ITAD BIR Ruling No. 240-14

October 9, 2014 ITAD BIR RULING NO. 240-14 Article 10, Philippines-Japan tax treaty, as amended Agan & Montenegro Law Offices Unit J-3, 7th Floor, Electra House Building 115-117 Esteban Street, Legaspi Village Makati City 1229 Attention: Atty. J. Carlito M. Montenegro Tax Counsel Gentlemen : This refers to your tax treaty relief application filed on June 26, 2013, on behalf of Isuzu Philippines Corporation ("Isuzu-Phil"), requesting confirmation that dividends paid by Isuzu-Phil to Isuzu Motors Limited ("Isuzu-Japan") and Mitsubishi Corporation ("Mitsubishi-Japan") are both 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 Isuzu-Japan, with address at 26-1, Minami-oi, Shinagawa-ku Tokyo, Japan, is a resident of Japan for the purpose of the Philippines-Japan tax treaty per the Certificate of Status of Taxable Person issued on April 4, 2013 by the District Director of Shinagawa Tax Office; that it is not registered either as a corporation or as a partnership in the Philippines per Certification of Non-Registration of Company issued by the Securities and Exchange Commission dated June 17, 2013; that Mitsubishi-Japan, with address at 3-1, Marunouchi 2-chome, Chiyoda-Ku, Tokyo, Japan, is a resident of Japan for the purpose of the Philippines-Japan tax treaty per the Residence Certificate issued on April 19, 2013 by the District Director of Kojimachi Tax Office; that it was licensed to establish its branch office in the Philippines ("Mitsubishi-Philippine Branch") per Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission dated June 13, 2013; that Mitsubishi-Philippine Branch issued an Affidavit stating that: 1) it has neither investments nor shares of stocks in Isuzu-Phil, 2) Mitsubishi-Japan directly acquired the Isuzu-Phil shares, 3) it does not use or hold for use in the conduct of its trade or business any shares of stock of Mitsubishi-Japan in Isuzu-Phil and, 4) all gains inured to the sole benefit of Mitsubishi-Japan and Mitsubishi-Philippine Branch did not received any of the gains; and that, on the other hand, Isuzu-Phil is a corporation, organized and existing under the laws of the Philippines with principal address at 114 Technology Avenue, Laguna Technopark, Bian, Laguna. TSaEcH It is further represented, that on March 7, 2013, the Board of Directors of Isuzu-Phil approved the declaration of cash dividends amounting to One Hundred Ninety-Three Million Three Hundred Seventy-One Thousand and Fifty-One Pesos (Php193,371,051.00), in favor of all stockholders of record as of December 31, 2012 in accordance with their respective shareholdings, which shall be payable immediately; that based on the April 3, 2013 Secretary's Certificate issued by Isuzu-Phil, as of December 31, 2012 and as of the date on which the dividends will be paid, Isuzu-Japan and Mitsubishi-Japan (including the three shares of their respective nominees shareholders), are both legal and beneficial owners of 350,000 common shares which represent approximately 35% of the total outstanding capital of Isuzu-Phil; that the shares were acquired by Isuzu-Japan and Mitsubishi-Japan from original subscription on September 22, 1995; and that, such dividends were remitted by Isuzu-Phil to Isuzu-Japan and Mitsubishi-Japan on June 28, 2013. It is finally represented that the 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 Certification issued by Isuzu-Phil dated June 21, 2013. 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 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 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%)." DAcSIC 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." The provisions of 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; IDCcEa b) 15 per cent of the gross amount of the dividends in all other cases. 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. 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. 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. xxx xxx xxx" Based on the aforequoted provisions, 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 of the gross amount of the dividends if (i) 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, or (ii) the dividends are paid by a company, being a resident of the Philippines, which is registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines; and (b) 15 percent of the gross amount of the dividends, in all other cases. ETHaDC 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-Japan has in the Philippines. Under paragraph 2 (b), Article 5 of the tax treaty, Mitsubishi-Philippine Branch, is considered a permanent establishment of Mitsubishi-Japan, 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. . . ." (Underscoring ours) On the question of whether dividends are 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 22, 2010 p.193) 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) TSaEcH Similarly, following the Supreme Court in Marubeni Corporation vs. Commissioner of Internal Revenue and the 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 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 Isuzu-Phil to Mitsubishi-Japan are not effectively connected with Mitsubishi-Philippine Branch since they are paid not in respect of holdings forming part of the assets of Mitsubishi-Philippine Branch or otherwise effectively connected therewith, and since the business activities that give rise to such dividends are not conducted through Mitsubishi-Philippine Branch. This is because Mitsubishi-Philippine Branch neither has investments nor owns shares of stock in Isuzu-Phil, and does not use or hold for use in the conduct of its trade or business any shares of stock in Isuzu-Phil; Mitsubishi-Japan acquired such shares in Isuzu-Phil directly and without the participation of Mitsubishi-Philippine Branch; and, dividends arising from these shares inure solely to the benefit of Mitsubishi-Japan and Mitsubishi-Philippine Branch did not receive any of these dividends. Hence, Mitsubishi-Philippine Branch is not a material factor in the realization of dividends received by Mitsubishi-Japan. CSEHcT In view thereof and considering that Mitsubishi-Japan and Isuzu-Japan, being both residents of Japan with no fixed place of business in the Philippines, hold 35 percent ownership of the capital of Isuzu-Phil for more than six months immediately preceding the date of payment of the dividends or since September 22, 1995, such dividends paid by Isuzu-Phil to Mitsubishi-Japan and Isuzu-Japan are subject to the preferential tax rate of 10 percent of the gross amount thereof, pursuant to paragraph 2 (a), Article 10 of the Philippines-Japan tax treaty, as amended. 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. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner Bureau of Internal Revenue