ITAD Ruling No. 015-02

January 31, 2002 ITAD RULING NO. 015-02 RP-US Tax Treaty, Article 14 Tax Code of 1997, Section 176 BIR Ruling No. ITAD 84-01 Sycip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: E. C. Alcantara Tax Division Gentlemen : This refers to your letter dated November 8, 2001 on behalf of your client, Marubeni Pacific Energy Holdings Corporation (MPEHC), requesting confirmation of your opinion that the proposed redemption by MPEHC of its redeemable preferred shares owned by Marubeni America Corporation (MAC) is exempt from the payment of capital gains tax pursuant to the provisions of the RP-US tax treaty. It is represented that MAC is a foreign corporation organized and existing under the laws of the State of New York with its principal office at 450 Lexington Avenue, New York, New York 10017-3984; that MAC is not registered either as a corporation or as a partnership licensed to do business in the Philippines as per certification dated September 25, 2001 issued by the Securities and Exchange Commission; that MPEHC is a domestic corporation organized and existing under the laws of the Philippines with principal address at 7/F L.V. Locsin Building, Ayala cor. Makati Avenues, Makati City; that MPEHC exercised its right to redeem its 30,523 preferred shares owned by MAC at a redemption price higher than MAC's adjusted cost basis of the said shares. In reply, please be informed that Article 14 of the RP-US tax treaty provides as follows: "ARTICLE 14 "CAPITAL GAINS "1. Gains from the alienation of tangible personal (movable) property forming part of the business property of a permanent establishment which a resident of a Contracting State has in the other Contracting State or of tangible personal (movable) property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or together with the whole enterprise) or of such a fixed base, may be taxed in the other State. However, gains derived by a resident of a Contracting State from the alienation of ships, aircraft or containers operated by such resident in international traffic shall be taxable only in that State, and gains described in Article 13 (Royalties) shall be taxable only in accordance with the provisions of Article 13. "2. Gains from the alienation of any property other than those mentioned in paragraph (1) or in article 7 (Income from Real Property) shall be taxable only in the Contracting State of which the alienator is a resident." On the other hand, the Reservation Clause of the RP-US tax treaty, in pertinent part, provides: SDECAI "Article 1 ". . . notwithstanding the provisions of Article 14 relating to capital gains, both the United States and the Philippines may tax gain from the disposition of an interest in a corporation if its assets consists principally of a real property interest located in that country. Likewise, both countries may tax gain from the disposition of an interest in a partnership, trust or estate to the extent the gain is attributable to a real property interest in one of the countries. The term `real property interest' is to have the meaning it has under the law of the country in which the underlying real property is located." xxx xxx xxx It is clear from the aforequoted provisions that any capital gains which may be derived by MAC from the alienation of any property other than those mentioned in paragraph (1) of Article 14 (Capital Gains) or in Article 7 (Income from Real Property) of the RP-US tax treaty shall be taxable only in the State where the alienator is a resident. It is to be noted, however, that under the Reservation Clause, the Philippines may tax the gains derived from the disposition of interest in a corporation if its assets consist principally of real property interests located in the Philippines. "Principally" means more than 50% of the entire assets in terms of value (Sec. 2(a) and (b), Revenue Regulations No. 4-86) Verification of the Annual Audited Financial Statements ending December 31, 2000 of MPEHC disclosed that it has no real property interest located in the Philippines, thereby making the assets of MPEHC not principally consisted of real property interest located in the Philippines. Accordingly, this Office is of the opinion as it holds that the gain realized by MAC consisting of the difference between the redemption price of the MPEHC redeemable preferred shares and MAC's adjusted cost basis of the said shares is exempt from capital gains tax under Section 28(B)(5)(c) of the Tax Code of 1997, as amended, pursuant to Article 14(2) of the RP-US tax treaty. (BIR Ruling No. ITAD 40-01 dated April 6, 2001). However, the Redemption Agreement entered into by MAC and MPEHC shall be subject to documentary stamp tax imposed under Section 176 of the Tax Code of 1997. This ruling is issued on the basis of the facts as represented. However, if upon investigation it shall be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service