ITAD BIR Ruling No. 181-15

June 3, 2015 ITAD BIR RULING NO. 181-15 Article 10, Philippines-Japan tax treaty, as amended Sycip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: Romulo S. Danao, Jr. Partner, Tax Services Gentlemen : This refers to your tax treaty relief application filed on July 9, 2014 requesting confirmation that dividends paid by Taganito Mining Corporation ("Taganito") to Pacific Metals Co., Ltd. ("Pacific Metals") 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 Protocol 1 ("Philippines-Japan tax treaty, as amended") . Facts Pacific Metals is a corporation organized and existing under the laws of Japan and is a resident thereof based on its Articles of Incorporation and Certificate of Residency issued by the Kojimachi Tax Office in Japan on April 25, 2014. Based on the Certification of Corporate Filing/Information issued by the Securities and Exchange Commission on April 21, 2014, Pacific Metals has a permanent establishment in the Philippines in the nature of a representative office which license to operate was approved on October 23, 1970. To date, no petition for the withdrawal or cancellation of license have been filed by the corporation. On the other hand, Taganito is a domestic corporation organized and existing under Philippine laws. Based on Secretary's Certificate issued on July 7, 2014, the Board of Directors of Taganito , during a regular meeting on June 9, 2014, approved the declaration of cash dividends amounting to P300,000,000.00 in favor of the company's stockholders of record as of May 31, 2014, payable on July 15, 2014. As of May 31, 2014, Pacific Metals holds 502,500,000 (including shares held in trust) common shares of stock of Taganito , each share with a par value of P1.00, which constitute 33.50 percent ownership in the total outstanding shares of stock of Taganito . These shares were acquired by Pacific Metals from 1989 through 2009 by way of purchase and stock dividend. Based on the Certification issued by Metropolitan Bank and Trust Company, Taganito remitted such dividend to Pacific Metals on July 15, 2014. Based on a certification issued by the representative office of Pacific Metals ("Pacific Metals Representative Office") on July 1, 2014, Pacific Metals Representative Office has no participation whatsoever, directly or indirectly, in the investments of Pacific Metals in Taganito , and that the dividend income received by Pacific Metals from the said investments is neither attributable to nor effectively connected with Pacific Metals Representative Office and any payment of dividends is directly remitted to Pacific Metals . Finally, the dividends subject of the request 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 Vice-President for Finance and Administration of Taganito on June 16, 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 where 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 Shimizu n 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 Pacific Metals Representative Office's business functions in the Philippines do not include the putting up of investments in Taganito's shares of stock and receiving dividends from the latter but to promote exports of Philippine products, particularly minerals and other base metals to Japan and other countries and to provide export assistance to Philippine producers in the form of marketing, research, etc.; additionally, such investment in Taganito was made directly by Pacific Metals and independently of Pacific Metals Representative Office and this permanent establishment has no knowledge or effective participation in the investment, the holding of such shares in Taganito is not effectively connected with Pacific Metals Representative Office as contemplated in paragraph 5, Article 10 of the Philippines-Japan tax treaty, as amended. Moreover, since Pacific Metals holds directly 33.5 percent of the voting (common) shares and total shares of Taganito since 2009 , which is above the minimum 10 percent shareholding and more than the minimum six month holding period, such dividend paid by Taganito to Pacific Metals 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. n Note from the Publisher: "Shimizu" should be "Marubeni".