ITAD Ruling No. 093-03

July 15, 2003 ITAD RULING NO. 093-03 Article 10 RP-Netherlands Article 31 (1) Vienna Convention Article 1495 Civil Code Sec. 2 Presidential Decree No. 2029 BIR Ruling No. ITAD 129-02; 47-03; DA-052-03-25-02 Joaquin Cunanan & Co. 29th Floor Philamlife Tower 8767 Paseo de Roxas 1226 Makati City Attention: Tomasa H. Lipana Managing Partner, Tax Services Gentlemen : This refers to your letter dated March 27, 2002, requesting confirmation of your opinion that the dividend to be paid and remitted by Lear Automotive (EEDS) Philippines, Inc. (LAPI) to Lear Automotive Services (Netherlands) B.V. (LASN), is subject to the preferential tax rate of 10% pursuant to the RP-Netherlands tax treaty. It is represented that LASN is a non-resident foreign corporation organized and existing under the laws of the Netherlands with business address at Korte Muiderweg 2 1382 LR Weesp, The Netherlands; that it is not registered either as a corporation or as a partnership and has not been licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated April 5, 2002; that LAPI is a domestic corporation organized and existing under the laws of the Philippines with principal office located within the Mactan Export Processing Zone, Lapu-lapu City; that it is engaged in the business of manufacturing, assembling, processing, designing, exporting, buying and selling wholesale automotive wiring harnesses, electric wire assemblies, electric motors, electrical switches, terminals and connectors and other automotive assemblies and fittings; that the Lear group of companies is currently restructuring its business operations; that LAPI was previously wholly-owned by Lear Automotive Dearborn, Inc. (LADI), a foreign corporation organized and existing under the laws of Delaware, U.S.A.; that in line with the business restructuring of the Lear group of companies, LADI executed a Deed of Assignment on December 30, 2001 transferring all its equity/investment in LAPI to LASN consisting of 140,730 preferred shares and 79,681 common shares, all of which having a par value of P2,050.00, in exchange solely for 9,837,233 shares of stock in LASN with a par value of 1 EURO, without cash payment or other consideration; that on March 19, 2002, the Board of Directors of LAPI declared a cash dividend in the amount of One Billion Two Hundred Thirty Nine Million Five Hundred Ninety Six Thousand Eight Hundred Sixty Two Pesos (P1,239,596,862) out of its unrestricted retained earnings to be distributed to the company's common stockholders as of March 19, 2002; that the dividends are payable on or before March 31, 2002; that LASN owns 99.99% of LAPI's equity consisting of 140,730 preferred shares and 79,681 common shares; that the notes of LAPI to the audited financial statements for the year ended December 31, 2001 disclose that the shares held by LADI had been transferred to LASN and the shares remain in the name of LADI pending issuance of a tax clearance; that although LAPI was promptly notified and furnished with a copy of the Deed of Assignment of its shares from LADI to LASN, the said transfer cannot be recorded in the stock and transfer book of LAPI because of a requirement from the Bureau of Internal Revenue to secure the necessary tax clearance before such transfer can be recorded; and that LADI is merely holding the shares in trust for LASN and the latter is the beneficial owner of the shares as evidenced by a notarized certification by the Assistant Corporate Secretary of LAPI dated May 21, 2002 expressly stating that LADI unconditionally and irrevocably assigned, transferred and conveyed all of its rights and interests in and to all its shares of stock in LAPI, including the nominal shares registered in the names of Mr. Kong, Mr. Mann, Ms. Tan, Mr. Roman and Mr. Cheng, to LASN effective December 30, 2001. In reply, please be informed that Article 10 of the RP-Netherlands tax treaty provides: "Article 10 "DIVIDENDS "1. Dividends paid by a company which is a resident of one of the States to a resident of the other State may be taxed in that other State. "2. However, such dividends may also be taxed in the State of which the company paying the dividends is a resident and according to the laws of that State, but if the recipient is the beneficial owner of the dividends the tax so charged shall not exceed: a) 10 per cent of the gross amount of the dividends if the recipient is a company the capital of which is wholly or partly divided into shares and which holds directly at least 10 per cent of the capital of the company paying the dividends; b) 15 per cent of the gross amount of the dividends in all other cases. Based on the aforequoted provisions, dividends paid by a Philippine company to a resident of the Netherlands may be taxed at a rate not exceeding 10 per cent of the gross amount of the dividends if the recipient is the beneficial owner and is a company which holds directly at least 10 per cent of the capital of the Philippine corporation. Otherwise, the tax rate of 15 per cent applies. (BIR Ruling No. DA-ITAD 129-02 dated August 2, 2002) Thus, to be entitled to the preferential tax treaty rate of 10 per cent on the dividends declared by LAPI, LASN must comply with the following requirements: 1) LASN must be the beneficial owner of the subject dividends as of the relevant date of their declaration; and, 2) LASN must directly hold at least 10 per cent of the capital of LAPI. In view of all the above, please find the relevant discussions hereunder: 1) Whether LASN is considered a beneficial owner . A beneficial owner is he who has power or control over the shares of stock; he is the one who has the power to exercise the benefits accruing from such shares or to dispose of such shares, if so desired. In the instant case, LASN is clearly the beneficial owner of the dividends issued by LAPI by virtue of the Deed of Assignment transferring to LASN all the title and interests of LADI over the subject LAPI shares. Upon assignment, LADI no longer has any power or control over such shares as they are now lodged with LASN as the assignee so that benefits from such shares shall accrue to LASN and no longer to LADI. (BIR Ruling No. DA-ITAD 47-03 dated March 21, 2003) 2) Whether LASN's ownership of LAPI shares by virtue of the Deed of Assignment is covered by the expression `holds directly" as used in Article 10(2)(a) of the treaty. Inasmuch as nothing in the treaty categorically defines the term "holds directly", we take cognizance of Article 3(2) thereof, to wit: "As regards the application of the convention by either of the States, any term not otherwise defined shall, unless the context otherwise requires, have the meaning which it has under the laws of that state relating to taxes which are under the subject of this Convention." In this light, a term not defined in the treaty has to be given meaning in the sense of the Philippine domestic law and jurisprudence. Thus, in the absence of a treaty definition of the term "holds directly", an interpretation thereof may be drawn from various Philippine laws, to wit: a) Buyer Assumes the Rights of the Seller Under Article 1495 of the Civil Code, one of the obligations of a seller in a contract of sale is to transfer the ownership of and deliver, as well as warrant the thing which is the object of the contract. Once ownership is transferred, the buyer acquires all the rights and obligations over the thing sold. At the same time, the buyer may be said to have been placed in the shoes of the seller with respect to the object of the contract. Accordingly, when LASN acquired all the rights and obligations previously held by LADI over the LAPI shares as buyer/assignee, LASN was placed in the shoes of LADI insofar as the assigned shares of stock are concerned. There is no question that LADI was a "direct holder" of LAPI during the time it owned the latter's shares of stock. Therefore, when LASN acquired the rights and assumed the place of LADI, LASN likewise assumed the latter's status as a direct holder of LAPI. b) Concept of "direct shareholding/ownership " Section 2 of Presidential Decree (PD) No. 2029, dated February 4, 1986, in its definition of a government-owned or controlled corporation, states that an indirect shareholding or ownership, in contrast to a direct one, is one that is made through another entity. We quote the relevant provision of PD 2029 as follows: "A government-owned or controlled corporation is a stock or a non-stock corporation, whether performing governmental or proprietary functions, which is directly chartered by special law or if organized under the general corporation law is owned or controlled by the government directly or indirectly through a parent corporation or subsidiary corporation , to the extent of at least a majority of its outstanding capital stock or of its outstanding voting capital stock . . ." Under PD 2029, indirect ownership is taken to mean ownership of shares through another corporation, which in turn directly owns such shares. The BIR had the occasion to take a similar interpretation in issuing rulings. Thus, in BIR Ruling DA-052-03-25-02, Hydro Electric Development Corporation (HEDCOR) was considered directly owned by Aboitiz Power Corporation (APC) prior to the year 2000 and indirectly owned by APC in the year 2000 after the latter's entire direct holdings in HEDCOR were sold to Philippine Hydropower Corporation (PHC), which in turn is wholly-owned by APC. Conversely, LASN is considered a "direct holder" of the subject shares in LAPI because there is no intervening company as contemplated by PD 2029 and BIR Ruling DA-052-03-25-02. Thus, in the absence of any intervening entity, holding the shares in the concept of an owner, between the investor and investee company, the shares would be considered as being directly owned or held. c) It is in accordance with the object and purpose of the treaty Tax treaties generally need to be interpreted in the light of Article 31(1) of the Vienna Convention on the Law of Treaties, to which the Philippines is a signatory which outlines the general rule for the interpretation of treaties, to wit: "Article 31 "General Rule of Interpretation "1. A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose." Generally, tax treaties grant a lower preferential tax rate (10% in this case) to dividends paid upon meeting a certain holding percentage of investments of a direct, as opposed to a portfolio, nature. The purpose is to encourage direct foreign investments as against mere "hands-off" portfolio investment. The much lower rate of 10% is clearly intended to cover a direct parent-subsidiary relationship, such as that between LASN and LAPI. This view is consistent with existing commentaries of the Organization for Economic Cooperation and Development (OECD) Committee on Fiscal Affairs on Model Tax Convention on Article 10(2), which we pertinently quote as follows: ". . . a lower rate (5 per cent) is expressly provided in respect of dividends, paid by a subsidiary company to its parent company. If a company of one of the States owns directly a holding of at least 25 per cent in a company of the other State, it is reasonable that payments of profits by the subsidiary to the foreign parent company should be taxed less heavily to avoid recurrent taxation and to facilitate international investment." The increased control and ownership inherent in direct investments translates to a business relationship that should facilitate transfers of technology and such other things that would provide broader economic benefits to the subsidiary's state of residence. In view of the foregoing, this Office is of the opinion and so holds that LASN became the beneficial owner and direct holder of the subject shares in LAPI as of December 30, 2001 so that any dividends declared by LAPI in favor of such shares beginning at that date are beneficially owned by LASN. It is clear that LASN, in the absence of any intervening entities, had already acquired as of December 30, 2001 the right to enjoy the benefits of the shares in the domestic companies and had already accepted any risk of loss that might arise with respect to such shares, regardless of the date on which the name "LASN" shall consequently be reflected in the stock and transfer books of the domestic companies, which requirement merely serves as protection of investee corporations from fictitious or fraudulent transfers of shares of stock. [ Escao vs. Filipinas Mining Corporation, et. al (74 Philippines 711 (1944))] cTIESa Considering that LASN is the beneficial owner which directly holds 99.99 percent (99.99%) of the capital stock of LAPI as of March 19, 2002, the dividend payment by LAPI to LASN shall be subject to the preferential tax rate of 10 percent pursuant to Article 10(2)(a) of the RP-Netherlands tax treaty. 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