ITAD Ruling No. 032-02

March 22, 2002 ITAD RULING NO. 032-02 RP-US Tax Treaty Art. 14 (2) Section 176 of NIRC BIR Ruling ITAD No. 136-00 Bengzon Narciso Cudala Jimenez Gonzales & Liwanag SOL Building, 112 Amorsolo Street Legaspi Village, Makati City Attention: Atty. V. E. Jimenez and Atty. Melissa A.R. Pastor Gentlemen : This refers to your letter dated July 22, 1999 requesting for confirmation of your opinion that the transfer by Transitions Optical Inc. (TOI) of its shareholdings in Transitions Optical Philippines, Inc. (TOPI) in favor of the new holding company, Transitions Holdings BV (TOH), is not subject to capital gains tax pursuant to the provisions of Article 14(2) of the RP-US tax treaty. It is represented that TOPI is a domestic corporation organized and existing under the laws of the Philippines and engaged in the manufacture, production, distribution, sale and export of opthalmic lenses and related products; that it is a PEZA-registered Ecozone Export Enterprise with Certificate of Registration No. 98-060; that TOH is a corporation organized and existing under the laws of the Netherlands with business address at Rijksweg West 22, 9608PC Westerbroek, Postbus 50, 96008 AB Hoggezand, The Netherlands; that TOI is a corporation organized and existing under and by virtue of the laws of the State of Delaware, U.S.A. with office address at 9251 Belcher Road, Pinellas Park, Florida, U.S.A.; that TOI is the registered holder of 82,392 common shares of stock in TOPI, as well as the beneficial owner of eight (8) other shares under the name of its nominee incorporators/directors or a total of 82,400 shares with a par value of P100.00 per share; that TOI has made a deposit of future stock subscriptions in TOPI in the amount equivalent to P93,920,000.00; that TOI has likewise given cash advances to TOPI in the amount equivalent to P72,100,670.37 for TOPI's plan construction and pre-operating expenses; and that on March 30, 1999, a Deed of Conveyance was executed by TOI in favor of TOH whereby the former transferred to the latter the 82,400 shares of stock in TOPI for and in consideration of US$4,347,250.12 equivalent to P173,902,876.96 broken down as follows: Issued and Outstanding Stock P8,240,000.00 Deposit for Future Stock Subscriptions 93,920,000.00 Advances from TOI to TOPI 71,742,876.96 P173,902,876.96 ============= In reply, please be informed that Article 14 of the RP-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." (Emphasis supplied) Relative thereto, the Reservation Clause of the same Treaty provides, viz: " . . . 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 consist 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." (Emphasis supplied) Under the aforequoted provisions, the gains which will be realized by TOI from the sale of its shares of stock in TOPI to TOH, shall be taxable only in the US. However, the Philippines may tax the gain from the disposition of an interest in a corporation if the assets of the corporation 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) Verification of the Audited Financial Statements of TOPI disclosed that its real property interest located in the Philippines is only 37.85% of its total assets, thereby making the assets of TOPI not principally consisted of real property interest located in the Philippines. Accordingly, this Office is of the opinion and so holds that the sale by TRANSITIONS OPTICAL INC. of its shares of stock in TRANSITIONS OPTICAL PHILIPPINES, INC. is not subject to Philippine income tax since the assets of TRANSITIONS OPTICAL PHILIPPINES, INC. do not consist principally of real property located in the Philippines pursuant to the provisions of Article 14(2) of the RP-US tax treaty. However, notwithstanding this exemption, the Deed of Conveyance is subject to the documentary stamp tax imposed under Section 176 of the Tax Code of 1997. (BIR Ruling No. ITAD 136-00 dated September 19, 2000) This ruling is issued on the basis of the foregoing 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