ITAD BIR Ruling No. 196-12

May 21, 2012 ITAD BIR RULING NO. 196-12 Article 10 (3), Philippines-Japan tax treaty, as amended; BIR Ruling No. ITAD-073-10 Mitsubishi Corporation Manila Branch 52nd Floor, PBCom Tower 6795 Ayala Avenue corner V.A. Rufino Street Salcedo Village, Makati City Attention: Nobuya Ichiki General Manager Gentlemen : This refers to your Tax Treaty Relief Application (TTRA) filed on May 17, 2011, on behalf of Mitsubishi Corporation Tokyo Head Office ("Mitsubishi-Japan") ,requesting confirmation that the dividends to be paid and remitted by Manila Water Company, Inc. ("Manila Water") to Mitsubishi-Japan are subject to the preferential final withholding tax rate of 10 percent pursuant to Article 10 (3) 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") . IaTSED It is represented that Mitsubishi-Japan, with principal address at 3-1, Marunouchi 2-chome, Chiyoda-ku, Tokyo, Japan is a corporation organized and existing under the laws of Japan and is a resident thereof within the meaning of the Philippines-Japan tax treaty based on a Residence Certificate issued by the District Director of Kojimachi Tax Office on January 14, 2011; that it was licensed to engage in business in the Philippines on March 20, 1967 per Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission dated February 18, 2011, and that to date, no petition for the withdrawal or cancellation of license has been filed by it; that pursuant to the said license, Mitsubishi-Japan established a branch in the Philippines (Mitsubishi Corporation-Philippine Branch); that, on the other hand, Manila Water, with principal address at MWSS-Admin. Building, Katipunan Road, 1105 Balara, Quezon City is a corporation registered with the Board of Investments (BOI) on a pioneer status as a new operator of water supply and sewerage system for the East Zone Service Area with Certificate of Registration No. 97-188 issued on August 20, 1997. It is further represented, based on the affidavit executed by Mitsubishi Corporation-Philippine Branch on May 13, 2011, that although Mitsubishi-Japan has a branch in the Philippines: (1) Mitsubishi Corporation-Philippine Branch has no investments in Manila Water and does not own shares of stock in Manila Water as shown in the Audited Financial Statements of Mitsubishi Corporation-Philippine Branch for the Fiscal Year ending March 31, 2010; (2) Mitsubishi Corporation-Philippine Branch likewise does not use or hold for use in the conduct of its trade or business any shares of stock in Manila Water; (3) Mitsubishi-Japan acquired the Manila Water's shares and the said acquisition was made without the participation of Mitsubishi Corporation-Philippine Branch; and (4) all gains inured to the sole benefit of Mitsubishi-Japan and Mitsubishi Corporation-Philippine Branch did not receive any of the gains, and hence, Mitsubishi Corporation-Philippine Branch is not a material factor in the realization of any gain received by Mitsubishi-Japan; that at the regular meeting of the Board of Directors of Manila Water held on April 11, 2011, it approved the declaration of cash dividends for the first semester of 2011, payable to all stockholders of record as of April 27, 2011, as follows: (a) P0.28 per share on the outstanding Common shares; and (b) P0.28 per share on the outstanding Participating Preferred shares; that the said dividends were payable on May 19, 2011; that per the Secretary's Certificate issued by Manila Water on May 12, 2011, as of April 30, 2011, Mitsubishi-Japan is the registered owner of 168,999,999 common shares in Manila Water with par value of One peso (Php1.00) per share and a total par value of One Hundred Sixty-Eight Million Nine Hundred Ninety-Nine Thousand Nine Hundred Ninety-Nine Pesos (Php168,999,999.00),representing 8.31% of the outstanding voting common shares of Manila Water; that per the same Secretary's Certificate issued by Manila Water, Mr. Keiichi Asai, a nominee of Mitsubishi-Japan in the Board of Directors of Manila Water, owns one (1) common share in Manila Water, with a par value of One (Php1.00) under Stock Certificate No. 6600. It is finally represented that the issue or 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 notarized affidavit issued by Manila Water dated May 6, 2011. 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 received by a nonresident foreign corporation. It provides: "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%)." aDcTHE 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." Thus, 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 percent 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. The provisions of this paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid. 3. Notwithstanding the provisions of paragraph (2),the amount of tax imposed by the Philippines on the dividends paid by a company, being a resident of the Philippines, registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines to a resident of Japan, who is the beneficial owner of the dividends, shall not exceed 10 per cent of the gross amount of the dividends. 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." ACTESI Based on the aforequoted provisions, the Philippines may tax the dividends paid by a resident of the Philippines registered with the BOI and engaged in preferred areas of investment under the investment incentives laws of the Philippines to a resident of Japan who is the beneficial owner of the dividends at a rate not exceeding 10 percent of the gross amount of the dividends. 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 has in the Philippines. Under paragraph 2 (b),Article 5 of the tax treaty, Mitsubishi Corporation-Philippine Branch, being the branch office in the Philippines of Mitsubishi-Japan, is considered a permanent establishment of Mitsubishi, 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: 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." On the question of dividends being 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 17, 2008) 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) (Pages 156-157) SEDIaH Similarly, following the Supreme Court in Marubeni Corporation vs. Commissioner of Internal Revenue and 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: " 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 of 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) Accordingly, the holdings in respect of the dividends paid by Manila Water to Mitsubishi-Japan are not effectively connected with Mitsubishi Corporation-Philippine branch since they are not paid in respect of holdings forming part of the assets of Mitsubishi Corporation-Philippine branch or otherwise effectively connected therewith, and since the business activities that give rise to such dividends are not conducted through Mitsubishi Corporation-Philippine branch. This is because Mitsubishi Corporation-Philippine branch has neither investments nor shares of stock in Manila Water; does not use or hold for use in the conduct of its trade or business any shares of stock in Manila Water; the head office of Mitsubishi in Japan acquired such shares in Manila Water directly and without the participation of Mitsubishi Corporation-Philippine branch; dividends arise from these shares inure to the sole benefit of Mitsubishi-Japan and Mitsubishi Corporation-Philippine branch did not receive any of these dividends; and, lastly, Mitsubishi Corporation-Philippine branch is not a material factor in the realization of dividends received by the Mitsubishi-Japan. In view thereof and considering that Manila Water is a resident company of the Philippines registered with the BOI and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines, and considering further that Mitsubishi-Japan directly invested with Manila Water without the participation of its Philippine Branch, the dividend payment of Manila Water to Mitsubishi-Japan shall be subject to the preferential tax treaty rate of 10 percent, pursuant to the Article 10 (3) of the Philippines-Japan tax treaty, as amended. (BIR Ruling No. ITAD-073-10 dated December 7, 2010) 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. TCAScE Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue