Treaties and treats

In the heyday of strict implementation of tax laws, it is a welcome relief to some taxpayers that a tax treaty relief application (TTRA) is after all, what it is supposed to be, a relief.

To begin with, tax treaties are entered into by countries to reconcile their respective fiscal legislations, and in turn help the taxpayer avoid double taxation in two different jurisdictions. This benefit cannot be overlooked as it promotes commerce and investments among contracting States.

On Sept. 11, 2015, the Bureau of Internal Revenue (BIR) issued a ruling granting Mitsubishi Corp. – Tokyo (Mitsubishi-JP) a reprieve from the 15-day period rule laid down in Revenue Memorandum Order No. 1-2000, as amended (RMO 1-00).

Under RMO 1-00, taxpayers who intend to avail of tax treaty provisions are required to file an application for treaty relief with the International Tax Affairs Division (ITAD) of the BIR within 15 days before the transaction or the first taxable event. Failure to properly file within the period has the effect of disqualifying the TTRA, consequently forcing taxpayers to pay the tax at its full extent instead of the preferential rate or exemption it would have enjoyed under the treaty.

Unavoidably, this issuance spurred a debate between taxpayers and the BIR. With one side arguing a mere issuance cannot supplant treaty obligations of the State, on the other, BIR holding its cudgels for the government, maintaining its stand the taxpayer must prove its entitlement of treaty benefits by filing the TTRA within the 15-day period.

The contentions of both has merit, but the Supreme Court finally set its foot down to put the debate at rest. On Aug. 19, 2013, the Supreme Court decision on Deutsche Bank AG Manila Branch vs. Commissioner of Internal Revenue was promulgated. The Supreme Court settled the issue by declaring that the period of availment of tax treaty relief as required by RMO 1-00 should not operate to divest entitlement to the relief as it would constitute a violation of the duty required by good faith in complying with a tax treaty. The SC decision also pointed out that non-compliance with tax treaties has negative implications on international relations, whereas the rationale of RMO 1-00 involve an administrative procedure that may be remedied through other processes like imposition of fines and penalties.

It is through the pronouncements of the Deutsche case that the BIR started reconsidering the disposition of applications filed before it. Mitsubishi-JP was one to reap BIR’s beneficence. Back in July 2010, a TTRA in behalf of Mitsubishi-JP was filed for the dividends that it received from Ayala Corp. The TTRA was initially denied because it was filed on the same day that the dividends were paid. The ruling held that, as per RMO 1-00 Mitsubishi-JP must file the application at least 15 days BEFORE the transaction. Hence, Mitsubishi-JP was disqualified to avail of the 10 percent preferential tax rate under the RP-Japan Tax Treaty, and was instead decreed to pay the income tax rate of 30 percent.

Patience truly is a virtue. Moving forward to 2015, the denial of the TTRA was reversed through ITAD BIR Ruling No. 269-15, favoring Mitsubishi-JP with a confirmation that the dividends it received from Ayala are subject to income tax rate of 10 percent pursuant to the treaty.

In this ruling, the BIR ruled that Mitsubishi-JP may avail of the 10 percent rate on the basis of Article 10(2) in relation to Article 10(5) of the Phl-Japan Treaty. Article 10(2) states the lower rate of 10 percent as applied to the gross amount of dividends received from a Philippine corporation, may be availed of by a Japanese resident if it is the beneficial owner and it holds directly at least 10 percent of the voting shares or total shares issued by the Philippine corporation, six months immediately preceding the date of payment of dividends. Article 10(5) on the other hand, provides that the rate of 10 percent will not readily apply if the beneficial owner of the dividends carries on business in the Philippines through a permanent establishment and that the dividends paid are effectively connected with it.

Mitsubishi-JP holds directly 10.7995 percent of the total shares of Ayala Corp.  during the six month period preceding the date of payment of the dividends. Also, while Mitsubishi-JP has a branch office in the Philippines (Mitsubishi Philippines), the investment was not conducted through its Philippine branch. Mitsubishi-JP acquired the Ayala shares independent of and without the participation of Mitsubishi Philippines. Essentially, it is the Japanese entity which is the stockholder. Any gain from the investment and the corresponding tax obligation from these shares inure to Mitsubishi-JP.

Basically, Mitsubishi-JP can be taxed at the rate of 30 percent on its taxable income. But the ITAD ruling asserted the income tax rate of 30 percent applicable to resident foreign corporations is inapplicable to Mitsubishi-JP’s case. To support this, the BIR quoted the Supreme Court’s ruling in Marubeni Corp. vs. Commissioner of Internal Revenue and the Court of Tax Appeals. It proclaimed that dividends derived by a foreign corporation which has a branch office in the Philippines are effectively connected with the branch office IF the business activities that give rise to such dividends are conducted through the branch office following a principal-agent relationship theory.

Since Mitsubishi-JP’s investment in Ayala did not arise and was not connected to the business of Mitsubishi Philippines, and its holdings in Ayala satisfies the 10 percent of total shares issued as required by Article 10(2), it behooves the BIR to grant confirmation that indeed the dividends that Mitsubishi-JP received was subject to 10 percent and not 30 percent income tax rate.

It may have taken Mitsubishi-JP five years to recoup from the denial of its claim for relief. It took the same five years to prove that it was entitled to the relief. At the end of the day, Mitsubishi-JP’s plight surely showed us that sometimes it may be necessary to jump through hoops, just so you can get the treat that comes with it. 

Anne Gillian Suba-Rodriguez is a supervisor from the tax group of KPMG R.G. Manabat & Co. (KPMG RGM&Co.), the Philippine member firm of KPMG International. KPMG RGM&Co. has been recognized as a Tier 1 tax practice, Tier 1 transfer pricing practice and Tier 1 leading tax transactional firm in the Philippines by the International Tax Review.

This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.

The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or KPMG RGM&Co. For comments or inquiries, please email [email protected] or [email protected].