ITAD BIR Ruling No. 163-15

June 2, 2015 ITAD BIR RULING NO. 163-15 Article 10, Philippines-Japan tax treaty, as amended First Sumiden Realty, Inc. Ampere St., corner Main Avenue LISPP Bo. Diezmo Cabuyao, Laguna Attention: Ms. Liz M. Fernandez Gentlemen : This refers to your tax treaty relief application filed on September 22, 2014 requesting confirmation that dividend paid by First Sumiden Realty, Inc. ("First Sumiden") to Sumitomo Electric Industries, Ltd. ("Sumitomo Electric") is 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 Protocol 1 ("Philippines-Japan tax treaty, as amended") . Facts Sumitomo Electric is a corporation organized and existing under the laws of Japan and is a resident thereof based on its Articles of Incorporation. and Residence Certificate issued by the Higashi Tax Office in Japan on August 8, 2014. Based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission (SEC) on September 15, 2014, Sumitomo Electric is not registered as a corporation or partnership in the Philippines. In addition, the Certificate of Withdrawal License of a Foreign Corporation was issued by SEC to Sumitomo Electric on October 31, 2012. On the other hand, First Sumiden is a domestic corporation organized and existing under Philippine laws. Based on Secretary's Certificate issued on September 16, 2014, the Board of Directors of First Sumiden , during a regular meeting on June 5, 2014, approved the declaration of cash dividends for the year ended December 31, 2013 amounting to US$250,000.00 to all of the company's stockholders of record proportionate to their shareholdings. As of June 5, 2014, Sumitomo Electric holds 139,998 common shares of stock of First Sumiden , each share with a par value of P100.00, which constitute 40 percent ownership in the total outstanding shares of stock of First Sumiden . These shares were acquired by Sumitomo Electric on April 12, 1996 by way of subscription. The dividend was remitted to Sumitomo Electric on September 29, 2014. Based on a certification issued by Sumitomo Electric on December 4, 2014, Sumitomo Electric Industries, Ltd.-Manila Representative Office has no participation whatsoever, directly or indirectly, in the dividends received by Sumitomo Electric from First Sumiden and that such dividends do not form part of the assets of Sumitomo Philippine Branch . Finally, the dividend subject of the request is 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 President of First Sumiden on September 22, 2014. Ruling In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ( "Tax Code" ), as amended, income derived by a foreign corporation not engaged in trade or business is 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 income is 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, paragraphs 1, 2 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: 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." Under this article, 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 dividends, and (b) 15 percent in all other cases (paragraphs 1 and 2) . However, the preferential rates do not apply if the recipient 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 it has been represented that Sumitomo Philippine Branch has no participation in the investments of Sumitomo Electric in First Sumiden ; that it has no connection with the dividend received by Sumitomo Electric from First Sumiden ; and that dividends do not form part of the assets of Sumitomo Philippine Branch . Therefore, Sumitomo Philippine Branch is not a material factor in the realization of the dividends received by Sumitomo Electric . Moreover, since Sumitomo Electric holds directly 40 percent of the common shares and total shares of First Sumiden since 1996 , which is above the minimum 10 percent shareholding and more than the minimum six month holding period, such dividend paid by First Sumiden to Sumitomo Electric are 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. n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.