ITAD Ruling No. 072-04

July 21, 2004 ITAD RULING NO. 072-04 Article 6 & 13, Philippines-Malaysia Sycip Salazar Hernandez & Gatmaitan SYCIPLAW All Asia Capital Center 105 Paseo de Roxas Makati City Attention: Atty. Hector M. de Leon, Jr. Atty. Francis Joseph H. Ampil Gentlemen : This refers to your letters dated November 28, 2000 and August 26, 2003 on behalf of your client, UNITED ENGINEERS (Malaysia) BERHAD (UEM), applying for tax treaty relief on the gains realized from the sale of its 100% stockholdings in UEM-MARA Philippines Corporation (UEM-MARA) to the Coastal Road Corporation (CRC) pursuant to Article 13 of the Philippines-Malaysia Tax Treaty. It is represented that UEM is a corporation duly organized and existing under and by virtue of the laws of Malaysia with head office address at No. 5 Jalan 217 46050 Petaling Jaya Selangor Darul Ehsan, Malaysia; that UEM is not registered as a corporation/partnership licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated August 23, 2000; that on December 27, 1994, the Public Estates, Authority (PEA), UEM (as assignee of the rights, liabilities and obligations of Renong Berhad) and Majlis Amanah Rakyat (MARA) entered into a Joint Venture Agreement (JVA) for the design, construction, operation and maintenance of the R-1 Expressway, R-1 Expressway Extension and the C-5 Link Expressway toll facilities, collectively referred to as the Manila Cavite Toll Expressway Project (hereinafter referred to as "MCTEP"); that UEM-MARA was subsequently incorporated to perform the obligation of UEM and MARA under the JVA; that UEM-MARA is a corporation duly organized and existing under and by virtue of the laws of the Philippines and with office address at 9th Floor, PDCP Building Center, 8737 Paseo de Roxas, Makati City; that as of December 15, 1999, UEM owns 283,744 shares of stock with a par value of P100.00 per share which represents 99% of the entire outstanding capital stock of UEM-MARA as confirmed by the certification issued by the corporate secretary on November 20, 2000; that on December 15, 1999, UEM sold to CRC the said 283,744 shares of stock for and in consideration of Forty-Four Million Seven Hundred Sixty Eight Thousand Eight Hundred Fifty-Seven Pesos (P44,768,857.00) as shown in the Deed of Assignment. It is your contention that the sale by UEM of its shares in UEM-MARA to CRC is exempt from capital gains tax on the basis of Article 13(4) of the Philippines-Malaysia tax treaty, premised on the ground that the concession assets of UEM-MARA reflected in its 1999 Audited Financial Statements do not represent or constitute immovable property under Article 415 of the Civil Code of the Philippines. In reply, please be informed that Article 13 of the Philippines-Malaysia tax treaty provides: "ARTICLE 13 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 Contracting 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 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." In this connection, Article 6(2) of the same tax treaty defines "immovable property" as follows: "ARTICLE 6 INCOME FROM IMMOVABLE PROPERTY 1. . . . 2. For the purposes of this Agreement, the term "immovable property" shall be defined in accordance with the laws of the Contracting State in which the property in question is situated . The term shall in any case include property accessory to immovable property, livestock and equipment used in agriculture and forestry, rights to which the 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, oil or gas wells, quarries and other places of extracting of natural resources including timber or other forest produce. Ships, boats and aircraft shall not be regarded as immovable property. (Emphasis Supplied) "xxx xxx xxx" Based on the aforequoted provisions, capital gains derived by UEM from its transfer of shares of stock to CRC is generally taxable in Malaysia. However, paragraph 3 of Article 13 above grants to the Philippines the right to tax gains derived from the disposition of interest in a corporation if its assets consist principally of real property interests located in the Philippines. "Real Property Interest" means 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 1998 and 1999 Audited Financial Statements of UEM-MARA: Philippines disclosed that its net property and equipment located in the Philippines are valued at Php1,110,261,852.00 (Php1,165,491,309.00 less depreciation in the amount of Php55,229,457.00) as of December 31, 1999. Under the schedule or breakdown of these accounts, it has been shown to include the Concession Assets account which amounted to P1,154,506,567.00, the carrying value of the completed segment of the MCTEP under the aforementioned Joint Venture Agreement. Since the greater part of the total assets of UEM-MARA consists of the Concession Assets account, the controversy in the instant case revolves on the issue on whether these concession assets are immovable properties. It is your opinion that these concession assets are not in the nature of immovable property under Philippine Laws since these assets only represent the expenditures or cost advances by UEM-MARA in the course of complying with their obligation to carry out the MCTEP. That this concession asset account represents the deferred costs and expenses incurred by UEM-MARA for the design and construction of the Project, the cost of investment of UEM and MARA in the joint venture formed with PEA. Being mere return of investment, it is your opinion that these concession assets are naturally movable property. We do not agree with your opinion. On the contrary, this Office is of the opinion that the disputed concession assets are immovable properties. Under the pertinent provisions of Revenue Regulations No. 4-86 in relation to Article 415 paragraph (10) of the New Civil Code of the Philippines, contracts for public works and servitudes and other real rights over immovable property are considered real property interest/immovable. The Joint Venture Agreement executed by UEM, MARA and PEA for the construction of the MCTEP is clearly a contract for public works classified as immovable property. While the piece of paper on which the contract for public works has been written is necessarily personal property, but the contract itself, or rather the right to the contract, is real property (Paras citing Manresa, Civil Code of the Philippines Annotated II 1994 Ed., p. 26). Accordingly, since the concession assets represent the consideration or rights of UEM-MARA arising from the JVA, a contract for public work with PEA, concession assets are necessarily immovable properties. Furthermore, a plain reading of Article 415 of the New Civil Code of the Philippines shows that the contract itself is made immovable. It is but logical to consider the whole contract price or the subject concession assets, the cause for UEM-MARA to enter into the JVA, as the basis for the computation of real property interest, it being an essential element in the formation of a contract (Article 1318, New Civil Code of the Philippines). In other words, as the contract itself is made immovable by law, the cause being an essential element thereof, follows to be immovable as well, for without it there can be no contract to speak of. Accordingly, the value of the concession assets which arose from the Joint Venture Agreement shall be classified as real property in the determination of the value of the real property interest of UEM-MARA. Such being the case, the value of the real interest/real property of UEM-MARA located in the Philippines consisting of the concession assets and leasehold improvements is more than 50% of its total assets of Php1,575,480,587.00, thereby rendering the assets of UEM-MARA consisting principally of real property situated in the Philippines. Therefore, as the capital gains derived by UEM on the sale of its shares of stock in UEM-MARA to CRC shall be taxed in the Philippines pursuant to Article 13(3) of the Philippines-Malaysia tax treaty, your application for tax treaty relief is hereby DENIED for lack of legal basis. acHETI Accordingly, such gains shall be subject to tax in accordance with Section 28(B)(5)(c) of the Tax Code of 1997, quoted as follows, to wit: "SEC. 28. Rates of Income Tax on Foreign Corporations . (B) Tax on Nonresident Foreign Corporation . xxx xxx xxx (5) Tax on Certain Incomes Received by a Nonresident Foreign Corporation. xxx xxx xxx (c) Capital Gains from Sale of Shares of Stock not Traded in the Stock Exchange. 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 of through the stock exchange: "Not over P100,000 5% "On any amount in excess of P100,000 10% Finally, the Deed of Assignment of Shares of Stock shall be subject to documentary stamp tax imposed under Section 176 of the Tax Code of 1997. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group