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In determining whether the assets of the Philippine company whose shares are being sold principally consist of immovables or real properties, the Audited Financial Statements (AFS) are usually resorted to.  While the value of the real properties listed in RR No. 04-86 can be easily reckoned from the AFS, there is ambiguity for contracts for public works.  What constitutes a contract for public works and how do you value a contract for public works for tax treaty purposes?  For a Philippine company that has entered into a contract for public works and has concession assets indicated in its AFS, will the concession assets per AFS be the value to be used in determining whether the assets of the Philippine company principally consist of immovables?

A 2013 Court of Tax Appeals case (CTA Case No. 8307, dated 07 November 2013) may be helpful when tackling this question. In the case, the Tax Court explained that contracts for public works can be construed as referring to all fixed works constructed for public use or fixed public infrastructures for use of the public. It denotes that there are works conducted, i.e., construction and maintenance of infrastructure facilities such as national highways, flood control, water resources development systems, etc.

However, the Tax Court noted that there is a need to examine the composition of the concession assets because being non-physical assets, it is necessary to determine whether the underlying component of the concession assets pertain to real or personal property.  In the said 2013 CTA Case, the concession assets consisted of the present value of total estimated concession fee payments pursuant to the concession agreement and the costs of rehabilitation works incurred (called network assets).  The Tax Court ruled that only the portion pertaining to the network assets should be classified as real property.

The condition that the assets of the Philippine company whose shares are being sold or transferred should not principally consist of immovables or real properties is not a uniform consideration in other tax treaties.  Some tax treaties provide other requirements for the availment of exemption for CGT on sale or disposal of shares. 

Take the case of the Double Tax Agreements of the Philippines with Netherlands and United Kingdom (UK).  These tax treaties do not provide for a condition that the assets of the Philippine company should not principally consist of immovables in order for the gains from the sale of shares to be taxable only in Netherlands or in UK. 

Another treaty that provides for a different condition for CGT exemption is the Philippines-Australia Double Tax Agreement.  Here, the condition in order for CGT exemption to apply is that the assets of the Philippine company whose shares are being sold do not principally consist of direct interest in or over land in the Philippines, or of rights to exploit or to explore for, natural resources in the Philippines.  Note that the subject tax treaty used the word “land” and “natural resources”, instead of the broader term “real properties” or “immovables”. 

Considering the wordings used in the Philippines-Australia Double Tax Agreement, should the enumeration of real properties or immovables under RR No. 04-86 be used in determining whether the treaty condition for CGT exemption is complied with?  Or, since the tax treaty clearly veered away from the generic term of “real properties” or “immovables”, is it not that the intention is to limit the assets to be considered in determining whether CGT exemption is applicable or not to land and natural resources in the Philippines?

To equate “land” and “rights to exploit, or to explore for, natural resources” (as expressly delineated under the Philippines-Australia Double Tax Agreement) with “real properties” or “immovables” will have the effect of adding or expanding the conditions laid down by the treaty.  Further, it is not consistent with the plain-meaning rule or verba legis in statutory construction that when the words themselves are clear, plain, and free from ambiguity, there is no need to go beyond the ordinary and literal meaning.

Coming up with a business structure does not stop at the setting-up or establishment stage.  One must also think of the tax implications during the holding period.  And last but not definitely not the least, one must also think about an exit strategy so that taxes don’t trip you up on your way out.

Mary Karen E. Quizon-Sakkam is a Partner and Hanna Karen V. 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 ph-inquiry@kpmg.com.