ITAD Ruling No. 017-03

January 30, 2003 ITAD RULING NO. 017-03 RP-Malaysia, Articles 4 & 13 Sec. 176, NIRC BIR Ruling No. DA-194-99 BIR Ruling No. DA-ITAD-68-02 Roxas De Los Reyes Laurel & Soriano Law Offices 19/F 1st e-Bank Tower, Paseo de Roxas 1200 Makati City Attention: Atty Anna Melissa R. Lichaytoo Atty. Maria Portia E. Rosell Gentlemen : This refers to your letter dated July 19, 2002 requesting confirmation of your opinion to the effect that the sale and transfer by your clients, Messrs. Tan Tiong Eng (Mr. Tan), Teng Woei E'n (Mr. Teng) and Teh Yeoug Siang (Mr. Teh) of their shares of stock in Engtek Precision Philippines, Inc. (EPPI) to Eng Teknologi Holdings Bhd (ETHB) is not subject to capital gains tax pursuant to the RP-Malaysia tax treaty. It is represented that EPPI is a corporation duly organized and existing under the laws of the Philippines; that ETHB is a non-resident foreign corporation duly organized and existing under the laws of Malaysia; that Mr. Tan, Mr. Teh and Mr. Teng (hereinafter known as the "Sellers") are all Malaysian citizens; that Mr. Tan and Mr. Teh both maintain their residence in Penang, Malaysia while Mr. Teng maintains residence both in the Philippines and in Malaysia; that Mr. Teng is the Senior Vice President of ETHB and currently holding office and maintains family residence at Penang, Malaysia; that Mr. Teng is a holder of a Special Non-Immigrant Visa granted by the Philippine Board of Investments for purposes of facilitating his visits to the Philippines to monitor the subsidiaries of ETHB in the Philippines; that Mr. Tan is the registered and beneficial owner of 1,000,000 common shares of stock of EPPI while Mr. Teh and Mr. Teng each own 500,000 common shares of stock of EPPI; and that on July 9, 2002, pursuant to the Share Sale Agreement executed individually by the sellers with ETHB, each sold their respective shareholdings in EPPI to ETHB for and in consideration of the amount of Ringit Malaysia (RM) 1.056 per share. CDHcaS It is further represented that EPPI entered into a lease agreement dated May 10, 2000 with Engtek Philippines, Inc. (EPI) whereby the latter sub-leased its building to EPPI located at Lot 10 Phase II-A SEPZ, Carmelray Industrial Park I, Calamba, Laguna, a parcel of land being leased by AYT Dev., Inc. to EPI; and that Section IV of lease contract provides: "ALTERATION, ADDITIONS AND IMPROVEMENTS 4.1 The LESSEE may place any alterations, additions or improvements on the Leased Premises provided that upon termination of the lease, said alteration, additions and improvements shall automatically become the property of LESSOR without need of reimbursement to the LESSEE. In this regard, LESSEE shall execute and deliver such documents or instruments necessary to confer absolute ownership over them. The LESSEE shall, however, retain ownership of all other furniture, equipment, and other movables, and such equipment and machinery that may be removed without defacing the immovable to which they may be affixed or attached, provided the LESSEE removes the same from the Leased Premises within one (1) month from the expiration of the lease period or any renewal thereof. " In reply, please be informed that to determine the residence of Mr. Teng for purposes of the RP-Malaysia tax treaty, Article 4 of the treaty provides as follows: "Article 4 RESIDENT 1. For the purposes of this Agreement, the term 'resident of a Contracting State' means: (a) in the case of Malaysia, a person who is resident in Malaysia for the purposes of Malaysian tax; and (b) in the case of the Philippines, a person who is resident in the Philippines for the purpose of Philippine tax. 2. Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting States, then his status shall be determined in accordance with the following rules: (a) he shall be deemed to be a resident of the State in which he has a permanent home available to him. If he has a permanent home available to him in both States, he shall be deemed to be a resident of the State with which his personal and economic relations are closer (centre of vital interests); (b) if the State in which he has his centre of vital interests cannot be determined, or if he has a permanent home available to him in either State, he shall be deemed to be a resident of the State in which he has an habitual abode; (c) if he has an habitual abode in both States or in neither of them, he shall be deemed to be a resident of the State of which he is a national; (d) if he is a national of both States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement. "xxx xxx xxx" Based on the aforecited provisions, an individual who is a resident of both Malaysia and the Philippines shall be deemed to be a resident of the country, firstly, in which he has his permanent home, secondly, where his center of vital interest is closer and thirdly, where he has an habitual abode and lastly, where he is a national. Hence, since Mr. Teng maintains his family residence and his principal business office as the Senior Vice-President of ETHB both in Penang, Malaysia, he is deemed a resident of Malaysia. (BIR Ruling No. 481-93 dated December 10, 1993) Consequently, even while Mr. Teng is a holder of a Special Non-Immigrant Visa as a temporary visitor with an authorized stay of 59 days pursuant to Bureau of Immigration Office Memorandum Order No. 93-047 dated July 6, 1993 to monitor the subsidiaries of ETHB in the Philippines, Mr. Teng is still considered a resident of Malaysia for tax treaty purposes. Therefore, Mr. Teng, Mr. Tan and Mr. Teh, all being residents of Malaysia, may invoke the provisions of Article 13 of the RP-Malaysia tax treaty which reads: "Article 13 Gains from the Alienation of Property 1. Gains from the alienation of immovable property, as defined in paragraph 2 of Article 6, may be taxed in the Contracting State in which such property is situated. 2. Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of a Contacting State has in the other Contracting State or of 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 professional 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 from the alienation of ships or aircraft operated by an enterprise of a Contracting State in international traffic and movable property pertaining to the operation of such ships or aircraft shall be taxable only in the State of which the enterprise is a resident. 3. Gains from the alienation of shares of a company, the property of which consists principally of the immovable property situated in a Contracting State, may be taxed in that State. Gains from the alienation of an interest in a partnership or a trust, the property of which consists principally of immovable property situated in a Contracting State, may be taxed in that State. (Emphasis supplied) 4. Gains from the alienation of any property or assets, other than those mentioned in paragraphs 1, 2, and 3 of this Article shall be taxable only in the Contracting State of which the alienator is a resident. (Emphasis supplied)" The gains realized by the sellers from the sale of their shares of stock in EPPI to ETHB are taxable only in Malaysia. However, under paragraph 3 of the aforequoted provision, the Philippines may tax the gains derived from the disposition of interest in a corporation if its entire assets consist principally of real property interest located in the Philippines. "Real Property Interest" means interest on properties enumerated in Section 3 of Revenue Regulations No. 4-86, which are not, however, exclusive of others that are similarly situated. As used in the treaties and in the Regulations, it shall be understood to include real properties as understood under Philippine Laws. Moreover, "Principally" means more than 50% of the entire assets in terms of value. (Sec. 2(a) and (b), Revenue Regulations No. 4-86). EHSCcT Paragraph 5 of Section 3 of the same Regulations provides, viz: "Section 3. Properties . The following are real property interest and/or real properties: "5. Machinery, receptacles, instruments or implements intended by the owner of the tenement for an industry or works which may be carried on in a building or on a piece of land, and which tend directly to meet the needs of the said industry or works; "Machinery mentioned above shall embrace machines, mechanical contrivances, instruments, appliances and apparatus attached to the real estate. It includes the physical facilities available for production, as well as the installations and appurtenant services facilities, together with all the other equipment designed for or essential to its manufacturing, industrial or agricultural purposes." In the case of Davao Saw Mill Co. Inc. vs. Aproniano G. Castillo, et al., ( supra), the Supreme Court [citing the United States case of Valdez vs. Central Altagracia (225 US 58)] held that: ". . . . Machinery which is movable in its nature only becomes immobilized when placed in a plant by the owner of the property or plant, but not so when placed by a tenant, a usufructuary, or any person having only a temporary right, unless such person acted as the agent of the owner. " xxx xxx xxx "The distinction rests . . . upon the fact that one only having a temporary right to the possession or enjoyment of property is not presumed by the law to have applied movable property belonging to him so as to deprive him of it by causing it by an act of immobilization to become the property of another. It follows that abstractly speaking the machinery put by the Altagracia Company in the plant belonging to Sanchez did not lose its character of movable property and become immovable by destination. But if the concrete immobilization took place because of the express provisions of the lease under which the Altagracia held, since the lease in substance required the putting in of improved machinery, deprived the tenant of any right to charge against the lessor the cost of such machinery, and it was expressly stipulated that the machinery so put in should become part of the plant belonging to the owner without compensation to the lessee. Under such conditions the tenant in putting in the machinery was acting but as the agent of the owner in compliance with the obligations resting upon him, and the immobilization of the machinery which resulted arose in legal effect from the act of the owner in giving by contract a permanent destination to the machinery." In view of the foregoing, the machinery of EPPI located on the property leased from Engtek Philippines, Inc. may not be treated as real property not only because it is so placed by a mere lessee but also because the latter did not act as an agent of the lessor, Engtek Philippines, Inc., since it is stipulated in the said lease contract that the EPPI shall retain ownership over the subject machinery which may be removed without defacing the immovable to which they may be affixed or attached. Hence, the machinery placed by lessee shall be considered as personal property for purposes of determining whether a Philippine Corporation's entire assets consist principally of immovable property. ( BIR Ruling No. DA ITAD-68-02 dated April 24, 2002 ) Verification of the 2001 Audited Financial Statements of EPPI disclosed that its real property interest located in the Philippines is only 1.4% of its total assets, thereby making the assets of EPPI not principally consisted of real property interest located in the Philippines. Hence, the gains from the sale by the Sellers of their shares of stock in EPPI shall not be taxable in the Philippines. aEIcHA Accordingly, this Office is of the opinion and so holds that the sale by the Sellers to ETHB of their respective shares in EPPI is not subject to capital gains tax pursuant to Article 13 of the RP-Malaysia tax treaty. ( BIR Ruling No. DA-194-99 dated March 29, 1999 ) However, a certificate of authority to register the said transaction in the books of EPPI must be secured. Thus, the Sellers, being non-resident aliens, are required to file, although not required to pay the capital gains tax as above mentioned, a Capital Gains Tax Return (BIR Form No. 1707) accompanied by copies of the Shares Sale Agreement and this ruling, with Revenue District Office No. 39 South, Quezon City (RDO 39), for the issuance of Certificate Authorizing Registration (CAR) of the said shares of stock in favor ETHB. Upon presentation of the aforesaid Capital Gains Tax Return as filed, the CAR, as well as the proof of payment of the documentary stamp tax due thereon, the corporate secretary of EPPI shall be authorized to register the transfer of said shares from the Sellers to ETHB in the Stock and Transfer Book of the EPPI and to issue a new certificate in the name of ETHB. 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 without force and effect insofar as the herein parties are concerned. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service