome, Chiyado-Ku, Tokyo, Japan; that Mitsubishi has a permanent establishment in the Philippines in the nature of branch , namely, Mitsubishi Corporation-Manila Branch ("Mitsubishi Manila Branch") , which is registered with and licensed by the Securities and Exchange Commission under SEC Registration No. F000000491; Mitsubishi Manila Branch is located at 14th Floor, LV Locsin Building, 6752 Ayala Avenue corner Makati Avenue, Makati City, Philippines; and that, on the other hand, Davao Central is a domestic corporation with principal office address at Kilometer 19 Tibungco, Davao City, Philippines. It is also represented based on the Secretary's Certificate issued on March 27, 2014, that the Board of Directors of Davao Central, at a special meeting on the same date, unanimously approved a resolution declaring cash dividends amounting to P15,170,400.00 in favor of the company's shareholders of record as of March 27, 2014, and payable on March 31, 2014; that the dividends will be taken out of the unrestricted retained earnings of Davao Central as of December 31, 2013; that as of record date on March 27, 2014, Mitsubishi holds 20 percent of the total shares of stock issued by Davao Central as described hereunder: Stockholder Number and Mode of Acquisition Date Percentage of Value of Shares Acquisition Ownership Mitsubishi 177,330 Subscription Prior to 20 percent November 11, 1998 177,333 Purchase November 11, 1998 233,337 Subscription January 11, 1999 Total 588,000 (P5,880,000.00) ============ It is further represented based on the Certificate of Remittance issued by Bank of Tokyo-Mitsubishi UFJ-Manila Branch 2 on April 2, 2014, Davao Chemical remitted such dividends to Mitsubishi on March 28, 2014. It is finally represented based on an Affidavit issued by Mitsubishi Manila Branch on March 20, 2014 that Mitsubishi Manila Branch has no investments in Davao Central ; that it does not use or hold for use in the conduct of its trade or business any shares if stock in Davao Central ; that Mitsubishi acquired the Davao Central shares directly without the participation of Mitsubishi Manila Branch ; that all gains inured to the sole benefit of Mitsubishi and Mitsubishi Manila branch did not receive any of the gains; and that such dividends is not a material factor in the realization of any gain received by Mitsubishi. TCacIE In reply, please be informed that under Section 42 (A) (2) (a) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, dividends are considered derived in the Philippines if paid by a domestic corporation, to wit: "SEC. 42. Income from Sources within the Philippines. (A) Gross Income from Sources within the Philippines. The following items of gross income shall be treated as gross income from sources within the Philippines: xxx xxx xxx (2) Dividends. The amount received as dividends: (a) From a domestic corporation; and" Moreover, under Section 28 (B) (1) of the Tax Code, dividends paid to a foreign corporation not engaged in trade or business in the Philippines are subject to income tax at the rate of 30 percent, to wit: "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: n Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." However, under Section 32 (B) (5) of the Tax Code, such dividends are exempt or partially exempt to the extent required by any treaty obligation on the Philippines, to wit: "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." In this particular case, you invoke the Philippines-Japan tax treaty, as amended. Article 10 thereof provides: "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; b) 15 per cent of the gross amount of the dividends in all other cases. 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." HSIADc Based on the above 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 10 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, and (b) 15 percent in all other cases (paragraphs 1 and 2) . However, the preferential rates do not apply if the recipient of dividends carries on business in the Philippines through a permanent establishment situated therein and the holding in respect of which the dividends are paid is effectively connected with such permanent establishment (paragraph 5) . On the question of dividends 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 22, 2010, p. 193) mention that this is the case if the dividends are paid in respect of holdings forming part of the assets of the permanent establishment or otherwise effectively connected with that establishment, thus: "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 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 . . ." (Underscoring supplied) 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 ruled that dividends derived by a foreign corporation which has a branch office in the Philippines are effectively connected with the branch office only if the business activities that give rise to the 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 that 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, since Mitsubishi Manila Branch has no participation (direct or indirect) in the investments of Mitsubishi in Davao Chemical ; that it has no connection with the dividends received by Mitsubishi from Davao Chemical ; and that such dividends do not form part of the assets of Mitsubishi Manila Branch , such dividends are not effectively with Mitsubishi Manila Branch. Moreover, since Mitsubishi holds 20 percent of the total shares of Davao Chemical since January 11, 1999, such dividends paid by Davao Chemical to Mitsubishi shall be subject to income tax at the rate of 10 percent pursuant to paragraph 2 (a), Article 10 of the Philippines-Japan tax treaty, as amended. 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. 2. Located at 15th Floor 6788 Ayala 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.