ITAD BIR Ruling No. 195-14

September 22, 2014 ITAD BIR RULING NO. 195-14 Article 11, Philippines-Japan tax treaty, as amended De Lumen Valdez Zamora and Associates Units 401-402, CRM II Bldg., Kamias Rd., Quezon City 1102 Attention: Sherry Obiles-Baura Authorized Representative Gentlemen : This refers to your Tax Treaty Relief Application (TTRA) filed on 23 January 2013, on behalf of your client, Itochu Corporation ("Itochu-Japan") requesting confirmation that the interest income earned by Itochu-Japan from Isla Petroleum & Gas Corporation ("Isla Petroleum-Philippines") on account of a Loan Agreement is subject to the 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 1 (Philippines-Japan tax treaty). The facts, as represented, are as follows: Itochu-Japan is non-resident foreign corporation organized and existing under the laws of Japan with office address at 1-3, Umeda, 3-chome, Kita-ku, Osaka-shi, Osaka-fu, Japan based on a consularized and notarized Certificate of Status of Taxable Person issued by the Ministry of Foreign Affairs of Japan. The company Itochu-Japan was granted a license to engage business in the Philippines on 19 May 1967 based on a Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission. Itochu-Japan has an established branch in the Philippines, Itochu Corporation-Manila Branch ("Itochu-Philippines") with office address at 16th Floor, 6788 Ayala Avenue, Oledan Square, Makati City. The company Itochu-Philippines is not a party to the Loan Agreement between Itochu-Japan and Isla Petroleum-Philippines based on a notarized Certification issued by the General Manager of Itochu-Philippines. Isla Petroleum-Philippines is a domestic corporation with office address at 4th Floor, SGV II Bldg., 6758 Ayala Avenue, Makati City. The company Isla Petroleum-Philippines has an authorized capital stock of 13,000,000 shares with a par value of P100 each with a total value of One Billion Three Million Pesos (P1,300,000,000.00) and that 4,234,536 of these shares is owned by Itochu-Japan based on a notarized certification from the Assistant Corporate Secretary of Isla Petroleum-Philippines. AaIDHS On 19 January 2012, Isla Petroleum-Philippines and Itochu-Japan entered into a Loan Agreement whereby Itochu-Japan loaned the amount of Thirty Million US Dollars (US$30,000,000.00) to Isla Petroleum-Philippines. According to the notarized and Certified True Copy of the Loan Agreement, the applicable rate shall be based on LIBOR 2 for each interest period plus the margin. 3 It is further indicated in the Loan Agreement that interest periods 4 shall be periods of one (1), two (2), three (3) or six (6) months at the selection of Isla Petroleum-Philippines provided that the First Interest Period shall commence on the Disbursement date. 5 Pursuant to Section 4.2 of the Loan Agreement, Isla Petroleum-Philippines chose the interest period of 6 months to commence on the Disbursement Date. Isla Petroleum-Philippines requested Itochu-Japan to extend the First Interest Period from its original commencement period of 24 July 2012 6 to 24 January 2013 based on the notarized Request to Extend First Interest Period date to 24 January 2013. Based on a notarized Certificate of Inward Remittance from Banco de Oro, Makati City, the amount of Thirty Million US Dollars (US$30,000,000.00) has been credited to the account of Isla Petroleum-Philippines by order of Itochu-Japan on 24 January 2012. On 05 February 2013, Isla Petroleum-Philippines made an outward remittance of Three Hundred Forty Five Thousand Five Hundred Eleven US Dollars and Seventy Five Cents (US$345,511.75) through Standard Chartered Bank for the account of Itochu-Japan through Bank of Tokyo-Mitsubishi UFJ, Ltd. Based on a notarized Certificate of Remittance of Payment from Standard Chartered Bank. The interest subject of this ruling 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 a notarized Sworn Statement issued by authorized representative of Itochu-Japan on 05 October 2012. Ruling A. On Interest Payments In reply, please be informed that such interest paid to Itochu-Japan and all foreign corporations not engaged in trade or business in the Philippines, is subject to income tax at the rate of 20 percent. Section 28 (B) (5) of the National Internal Revenue Code of 1997 (" NIRC of 1997 "), as amended, provides: IHEaAc "Section 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; xxx xxx xxx" However, such interest may be exempt or subject to a reduced rate to the extent required by any treaty obligation on the Philippines. Section 32 (B) (5) of the NIRC 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. xxx xxx xxx" In this particular case, you invoke the Philippines-Japan tax treaty. Paragraphs 1 to 4, Article 11, as amended by the 2009 Protocol provide as follows: EDcIAC "Article 11 1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State. 2. However, such interest may also be taxed in the Contracting State in which it arises, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the interest the tax so charged shall not exceed 10 per cent of the gross amount of the interest. 3. Notwithstanding the provisions of paragraph (2), interest arising in a Contracting State and derived by the Government of the other Contracting State including political subdivisions and local authorities thereof, the Central Bank of that other Contracting State or any financial institution wholly owned by that Government, or by any resident of the other Contracting State with respect to debt-claims guaranteed, insured or indirectly financed by the Government of that other Contracting State including political subdivisions and local authorities thereof, the Central Bank of that other Contracting State or any financial institution wholly owned by that Government shall be exempt from tax in the first-mentioned Contracting State. For the purposes of this paragraph, the term "financial institution wholly owned by the Government" means: (a) In the case of Japan, the Japan Bank for International Cooperation and the Nippon Export and Investment Insurance; (b) In the case of the Philippines, the Development Bank of the Philippines and the Land Bank of the Philippines; and (c) Any such financial institution the capital of which is wholly owned by the Government of either Contracting State, other than those referred to in sub-paragraphs (a) and (b) above, as may be agreed from time to time between the Governments of the two Contracting States. ETaSDc 4. The term "interest" as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and in particular, income from Government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. xxx xxx xxx" Based on the above provisions, interest arising in the Philippines and paid to a resident of Japan may be taxed in the Philippines at a rate not to exceed ten percent (10%). The term interest means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and in particular, income from government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. Accordingly, since the interest arising from the Loan Agreement is not in respect of government securities, bonds or debentures at hand, and since Isla Petroleum-Philippines is not registered with the Board of Investments as such, and since the interest is not paid to the Government of Japan, etc., such interest to be paid by Isla Petroleum-Philippines to Itochu-Japan in relation to the Loan Agreement is subject to income tax at the rate of 10 percent of the gross amount thereof pursuant to Article 11 (2) of the Philippines-Japan tax treaty, as amended. B. On permanent establishment On the question of whether the interest payments are effectively connected with a permanent establishment, the Supreme Court ruled that such payments are effectively connected only if they are paid in respect of assets owned by the permanent establishment or otherwise effectively connected with that establishment, thus in Marubeni Corporation vs. Commissioner of Internal Revenue and Court of Tax Appeals (G.R. No. 76573 dated September 14, 1989) : " 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. Consequently, the taxpayer is 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) HTASIa Considering that Itochu-Philippines is not a party to the loan based on the foregoing Loan Agreement between Itochu-Japan and Isla Petroleum-Philippines , Itochu-Japan is deemed not to have a permanent establishment in the Philippines. C. On documentary stamp tax Finally, the Loan Agreement, being a debt instrument, executed by Isla Petroleum-Philippines in favor of Itochu-Japan is subject to documentary stamp tax equivalent to P1.00 for every P200.00, or fractional part thereof, of the issue price or the amount subject of the Loan Agreement. Section 179 of the Tax Code, as amended, provides: "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 a fractional part thereof, of the issue price of any such debt instruments: Provided, that for such debt instruments with terms of less than one year, the documentary stamp tax to be collected shall be of a proportional amount in accordance with the ration of its term in number of days to three hundred sixty-five days, provided, further, that only one documentary stamp tax shall be imposed on either loan agreement, or promissory notes issued to secure such loan. xxx xxx xxx" 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. As amended by the 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. 2. Section 1, 1.1 (g) of the Loan Agreement: "LIBOR" means, for any interest period with respect to the Loan, (a) the rate per annum equal to the offered rate quoted on Reuters page USDD=SUML (or any successor thereto) that displays Sumitomo Mitsui Banking Corporation Europe Limited Rate for deposits in dollars (for delivery on the first day of such interest period) with a term equivalent to such Interest Period, determined as of approximately 11:00 a.m. (London time) [two (2)] Business Days prior to the first day of such interest period, or (b) if the rate referenced in the preceding subsection (a) does not appear on such pare or service or such page or service shall cease to be available, the rate per annum equal to the offered rate of Sumitomo Mitsui Banking Corporation for deposits in dollars (for delivery on the first day of such Interest Period) with a term equivalent to such Interest Period, determined as of approximately 11:00 a.m. (London time) [two (2)] Business Days prior to the first day of such Interest Period. 3. Section 1, 1.1 (g) of the Loan Agreement: "Margin" means 1.75% per annum. 4. Section 4, 4.2 of the Loan Agreement. 5. Section 1, 1.1 of the Loan Agreement: "Disbursement Date" means the Business Day which is three (3) Business Days immediately following the date on which all of the conditions as set forth in Clause 3.1 have been satisfied at Itochu's sole discretion. 6. See Section 4.2 of the Loan Agreement.