ITAD Ruling No. 070-04

July 13, 2004 ITAD RULING NO. 070-04 Article 13, Philippines-Netherlands tax treaty Section 176, NIRC of 1997 BIR Ruling No. ITAD 201-02 Punongbayan & Araullo Ernst and Young International 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue, 1200 Makati City Attention: Atty. Romeo H. Duran Tax Partner Gentlemen : This refers to your application for relief from double taxation dated February 9, 2004, on behalf of your client American Power Conversion (Phils) (APCP), requesting confirmation of your opinion: (1) that any gain from liquidating dividends derived by American Power Conversion BV (APC-BV) from the surrender of its shares of stock in APCP as a consequence of APCP's dissolution shall be considered as income of APC-BV, and (2) that any gain realized by APC-BV arising from its receipt of liquidating dividends from APCP as a result of APCP's dissolution is exempt from capital gains tax, pursuant to Article 13 of the Philippine-Netherlands tax treaty. It is represented that APCP is a corporation organized and existing under Philippine law and duly registered with the Securities and Exchange Commission; that it is a wholly owned subsidiary of APC-BV, a holding company based in the Netherlands; that APC-BV is a corporation organized and existing under the laws of the Netherlands; that APC-BV is fully owned by American Power Conversion Corporation (APCC), a corporation existing and organized under the laws of the United States of America; that APCP is registered with the Philippine Economic Zone Authority (PEZA) as an Export Enterprise authorized to engage in the manufacture, assembly and export of uninterrupted power supply equipment, such as power converters and voltage regulators at the Cavite Special Economic Zone; that as a PEZA-registered enterprise, APCP was granted a four (4)-year income tax holiday effective in 1996, which was further extended up to July, 2003; that after this date, APCP became subject to the 5% special tax rate under Section 24 of Republic Act No. (RA) 7916, as amended (otherwise known as the Special Economic Zone Act of 1995); that in accordance with the restructuring of APCC's operations worldwide, the Philippine operations, previously undertaken through APCP, was converted from that of a subsidiary into a branch; that, the Philippine operations shall be transformed from contract manufacturer to full time manufacturer that hold its own technology; that after the conversion of the Philippine operations from a subsidiary into a branch, the latter shall continue and carry-on the business of the existing subsidiary; that to implement the conversion of the Philippine operations from a subsidiary into a branch, a branch would be established, and the entire assets, business and liabilities of APCP shall be transferred to the branch; that after said assets, business and liabilities of APCP shall have been transferred to the APC-Phil branch, the latter shall continue the Philippine operations, and APCP shall permanently cease its business operation in the Philippines and shall be dissolved and liquidated; that on January 11, 2002, APC-BV was licensed by the SEC to transact business in the Philippines through the establishment of a Philippine branch (APC-Phil branch); that while APC-BV maintains a Philippine branch, the said branch does not have any participation whatsoever in the negotiation and implementation of the dissolution of APCP and of the issuance of liquidating dividends; that when APCP was incorporated in May 15, 1996 (SEC Registration No. AS096-005079), during which the investment of APC-BV was made, APC-Phil branch was not yet in existence, and thus, APC-Phil branch is not privy to the transactions between APC-BV and APCP; that APC-Phil branch was likewise registered with PEZA on May 22, 2003 as an Ecozone Export Enterprise under PEZA Certificate of Registration No. 02-023; that on May 27, 2002, a special stockholders and director's meeting of the APCP was held approving (1) the conversion of the corporate structure of APCP to a branch office of APC-BV, and (2) the dissolution of APCP, upon completion of the sale of all or substantially all the business, property and assets of APCP to APC-Phil. branch; that on August 25, 2003, APCP and APC-Phil branch signed an Agreement for the Sale and Purchase of the Business and Business Assets, under which APCP sold to APC-Phil branch, and the latter purchased the business and business assets, specific assets and other contracts specified in said Agreement; and that after the transfer of the Philippine operations from APCP to APCP-BV Philippine branch, it is intended that APCP shall permanently cease its business operations in the Philippines, and shall be dissolved and liquidated. In reply, please be informed as follows: 1. Gains derived by APC-BV from the surrender of its shares of stocks in APCP as a consequence of APCP's dissolution shall be considered APC-BV's income and NOT of APC-Phil branch The situation where a parent company enters into a business transaction without the participation of its branch is recognized by the Supreme Court to be a separate and distinct activity of the parent company from the branch for tax purposes. Thus, in the case of Marubeni vs. CIR , (G.R. No. 76573 dated September 14, 1989), the Supreme Court said: "The Solicitor General has adequately refuted petitioner's argument in this wise: `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 that 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 of the branch. Consequently, the taxpayer is the foreign corporation, not the branch or the resident foreign corporation. `Corollary, if the business transaction is conducted through the branch office, the latter becomes the taxpayer, and not the foreign corporation.' In the instant case, since it is represented (1) that while APC-BV maintains a Philippine branch, the said branch does not have any participation whatsoever in the negotiation and implementation of the dissolution of APCP and of the issuance of liquidating dividends, and (2) that APC-Phil branch is not privy to the investment transaction between APC-BV and APCP, it is thus clear that the gains derived by APC-BV arising from the surrender of its shares of stocks in APCP shall be considered as income of APC-BV and not of APC-Phil branch. 2. Gains that may be derived by APC-BV arising from the payment of liquidating dividends is exempt from capital gains tax, pursuant to Article 13 of the Philippines-Netherlands tax treaty Article 13 of the Philippines-Netherlands tax treaty provides as follows, viz : "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 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 one of the States has in the other State, or of movable property pertaining to a fixed base available to a resident of one of the States in the other 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. "3. Notwithstanding the provisions of paragraph 2, gains derived by an enterprise of one of the States from the alienation of ships and aircraft operated in international traffic and movable property pertaining to the operation of such ships or aircraft shall be taxable only in that State. "4. Gains from the alienation of any property other than those mentioned in paragraphs 1, 2 and 3, shall be taxable only in the State of which the alienator is a resident. "5. The provisions of paragraph 4 shall not affect the right of each of the States to levy according to its domestic law a tax on gains from the alienation of any property derived by an individual who is a resident of the other State and has been a resident of the first-mentioned State at any time during the six years immediately preceding the alienation of the property." The ordinary connotation of liquidating dividend involves the distribution of assets by a corporation to its stockholder upon dissolution ( Klein, Federal Income Taxation, 253-254 cited in the case of Wise & Co., Inc. et al. vs. Meer, et al., G.R. No. 48231, June 30, 1947 ). When a corporation is dissolved and in the process of complete liquidation and its shareholders surrendered their stock to it and it paid sums of money to them in exchange, a transaction took place, which is no different in its essence from a sale of the same stock to a third party who paid therefor (Read the case of Wise & Co., Inc. et al. vs. Meer, et al., supra ). In addition, the annotations on the Corporation Code of the Philippines by Paras et al. , define " liquidating dividends " as follows "These are dividends that are declared when a corporation liquidates by redeeming its outstanding stock for cash, or by distributing its assets to stockholders in exchange for their stock. Such distribution is also known as distribution in liquidation. For tax purposes, liquidating dividends are treated, in effect, as sales of stock; hence any gain or loss to the stockholder is treated as capital gain or loss." It is clear from the aforequoted provisions of the Philippines-Netherlands tax treaty that capital gains from the alienation of any property other than those mentioned in paragraphs 1, 2 and 3 of Article 13 of the tax treaty shall be taxable only in the State where the alienator is a resident. Considering that the surrender of stock to APCP by APC-BV in exchange for the payment of liquidating dividends is deemed a sale of shares of stock and such transaction is not among those mentioned in said paragraphs 1, 2 and 3 of Article 13 of the said tax treaty, the gains that may be derived by APC-BV, which is a resident of The Netherlands, from the surrender of its shares of stock in APCP, a domestic corporation, shall not be subject to Philippine income tax under Section 28(B)(5)(c) of the Tax Code of 1997, but are subject to tax only in the Netherlands. ( BIR Ruling No. DA-ITAD 201-02 dated November 25, 2002 ) This ruling is issued on the basis of the facts as represented. However, if upon investigation it shall be disclosed or discovered that the facts are different, then this ruling shall be without force and effect insofar as herein parties are concerned. SDTaHc Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service