ITAD Ruling No. 109-03

July 29, 2003 ITAD RULING NO. 109-03 Article 11 RP-Germany BIR Ruling No. ITAD 216-89 & 89-02 Smart Communications, Inc. Smart Tower 6799 Ayala Avenue Makati City 1226 Attention: Ms Rina R. Manuel Tax Manager Gentlemen : This refers to your letter dated June 25, 2001, requesting for a confirmatory ruling that the proportionate share of your company's interest payments to Sampo-Leonia (Leonia) which are attributable to Kreditanstalt fr Wiederaufbau (KfW), a tax-exempt entity under the RP-Germany tax treaty, are exempt from Philippine tax and consequently from the final withholding tax imposed under Section 28(B) of the Tax Code. It is represented that Smart Communications, Inc. (Smart) is a domestic corporation duly organized and existing under Philippine laws with principal address at Smart Tower 6799 Ayala Avenue, Makati City; that Leonia is a non-resident foreign corporation duly organized and existing under and by virtue of the laws of the Republic of Finland with office address at Etelesplanadi 8, FIN-00007 Helsinki, Finland; that Leonia is not registered either as a corporation or as a partnership and has not been licensed to engage in business in the Philippines per certification issued by the Securities and Exchange Commission dated November 4, 1999; that KfW is also a non-resident foreign corporation duly organized and existing under the laws of the Federal Republic of Germany with principal office at Palmengartenstrasse 5-9, 60325 Frankfurt am Main, Germany; that KfW is not registered either as a corporation or as a partnership and has not been licensed to engage in business in the Philippines per certification issued by the Securities and Exchange Commission dated November 8, 2001; that on March 7, 2000, a Loan Agreement was entered into by and between Leonia and Smart whereby the former granted the latter a term facility in the amount of US$26,983,520 to finance, among others, the design, procurement, installation, commissioning and operation of eighty-five percent (85%) of the Phase 2 Payments and Relevant Phase 3 Payments and eighty-five percent (85%) of the Finnvera Guarantee Premium as the terms are defined in the Loan Agreement where Smart was named as "Borrower", Leonia and Merita as "Arrangers", KfW as "Co-arranger" and Leonia as "Lender"; that on the same date, a Participation Agreement was executed between Leonia as "Lender" and certain banks/financial institutions as "Participants"; that under the Participation Agreement, the Participants agreed to make advances to Leonia to assist it in funding the advances to Smart; that the following are the Participants and their agreed commitment to Leonia: Banks Agreed Commitment Percentage Leonia Corporate Bank Plc US$ 8,994,506.67 33 1/3 Merita Bank Plc. Singapore US$ 8,994,506.67 33 1/3 Kreditanstalt fr Wiederaufbau US$ 8,994,506.67 33 1/3 that under the Participation Agreement, for any repayment of the principal or a payment of interest or fees received by Leonia from Smart, Leonia would have to immediately pay to each Participant an amount proportional to its Agreed Participation to the aggregate amount of the loan; that according to the Participation Agreement, the Repayments states as follows: a) Repayments the Lender shall be obliged to repay the principal of any Advance funded by a Participant hereunder, and to pay interest thereon, only in the manner and to the extent expressly provided for in this Agreement; b) Principal and Interest . . . in the event and to the extent only that a repayment of principal or a payment of interest or fees is received by the Lender from the Borrower under the Loan Agreement, the Lender shall immediately pay to each Participant, in like funds as are received by the Lender an amount equal to the proportion of the amount so received from the Borrower under the Loan Agreement which the Agreed Participation of that Participant bears to the aggregate Agreed Participations of all Funding Parties provided that any payment of interest received by the Lender from the Borrower under the Loan Agreement which represents interest on the Loan (or part hereof) during an Interest Period relating thereto calculated at the rate(s) specified in clause 7.02 or 7.03 of the Loan Agreement shall be distributed to the Participants in proportion to the amounts which represent the cost to each Participant of funding its Agreed Participation during such Interest Period , . . .. HTSAEa In consideration of all the above, you are of the opinion that the interest payments of your company to Leonia which are attributable to KfW, a tax-exempt entity under the RP-Germany tax treaty, are exempt from Philippine tax. In reply, we are of the observation that KfW is merely referred to as a co-arranger, not the lender, in the Facility/Loan Agreement between Smart and Leonia. It will be noted also that Smart is not a party to the Participation Agreement executed by and between Leonia and the Banks and other Financial Institutions including KfW. Moreover, it is clear form the Participation Agreement that when Leonia receives payment of the principal or of the interest from Smart under the Loan Agreement, Leonia shall immediately pay to each Participant which includes KfW an amount equal to the proportion of the amount received by Leonia from Smart These circumstances clearly establish that since Smart is not privy to the Participation Agreement, KfW could not be the payee of the interest payments of Smart arising from the Facility/Loan Agreement but Leonia. If ever, the source of income of KfW is from Finland and not from the Philippines. Accordingly, the recipient and the beneficial owner of the principal and interest payments of Smart under the Loan Agreement is Leonia, a resident of Finland, so that the provisions of the RP-Finland tax treaty shall apply in determining the preferential tax rate applicable to the interest payments of Smart. Relative thereto, Article 11 of the RP-Finland tax treaty states, to wit: "Article 11 "INTEREST "1. Interest arising in a Contracting State and paid to a resident of the ocher Contracting State may be taxed in that other State. "2. However, such interest may be taxed in the Contracting State in which it arises, and according to the law of that State, but if the recipient is the beneficial owner of the interest the tax so charged shall not exceed 15 per cent of the gross amount of the interest. The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of this limitation. "3. The term "interest" as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage, and whether or not carrying a right to participate in the debtor's profits, and in particular, income from government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures, as well as income assimilated to income from money lent by the taxation law of the State in which the income arises, including interest on deferred payment sales. Penalty charges for late payment shall not be regarded as interest for purposes of this Article. "xxx xxx xxx "7. Notwithstanding the provisions of paragraph 2, "xxx xxx xxx b) interest arising in a Contracting State and paid to a resident of the other Contracting State shall be taxable only in that other Contracting State if it is paid in respect of a loan made, guaranteed or insured, or a credit extended, guaranteed or insured by the Central Bank of the Philippines or the Finnish Export Credit Limited; "xxx xxx xxx" Such being the case, this Office is of the opinion and so holds that the interest payments made by Smart to Leonia are subject to a preferential tax rate of fifteen percent (15%) of the gross amount of interest, pursuant to Article 11 of the RP-Finland tax treaty, contrary to your opinion that the said interest payments are exempt from Philippine tax pursuant to Article 11(3)(b) of the RP-Germany tax treaty. [ BIR Ruling No. DA-ITAD 89-02 dated May 9, 2002 ] This ruling is issued based on 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 parties herein are concerned. ACcDEa Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service