ITAD BIR Ruling No. 242-12

June 6, 2012 ITAD BIR RULING NO. 242-12 Article 10, Philippines-Korea tax treaty Samsung Electronics Philippines Manufacturing Corporation Block 6, CPIP Batino Calamba City, Laguna Attention: Mr. In Chul Jung Chief Financial Officer Gentlemen : This refers to your tax treaty relief application filed on February 27, 2012, requesting confirmation that dividends paid to Samsung Electronics Company, Limited ("Samsung") by Samsung Electronics Philippines Manufacturing Corporation ("Samsung-Philippines") are subject to a preferential tax rate of 10 percent pursuant to the Convention between the Republic of the Philippines and the Republic of Korea for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Korea tax treaty"). It is represented that Samsung is a foreign corporation organized and existing under the laws of Korea and is a resident thereof based on the Certificate of Residence issued by Dongsuwon District Tax Office on February 16, 2012; that Samsung is situated at 416 Maetan-3 Dong Yeoungtong-Gu, Suwon Gyeonggi-Do, Korea; that Samsung is licensed to engage in business in the Philippines since April 4, 1990, under Securities and Exchange Commission (SEC) No. F000001298 and, to date, Samsung has not filed a petition to withdraw or cancel such license, based on the Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission ("SEC") on January 17, 2012; and that, on the other hand, Samsung-Philippines is a domestic corporation situated at Block 6, CPIP Batino, Calamba City, Laguna, Philippines. It is further represented, that on January 31, 2012, the Board of Directors of Samsung-Philippines ,at its meeting, declared cash dividends amounting to US$70,000,000.00, subject to the approval of Samsung ,in favor of the stockholders of record of Samsung-Philippines as of December 31, 2011, to be paid on or before April 30, 2012; that upon Samsung approval of the cash declaration of dividends on February 25, 2012, the Board of Directors of Samsung-Philippines ,at its meeting on February 27, 2012, passed a resolution declaring the aforesaid cash declaration approved, ratified and confirmed and to be paid on February 28, 2012; that Samsung is the legal and beneficial owner of 9,875,810 shares constituting 99.99 percent of the entire stockholdings of Samsung-Philippines . cDCIHT It is further represented based on the Affidavit issued by the Senior Legal Counsel of Samsung stated that its Representative Office in the Philippines is situated at 1535 M. Adriatico Street, Malate, Manila; that the activities of the Representative Office were limited to conducting market survey of Samsung products, acted as communication link between Samsung and the customers in the Philippines, and conducted such other activities which are purely coordination work; that said Representative Office as of this date is no longer operational and has no office and employees in the Philippines; that the Representative Office has not engaged in any business activity in the Philippines nor derived any income from the conduct of its operations; that the head office of Samsung in Korea acquired such shares in Samsung-Philippines directly and without the participation of Samsung Representative Office; that, consequently, all gains that arise from these shares inure to the sole benefit of Samsung and that Samsung Representative Office did not receive any such gains; and that Samsung Representative Office is not a material factor in the realization of such gains received by Samsung . It is finally represented that the dividends subject of this ruling 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 Certification issued by the Chief Financial Officer of Samsung-Philippines on February 24, 2012. 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 Samsung ,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%). aHECST 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" With respect to a tax treaty, you invoke the Philippines-Korea tax treaty. Paragraphs 1, 2, and 3, Article 10 thereof provide: "Article 10 DIVIDENDS 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 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 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 (other than a partnership) which holds directly at least 25 per cent of the capital of the company paying the dividends; and CcEHaI b) 25 per cent of the gross amount of the dividends in all other cases. 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 hereof, 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 Korea, who is the beneficial owner of the dividends, shall not exceed 10 per cent of the gross amount of the dividends. xxx xxx xxx" Based on the aforequoted provisions, dividends arising in the Philippines paid to a resident of Korea may be taxed in the Philippines at a rate not to exceed: (a) 10 percent of the gross amount of dividends if the company recipient of the dividends holds directly at least 25 percent of the company paying the dividends; (b) 10 percent of the gross amount of the dividends if the domestic company paying the dividends is registered with the Board of Investments and engaged in preferred areas of investments under the investment incentives laws of the Philippines; and (c) 25 percent of the gross amount of the dividends in all other cases. Accordingly, considering that Samsung holds directly at least 99.99 percent of the total shares of stock of Samsung-Philippines ,such dividends paid by Samsung-Philippines to Samsung 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-Korea tax treaty. 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 Samsung has in the Philippines. Under paragraph 2 (b),Article 5 of the tax treaty, Samsung Representative Office, being the branch office in the Philippines of Samsung ,is considered a permanent establishment thereof, thus: "Article 5 PERMANENT ESTABLISHMENT 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. AIHaCc 2. The term 'permanent establishment' includes especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources; g) premises used as a sales outlet; and h) a warehouse, in relation to a person providing storage facilities for others." 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) TcDIaA 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 Samsung-Philippines to Samsung are not effectively connected with Samsung Representative Office since they are not paid in respect of holdings forming part of the assets of Samsung Representative Office or otherwise effectively connected therewith, and since the business activities that give rise to such dividends are not conducted through Samsung Representative Office. This is because Samsung Representative Office has no investments nor owns shares of stock of Samsung-Philippines ;does not use or hold for use in the conduct of its trade or business any shares of stock of Samsung-Philippines ;the head office of Samsung in Korea acquired such shares in Samsung-Philippines directly and without the participation of Samsung Representative Office ;dividends arise from these shares inure to the sole benefit of Samsung Representative Office and Samsung Representative Office did not receive any of these dividends; and Samsung Representative Office is not a material factor in the realization of dividends received by Samsung . Thus, to reiterate, such dividends paid by Samsung-Philippines to Samsung 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-Korea tax treaty. CAaSHI 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