ITAD BIR Ruling No. 288-12

July 17, 2012 ITAD BIR RULING NO. 288-12 Article 11, Philippines-Japan Tax Treaty, as amended Manabat Sanagustin & Co. 9th Floor, KPMG Center 6787 Ayala Avenue Makati City 1226 Attention: Maria Carmela M. Peralta Principal, Tax Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on December 21, 2010, that the interest paid by Energy Development Corporation ("EDC") to Mizuho Corporate Bank Ltd. ("Mizuho-Japan") is subject to final withholding tax at a rate of 10 percent pursuant to Article 11 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 Mizuho-Japan, with address at 1-3-3 Marunouchi, Chiyoda-ku, Tokyo, Japan, is a corporation organized and existing under the laws of Japan, and a resident thereof within the meaning of the Philippines-Japan tax treaty per the Certificate of Residence issued by the District Director of Kjimachi Tax Office dated November 26, 2010; that it was licensed to establish a branch in the Philippines per Certificate issued by the Securities and Exchange Commission dated November 5, 2010; that pursuant to the grant of license, Mizuho-Japan put up a branch in the Philippines ("Mizuho-Philippine Branch") ;and that, on the other hand, EDC is a corporation organized and existing under the laws of the Philippines with principal address at Building 5, Energy Center, Merritt Road, Fort Bonifacio, 1201 Taguig City. It is further represented that on June 17, 2010, a Transferable Syndicated Term Loan Facility ("Agreement") in the amount of US$175,000,000.00 was entered into by and between EDC, as borrower, and several Financial Institutions, as lenders, and participated in by several banks, as arrangers and facility agent; that the purposes of the loan are as follows: (a) the general corporate funding purposes of EDC; (b) the repayment of Philippine National Oil Company On-Lent Loans; (c) the refinancing and/or repayment of maturing loan obligations; (d) rehabilitation of the Palinpinon Plants and the Tongonan Plants; and/or (e) payment in full of the Front-end Fees and Underwriting Fees agreed in the Fee Letter between the mandated Lead Arrangers and Bookrunners and EDC; that under the Agreement, Mizuho-Hong Kong Branch has committed to extend an amount of US$5,000,000; that the loan facility has an interest rate of 3.25%+LIBOR, and a payment term of six (6) months; that per the Sworn Certification issued on February 10, 2011 by Mizuho-Philippine Branch, the following statements were undertaken: 1. The Head Office of Mizuho-Philippine Branch is Mizuho-Japan, a corporation organized and existing under the laws of Japan; 2. There is an existing Syndicated Credit Agreement ("Agreement") entered into by EDC as the borrower and Mizuho-Hong Kong Branch, as one of the lenders; EcATDH 3. Mizuho-Philippine Branch, in its own right, is a signatory in the Agreement also as a lender of US$5,000,000; 4. The rights and obligations of Mizuho-Philippine Branch and Mizuho-Hong Kong Branch as lenders under the Agreement are separate and independent; 5. Interests arising from the Agreement will be received by Mizuho-Philippine Branch and Mizuho-Hong Kong Branch separately and independently of each other. Each Mizuho-Japan branch has its own independent right in collecting the interest from EDC pursuant to the Agreement; and 6. Mizuho-Hong Kong Branch and Mizuho-Philippine Branch are lenders of EDC under the subject loan agreement and that each branch independently books their respective interest income from the loan. The interest income earned by Hong Kong Branch is not used or held to be used by Philippine Branch. That based on the submitted proof of bank remittance shows that EDC remitted to the Standard Chartered Bank New York, the Facility agent, the amount of US$3,557,941.92 on December 23, 2010 as interest payment to Mizuho-Japan. It is finally represented, per the Sworn Certification issued on December 20, 2010 issued by EDC, that the issue or 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. In reply, please be informed that interest income derived by a nonresident foreign corporation is generally taxable under Section 28 (B) (5) (a) of the National Internal Revenue Code of 1997 (NIRC of 1997), as amended. It provides: "Section 28. Rates of Income Tax on Foreign Corporations. (B) Tax on Nonresident Foreign Corporation. xxx xxx xxx (5) Tax on Certain Incomes Received by a Nonresident Foreign Corporation. EHTISC (a) Interest on Foreign Loans. A final withholding tax at the rate of twenty percent (20%) is hereby imposed on the amount of interest on foreign loans contracted on or after August 1, 1986; However, said income may be exempt from income tax or partially exempt pursuant to a treaty obligation to which the Philippine government is bound. Thus, Section 32 (B) (5) of the NIRC 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." Thus, Article 11 of the Philippines-Japan tax treaty, as amended, which you invoke, may apply to the instant case. It states: "Article 11 1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State. 2. However, such interest may also be taxed in the Contracting State in which it arises, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the interest the tax so charged shall not exceed 10 per cent of the gross amount of the interest. xxx xxx xxx 3. The term 'interest' as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and in particular, income from Government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures." Based on the above provisions, interest derived by a corporation which is a resident of Japan may qualify for a preferential rate of 10 percent of the gross amount thereof, under the Philippines-Japan tax treaty, as amended, if the recipient of such interest is also the beneficial owner thereof. However, the 10 percent tax rate shall not apply if the Japanese corporation has a permanent establishment in the Philippines and the subject interest income is effectively connected to the said permanent establishment. 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 interest is paid is effectively connected with a permanent establishment which Mizuho-Japan has in the Philippines. Under paragraph 2 (b),Article 5 of the tax treaty, Mizuho-Philippine Branch, is considered a permanent establishment of Mizuho-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) LibLex On the question of whether interests 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 interests 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) cCESaH Accordingly, the holdings in respect of the interest paid by EDC to Mizuho-Japan are not effectively connected with Mizuho-Philippine Branch since they are paid not in respect of holdings forming part of the assets of Mizuho-Philippine Branch or otherwise effectively connected therewith, and since the business activities that give rise to such interest are not conducted through Mizuho-Philippine Branch. This is because Mizuho-Philippine Branch has neither investments nor owns shares of stock in EDC; does not use or hold for use in the conduct of its trade or business any shares of stock in EDC; Mizuho-Japan acquired such shares in EDC directly and without the participation of Mizuho-Philippine Branch; and, interest arising from these shares inure solely to the benefit of Mizuho-Japan and Mizuho-Philippine Branch did not receive any of these interest. Hence, Mizuho-Philippine Branch is not a material factor in the realization of interest received by the Mizuho-Japan. In view of the foregoing, and considering that the interest income of Mizuho-Japan from the participation of its Hong Kong branch as lender of US$5,000,000 to EDC, is not effectively connected to Mizuho-Philippine Branch, this office is of the opinion and so holds that the interest paid by EDC to Mizuho-Japan, is subject to Philippine income tax at the rate not exceeding 10 percent of the gross amount thereof pursuant to Article 11 (2) of the Philippines-Japan tax treaty, as amended. Moreover, the subject Syndicated Credit Agreement entered into between EDC and Mizuho-Japan is subject to documentary stamp tax imposed under Section 179 of the Tax Code of 1997, as amended, at the rate of One Peso (P1.00) on each Two Hundred Pesos (P200) or fractional part thereof, of the issue price of any such loan agreement. 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 of Internal Revenue