ITAD BIR Ruling No. 339-14

December 22, 2014 ITAD BIR RULING NO. 339-14 Article 10 (Dividends), Philippines-Japan tax treaty Isla Lipana & Co. 29th Floor, Philamlife Tower 8767 Paseo de Roxas 1226 Makati City Attention: Roselle K. Yu Authorized Representative Gentlemen : This refers to your tax treaty application ("TTRA") filed on February 20, 2014, requesting confirmation that dividends paid by Karumona Nagano Seiko, Inc. ("KNSI") to Nagano Seiko Co., Ltd. ("Nagano") are subject to income tax at the rate of 10% pursuant to the Convention between the Government of the Republic of the Philippines and the Government of Japan with respect to Taxes on Income, as amended by the 2009 Protocol ("Philippines-Japan tax treaty"). It is represented that Nagano is a foreign corporation organized and existing under the laws of Japan and is a resident thereof within the meaning of Article 4 of the Convention between the Philippines and Japan on the avoidance of double taxation with business address at 6-7 Honmachi Higashi, Chino City, Nagano Perfecture, Japan; that it has been issued a license to establish a representative office in the Philippines (Nagano-PH) by the Securities and Exchange Commission on May 3, 1994 per certification issued on January 27, 2014; that its Nagano-PH is located at Block 3, Lot 15 & 16 People's Technology Complex, Carmona, Cavite whose business is to undertake research, development and activities such as dissemination, promotion as well as quality control of company's products. Nevertheless, it is represented that any shares held or acquired by Nagano in KNSI were acquired without the participation of Nagano-PH; that Nagano-PH does not hold any shares of stock in KNSI; and that on the other hand, KNSI is a domestic corporation duly organized and existing under the laws of the Philippines with principal address at Block 3, Lot 1 People's Technology Complex, Carmona, Cavite. It is also represented that Nagano is the registered owner of Ninety-Six Thousand One Hundred Forty-Four (96,144) common shares inclusive of Five (5) nominal shares with a par value of Php1,000 per share constituting One Hundred percent (100%) of the issued and outstanding shares in KNSI. The following are the details of the acquisition of shares of KNSI by Nagano : cSaCDT Acquisition date No. of Shares Mode of Acquisition June 3, 2005 15,000 Original Share Issuance October 5, 2006 52,470 Conversion of Advances to Equity February 29, 2008 18,674 Conversion of Advances to Equity December 10, 2008 5,000 Share purchase from Philippine Nagano Seiko, Inc. July 26, 2010 4,995 Share Purchase from Nagano Sogyo Co., Ltd. It is also represented that on February 10, 2014, the board of directors of KNSI has declared cash dividend in the total amount of Php29,386,666.67 to all stockholders of records as of November 22, 2013 out of the retained earnings as of September 30, 2013, in the amount of Php304,953,085.00 to be paid on or before February 28, 2014; and that on February 25, 2014, the amount of Sixty Million Yen (Y60,000,000) was paid to Nagano by KNSI per bank certification issued by RCBC on February 25, 2014. It is also represented, per sworn certification issued by KNSI dated February 7, 2014, that the issue subject of the above request is not under any investigation or on-going audit, administrative protest, claim for refund or issuance of tax credit certificate, collection proceedings, or a judicial appeal. In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code"), as amended, dividends paid to Nagano are subject to income tax at the rate of 30 percent, thus: "SEC. 28. Rates of Income Tax on Foreign Corporations. xxx xxx xxx (B) Tax on Non-resident 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) and (d) above: n Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." aCITEH However, under Section 32 (B) (5) of the Tax Code, these dividends may be subject to a reduced rate to the extent required by any treaty obligation on the Philippines, thus: "SEC. 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." For this purpose, you invoke the Philippines-Japan tax treaty as amended. Paragraphs 1, 2, 3, 5 & 6 of Article 10 thereof 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 percent 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 percent 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. cECTaD (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. (6) Where a company which is a resident of a Contracting State derives profits or income from the other Contracting State, that other Contracting State may not impose any tax on the dividends paid by the company, except insofar as such dividends are paid to a resident of that other Contracting State or insofar as the holding in respect of which the dividends are paid is effectively connected with a permanent establishment or a fixed base situated in that other Contracting State, nor subject the company's undistributed profits to a tax on the company's undistributed profits, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in that other Contracting State. Under paragraphs 2 and 3 of Article 10, 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 if the company recipient of the dividends holds directly at least 10 percent of the voting shares or the total shares of the company paying the dividends during the period of six months immediately preceding the date of payment of the dividends; (b) 10 percent if the dividends are paid by a domestic company registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines; and (c) 15 percent in all other cases. However, the preferential tax rates shall not apply if the Japanese corporation has a permanent establishment in the Philippines and the subject dividend income is effectively connected to the said permanent establishment. Article five (5) of the Philippines-Japan tax treaty, as amended, defines "permanent establishment" as follows: THAICD 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. xxx xxx xxx A perusal of the records shows that Nagano has a branch here in the Philippines Nagano-PH. As to whether the dividends paid by KNSI to Nagano is considered to have been made through a permanent establishment in the Philippines, the commentaries of the Organization for Economic Cooperation and Development ("OECD") Model Tax Convention on Income and on Capital 1 are relevant: ". . . the right to tax of the State where the permanent establishment is situated does not extend to profits that the enterprise may derive from that State but that are not attributable to the permanent establishment. This is a question on which there have historically been differences of view, a few countries having some time ago pursued a principle of general "force of attraction" according to which income such as other business profits, dividends, interest and royalties arising from sources in their territory was fully taxable by them if the beneficiary had a permanent establishment therein even though such income was clearly not attributable to that permanent establishment. Whilst some bilateral tax conventions include a limited anti-avoidance rule based on a restricted force of attraction approach that only applies to business profits derived from activities similar to those carried on by a permanent establishment, the general force of attraction approach described above has now been rejected in international tax treaty practice. The principle that is now generally accepted in double taxation conventions is based on the view that in taxing the profits that a foreign enterprise derives from a particular country, the tax authorities of that country should look at the separate sources of profit that the enterprise derives from their country and should apply to each permanent establishment test, subject to the possible application of other Articles of Convention. This solution allows simpler and more efficient tax administration and compliance, and is more closely adapted to the way in which business is commonly carried on. . . ." HSTCcD In the same context, the Supreme Court in the case of Marubeni Corporation vs. Commissioner of Internal Revenue and Court of Tax Appeals 2 held that: "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 become 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. Consequently, the taxpayer is 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." Therefore, based on the above rationalization, the income paid to the head office of a foreign corporation which has a branch office in the Philippines shall not be subject to the preferential tax rate if the income is effectively connected to the said branch office. However, if the business transactions that created the income came from a separate and independent transaction from the branch in the Philippines, then such income shall be subject to the preferential tax rate under the tax treaty. In the case at hand, it is represented that the rights and obligations of Nagano arising from the investment in KNSI are solely for the account of Nagano and are not in any way effectively connected with the business activity of Nagano-PH. Therefore, applying the rules enunciated above, such dividends paid by KNSI to Nagano cannot be considered as effectively connected with Nagano-PH. Accordingly, the dividend paid by KNSI to Nagano is subject to income tax at the rate of ten percent (10%) of the gross amount thereof, pursuant to Article 10 (2) (a) of the Philippines-Japan tax treaty as (1) Nagano holds 96,144 common shares constituting 100 percent of the total shares of KNSI, which is more than ten percent (10%) of the capital of the said company and (2) Nagano holds the said shares during the period of more than 6 months immediately preceding the date of payment of the dividends on February 25, 2014 or since July 26, 2010. 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. HDCTAc Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner Bureau of Internal Revenue Footnotes 1. OECD Model Tax Convention on Income and on Capital, Condensed Version, Eighth Edition, 2010, p. 157. 2. G.R. No. 76573 dated September 14, 1989. n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.