ITAD BIR Ruling No. 241-13

August 16, 2013 ITAD BIR RULING NO. 241-13 Article 10, Philippines-Japan tax treaty Sycip Gorres Velayo and Co. 6760 Ayala Avenue 1226 Makati City Attention: Romulo S. Danao Partner, Tax Services Gentlemen : This refers to your tax treaty relief application filed on April 20, 2012, requesting confirmation that dividends received by Artnature, Inc. ("ANI") from Artnature Manufacturing Philippines, Inc. ("ANMP") are subject to income tax of 10 percent preferential rate 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 ("Philippines-Japan tax treaty") , as amended by a Protocol 1 effective January 1, 2009. Facts It is represented that ANI is a foreign corporation organized and existing under the laws of Japan and a resident thereof based on its Articles of Association and on the Certificate of Residence issued by Shibuya Tax Office of Japan on March 21, 2012; that ANI is situated at 3-40-7 Yoyogi, 3-Chome Shibuya-ku, Tokyo, Japan; that ANI is licensed to do business in the Philippines under Securities and Exchange Commission ("SEC') No. FS200615974 on October 10, 2006; and that, on the other hand, ANMP is a domestic corporation situated at Lot 2, First St., First Philippines Industrial Park, Barangay Sta. Anastacia, Sto. Tomas, Batangas, Philippines. It is further represented that, based on the Certificate issued by the Corporate Secretary of ANMP, a Board of Directors meeting of ANMP was held last March 15, 2012, during the special meeting, it approved the declaration of dividends in favor of its stockholders in the amount of Php5,760,000.00, of record March 15, 2012 and payable on April 27, 2012; that as of the date of dividend declaration, ANI is a stockholder of record holding and owning 59,995 commons shares equivalent to 99.99 percent of the outstanding capital shares of ANMP; and that the dividend income was remitted to ANI by ANMP last April 27, 2012, based on the notarized certification issued by Mizuho Corporate Bank, Ltd. Manila branch dated May 3, 2012. ICDSca It is further represented based on the Affidavit dated July 4, 2011 issued by the Resident Agent of ANI, that Artnature, Inc. Representative Office has no participation whatsoever, directly or indirectly, in the investment of ANI in ANMP; and that the dividend income to be received by ANI from ANMP is not in any way attributable to or effectively connected with Artnature, Inc. Representative Office and any payment of dividends is directly remitted to ANI and not shall not be coursed through said representative office. It is finally represented that the dividends subject of the above application are not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Affidavit issued by the President of ANMP dated March 19, 2012. Ruling In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code"), as amended, provides that dividends paid to ANI, being a foreign corporation not engaged in trade or business in the Philippines, are subject to income tax at the rate of 30 percent, thus: "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 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): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). ScAaHE xxx xxx xxx" However, Section 32 (B) (5) of the Code provides that 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: "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 this connection, paragraphs 1, 2, 3 and 5, Article 10 of the Philippines-Japan tax treaty, as amended, 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. SATDHE 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. 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. HCSDca Under paragraphs 2 and 3 above, 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, beginning January 1, 2009, (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 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; and (c) beginning January 1, 2009, 15 percent of the gross amount of the dividends in all other cases." HAaScT 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 ANI has in the Philippines. Under paragraph 2 (b), Article 5 of the tax treaty, Artnature, Inc. Representative Office, being the representative office in the Philippines of ANI, is considered a permanent establishment thereof, 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." TEcADS According to the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (Condensed Version, July 17, 2008), such dividends are effectively connected with the permanent establishment 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) CSTEHI Similarly, according to 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." (Emphasis added) Accordingly, the holdings in respect of the dividends paid by ANMP to ANI are not effectively connected with Artnature, Inc. Representative Office since they are not paid in respect of holdings forming part of the assets of Artnature, Inc. Representative Office or otherwise effectively connected therewith, and since the business activities that give rise to such dividends are not conducted through Artnature, Inc. Representative Office. This is because Artnature, Inc. Representative Office has no investments nor owns shares of stock of ANMP; does not use or hold for use in the conduct of its trade or business any shares of stock of ANMP; the head office of ANI in Japan acquired such shares in ANMP directly and without the participation of Artnature, Inc. Representative Office; dividends arise from these shares inure to the sole benefit of ANI and Artnature, Inc. Representative Office did not receive any of these dividends; and Artnature, Inc. Representative Office is not a material factor in the realization of dividends received by ANMP. EHSAaD Accordingly, considering that ANI holds directly at least 10 percent of the total shares of stock of ANMP or 99.99% during the period of six months immediately preceding the date of payment of the dividends (in fact, since March 16, 2009, to present), such dividends paid by ANMP to ANI are subject to income tax at the reduced 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 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.