ITAD BIR Ruling No. 322-13

December 2, 2013 ITAD BIR RULING NO. 322-13 Article 10, Philippines-Japan Tax Treaty, as amended by its Protocol; Section 28 (B) (1) in relation to Section 32 (B) (5) of the Tax Code of 1997, as amended Mitsubishi Corporation-Manila Branch 14th Floor L.V. Locsin 6752 Ayala Avenue, corner Makati Avenue Makati City Attention: Mr. Kiyoshi Takagi Treasurer Gentlemen : This refers to your tax treaty relief application filed on May 10, 2013 requesting for confirmation of your opinion that the dividends received by MITSUBISHI CORPORATION (MITSUBISHI) from MANILA WATER COMPANY, INC. (MANILA WATER) are subject to 10 percent preferential tax 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. It is represented that MITSUBISHI is a foreign corporation and a resident of Japan, as evidenced by its Articles of Incorporation as amended, and the Residence Certificate dated January 1, 2013 issued by the District Director of Kojimachi Tax Office, Japan; that its principal office is situated at 3-1, Marunouchi 2-chome, Chiyoda-ku, Tokyo, Japan; that MITSUBISHI is licensed to do business in the Philippines since March 20, 1967, under Securities and Exchange Commission (SEC) No. F000000491 and, to date, MITSUBISHI has not filed a petition to withdraw or cancel such license, based on the Certificate of Corporate Filing/Information issued by the SEC on May 23, 2013; and that, on the other hand, MANILA WATER, with principal address at MWSS-Administration Building, Katipunan Road, 1105 Balara, Quezon City, Philippines, is a corporation registered with the Board of Investments (BOI) on a pioneer status as a new operator of water supply and sewerage system for the East Zone Service Area with Certificate of Registration No. 97-188 issued on August 20, 1997. HAEIac It is further represented, based on the Affidavit executed by Mitsubishi Corporation-Philippine Branch on April 15, 2013, that although MITSUBISHI has a branch in the Philippines; (1) Mitsubishi Corporation-Philippine Branch has no investments in MANILA WATER and does not own shares of stock in MANILA WATER as shown in the Audited Financial Statements of Mitsubishi Corporation-Philippine Branch as of March 31, 2012 and 2011 (2) Mitsubishi Corporation-Philippine Branch likewise does not use or hold for use in the conduct of its trade or business any shares of stock in MANILA WATER; (3) MITSUBISHI acquired the MANILA WATER's shares and the said acquisition was made without the participation of Mitsubishi Corporation-Philippine Branch ; and (4) all gains inured to the sole benefit of MITSUBISHI and Mitsubishi Corporation-Philippine Branch did not receive any of the gains, and hence, Mitsubishi Corporation-Philippine Branch is not a material factor in the realization of any gain received by MITSUBISHI; that at the regular meeting of the Board of Directors of MANILA WATER held on April 15, 2013, it approved the declaration of cash dividends for the first semester of 2013, payable on May 15, 2013 to stockholders of record of MANILA WATER as of April 29, 2013, as follows: (a) P0.382 per share on the outstanding Common shares; and (b) P0.0382 per share on the outstanding Participating Preferred shares; that per Secretary's Certificate issued by the MANILA WATER on April 30, 2013, as of April 29, 2013, MITSUBISHI is the owner of 168,999,999 common shares with a total value of P6,759,999,960.00, representing 8.28 percent of the outstanding and voting common shares of MANILA WATER and acquired said shares in 1997 and fully paid the subscription on July 31, 1998; that per same Secretary's Certificate issued by the MANILA WATER, Mr. Masaji Santo, a nominee of MITSUBISHI in the Board of Directors of MANILA WATER, owns one (1) common share in MANILA WATER, with a par value of One Peso (P1.00); and lastly, said dividends have been remitted to MITSUBISHI through foreign telegraphic transfer amounting to USD1,410,589.95 on May 15, 2013 as evidenced by the duly notarized copy of the machine validated Single Customer Credit Transfer of the Bank of the Philippine Islands. 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 Chief Finance Officer and Treasurer of the MANILA WATER on April 24, 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 dividends received by a nonresident foreign corporation in the Philippines. It provides: ACaDTH "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%). xxx xxx xxx" However, Section 32 (B) (5) of the Tax Code of 1997, as amended, provides that such income 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: TSEHcA 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. 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." IDcHCS Based on the aforequoted provisions, the Philippines may tax the dividends paid by a resident of the Philippines registered with the BOI and engaged in preferred areas of investment under the investment incentives laws of the Philippines to a resident of Japan who is the beneficial owner of the dividends at a rate not exceeding 10 percent of the gross amount of the dividends. 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 has in the Philippines. Under paragraph 2 (b), Article 5 of the tax treaty, Mitsubishi Corporation-Philippine Branch , being the branch office in the Philippines of MITSUBISHI, 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; aETDIc e) a workshop; f) a warehouse; g) a mine, an oil or gas well, a quarry or other place of extraction of natural resources." 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) cHAaCE 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 MANILA WATER to MITSUBISHI are not effectively connected with Mitsubishi Corporation-Philippine Branch since they are not paid in respect of holdings forming part of the assets of Mitsubishi Corporation-Philippine Branch or otherwise effectively connected therewith, and since the business activities that give rise to such dividends are not conducted through Mitsubishi Corporation-Philippine Branch . This is because Mitsubishi Corporation-Philippine Branch has no investments nor owns shares of stock of MANILA WATER; does not use or hold for use in the conduct of its trade or business any shares of stock of MANILA WATER; the head office of MITSUBISHI in Japan acquired such shares in MANILA WATER directly and without the participation of Mitsubishi Corporation-Philippine Branch ; dividends arise from these shares inure to the sole benefit of MITSUBISHI and Mitsubishi Corporation-Philippine Branch did not receive any of these dividends; and Mitsubishi Corporation-Philippine Branch is not a material factor in the realization of dividends received by MITSUBISHI. AHcDEI Thus, to reiterate, such dividends paid by MANILA WATER to MITSUBISHI are subject to income tax at the rate of 10 percent of the gross amount thereof, pursuant to Article 10 (3) 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 .