ITAD BIR Ruling No. 362-12

October 22, 2012 ITAD BIR RULING NO. 362-12 Article 11, Philippines-Japan tax treaty, as amended SGV & Co. 6760 Ayala Avenue 1226 Makati City Attention: Atty. Antonette C. Tionko Principal, Tax Services Gentlemen : This refers to your tax treaty relief application filed July 12, 2010, on behalf of Sumitomo Mitsui Banking Corporation ("SMBC") requesting confirmation that the interest paid by International Electric Wires Philippines Corporation ("IEWPC") to SMBC is subject to 10 percent final withholding tax pursuant to 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 SMBC, with principal office at 1-2 Yurakucho 1-chome, Chiyoda-ku, Tokyo 100-0006, Japan, is a resident of Japan within the meaning of the Philippines-Japan tax treaty based on the certification issued by the District Director of Kojimachi Tax Office on April 2, 2010; that SMBC was issued a license to establish its representative office in the Philippines on March 24, 1995, as shown in the Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission on February 3, 2010; and pursuant to the said license, SMBC established an office 1 in the Philippines, hereinafter referred to as " SMBC-Manila " for the following purposes: (a) collect and analyze the macro information on the Philippines and report to the bank's domestic and overseas customers; (b) help SMBC's customers to invest in the Philippines and to search Philippine partner; and (c) prepare for the establishment of a branch or subsidiary in the future; and that IEWPC, on the other hand, is a domestic corporation, with office address located at Luisita Industrial Park, Special Export Processing Zone (SEPZ), San Miguel, Tarlac City. It is further represented that IEWPC executed a Promissory Note on September 17, 2009 promising to pay to SMBC the amount of loan granted by the latter to the former in the amount of Three Million US Dollars (US$3,000,000.00) on November 17, 2009 at an initial base interest rate of 0.37% plus a spread of 0.30% per annum; and that as confirmed by the Osaka head Office of Foreign Exchange Department, Sumitomo Mitsui Banking Corporation in its letter dated May 9, 2012, interest payment on the subject loan in the amount of US$3,625.00 was debited to the account of IEWPC on August 13, 2010. It is moreover represented that SMBC-Manila is not privy and does not have any participation whatsoever with the loan contracted by IEWPC from SMBC; and that SMBC-Manila is not a material factor in the realization of interest income by SMBC, the said interest being not in any way connected to the operations of SMBC-Manila . aSTAIH It is finally represented, based on the Sworn Certification by the President of IEWPC on April 14, 2010, that the transaction subject of the request for ruling is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal of the taxpayer/s involved. In reply, please be informed that interest income derived by a nonresident foreign corporation is generally taxable under Section 28 (B) (5), of the National Internal Revenue Code of 1997 ("NIRC of 1997"), as amended. It provides: "SEC. 28. Rates of Income Tax on Foreign Corporations . xxx xxx xxx (B) Tax on Nonresident Foreign Corporation . (5) Tax on Certain Incomes Received by a Nonresident Foreign Corporation . (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 interest 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, viz. : "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." Accordingly, the Philippines-Japan tax treaty, as amended, which you have invoked, may apply to the interest payments of IEWPC to SMBC. Its Article 11 provides, viz. : "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. 3. Notwithstanding the provisions of paragraph 2, the amount of tax imposed by the Philippines on the interest 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 interest, shall not exceed 10 per cent of the gross amount of the interest. 4. Notwithstanding the provisions of paragraphs 2 and 3, interest arising in a Contracting State and derived by the Government of the other Contracting State including political subdivisions and local authorities thereof, the Central Bank of that other Contracting State or any financial institution wholly owned by that Government, or by any resident of the other Contracting State with respect to debt-claims guaranteed or indirectly financed by the Government of that other Contracting State including political subdivisions and local authorities thereof, the Central Bank of that other Contracting State or any financial institution wholly owned by that Government shall be exempt from tax in the first-mentioned Contracting State. IcDESA For the purposes of this paragraph, the term "financial institution wholly owned by the Government" means: a) In the case of Japan, the Export-Import Bank of Japan, the Overseas Economic Cooperation Fund and the Japan International Cooperation Agency; b) In the case of the Philippines, the Development Bank of the Philippines; and c) Any such financial institution the capital of which is wholly owned by the Government of either Contracting State, other than those referred to in sub-paragraphs (a) and (b) above, as may be agreed from time to time between the Governments of the two Contracting States. 5. 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. 6. The provisions of paragraphs 1, 2 and 3 above shall not apply if the beneficial owner of the interest, being a resident of a Contracting State, carries on business in the other Contracting State in which the interest arises, through a permanent establishment situated therein, or performs in that other Contracting State independent personal services from a fixed base situated therein, and the debt-claim in respect of which the interest is 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. xxx xxx xxx" Based on the above provisions, interests on foreign loans are generally taxable in the Philippines at the rate of 20 percent. However, interests 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. As to the definition of permanent establishment, Article 5 of the Philippines-Japan tax treaty, as amended, provides, as follows: "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" Based on the foregoing, the reduced rate on interest under paragraphs 2 and 3, Article 10 of the Philippines-Japan tax treaty may not apply to the interests paid by IEWPC to SMBC if such are effectively connected with a permanent establishment which the latter may have in the Philippines, such as SMBC-Manila . On the question of interest being effectively connected with a permanent establishment, the relevant commentaries of the Organisation for Economic Cooperation and Development ("OECD") Model Tax Convention on Income and on Capital (Condensed Version, July 17, 2008) mention that 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: aEcADH "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) Similarly, the pronouncement of the Supreme Court in Marubeni Corporation vs. Commissioner of Internal Revenue and Court of Tax Appeals (G.R. No. 76573 dated September 14, 1989) may also apply to the herein case notwithstanding that the income included in the Marubeni case is dividends. In the said case, the Supreme Court said that dividends paid to the head office of a foreign corporation which has a branch office in the Philippines are effectively connected to the branch office if the business transactions that give rise to the dividends are conducted through the branch office, 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. 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." Applying the OECD commentaries and the principle enumerated in the Supreme Court ruling, such interest paid by IEWPC to SMBC cannot be considered as effectively connected with SMBC-Manila since, as represented, it does not have any participation whatsoever with regard to the loan between IEWPC and SMBC. Moreover, SMBC-Manila does not use or hold for use in the conduct of its trade or business any shares of stock in IEWPC, and that those shares in IEWPC were acquired directly by the head office of SMBC in Japan without the participation of SMBC-Manila . Consequently, all interest gains of SMBC that arise inure to its sole benefit and are not received by SMBC-Manila . And, finally, SMBC-Manila is not a material factor in the realization of such interest income received by the head office. In view of all of the foregoing, and considering that SMBC's interest income is not effectively connected to its representative office in the Philippines, SMBC-Manila , this Office is of the opinion and so holds that the interests derived by SMBC from IEWPC are subject tax at the preferential rate of 10 percent of the gross amount of the interests, pursuant to Article 11 (2) of the Philippines-Japan tax treaty, as amended. In addition thereto, the herein Loan Agreement entered into between SMBC and IEWPC 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 Footnotes 1. Situated at the 20th Floor, Rufino Pacific Tower, 6784 Ayala Avenue, Makati City, Philippines.