ITAD BIR Ruling No. 200-11

July 26, 2011 ITAD BIR RULING NO. 200-11 Article 10 (2) (a), Philippines-Japan tax treaty, as amended; BIR Ruling No. ITAD 058-11; BIR Ruling No. ITAD-051-10; BIR Ruling No. ITAD-007-10 Maxima Machineries 871 Quezon Avenue Quezon City Attention: Yusaku Nemoto Executive Vice President Gentlemen : This refers to your Tax Treaty Relief Application (TTRA) filed on December 13, 2010, on behalf of Marubeni Corporation ("Marubeni") , requesting confirmation that the cash dividends paid by Maxima Machineries, Inc. ("Maxima") to Marubeni are subject to the 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") . It is represented that Marubeni , with head office address at 4-2, Ohtemachi 1-Chome, Chiyoda-Ku, Tokyo 100-8088, Japan, is a corporation organized and existing under the laws of Japan, and is resident of Japan per Certificate issued by the District Director of Kojimachi Tax Office on December 17, 2010; that Marubeni was issued a license to do business in the Philippines on March 20, 1967, as shown in the Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission on January 18, 2011; and that, on the other hand, Maxima is a domestic corporation, with office address located at 908 Quezon Avenue corner Dr. Garcia St., Quezon City, Philippines. It is further represented that the Board of Directors of Maxima , at its meeting on October 21, 2010, approved a resolution declaring dividends amounting to Php52,774,755.00, payable on December 15, 2010, based on the Secretary's Certificate issued by Maxima on December 10, 2010; and that as of May 25, 2007, Marubeni owns 3,200,000 shares of stocks in Maxima , with a total par value of P320,000,000.00, equivalent to 40% of the total outstanding capital stock of Maxima . It is further represented that the branch office of Marubeni in the Philippines ("Marubeni Manila Branch") 1 has no investments nor owns shares of stock in Maxima , based on the Affidavit issued by the Treasurer of Marubeni Manila Branch on March 25, 2011; that Marubeni Manila Branch neither uses nor holds for use in the conduct of its trade or business any shares of stock in Maxima and that such shares were acquired directly by its head office in Japan without the participation of Marubeni Manila Branch ; and that, consequently, all gains that arise from the subject shares inure to the sole benefit of the head office that these gains are not received by Marubeni Manila Branch ; and that Marubeni Manila Branch is not a material factor in the realization of such gains received by the head office. It is finally represented that the dividend payment subject of the request for ruling is not subject of investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Certificate dated December 21, 2010 issued by the Corporate Secretary of Maxima . ITaESD 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 dividends derived in the Philippines 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 . . . dividends, rents, royalties . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, Section 32 (B) (5) of the Tax Code of 1997, as amended, provides that the dividends may be exempt or partially exempt from income tax (if subject to a reduced rate only) to the extent required by any treaty obligation binding upon the Philippine Government, thus: "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 relation thereto, you invoke Article 10 of the Philippines-Japan tax treaty, as amended. 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; 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. xxx xxx xxx 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. 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." HCacTI Under paragraphs 2 and 3, Article 10 of the Philippines-Japan tax treaty, as amended, dividends arising in the Philippines and paid to a resident of Japan may be taxed in the Philippines, but the rate of income tax that may be imposed thereon shall not exceed: (a) 10 percent of the gross amount of the dividends if the beneficial owner is a company which holds directly at least 10 percent 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) 10 percent of the gross amount of the dividends if the dividends are paid by a domestic company registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines; and (c) 15 percent of the gross amount of the dividends in all other cases. Accordingly, inasmuch as Marubeni holds directly 40% of the outstanding capital stock of Maxima (which in fact exceeds the minimum required percentage holding of 10 percent), and since Marubeni maintains such holdings since 2007, and, in effect, during the period of six months immediately preceding the date of payment of the dividends, such dividends paid by Maxima to Marubeni are subject to income tax at the rate of 10 percent of the gross amount thereof, pursuant to paragraph 2 (a), Article 10 of the Philippines-Japan tax treaty, as amended. (BIR Ruling No. ITAD 58-11 dated February 22, 2011; BIR Ruling No. ITAD 51-10 dated October 13, 2010; BIR Ruling No. ITAD 007-10 dated May 20, 2010) However, under paragraph 5, Article 10 of the Philippines-Japan tax treaty, as amended, the reduced rates on dividends under paragraphs 2 and 3 of Article 10 will not apply to such dividends paid to Marubeni if they are effectively connected with a permanent establishment which Marubeni has in the Philippines. Under paragraph 2 (b), Article 5 of the tax treaty, Marubeni Manila Branch , being a branch office of Marubeni in the Philippines, is considered a permanent establishment of Marubeni in the Philippines, 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 whether dividends are effectively connected with a permanent establishment, the relevant 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 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)." (Emphasis added) (Pages 156-157) cSEDTC Similarly, based on the Supreme Court ruling in Marubeni Corporation vs. Commissioner of Internal Revenue and Court of Tax Appeals (G.R. No. 76573 dated September 14, 1989), dividends paid to the head office of a foreign corporation which has a branch office in the Philippines are effectively connected to the branch office if the business transactions that give rise to the dividends are conducted through the branch office, 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 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." Applying the OECD commentaries and the Supreme Court ruling, such dividends paid by Maxima to Marubeni cannot be considered as effectively connected with the Marubeni Manila Branch since, as represented, Marubeni Manila Branch has no investments nor owns shares of stock in Maxima; Marubeni Manila Branch neither uses nor holds for use in the conduct of its trade or business any shares of stock in Maxima ; and those shares in Maxima were acquired directly by its head office in Japan without the participation of Marubeni Manila Branch . Consequently, all gains (dividends) that arise from these shares inure to the sole benefit of the head office and are not received by Marubeni Manila Branch , and hence, Marubeni Branch Office is not a material factor in the realization of such gains (dividends) received by the head office. This being the case, such dividends paid by Maxima to Marubeni are subject to income tax at the rate of 10 percent of the gross amount thereof, pursuant to paragraph 2 (a), Article 10 of the Philippines-Japan tax treaty, as amended. ( BIR Ruling No. ITAD 58-11 dated February 22, 2011; BIR Ruling No. ITAD 51-10 dated October 13, 2010; BIR Ruling No. ITAD 007-10 dated May 20, 2010) 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. DSHTaC Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Situated at the 8th and 9th Floors, L.V. Locsin Building, 6752 Ayala Avenue corner Makati Avenue, Makati City, Philippines.