ITAD BIR Ruling No. 233-15

July 27, 2015 ITAD BIR RULING NO. 233-15 Article 10, Philippines-Japan tax treaty, as amended Sycip Gorres Velayo & Co. 6760 Ayala Avenue Makati City Attention: W. U. Villanueva Principal, Tax Services Gentlemen : This refers to your appeal filed with the Office of the President on behalf of your client, Mitsubishi Corporation Tokyo Head Office ("Mitsubishi JP") from the Decision of the Secretary of Finance dated April 19, 2012, affirming the Bureau of Internal Revenue ITAD Ruling No. 096-12 dated February 16, 2012. ITAD Ruling No. 096-12 denied the tax treaty relief application (TTRA) filed by Mitsubishi JP requesting for confirmation that dividends received from Ayala Corporation ("Ayala") are subject to the preferential tax rate of 10 percent of the gross amount thereof, 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 a Protocol 1 ("Philippines-Japan tax treaty"). The TTRA was denied for having been filed beyond the 15-day period prescribed by Revenue Memorandum Order No. 1-2000. CAIHTE The Office of the President remanded the case to this Office for re-assessment or re-evaluation of the TTRA filed by Mitsubishi JP. It is represented that Mitsubishi JP is a foreign corporation organized and existing under the laws of Japan per Residence Certificate dated January 15, 2010 issued by the District Director of Kojimachi Tax Office; that based on the Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission ("SEC") on May 13, 2010, Mitsubishi is licensed by the SEC to engage in trade or business in the Philippines, and that to date, it has not filed a petition to cancel or withdraw such license; and that, on the other hand Ayala Corporation is a domestic corporation organized and existing under the laws of the Philippines. It is further represented based on the Certificate issued by the Assistant Corporate Secretary of Ayala on December 23, 2009, that Ayala declared cash dividends of PhP2.00 per share to all outstanding common shares of Ayala as of record date January 8, 2010 and that as of June 22, 2010, Mitsubishi JP owns 52,564,617 common shares in Ayala, equivalent to 10.54 percent of the total voting shares of Ayala. It is further represented based on the Affidavit issued by the Treasurer of Mitsubishi Corporation Manila Branch ("Mitsubishi Philippine Branch") on January 20, 2010, that Mitsubishi Philippine Branch has no investments in nor owns shares of stock of Ayala ; that Mitsubishi Philippine Branch does not use or hold for use in the conduct of its trade or business any shares of stock of Ayala ; that Mitsubishi JP acquired directly these shares without the participation of Mitsubishi Philippine Branch ; that, consequently, all gains on such shares, such as gains and dividends, inure solely to the benefit of and is received directly by Mitsubishi JP ; that Mitsubishi Philippine Branch is not a material factor in the realization of any gain received by Mitsubishi JP ; and that Mitsubishi Philippine Branch is situated at 14th Floor, L.V. Locsin Building, 6752 Ayala Avenue corner Makati Avenue, Makati City, Philippines. It is finally represented that the dividends subject of this ruling are 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 Sworn Certification issued by the Assistant Corporate Secretary of Ayala on July 14, 2010. DETACa In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code"), as amended, dividends paid to Mitsubishi JP are subject to income tax at the rate of 30 percent, thus: "SEC. 28. Rates of Income Tax on Foreign Corporations . (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 dividends may be exempt from income tax or subject to a reduced rate to the extent required by any treaty obligation on the Philippines, thus: ATICcS "SEC. 32. Gross Income. (B) Exclusions from Gross Income. The following items shall not be included in gross income and shall be exempt from taxation under this Title: (5) Income Exempt under Treaty. Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines." With respect to a treaty, you invoke the Philippines-Japan tax treaty. Paragraphs 1, 2 and 3, 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. 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." TIADCc Under paragraphs 2 and 3 of Article 10, 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 during the period of six months immediately preceding the date of payment of the dividends; (b) 10 percent 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 in all other cases. Accordingly, upon re-evaluation of this application, since Mitsubishi JP holds directly 10.54 percent of the voting shares or the total shares of Ayala during the period of six months immediately preceding the date of payment of the dividends, such dividends paid by Ayala to Mitsubishi JP are subject to income tax at the rate of 10 percent of the gross amount thereof, pursuant to paragraph 2 (b), Article 10 of the Philippines-Japan tax treaty. However, under paragraph 5, Article 10 of the tax treaty, the reduced rate of income tax of 15 percent does not readily apply if the shares in respect of which the dividends are paid are effectively connected with Mitsubishi Philippine Branch, Mitsubishi JP 's permanent establishment in the Philippines, thus: "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 paragraphs 1 and 2, Article 5 of the tax treaty, a fixed place of business like a branch or an office is considered a permanent establishment, 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; xxx xxx xxx" On the question of dividends being 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 2010) 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: SDAaTC "Paragraph 4 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 source and in the State of the 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. In that case, paragraph 4 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. (Page 193)" AaCTcI Similarly, in Marubeni Corporation vs. Commissioner of Internal Revenue and the Court of Tax Appeals (G.R. No. 76573 dated September 14, 1989) , the Supreme Court mentioned that dividends derived by a foreign corporation which has a branch office in the Philippines are effectively connected with the branch office if the business activities that give rise to such dividends are conducted through the branch office following a principal-agent relationship theory between the foreign corporation and 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 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." On whether dividends paid by Ayala to Mitsubishi JP are effectively connected with Mitsubishi Philippine Branch , it appears that this is not the case since Mitsubishi Philippine Branch has no investments in nor owns shares of stock of Ayala; Mitsubishi Philippine Branch does not use or hold for use in the conduct of its trade or business any shares of stock of Ayala; Mitsubishi JP acquired directly these shares without the participation of Mitsubishi Philippine Branch ; consequently, all fruits of equity investment on such shares, such as gains and dividends, inure solely to the benefit of and is received directly by Mitsubishi JP ; and Mitsubishi Philippine Branch has no participation in the realization of such gains or dividends as Mitsubishi alone exercises all rights and duties of a stockholder of Ayala. This being so, dividends paid by Ayala to Mitsubishi JP are subject to income tax at the reduced rate of 10 percent of the gross amount thereof. This ruling supersedes BIR ITAD Ruling No. 096-12 dated February 16, 2012. 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. EcTCAD 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.