ITAD Ruling No. 094-03

July 16, 2003 ITAD RULING NO. 094-03 Art. 13, RP-Germany Sec. 176, NIRC BIR Ruling UN-210-7-13-94 Sebastian Liganor & Galinato Attorneys at Law 1409 East Tower, Philippine Stock Exchange Centre Exchange Road, Ortigas Center, Pasig City Attention: Atty. Jeffrey N. Ong Atty. Stephen Anthony T. Llaguison Gentlemen : This refers to your letters dated September 13, 2002 and December 10, 2002 requesting confirmation of your opinion to the effect that the sale by Asta Medica Aktiengesellschaft (AM AG) of its shares of stock in Asta Medica Philippines, Inc. (AM Phil) to your client, Zuellig Pharma Holdings Ltd. (Zuellig), is not subject to capital gains tax pursuant to Article 13 of the RP-Germany tax treaty. It is represented that AM AG is a non-resident foreign corporation duly organized and existing under the laws of Germany with principal place of business at Weismullerstr. 45, 60314 Frankfurt am Main, Germany; that it is licensed to establish its regional or area headquarters in the Philippines with Securities and Exchange Commission (SEC) No. BSFM-110 per certification issued by the SEC dated June 18, 2002; that AM Phil is a corporation duly organized and existing under the laws of the Philippines with office address at Penthouse, Port Royal Place, 118 Rada St., Legaspi Village, Makati City; that Zuellig is a non-resident foreign corporation duly organized and existing under the laws of Malaysia with office address at Brumby House, Jalan Bahasa, 87011 Labuan F.T. Malaysia; that as of September 13, 2001, AM AG is the stockholder of record in AM Phil and owns thirteen thousand (13,000) shares of stock with a par value of One Thousand Pesos (P1000.00) per shares or with a total value of Thirteen Million Pesos (P13,000,000.00); that on September 13, 2001, several Deeds of Assignment were entered into by and between AM AG and Zuellig whereby AM AG sold, ceded, transferred and assigned to the latter all its aforementioned shares in AM Phil. It is your position that Article 13(3) of the RP-Germany tax treaty does not ipso facto make every alienation by a German national of his shares in a Philippine corporation as taxable in the Philippines as the provision is merely directory and ambiguous and therefore should be resolved in favor of the taxpayer. In reply, please find below the provisions of Article 13 of the RP-Germany tax treaty and our discussions of the issues raised pertaining thereto: "Article 13 CAPITAL GAINS 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. DACTSa 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 and aircraft operating in international traffic and movable property pertaining to the operation of such ships and aircraft, shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated. 3. Gains from the alienation of shares of a company which is a resident of a Contracting State may be taxed in that State. 4. Gains from the alienation of any property other than those mentioned in paragraphs 1 to 3 shall be taxable only in that Contracting State of which the alienator is a resident." 1. Whether Article 13(3) of the RP-Germany tax treaty is directory . Tax treaty provisions are generally patterned after certain models (e.g., OECD, UN Models) adopted by countries desiring to forge a treaty for purposes of convenience and facility. As such, these models are couched in general language to accommodate the varying domestic laws and principles of negotiating countries. It is against this backdrop that a tax treaty should be interpreted in the light of its overall context and objective, an isolated and rigid appreciation of a specific provision could lead to a situation not intended by the treaty negotiators. Thus, when the word "may" is used to authorize the exercise of the taxing power of a State, it only recognizes the alternative circumstance that the source country may or may not have a provision in its domestic laws imposing a tax on a particular type of income such as gains from the alienation of shares. In the latter case, the treaty could not supply for what is not found in the domestic laws. But when a tax imposition is in place, the right of the source State is primary and mandatory and whatever taxes paid therefor should be allowed by the residence State as a tax credit in its jurisdiction thereby achieving the objective of the tax treaty against the harmful effects of double taxation. 2. Whether Article 13(3) of the RP-Germany tax treaty is ambiguous . Article 13 of the RP-Germany tax treaty provides for the rules governing taxation of gains arising from alienation of properties. Paragraph 3 thereof governs the alienation of property consisting of shares of a company as taxable in the State of residence of the company issuing the shares. While the language of the disputed provision is constructed in a manner that the word "company" can relate either to "Gains" or "shares", it cannot be mistaken that the reference pertains to the "shares", which alienation subparagraph 3 specifically provides for the tax treatment, in the same manner that the preceding paragraphs respectively govern alienation of "immovable" and "movable" properties. On the other hand, should the word "company" be understood to relate to "Gains" so that the company deriving such gains may be taxable in the Contracting State where it is a resident, the conclusion would make the treaty insignificant as States usually tax their residents on their worldwide income. Also, a similar interpretation of Article 13(3) vis-a-vis Article 13(4), which reserves the right to tax in favor of the "Contracting State of which the alienator is a resident ," will render paragraph 3 irrelevant for merely being redundant of the rule laid down in the succeeding "catch-all" paragraph. cDTCIA On the basis of all the foregoing, and contrary to your opinion, capital gains derived from the sale by AM AG of its sale of shares of stock in AM Phil shall be subject to capital gains tax in the Philippines. (UN-210-7-13-94). In this regard, a final tax of 5% or 10%, as the case may be, is imposed against AM AG as the seller thereof upon the net capital gains realized from said transaction pursuant to Section 28(B)(5)(c) of the Tax Code of 1997 which reads, viz : "SEC. 28. Rates of Income Tax on Foreign Corporations . "xxx xxx xxx" (B) Tax on Nonresident Foreign Corporation. "xxx xxx xxx" (5) Tax on Certain Incomes Received by a Non-resident Foreign Corporation. "(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 P10,000 5% "On any amount in excess of P100,000 10% "xxx xxx xxx" In determining the capital gains tax base, the selling price of the subject shares of stock shall be the fair market value of the said shares and not the fair market value of the property received in exchange. In case the subject shares are listed in one or more stock exchanges, the highest closing price on the day when the shares are sold or transferred shall be the fair market value. When no sale is made in any stock exchange, the highest closing price on the day nearest to the date of sale or transfer shall be the fair market value. In cases where the subject shares are not listed in the stock exchange, the same shall be valued at their book value nearest the valuation state. The book value of these unlisted shares of stock shall be prima facie considered as their fair market value. (Section 6(a)(2) &( 3), Revenue Regulations 2-82) In payment thereof, BIR Form No. 1707 (Capital Gains Tax Return) shall be filed with Revenue District Office No. 39-South Quezon City, in duplicate, which payments thereof should be made within 30 days following each sale or disposition. (Section 7(b)(2), Revenue Regulations 2-82). Finally, the Deeds of Assignment shall also be subject to the documentary stamp tax imposed under Section 176 of the National Internal Revenue Code of 1997. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service