ITAD Ruling No. 117-02

June 4, 2002 ITAD RULING NO. 117-02 RP-US tax treaty, Article 12 Section 39, NIRC 1997 BIR Ruling ITAD 23-02 Sycip, Salazar, Hernandez & Gatmaitan Sycip All Asia Capital Center 105 Paseo de Roxas, City of Makati Attention: Atty. Ernesto S. Taino, Jr. Gentlemen : This refers to your letter dated October 25, 1999, requesting for a ruling to the effect that interest payments made by Lapanday Holdings Corporation (Lapanday) to BankBoston National Association (BankBoston) are subject to the preferential tax rate of 15% and the capital gains derived from the retirement of Notes are exempted from Philippine taxes, both pursuant to the RP-US tax treaty. It is represented that BankBoston (formerly First National Bank of Boston) is a corporation organized and existing under the laws of Massachusetts with business address at 150 Beach Road # 07-00 Gateway West, Singapore; that it had a Manila offshore banking unit (Manila OBU) registered with the Securities and Exchange Commission (SEC) with SEC Certification No. F-1019 authorized to do business in the Philippines; that Manila OBU filed a petition for the withdrawal of license on May 26, 1999 evidenced by the Certificate of Corporate Filing/Information issued by the SEC; that Manila OBU actually ceased commercial operations sometime during the month of March, 1999 and is presently winding up its operations in the Philippines; that on June 28, 1999, BankBoston in Singapore acquired Secured Floating Notes Due 2000 in the principal amount of Ten Million U.S. Dollar (US$10,000,000) issued by Lapanday, a corporation organized and existing under the laws of the Philippines, that the transaction occurred after cessation of commercial operations by the Manila OBU; that the interest is payable every six months; that the corporation may retire and redeem the Notes on an interest payment date falling due in December, 2000; that if the Notes are in fact retired, BankBoston will receive, in addition to the principal, an amount referred to as 'upside share' calculated on the basis of notional and hypothetical transaction as if BankBoston had exercised an option to purchase from the corporation a certain number of shares of Macondray & Co., Inc. (MCI) a subsidiary of Lapanday. In reply, please be informed that Article 12 or the RP-US tax treaty provides, viz : "Article 12 "INTEREST "1. Interest derived by a resident of one of the Contracting States from sources within the other Contracting State may be taxed by both Contracting States. "2. Interest derived by a resident of one of the Contracting States from sources within the other Contracting State shall not be taxed by the other Contracting State at a rate in excess of 15 percent of the gross amount of such interest. "xxx xxx xxx" "7. The term 'interest' as used in this Convention 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 Contracting State in which the income arises, including interest or deferred payment sales. "xxx xxx xxx" The RP-US tax treaty defines "interest" to include "income from bonds or debentures, including premiums and prizes attaching to such bonds or debentures." Thus, it may refer to any amount that the issuer of the bond or debenture pays, at the redemption or at issue, that is over and above the amount paid by the subscriber. This interpretation is founded on the Commentaries of the ORGANIZATION FOR ECONOMIC COOPERATION AND DEVELOPMENT (OECD) Committee on Fiscal Affairs on the Articles of the Model Convention, thus: "As regards, more particularly, government securities, and bonds and debentures the test specifies that premiums or prizes attaching thereto constitute interest. Generally speaking, what constitute interest yielded by a loan security, and may properly be taxed as such in the State of source, is all that the institution issuing the loan pays over and above the amount paid by the subscriber, that is to say the interest accruing plus any premium paid at the redemption or at issue . . . " (emphasis supplied) Accordingly, the Upside share remitted to BankBoston should also be subject to the preferential tax rate of 15%, pursuant to RP-US tax treaty. It is true that Section 39 of the Tax Code of 1997, provides that: "SEC. 39. Capital Gains and Losses . xxx xxx xxx (E) Retirement of Bonds, Etc. For the purpose of this Title, amounts received by the holder upon retirement of bonds, debentures, notes or certificates or other evidences of the indebtedness issued by any corporation (including those issued by a government or political subdivision thereof) with interest coupons or in registered form, shall be considered as amounts received in exchange therefor. xxx xxx xxx" This section regards the retirement of bonds as capital asset transaction merely for the purpose of determining their effect. However, for characterization purposes, such Upside share falls squarely within the definition of interest. This office adopts the commentary of the OECD in interpreting paragraph 3 of Article 11 (Interest) of the said Model Convention, viz : ". . . , the definition of the interest in the first sentence of paragraph 3 is, in principle, exhaustive. It has seemed preferable not to include a subsidiary reference to domestic laws in the text; this is justified by the following considerations; a.) the definition covers practically all the kinds of income which are regarded as interest in the various laws; b.) the formula employed offers greater security from the legal point of view and ensures that the conventions would be unaffected by future changes in any country's domestic laws; c.) in the Model Convention references to domestic laws should as far as possible be avoided. xxx xxx xxx In view of all the foregoing, this Office is of the opinion and so holds that the interest payments of Lapanday to BankBoston shall be subject to the 15% preferential tax rate. However, the capital gains derived from the retirement of the Secured Floating Notes should also be subjected thereto for the reasons above stated. The Secured Floating Notes Due 2000 shall also be subject to documentary stamp tax imposed under Section 180 of the Tax Code of 1997. This ruling is issued based on the foregoing facts as represented. If upon investigation it shall be disclosed that the said facts are different, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service