From soup to nuts: Revisiting tax treaties for tax planning

(First of 2 parts)

In the field of cross-border investments, the location of the holding company that will own shares in a Philippine company is a vital consideration when planning the business structure. Generally, income payments by domestic companies to non-resident foreign corporations are taxed at 25 percent final withholding tax (FWT), unless the holding company is situated in a country that has a tax treaty with the Philippines. In the latter case, preferential treaty rates may be availed of by the non-resident foreign corporation, subject to compliance with treaty conditions and administrative requirements for the availment of treaty benefits.

Not all tax treaties are uniform in the benefits they offer, however, as there are tax treaties that provide a more favorable tax rate compared to others.

As an example, the tax impact on passive income (dividends, interests and royalties) varies according to the applicable tax treaty during the holding period.

In the case of dividends, the Double Tax Agreements (DTA) of the Philippines with the Netherlands, Israel, Japan and United Arab Emirates provides for a preferential FWT rate of 10 to 15 percent, compared to the FWT of 15 to 25 percent found in other tax treaties. Further, comparing these treaties with the Philippines-Germany DTA, the Philippines-Germany DTA provides a more beneficial FWT of five percent for dividends, provided the beneficial owner is a company (other than a partnership) which holds directly at least 70 percent of the capital of the company paying the dividends.

For interest and royalties on the other hand, there are tax treaties that provide 10 percent as the lowest FWT rate, but there are those where the lowest FWT rate is 15 percent.

Another example is the tax impact of divesting investments in the Philippine company. One exit strategy commonly adopted by non-resident foreign corporation is to sell their shares in the Philippine company to a third party.

Under the Tax Code, the sale of unlisted shares is subject to 15 percent capital gains tax (CGT) based on capital gains, and 0.75 percent documentary stamp tax (DST) based on the total par value of the shares sold. There may also be donor’s tax implications when the shares are sold below its Fair Market Value (FMV).

If, however, the seller is a resident of a country that has a tax treaty with the Philippines, CGT exemption may be availed of, subject to compliance with treaty conditions and administrative requirements for availment of treaty benefits.

Most tax treaties provide that as a condition for CGT exemption to apply the assets of the Philippine company whose shares are being sold or transferred should not principally consist of immovables or real properties. Under Revenue Regulations (RR) 04-86, dated April 2, 1986, the term “principally consist” is defined as more than 50 percent of the entire assets in terms of value. RR 04-86 provides that the following assets are considered as immovables or real properties:

1. Land, buildings, roads and constructions of all kinds adhered to the soil.

2. Trees, plants and growing fruits, while they are attached to the land or form an integral part of an immovable.

3. Everything attached to an immovable in a fixed manner, in such a way that it cannot be separated therefrom without breaking the material or deterioration of the object.

4. Statues, reliefs, painting or other objects for use as ornamentation, placed in buildings or on lands by the owner of the immovable in such a manner that it reveals the intention to attach them permanently to the tenements.

5. Machinery receptacles, instruments or implements intended by the owner of the tenement for an industry or works which may be carried on in a building or on a piece of land, and which tend directly to meet the needs of the said industry or works.

6. Animal houses, pigeon-houses, beehives, fish ponds or breeding places of similar nature, in case their owner has placed them or preserves them with the intention to have them permanently attached to the land, and forming a permanent part of it; the animals in these places are included.

7. Fertilizer actually used on a piece of land.

8. Mines, quarries and slag dumps, while the matter thereof forms part of the bed, and waters either running or stagnant.

9. Docks and structures which, though floating, are intended by their nature and object to remain at a fixed place on a river, lake or coast.

10. Contracts for public works, and servitudes and other real rights over immovable property, including real estate mortgages, possessory retentions, antichresis, usufructs and lessee of property.

11. Accessory to the above mentioned properties, such as livestock and equipment used in agriculture and forestry, rights to which provisions of general law respecting landed property apply, usufruct of immovable property and rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources.

Mary Karen Quizon-Sakkam is a partner and Hanna Karen Almario is a senior manager 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 and Tier 1 transfer pricing practice 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].