ITAD BIR Ruling No. 168-12

April 20, 2012 ITAD BIR RULING NO. 168-12 Articles 11 (Interest) Philippines-Netherlands tax treaty Puno and Puno Law Offices 12th Floor, East Tower Philippine Stock Exchange Center Exchange Road, Ortigas Center Pasig City Attention: Maria Elizabeth E. Peralta-Loriega Ranulfo Gerardo V. Payos, Jr. Cecily Nerisse C. Ramirez-dela Cruz Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on July 11, 2011 requesting confirmation that interest paid by Century Properties, Inc. ("Century Properties") to APG Strategic Real Estate Pool NV ("APG Strategic") is subject to income tax at the rate of 15 percent pursuant to the Convention between the Kingdom of the Netherlands and the Republic of the Philippines for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Netherlands tax treaty"). Facts APG Strategic is a corporation organized and existing under the laws of the Netherlands and is resident thereof based on its Certificate of Incorporation, on the extract from the trade register of the Chambers of Commerce of Amsterdam in the Netherlands on July 12, 2011, and on the Declaration of Residence issued by the Tax Administration of Arnhem in the Netherlands on June 16, 2011. APG Strategic is situated at Gustav Mahlerplein 3, 1082 MS Amsterdam, the Netherlands. APG Strategic is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission on July 13, 2011. On the other hand, Century Properties is a domestic corporation situated at 21st Floor, Pacific Star Building, Sen. Gil Puyat Avenue corner Makati Avenue, Makati City, Philippines. On January 11, 2011, APG Strategic; Century Properties; Messrs. Jose E.B. Antonio, John Victor R. Antonio, Jose Marco R. Antonio, Jose Roberto R. Antonio, Jose Carlo R. Antonio (collectively, the " Majority Shareholders ");and Century City Development Corporation ("Century City Development") and Century Limitless Corporation ("Century Limitless") (collectively, the " Assignors ") entered into an Omnibus Agreement consisting of a Prefatory Agreement, a Convertible Bonds Subscription Agreement and an Assignment Agreement. Under the Prefatory Agreement, Century Properties has authorized the issuance of convertible bonds in the aggregate of P2,250,000,000.00 convertible into common shares of Century Properties ("Convertible Bonds") . APG Strategic has agreed to invest in the Convertible Bonds. As security for the timely payment, discharge, observance and performance by Century Properties of its obligations under the Omnibus Agreement and the Convertible Bonds, Century Properties, APG Strategic and the Assignors have agreed to enter into an Assignment Agreement. Under the Convertible Bonds Subscription Agreement, Century Properties ,as issuer, will issue the Convertible Bonds in two tranches: first tranche in the aggregate of P1,600,000,000.00 ("Tranche 1 Convertible Bonds") and second tranche in the aggregate of P650,000,000.00 ("Tranche 2 Convertible Bonds") .Each bond has a principal or denomination of P10,000,000.00. The Convertible Bonds will be issued at a subscription price equivalent to 100 percent of the principal amount of each respective tranches. The Convertible Bonds will be issued upon the issuance by the Singapore Exchange Securities Trading Ltd. of its approval in principle of the listing of the Convertible Bonds in its stock exchange, and upon the satisfaction of all other conditions set by the parties. Century Properties will maintain and keep a register on the names and addresses of the holders of the Convertible Bonds, including other related information such as subsequent transfers of these bonds. Century Properties will cause the Convertible Bonds to be listed in the Singapore Exchange Securities Trading Ltd. within five days from the date of their issuance. Century Properties will issue one certificate for each tranche of the Convertible Bonds. Century Properties will use the proceeds of the Convertible Bonds to fund its current and future property development projects and for general corporate and working capital purposes. The Convertible Bonds bear interest from the date of their issuance until Century Properties' common shares of stock are listed in the Philippine Stock Exchange (or other alternative stock exchange),or until the maturity date of these bonds falling on the fifth anniversary from the date of their issuance, whichever is earlier. The rate of interest is initially 12.50 percent per annum and will increase to 14.50 percent per annum from the third anniversary of the issuance of the bonds. Interest is payable semiannually. The Convertible Bonds will cease to bear interest when they are subsequently transformed into conversion shares or when they are redeemed on their maturity. The bonds are deemed conversion shares when Century Properties' shares are listed in the Philippine Stock Exchange (or other alternative stock exchange).Each Convertible Bond is redeemable at premium equivalent to 15 percent per annum of the principal of the bond. As of date, Century Properties has an authorized capital stock of P10,000,000.00 of which common shares with value of P6,857,227.00 are issued and outstanding. AICEDc Based on the Certificate of Inward Remittance issued by Deutsche Bank AG Manila 1 on September 6, 2011, APG Strategic remitted on January 13, 2011 the amount of P1,600,000,000.00 (28,318,584.07) for Tranche 1 Convertible Bonds, which was credited to the account of Century City Development. Ruling In reply, please be informed that under Section 14 of Revenue Memorandum Order No. 72-2010 (Guidelines on the Processing of Tax Treaty Relief Applications (TTRA) Pursuant to Existing Philippine Tax Treaties) ("RMO 72-2010") ,which covers income derived or which accrued on November 4, 2010 and thereafter, any availment of tax treaty relief (exemption from income tax or reduction of tax) shall be preceded by an application filed at the International Tax Affairs Division ("ITAD") of this Bureau before the first taxable event subject of the TTRA, to wit: "SEC. 14. When and Where to File the TTRA. All tax treaty relief applications (updated BIR Forms No. 0901-D, 0901-I, 0901-R, 0901-P, 0901-S, 0901-T, 0901-O and 0901-C) relative to the implementation and interpretation of the provisions of Philippine tax treaties shall only be submitted to and received by the International Tax Affairs Division (ITAD). If the forms or any necessary documents are submitted to any other BIR Office, the application shall be considered as improperly filed. Filing should always be made BEFORE the transaction. Transaction for purposes of filing the TTRA shall mean before the occurrence of the first taxable event . Failure to properly file the TTRA with ITAD within the period prescribed herein shall have the effect of disqualifying the TTRA under this RMO ." (Emphasis ours) In view of the foregoing, since the subject TTRA was filed on July 11, 2011 ,and the Omnibus Agreement that gives rise to the payment of interest by Century Properties to APG Strategic took effect on January 11, 2011 ,this Office hereby DENIES relief on interest paid on and before the filing of the TTRA, pursuant to Section 14 of RMO 72-2010. Accordingly, said interest paid on and before July 11, 2011 shall be subject to income tax at the rate of 20 percent under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") ,as amended, to wit: "SEC. 28. Rates of Income Tax on Foreign Corporations. xxx xxx xxx (B) Tax on Nonresident Foreign Corporation. xxx xxx xxx (5) Tax on Certain Incomes Received by a Nonresident Foreign Corporation. (a) Interest on Foreign Loans. A final withholding tax at the rate of twenty percent (20%) is hereby imposed on the amount of interest on foreign loans contracted on or after August 1, 1986." On the other hand, interest paid to APG Strategic on July 12, 2011 and thereafter is subject to relief under paragraphs 1 and 2, Article 11 of the Philippines-Netherlands tax treaty, to wit: "Article 11 INTEREST 1. Interest arising in one of the States and paid to a resident of the other State may be taxed in that other State. DCcIaE 2. However, such interest may also be taxed in the State in which it arises and according to the laws of that State, but if the recipient is the beneficial owner of the interest the tax so charged shall not exceed: a) 10 per cent of the gross amount if such interest is paid: (i) in connection with the sale on credit of any industrial, commercial or scientific equipment, or (ii) on any loan of whatever kind granted by a bank, or any other financial institution, (iii) in respect of public issues of bonds, debentures or similar obligations, b) 15 per cent of the gross amount of the interest in all other cases. xxx xxx xxx 5. The term 'interest' as used in this Article means income from Government securities, bonds or debentures, whether or not secured by mortgage but not carrying a right to participate in profits, and debt-claims of every kind as well as all other income assimilated to income from money lent by the taxation law of the State in which the income arises. Penalty charges for late payment shall not be regarded as interest for the purpose of this Article." Under paragraph 2 of Article 11, interest arising in the Philippines and paid to a resident of the Netherlands may be taxed in the Philippines at a rate not to exceed: (a) 10 percent if the interest is paid in connection with the sale on credit of any industrial, commercial or scientific equipment, on any loan of whatever kind granted by a bank or other financial institution, or in respect of public issues of bonds, debentures or similar obligations; and (b) 15 percent in all other cases. As to interest on bonds ,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: " Paragraph 3 18. Paragraph 3 specifies the meaning to be attached to the term 'interest' for the application of the taxation treatment defined by the Article. The term designates, in general, income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in profits. The term 'debt-claims of every kind' obviously embraces cash deposits and security in the form of money, as well as government securities, and bonds and debentures, although the three latter are specially mentioned because of their importance and of certain peculiarities that they may present. It is recognised, on the one hand, that mortgage interest comes within the category of income from movable capital (revenus de capitaux mobiliers) ,even though certain countries assimilate it to income from immovable property. On the other hand, debt-claims, and bonds and debentures in particular, which carry a right to participate in the debtor's profits are nonetheless regarded as loans if the contract by its general character clearly evidences a loan at interest. 19. Interest on participating bonds should not normally be considered as a dividend, and neither should interest on convertible bonds until such time as the bonds are actually converted into shares. However, the interest on such bonds should be considered as a dividend if the loan effectively shares the risks run by the debtor company (see inter alia paragraph 25 of the Commentary on Article 10).In situations of presumed thin capitalisation, it is sometimes difficult to distinguish between dividends and interest and in order to avoid any possibility of overlap between the categories of income dealt with in Article 10 and Article 11 respectively, it should be noted that the term 'interest' as used in Article 11 does not include items of income which are dealt with under Article 10. CcAITa 20. As regards, more particularly, government securities, and bonds and debentures, the text specifies that premiums or prizes attaching thereto constitute interest. Generally speaking, what constitutes interest yielded by a loan security, and may properly be taxed as such in the State of source, is all that the institution issuing the loan pays over and above the amount paid by the subscriber, that is to say, the interest accruing plus any premium paid at redemption or at issue. It follows that when a bond or debenture has been issued at a premium, the excess of the amount paid by the subscriber over that repaid to him may constitute negative interest which should be deducted from the interest that is taxable. On the other hand, any profit or loss which a holder of such a security realises by the sale thereof to another person does not enter into the concept of interest. Such profit or loss may, depending on the case, constitute either a business profit or a loss, a capital gain or a loss, or income falling under Article 21." Based on the commentaries, government securities, bonds and debentures are specially mentioned in Article 11 because of their importance and of certain peculiarities that they may present although income from these instruments is clearly in the nature of interest since these instruments have an underlying debt to speak of. Also, interest on convertible bonds remains to be treated as such and not dividends until these bonds are actually converted into shares. Furthermore, interest on bonds includes not only regular interest earned during the term of the bond but also premium paid by the issuer at the time of the redemption of the bond. Accordingly, with respect to interest on the Convertible Bonds paid by Century Properties to APG Strategic under the Omnibus Agreement, since the interest is not in connection with the sale on credit of any industrial, commercial or scientific equipment, on any loan of whatever kind granted by a bank or other financial institution, or in respect of public issues of bonds, debentures or similar obligations, such interest paid on July 12, 2011 and thereafter, including premium paid thereon at the time of redemption of the bonds, shall be subject to income tax at the rate of 15 percent under paragraph 2 (b), Article 11 of the Philippines-Netherlands tax treaty. Finally, under Section 179 of the Tax Code, the Convertible Bonds subject of the Omnibus Agreement is subject to documentary stamp tax equivalent to P1.00 for every P200.00 (or a fraction thereof) of the principal of the whole bonds, to wit: "SEC. 179. Stamp Tax on All Debt Instruments. On every original issue of debt instruments, there shall be collected a documentary stamp tax of One peso (P1.00) on each Two hundred pesos (P200),or fractional part thereof, of the issue price of any such debt instrument: Provided, That for such debt instruments with terms of less than one (1) year, the documentary stamp tax to be collected shall be of a proportional amount in accordance with the ratio of its terms in number of days to three hundred sixty-five (365) days: Provided, further, That only one documentary stamp tax shall be imposed on either loan agreement, or promissory notes issued to secure such loan. IaAScD For purposes of this section, the term debt instrument shall mean instruments representing borrowing and lending transactions including but not limited to debentures, certificates of indebtedness, due bills, bonds, loan agreements, including those signed abroad wherein the object of the contract is located or is used in the Philippines, instruments and securities issued by the government or any of its instrumentalities, deposit substitute debt instruments, certificates or other evidences of deposits that are either drawing interest significantly higher than the regular savings deposit taking into consideration the size of the deposit and the risks involved or drawing interest and having a specific maturity date, orders for payment of any sum of money otherwise than at sight or on demand, promissory notes, whether negotiable or non-negotiable, except bank notes issued for circulation." This ruling is issued on the basis of the actual facts as represented. However, if upon investigation it shall be disclosed that the 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. Situated at 26th Floor, Tower One and Exchange Plaza, Ayala Triangle, Ayala Avenue, Makati City, Philippines.