ITAD BIR Ruling No. 201-14

October 3, 2014 ITAD BIR RULING NO. 201-14 Article 10 Philippines-Japan tax treaty, as amended Aranas Law Office Ground Floor, Le Metropole Building 326 Tordesillas Street corner De la Costa Street, Salcedo Village Makati City Attention: Atty. Ma. Louella M. Aranas Gentlemen : This refers to your tax treaty relief application filed on September 11, 2013 requesting confirmation that dividends paid by SMCC Philippines, Inc. ( "SMCC Philippines" ) to Sumitomo Mitsui Construction Company Ltd. ( "Sumitomo" ) 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 Sumitomo is a corporation organized and existing under the laws of Japan and is a resident thereof based on its amended Articles of Incorporation and Certificate of Residency issued by the Kyobashi Tax Office on August 14, 2013. Sumitomo is located at 2-1-6, Tsukuda, Chuo-ku, Tokyo, Japan. Based on the Certificates of Corporate Filing/Information issued by the Securities and Exchange Commission on September 26 and 24, 2013, Sumitomo has a permanent establishment in the Philippines in the nature of a representative office and a branch office which licenses to operate were approved on May 24, 1995 and April 7, 1997, respectively. Both offices are located at 2nd Floor, Pioneer House Building, 108 Paseo de Roxas, Makati City, Philippines. On the other hand, SMCC Philippines is a domestic corporation also located at the same address. DcCITS Based on Secretary's Certificate issued on July 24, 2013, the Board of Directors of SMCC Philippines, during a special meeting on June 28, 2013, approved the declaration of cash dividends amounting to P47,880,000.00 in favor of the company's stockholders of record as of June 30, 2013. As of December 23, 2010, Sumitomo holds 39.99 percent of SMCC Philippines issued and outstanding capital stock. Based on the two Applications for Miscellaneous Transactions issued by Metropolitan Bank and Trust Company, SMCC Philippines remitted such dividends to Sumitomo on September 26, 2013. Based on an affidavit issued by the branch office of Sumitomo (" Sumitomo Branch Office ") on September 10, 2013, the branch office is tasked to undertake the construction of the 2nd Mandaue-Mactan Bridge Project Contract Package 1 and other government projects funded by the Overseas Economic Cooperative Fund of Japan. The investment of Sumitomo in SMCC Philippines' shares of stock was made directly by Sumitomo and independently of Sumitomo Branch Office. Sumitomo Branch Office has no knowledge or effective participation in such investment. Based on a similar affidavit issued by the representative office of Sumitomo ( "Sumitomo Representative Office" ) on September 10, 2013, the representative office is tasked, among others, to represent work between the head office and Philippine customers and suppliers and to conduct research in the construction industry. The investment of Sumitomo in SMCC Philippines' shares of stock was made directly by Sumitomo and independently of Sumitomo Representative Office . Sumitomo Branch Office has no knowledge or effective participation in such investment. 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: cADSCT "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 Cooperation 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: AScTaD "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 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 Sumitomo Branch Office's and Sumitomo Representative Office's respective business functions in the Philippines do not include the putting up of investments in SMCC Philippines' shares of stock and receiving dividends from the latter; and such investment in SMCC Philippines was made directly by Sumitomo and independently of Sumitomo Branch Office and Sumitomo Representative Office and these permanent establishments have no knowledge or effective participation in the investment, the holding of such shares in SMCC Philippines is not effectively connected with Sumitomo Branch Office and Sumitomo Representative Office as contemplated in paragraph 5, Article 10 of the amended Philippines-Japan tax treaty. Moreover, since Sumitomo holds directly 39.99 percent of the voting (common) shares and total shares of SMCC Philippines since December 23, 2010 , which is above the minimum 10 percent shareholding and more than the minimum six month holding period, such dividends paid by SMCC Philippines to Sumitomo 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. ICASEH 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.