ITAD Ruling No. 024-05

March 29, 2005 ITAD RULING NO. 024-05 Article 14 & Reservation Clause, Philippines-US tax treaty Section 25, NIRC of 1997 Atty. Francisco B. Gonzales, C.P.A. 429-D Shaw Boulevard Mandaluyong City S i r : This refers to your application for relief from double taxation dated March 29, 2004, requesting confirmation of your opinion that the sale/transfer of shares of stock in Capitol Medical Center, Inc. ("CMCI", for brevity) from Ms. SONIA NAVARRETE-WESTERFIELD ("Ms. Westerfield", for brevity) to CMCI is not subject to Philippine income/withholding tax, pursuant to the Philippines-United States of America (Philippines-US) tax treaty. It is represented that Ms. Westerfield is a citizen of the United States of America with address at 9926 Bourbon Court, San Diego, California, 92131 United States of America (USA); that she is a resident of the USA for purposes of US taxation per certification dated July 22, 2004, issued by Mr. Daniel J. Nally, Field Director, Philadelphia Accounts Management Center, Internal Revenue Service, USA; that CMCI is a domestic corporation established under the laws of the Republic of the Philippines, with principal address at Scout Magbanua corner Panay Avenue, Quezon City, Philippines; that Ms. Westerfield is a shareholder of CMCI to the extent of Seven Hundred Forty Six (746) common shares with a par value of P100 per share, broken down as follows: Acquisition date Certificate No. No. of shares Total value February 5, 1985 890 250 P25,000 June 30, 1986 1273 25 P2,500 January 31, 1990 1437 297 P29,700 August 31, 1992 1691 50 P5,000 October 31, 1996 2196 124 P12,400 Total 746 P74,000 ==== ======= that sometime in the year 2003, Ms. Westerfield learned that CMCI embarked on a program to reacquire its own shares of stock at the price of One Thousand Five Hundred Pesos (P1,500) per share, and was prompted to dispose of her shareholdings in the said company because she is no longer staying in the Philippines; that you were authorized by Ms. Westerfield, through a Special Power of Attorney dated February 17, 2004, to effect the said transfer of the subject shares to CMCI; that on March 19, 2004, a Deed of Absolute Sale covering the above shares of stock was executed between Ms. Westerfield, represented by you, and CMCI; that per Balance Sheet prepared by Ms. Eden B. Quiniquini and noted by Mr. Ernesto V. Gordovez (Chief Accountant), both of CMCI, the Property and Equipment and Other Current Assets of CMCI as of March 19, 2004 are broken down as follows: PROPERTY & EQUIPMENT (At cost) Land P27,513,918.00 Land Improvements 14,000.00 Building & Other Structures (net) 196,832,078.85 Hospital Equipment, Furniture & Fixtures (net) 31,484,072.18 Medical Equipment & Instruments 295,929,499.12 Office Equipment (net) 14,370,940.97 Transportation Equipment (net) 4,519,500.00 Building Machineries & Equipment (net) 78,176,005.80 Canteen Furniture & Fixtures (net) 234,696.78 Construction in Progress 1,615,900.43 Advances to Supplier & Contractors 5,610,387.07 Total Property & Equipment P656,300,999.20 Accumulated Depreciation: - Building & Other Structures P53,237,623.49 - Hospital Equipment, Furniture & Fixtures 24,707,457.32 - Medical Equipment & Instruments 188,181,087.77 - Office Equipment 12,398,279.55 - Transportation Equipment 2,239,435.97 - Building Machineries, & Equipment 21,815,380.25 - Canteen Furniture & Fixtures 170,300.56 Total P302,749,564.91 PROPERTY & EQUIPMENT (At appraisal) Land Appraisal Increase P237,597,082.00 OTHER CURRENT ASSETS Utility Deposit P2,769,710.00 Library Books & Periodicals 34,812.36 Other Assets 677,012.88 Lease Rental Deposit 20,000.00 Other Assets Linen 340,452.88 Other Assets Deferred Income Tax 965,117.95 Other Assets Hospital Equipment 877,347.50 Other Assets Medical Equipment 446,575.00 Other Assets Office Equipment 523,333.70 Total P6,654,362.27 and that the Total Asset of CMCI as of March 19, 2004 is P859,143,980.27. In reply, please be informed that Article 14 of the Philippines-US tax treaty, states: "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 Philippines-US tax treaty, in pertinent part, provides as follows, viz : "(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 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." Revenue Regulations (RR) No. 4-86 1 is the governing Revenue issuance implementing the provision on " real property interest " under Philippine tax treaties. The pertinent provisions thereof are as follows, to wit: "SEC. 2. Definitions . For purposes of these regulations, the following terms and phrases shall be understood to mean "a) `Real property interest' interests on properties enumerated in Section 3 which are not, however, exclusive of others that are similarly situated. As used in the treaties in these regulations, it shall be understood to include real Properties as understood under Philippines laws ; (Emphasis supplied) "b) `Principally', `wholly or principally', `directly principally' or 'attributable' more than fifty percent of the entire assets in terms of value; "c) 'Sale' includes disposition or any other means by which the ownership of a share or of an interest in a corporation, partnership, estate or trust is transferred/conveyed for valuable consideration; and "d) 'Corporation' includes partnership, estate or trust. "SEC. 3. Properties. The following are real property interest and/or real properties: "1. Land, buildings, roads and constructions of all kinds adhered to the soil; "2. Trees, plants and growing fruits, while they are attached to the land or form an integral part of an immovable; "3. Everything attached to an immovable in a fixed manner, in such a way that it cannot be separated therefrom without breaking the material or deterioration of the object; "This includes improvements, that is, valuable additions made to property or an amelioration in its condition, amounting to more than repairs or replacement of waste, costing labor or capital and intended to enhance its value, beauty or utility or to adopt it for new or further purposes. "4. Statues, reliefs, paintings or other objects for use as ornamentation, placed in buildings or on lands by the owner of the immovable in such a manner that it reveals the intention to attach them permanently to the tenements; "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; "The 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 service facilities, together with all the other equipment designed for or essential to its manufacturing, industrial or agricultural purposes. xxx xxx xxx "10. Contracts for public works, and servitudes and other real rights over immovable property including real estate mortgages, possessory retentions, antichresis, usufructs and lessee of property; "11. Accessory to the above mentioned properties , such as livestock and equipment used in agriculture and forestry, rights to which provisions of general law respecting landed property apply, usufruct of immovable property and rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources. (Emphasis supplied) "SEC. 4. Basis . The value of all the assets of the subject corporation both real and personal as appearing in its financial statement on the date of sale of the share or interest in such corporation, as verified by the BIR, shall be used as the basis for determining the composition of its assets. "In case the financial statement as of the date of the sale is not available, the most recent financial statement may be used, after the necessary adjustments are made to reflect transactions made during the period from the date of such financial statement to the date of the sale. "SEC. 5. Exception . When the book value of an asset is not reflected in the financial statement or when it is clearly manifest that the same is under or over stated, then the prevailing market value of such asset will be used as the basis . (Emphasis supplied) "xxx xxx xxx." Based on the foregoing provisions, the following assets of CMCI are deemed real property interests: (1) land, (2) land improvements, (3) buildings & other structures, (4) hospital equipment, furniture & fixtures, (5) medical equipment & instruments, (6) office equipment, (7) building machineries & equipment, (8) canteen furniture & fixtures, (9) land-appraisal increase, (10) other assets-hospital equipment, (11) other assets-medical equipment, and (12) other assets-office equipment. Land and Building & Other Structures fall under paragraph 1 of Section 3 of RR No. 4-86; Land Improvements falls under paragraph 3 thereof; Building Machineries & Equipment falls under paragraph 5; Hospital Equipment, Furniture and Fixtures, Medical Equipment & Instruments, Office Equipment, Canteen Furniture and Fixtures, Other Assets-Hospital Equipment, Other Assets-Medical Equipment, and Other Assets-Office Equipment fall under paragraph 11; and Land-Appraisal Increase falls under paragraph 1 of Section 3 in relation to Section 5 of RR No. 4-86. For purposes of paragraph 11 of Section 3 of RR No. 4-86, "accessories" signifies all of those things which have for their object the embellishment, use or preservation of another thing which is more important and to which they are not incorporated or attached. In other words, it includes all of those things which are necessary or convenient for the perfection of another thing, such as the equipment of a factory, the spare parts and tools of a machine, the key of a house, and others of a similar nature ( 8 Manresa, 5th Ed., Bk. 1, pp. 109-110 ). Thus, the said assets which fall under the said paragraph 11 are deemed included in the real property interest of CMCI. As regards the inclusion of Land-Appraisal Increase , suffice it to state that it is " clearly manifest " that the Land account is under-stated vis--vis its appraisal increase, hence, the prevailing market value of the said asset was used as basis. To summarize, the real property interest of CMCI is computed as follows: Land P27,513,918.00 Land Appraisal Increase 237,597,082.00 Land Improvements 14,000.00 Building & Other Structures P196,832,078.85 Less: Accumulated Depreciation 53,237,623.49 143,594,455.36 Hospital Equipment, Furniture & Fixtures P31,484,072.18 Less: Accumulated Depreciation 24,707,457.32 6,776,614.86 Medical Equipment & Instruments P295,929,499.12 Less: Accumulated Depreciation 188,181,087.77 107,748,411.35 Office Equipment P14,370,940.97 Less: Accumulated Depreciation 12,398,279.55 1,972,661.42 Building Machineries & Equipment P78,176,005.80 Less: Accumulated Depreciation 21,815,380.25 56,360,625.55 Canteen Furniture & Fixtures 234,696.78 Less: Accumulated Depreciation 170,300.56 64,396.22 Other Assets Hospital Equipment 877,347.50 Other Assets Medical Equipment 446,575.00 Other Assets Office Equipment 523,333.70 Total-Real Property Interest P583,489,420.96 =========== In view thereof, the assets of CMCI consist principally of real property interest located in the Philippines, representing 67.9152 % of the entire assets of CMCI, computed as follows: P583,489,420.96 divided by P859,143,980.27 (total assets). Such being the case, the Philippines may tax the net capital gain to be derived by Ms. Westerfield from the disposition of her interest in CMCI, under Subsection (A)(3) or Subsection (B) of Section 25 of the National Internal Revenue Code (Tax Code) of 1997, to wit: "SEC. 25. Tax on Nonresident Alien Individual . "(A) Nonresident Alien Engaged in Trade or Business Within the Philippines. xxx xxx xxx "(3) Capital Gains . Capital gains realized from sale, barter or exchange of shares stock in domestic corporations not traded through the local stock exchange, and real properties shall be subject to the tax prescribed under Subsections (C) and (D) of Section 24. "(B) Nonresident Alien Individual Not Engaged in Trade or Business Within the Philippines . . . . Capital gains realized by a nonresident alien individual not engaged in trade or business in the Philippines from the sale of shares of stock in any domestic corporation and real property shall be subject to the income tax prescribed under Subsections (C) and (D) of Section 24." Subsection (C) of Section 24 of the Tax Code of 1997 provides, viz : "SEC. 25. Income Tax Rates . xxx xxx xxx "(C) Capital Gains from Sale of Shares of Stock not Traded in the Stock Exchange . The provisions of Section 39(B) notwithstanding, a final tax at the rates prescribed below is hereby imposed upon the net capital gains realized during the taxable year from the sale, barter, exchange or other disposition of shares of stock in a domestic corporation, except shares sold, or disposed if through the stock exchange. "Not over P100,000 5% "On any amount in excess of P100,000 10%" Moreover, Section 176 of the Tax Code of 1997 (the law then in force when the Deed of Absolute Sale was executed) provides, viz : "SEC. 176. Stamp Tax on Sales, Agreements to Sell, Memoranda of Sales, Deliveries or Transfer of Due-bills, Certificates of Obligation, or Shares or Certificates of Stock . On all sales, or agreements to sell, or memoranda of sales, or deliveries, or transfer of due-bills, certificates of obligation, or shares or certificates of stock in any association, company, or corporation, or transfer of such securities by assignment in blank or by delivery, or by any paper or agreement, or memorandum or other evidences of transfer or sale whether entitling the holder in any manner to the benefit of such due-bills, certificates of obligation or stock, or to secure the fixture payment of money, or for the future transfer of any due-bill, certificate of obligation or stock, there shall be collected a documentary stamp tax of One peso and fifty centavos (P1.50) on each Two hundred pesos (P200), or fractional part thereof, of the par value of such due-bill, certificate of obligation or stock: Provided , That only one tax shall be collected on each sale or transfer of stock or securities from one person to another, regardless of whether or not a certificate of stock or obligation is issued, indorsed, or delivered in pursuance of such sale or transfer: and Provided, further , That in the case of stock without par value the amount of the documentary stamp tax herein prescribed shall be equivalent to twenty-five percent (25%) of the documentary stamp tax paid upon the original issue of said stock." cSICHD The same Code provides that the corresponding documentary stamp taxes shall be levied, collected and paid, for and in respect of the transactions so had or accomplished, by the person making, signing, issuing, accepting, or transferring the document, instrument or paper wherever the same is made, signed, issued, accepted or transferred when the obligation or right arises from Philippines sources or the property is situated in the Philippines. Thus, the burden of paying the documentary stamp tax is placed upon the parties to the contract and leaves the tax to be paid indifferently by either party, and accordingly, the party assuming payment of said tax under the contract becomes directly liable therefor. But if for one reason or another, the said tax is not paid, both parties to the contract may be made liable to the tax. In view of the foregoing and based on the Deed of Absolute Sale, the documentary stamp tax (including penalties thereto, if any) on the said transaction must be paid and the corresponding return thereon be filed by Ms. Westerfield in accordance with the provisions of the Tax Code of 1997. However, upon failure of Ms. Westerfield to do the same, CMCI may also be held liable for the said tax. It must be noted that only upon presentment/presentation of the proof of payment of the corresponding documentary stamp tax and the capital gains tax that the Corporate Secretary of CMCI can register in its Stock and Transfer Book the transfer of shares from Ms. Westerfield to CMCI. DcTAIH To recapitulate, this Office hereby rules as follows: 1. the transfer by Ms. Westerfield of her shares of stock in CMCI to CMCI shall be subject to capital gains tax imposed under Subsection (A)(3) or Subsection (B) of Section 25 in relation to Subsection (C) of Section 24 of the Tax Code of 1997, pursuant to Article 14 of the Philippines-US tax treaty; and 2. the Deed of Absolute Sale dated March 19, 2004 executed by and between Ms. Westerfield and CMCI shall be subject to documentary stamp tax under the old Section 176 of the Tax Code of 1997. Please be guided accordingly. Very truly yours, (SGD.) GUILLERMO L. PARAYNO, JR. Commissioner of Internal Revenue Footnotes 1. SUBJECT: Determination of whether the assets of a corporation consist principally of real property interest under the Philippine tax treaties.