ITAD BIR Ruling No. 178-13

July 3, 2013 ITAD BIR RULING NO. 178-13 Article 10, Philippines-Japan tax treaty, as amended Agan & Montenegro Law Offices Unit J-3, 7th Floor, Electra House Building 115-117 Esteban Street, Legaspi Village Makati City 1229 Attention: Atty. J. Carlito M. Montenegro Tax Counsel Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on June 13, 2012, on behalf of Isuzu Philippines Corporation ("Isuzu-Phil") , requesting confirmation that dividends paid by Isuzu-Phil to Isuzu Motors Limited ("Isuzu-Japan") and Mitsubishi Corporation ("Mitsubishi-Japan") are both subject to preferential tax rate of 10 percent pursuant to Article 10 (2) (a) of the amended 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, as amended") . ETDaIC It is represented that Isuzu-Japan , with address at 26-1, Minami-oi 6-chome, Shinagawa-ku Tokyo, 140-8722 Japan, is a resident of Japan for the purpose of the Philippines-Japan tax treaty per the Certificate of Status of Taxable Person issued on April 27, 2012 by the District Director of Shinagawa Tax Office; that it is not registered either as a corporation or as a partnership in the Philippines per Certification of Non-Registration of Company issued by the Securities and Exchange Commission dated April 12, 2012; that Mitsubishi-Japan , with address at 3-1, Marunouchi 2-chome, Chiyoda-Ku, Tokyo, Japan, is a resident of Japan for the purpose of the Philippines-Japan tax treaty per the Residence Certificate issued on April 20, 2012 by the District Director of Kojimachi Tax Office; that it was licensed to establish its branch office in the Philippines ("Mitsubishi-Philippine Branch") per Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission dated April 10, 2012; that per Affidavit issued by Mitsubishi-Philippine Branch, Mitsubishi-Philippine Branch has neither investments nor shares of stocks in Isuzu-Phil; that Mitsubishi-Japan directly acquired the Isuzu-Phil shares; that Mitsubishi-Philippine Branch does not use or hold for use in the conduct of its trade or business any shares of stock in Isuzu-Phil and consequently, all gains inured to the sole benefit of Mitsubishi-Japan and Mitsubishi-Philippine Branch did not received any of the gains; and that, on the other hand, Isuzu-Phil is a corporation, organized and existing under the laws of the Philippines with principal address at 114 Technology Avenue, Laguna Technopark, Bian, Laguna. It is further represented, that on February 29, 2012, the Board of Directors of Isuzu-Phil approved the declaration of cash dividends amounting to One Hundred Seventy Million Eight Hundred Two Thousand Eight Hundred Eighty-One Philippine Pesos (Php170,802,881.00), in favor of all stockholders of record as of December 31, 2011 in accordance with their respective shareholdings; that based on the separate Secretary's Certificate issued by Isuzu-Phil both dated March 23, 2012, through various subscription, beginning September 27, 1996 and up to date, Isuzu-Japan and Mitsubishi-Japan (including three shares of Isuzu-Japan 's nominees shareholders and three shares of Mitsubishi Japan 's nominees shareholders), are both legal and beneficial owners of 350,000 voting stocks of Isuzu-Phil, which is equivalent to 35% of the total outstanding capital stock of Isuzu-Phil; and that, based on a separate Certification issued by Bank of the Philippine Islands and Bank of Tokyo-Mitsubishi UFJ, the subject dividends were remitted to Isuzu-Japan and Mitsubishi-Japan on June 29, 2012. It is finally represented that the transaction subject of this request for ruling is not under investigation, on-going audit, administrative protest, claims for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal per Secretary's Certificate issued by Isuzu-Phil dated March 23, 2012. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended applies in general to income derived in the Philippines by a nonresident foreign corporation. It provides: DAETcC "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 Tax Code of 1997, as amended, provides: "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." The provisions of Article 10 of the Philippines-Japan tax treaty, as amended, which you invoke, may apply to the instant case. It 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; HTIEaS b) 15 per cent of the gross amount of the dividends in all other cases. xxx xxx xxx 4. The term 'dividends' as used in this Article means income from shares or other rights, not being debt-claims, participating in profits, as well as income from other corporate rights assimilated to income from shares by the taxation laws of the Contracting State of which the company making the distribution is a resident. 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." Based on the aforequoted provisions, the Philippines may tax the dividends paid by a resident thereof to a company which is a resident of Japan at a rate not exceeding 10 percent if the latter company holds directly at least 10 percent of either of the voting shares of the company paying the dividends or of the total shares issued by that company during the period of 6 months immediately preceding the date of payment of the dividends; otherwise, said dividends may be taxed at a rate not exceeding 15 percent of the gross amount in all other cases. However, under paragraph 5 of Article 10, the Philippines, being the source of the dividends, is not obliged to limit the tax rates on dividends under paragraphs 2 and 3 of the article if the holding in respect of which the dividends are paid is effectively connected with a permanent establishment which Mitsubishi-Japan has in the Philippines. Under paragraph 2 (b), Article 5 of the tax treaty, Mitsubishi-Philippine Branch , is considered a permanent establishment of Mitsubishi-Japan , 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: HCDaAS 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. . . . " (Underscoring ours) On the question of whether dividends are effectively connected with a permanent establishment, the following commentaries of the Organisation for Economic Co-operation and Development ("OECD") Model Tax Convention on Income and on Capital (Condensed Version, July 22, 2010 p. 193) 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: " 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)." (Underscoring supplied) Similarly, following 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 can become effectively connected with its branch office in the Philippines if the business activities that give rise to such dividends are conducted through the branch office, following the principal-agent relationship theory, thus: ESTCDA " 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 ." (Underscoring supplied) Accordingly, the holdings in respect of the dividends paid by Isuzu-Phil to Mitsubishi-Japan are not effectively connected with Mitsubishi-Philippine Branch since they are paid not in respect of holdings forming part of the assets of Mitsubishi-Philippine Branch or otherwise effectively connected therewith, and since the business activities that give rise to such dividends are not conducted through Mitsubishi-Philippine Branch . This is because Mitsubishi-Philippine Branch has neither investments nor owns shares of stock in Isuzu-Phil; does not use or hold for use in the conduct of its trade or business any shares of stock in Isuzu-Phil; Mitsubishi-Japan acquired such shares in Isuzu-Phil directly and without the participation of Mitsubishi-Philippine Branch ; and, dividends arising from these shares inure solely to the benefit of Mitsubishi-Japan and Mitsubishi-Philippine Branch did not receive any of these dividends. Hence, Mitsubishi-Philippine Branch is not a material factor in the realization of dividends received by the Mitsubishi-Japan . In view thereof and considering that Mitsubishi-Japan and Isuzu-Japan both have their shareholdings of more than 10 percent in Isuzu-Phil for more than six months immediately preceding the date of payment of the dividends, said dividends paid by Isuzu-Phil to Mitsubishi-Japan and Isuzu-Japan , are both subject to 10 percent preferential tax rate, pursuant to Article 10 (2) (a) of Philippines-Japan tax treaty, as amended. 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