ITAD Ruling No. 164-00

October 30, 2000 ITAD RULING NO. 164-00 Article 11, RP-Singapore Tax Treaty Section 39, NIRC of 1997 Sycip Salazar Hernandez & Gatmaitan Attorneys-At-Law Syciplaw-All Asia Capital Center 105 Paseo de Roxas, City of Makati 1226 Metro Manila Attention: Atty . Ernesto S . Taio, Jr . Gentlemen : This refers to your application for relief from double taxation dated September 22, 1999, on behalf of your client, VICKERS CAPITAL LIMITED (Vickers), requesting for a ruling on whether the interest payments made to Vickers on the Secured Floating Notes Due 2000 issued by Lapanday Holdings Corporation (Lapanday) are subject to the preferential tax rate of 15%, and the "Upside Share" paid upon retirement of the said Notes is considered a capital gain, pursuant to the RP-Singapore Tax Treaty. It is represented that Vickers held Secured Floating Notes Due 2000 (Notes) issued by Lapanday, a corporation organized and existing under the laws of the Philippines; that Vickers is a corporation organized and existing under the laws of the Singapore with no permanent establishment in the Philippines, as per certification dated September 8, 1999 issued by the Securities and Exchange Commission; that the principal amount of the Notes was US$6,000,000; that said Notes were issued in registered form in amounts of US$100,000 or an integral multiple of US$100,000; that the rate of interest applicable to the Notes was the aggregate of one percent plus the Singapore Inter-Bank Offered Rate; that the said interest was payable every six months from the date of issue of the Notes; that Lapanday may retire and redeem the Notes on an interest payment date but not later than the interest payment date falling due in December 2000; that if the Notes are retired, Vickers will receive, in addition to the principal and the interest accrued up to the retirement date, an amount (referred to as "Upside Share") calculated on the basis of a notional or hypothetical transaction as if Vickers had exercised an option to purchase from Lapanday a number of shares of Macondray & Co., Inc. (Macondray), a subsidiary of Lapanday, at a specified price; that the said notional transaction never actually happened no shares of Macondray are ever transferred to Vickers or to Lapanday. Based on the documents submitted, it was ascertained that the said Notes were retired on August 31, 1999 and that Vickers received P4,275,048.20 representing interest before deducting tax and P48,992,006.80 as Upside Share. Based on the provisions of the RP-Singapore Tax Treaty, the tax on the interest income was withheld by Lapanday at 15% and remitted to the government upon filing of the corresponding return. No tax was withheld on the Upside Share as it is your stand that such an amount received by Vickers upon retirement of the Notes is a capital gain derived from the exchange thereof and therefore exempt from Philippine income tax pursuant to Article 13(4) of the RP-Singapore Tax Treaty in relation to Section 39(E) of the National Internal Revenue Code (Tax Code) of 1997. In reply, please be informed that Article 11 of the RP-Singapore Tax Treaty provides, viz: "Article 11 INTEREST 1. Interest arising in a Contracting State and paid to a resident of the other 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 be mutual agreement settle the mode of application of this limitation. IHSTDE 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. (Emphasis supplied) xxx xxx xxx" Applying the foregoing provisions, the preferential tax rate to be withheld by Lapanday on its interest payment to Vickers shall be fifteen percent (15%). The interpretation of tax treaties is governed by customary international law, as embodied in the Vienna Convention on the Law of Treaties . Article 31(1) of the latter provides that 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 light of its object and purpose. The 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 redemption or at issue, that is over and above the amount paid by the subscriber. This interpretation is founded on the Commentaries of the ORGANISATION FOR ECONOMIC COOPERATION AND DEVELOPMENT (OECD) Committee on Fiscal Affairs on the Model Tax Convention, thus: "As regards, more particularly, government securities and bonds and debentures, the text specifies that premiums or prizes attaching thereto constitute interest. Generally speaking what constitutes 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 redemption or at issue . . . 1 (Emphasis supplied) Accordingly, the Upside Share remitted to Vickers should also be subject to the preferential tax rate of 15% as it is in the nature of interest pursuant to the RP-Singapore Tax Treaty. It is true that Section 39 of the Tax Code of 1997 provides: "SEC. 39. Capital Gains and Losses . "xxx xxx xxx "(E) Retirement of Bonds, Etc . For purposes of this Title, amounts received by the holder upon the retirement of bonds, debentures, notes or certificates or other evidences of 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 the Notes held by Vickers as a capital asset transaction and any gain derived therefrom is considered a capital gain from exchange of the note. However, the aforequoted provisions of the Tax Code will only apply if no tax treaty exists between the governments of the Philippines and Singapore, and the term "interest" is not defined so as to include premiums paid by the debtor upon retirement of an obligation. In case of conflict between a tax treaty and the Tax Code, the former shall prevail. This is so because a tax treaty is in the nature of a special law, i.e., a law which relates to particular persons or things of a class or to a particular portion or section of the State, which, in the case of the RP-Singapore Tax Treaty, the residents of Singapore insofar as the Philippines is concerned. On the other hand, the provisions of the Tax Code are in the nature of a general law or that which applied to all of the people of the State or to all of a particular class or persons in the State with equal force. TCHcAE It is a rule in statutory construction that a general law and a special law on the same subject should be read together and harmonized, if possible, with a view to giving effect to both. In case of conflict between the two, the special law shall prevail. The fact that one law is special and the other general, creates a presumption that the special law is to be considered as remaining an exception of the general law, one as a general law of the land and the other as the law of a particular case. Furthermore, this Office adopts the commentary of the OECD in not referring to the Tax Code in interpreting paragraph 3 of Article 11 (Interest) of the said Model Convention, viz: ". . ., the definition of 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 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. 2 xxx xxx xxx" In view of all the foregoing, this Office hereby, holds that the preferential tax rate of 15% shall be applied on the interest and the Upside Share payments of Lapanday to Vickers pursuant to the RP-Singapore Tax Treaty. This ruling is issued on the basis of the foregoing facts as represented. However, if upon investigation it will be disclosed that the facts are different, then this ruling shall be considered null and void. DHcTaE Very truly yours, (SGD.) LILIAN B. HEFTI Commissioner of Internal Revenue 1. Paragraph 20, p. 141, Commentaries on Article 11 (Interest), Model Tax Convention on Income and on Capital, June 1998 Condensed Version. 2. Paragraph 21, p. 142, supra; REFER also to The UNITED NATIONS Model Double Taxation Convention between Developed and Developing Countries [New York, 1980], p. 131.