Amendments to P.D. No. 1158, the National Internal Revenue Code of 1977

June 16, 2010 ITAD BIR RULING NO. 011-10 Article 12, Philippines-Japan Tax Treaty; Article 10, Philippines-Japan Tax Treaty; BIR Ruling No. ITAD-087-83; BIR Ruling No. ITAD-008-99; ITAD Ruling No. 020-99; BIR Ruling No. DA-ITAD-041-99; BIR Ruling No. DA-ITAD-047-99; BIR Ruling No. 096-81; BIR Ruling No. DA-ITAD-98-05; BIR Ruling No. DA-ITAD-60-06; BIR Ruling No. DA-ITAD-102-06; BIR Ruling No. DA-ITAD-65-08 Isla Lipana & Co. 29th Floor Philamlife Tower 8767 Paseo de Roxas 1226 Makati City Attention: Ms. Malou P. Lim Partner, Tax Services Gentlemen : This refers to your letter dated June 18, 2009 regarding the royalty and dividend payments made by TOSHIBA INFORMATION EQUIPMENT (PHILIPPINES), INC. (Toshiba-Philippines) to TOSHIBA CORPORATION (Toshiba-Japan) . It is represented that Toshiba-Japan is a nonresident foreign corporation organized and existing under the laws of Japan as evidenced by the Certificate of Status of Taxable Person dated March 30, 2009 issued by the District Director of Shiba Tax Office, Japan; that its principal office is located at 1-1, Shibaura 1-Chome, Minato-ku, Tokyo 105-8001, Japan; that Toshiba-Japan is engaged in the manufacture of certain kinds of hard disk drives and printed circuit boards for personal computers and possesses certain technical information and patents relating thereto; that it is not registered either as a corporation or as a partnership in the Philippines as evidenced by the Certificate of Non-Registration dated June 15, 2009 issued by the Securities and Exchange Commission (SEC); on the other hand, Toshiba-Philippines is a domestic corporation with principal office address located at 103 East Main Avenue, SEPZ, Laguna Technopark, Bian, Laguna; and that it is registered with the Philippine Economic Zone Authority (PEZA) under Certificate of Registration No. 95-99 and is primarily engaged in the business of manufacturing, assembling, importing, and exporting among others, office automation and information technology, including all types of computer-based equipment and systems, computer hardware and software of all kinds; and that it currently manufactures hard disk drives. On the Royalty Payments: It is represented that Toshiba-Philippines entered into a Technical Collaboration Agreement (Agreement) with Toshiba-Japan on June 6, 1996 under which Toshiba-Japan agreed to furnish Toshiba-Philippines technical information, technical services and a license to manufacture Contract Products 1 under Toshiba-Japan patents; that under the Original Agreement, Toshiba-Philippines shall pay Toshiba-Japan under the following formula: a) For hard disk drives: Number of Contract Products x 3.0% x Net Sales b) For optical disk drives: Number of Contract Products x 3.0% x Net Sales c) For printed circuit board for personal computers: Number of Contract Products x 1.0% x Net Sales That the Original Agreement's term shall expire 5 years after or on June 12, 2001. This was renewed from June 13, 2001 until September 30, 2006. Then again, it was renewed for another five (5) years beginning October 1, 2006 up to September 30, 2011. This time, under the Agreement, the Contract Product is only limited to hard disk drives. Confirmation is being requested on the royalty payments made by Toshiba-Philippines to Toshiba-Japan , under the Agreement, be subjected to the preferential treaty rate for royalties pursuant to paragraph (2) of Article 12 of the Philippines-Japan tax treaty, as amended by the Protocol. On the Dividend Payments: Toshiba-Philippines is represented as a wholly-owned subsidiary of Toshiba-Japan ; that as a shareholder, Toshiba-Japan also receives dividends from Toshiba-Philippines ; that in a meeting held on January 23, 2009, the Board of Directors of Toshiba-Philippines declared cash dividends in the total amount of United States Dollars Two Million Three Hundred Thirty-Eight Thousand (US$2,338,000) payable to all stockholders on record not later than February 27, 2009; that in a subsequent meeting on March 5, 2009, the Board of Directors of Toshiba-Philippines declared cash dividends in the amount of United States Dollars Fourteen Million One Hundred Thousand (US$14,100,000) payable to all stockholders on record not later than March 31, 2009; that Toshiba-Japan is the direct and beneficial owner of Two Million Three Hundred Forty-One Thousand Nine (2,341,009) shares in Toshiba-Philippines with par value of Php1,000 per share representing 99.9% of the total issued and outstanding shares in Toshiba-Philippines as of March 31, 2009; and that, the dividends paid by Toshiba-Philippines to Toshiba-Japan be also entitled to the preferential rate of 10%. Lastly, the issue or transaction subject of the above application is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or a judicial appeal. In reply, please be informed that a foreign corporation like Toshiba-Japan , whether or not engaged in trade or business in the Philippines, is taxable only on income derived in the Philippines (Section 23, National Internal Revenue Code of 1997, as amended, [Tax Code]). Since Toshiba-Japan is not engaged in trade or business in the Philippines based on the Certificate of Non-Registration issued by the SEC, such income derived by Toshiba-Japan in the Philippines is generally subject to income tax at the rate of 35% based on the gross amount thereof. Section 28 (B) (1) of the Tax Code provides: "Section 28. Rates of Income Tax on Foreign Corporations . xxx xxx xxx (B) Tax on Nonresident Foreign Corporation. (1) In General. Except as otherwise provided in this Code, a foreign corporation not engaged in trade or business in the Philippines shall pay a tax equal to thirty-five percent (35%) of the gross income received during each taxable year from all sources within the Philippines, such as interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and capital gains, except capital gains subject to tax under subparagraph 5(c): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, Section 32 (B) (5) of the Tax Code of the 1997, as amended, provides: "Section 32. Gross Income . xxx xxx xxx (B) Exclusions from Gross Income. The following items shall not be included in gross income and shall be exempt from taxation under this Title: xxx xxx xxx (5) Income Exempt under Treaty. Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines. xxx xxx xxx" For the Royalty Payments: Prior to the amendment of the Philippines-Japan tax treaty on December 9, 2006 which took effect on January 1, 2009, said tax treaty provides, to wit: "Article 12 1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State. 2. However, such royalties may also be taxed in the Contracting State in which they arise, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the royalties the tax so charged shall not exceed: a) 15 per cent of the gross amount of the royalties if the royalties are paid in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting; b) 25 per cent of the gross amount of the royalties in all other cases. xxx xxx xxx 3. Notwithstanding the provisions of paragraph 2, the amount of tax imposed by the Philippines on the royalties paid by a company, being a resident of the Philippines, registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines to a resident of Japan, who is the beneficial owner of the royalties, shall not exceed 10 per cent of the gross amount of the royalties. 4. The term 'royalties' as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films and films or tapes for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment or for information concerning industrial, commercial or scientific experience. xxx xxx xxx." Based on the foregoing, royalties arising in the Philippines and derived by a resident in Japan may be taxed in Japan (par. 1). However, the same royalties may also be taxed in the Philippines but the rate of income tax that may be imposed thereon will not exceed 10 percent if the payor is a Board of Investments (BOI)-registered enterprise and engaged in preferred pioneer areas of investment, 15 percent if the payments are in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, and in all other cases, 25 percent of the gross amount of the royalties. (pars. 2 & 3) The Protocol amending the Philippines-Japan tax treaty which took effect on January 1, 2009 provides: "ARTICLE V Paragraph (2) of Article 12 of the Convention shall be deleted and replaced by the following: (2) However, such royalties may also be taxed in the Contracting State in which they arise, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the royalties the tax so charged shall not exceed: (a) 15 per cent of the gross amount of the royalties if the royalties are paid in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting; (b) 10 per cent of the gross amount of the royalties in all other cases." Based on the foregoing provisions, the royalty payments will be taxed on the preferential tax rate of 15 percent if the payments are in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, and in all other cases, 10 percent of the gross amount of the royalties. Such being the case, this Office is of the opinion and so holds that since Toshiba-Philippines is not a BOI-registered enterprise engaged in preferred pioneer areas of investment, and, since the subject royalty payments are not paid in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, the said royalty payments by Toshiba-Philippines to Toshiba-Japan under the existing Agreement shall be subject to tax at the rate not exceeding 25 percent of the gross amount of the royalties, pursuant to Article 12 (2) (b) of the Philippines-Japan tax treaty from October 1, 2006 until December 31, 2008. (BIR Ruling No. 096-81 dated June 11, 1981; BIR Ruling No. DA-ITAD-98-05 dated September 7, 2005; BIR Ruling No. DA-ITAD-60-06 dated May 30, 2006; BIR Ruling No. DA-ITAD-102-06 dated August 28, 2006; and BIR Ruling No. DA-ITAD 065-08 dated September 10, 2008) On the other hand, the royalty payments from January 1, 2009 up to September 30, 2011 under the existing Agreement shall be subject to 10 percent preferential tax rate pursuant to the Protocol. On the Dividend Payments: Article 10 of the Philippines-Japan tax treaty provides: "Article 10 1. Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other Contracting State. 2. However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the dividends the tax so charged shall not exceed: a) 10 per cent of the gross amount of the dividends if the beneficial owner is a company which holds directly at least 25 per cent either of the voting shares of the company paying the dividends or of the total shares issued by that company during the period of six months immediately preceding the date of payment of the dividends; b) 25 per cent of the gross amount of the dividends in all other cases. The provisions of this paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid. xxx xxx xxx 4. The term "dividends" as used in this Article means income from shares or other rights, not being debt-claims, participating in profits, as well as income from other corporate rights assimilated to income from shares by the taxation laws of the Contracting State of which the company making the distribution is a resident. xxx xxx xxx The foregoing Article, however, was amended by a Protocol which provides: "ARTICLE III Paragraph (2) of Article 10 of the Convention shall be deleted and replaced by the following: "(2) However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the dividends the tax so charged shall not exceed: (a) 10 per cent of the gross amount of the dividends if the beneficial owner is a company which holds directly at least 10 per cent either of the voting shares of the company paying the dividends or of the total shares issued by that company during the period of six months immediately preceding the date of payment of the dividends; (b) 15 per cent of the gross amount of the dividends in all other cases. The provisions of this paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid." Pursuant to the foregoing, the 10 percent preferential tax rate on dividends applies whenever the beneficial owner of the dividends owns at least 10 percent either of the voting shares of the company paying the dividends or of the total shares issued by the company during the period of six months immediately preceding the date of payment of the dividends. In all other cases, the 15 percent preferential tax rate applies. Such being the case and considering that Toshiba-Japan holds more than 10 percent of the capital of Toshiba-Philippines during the period of six months immediately preceding the date of payment of the dividends, this Office is of the opinion and so holds that the dividend payments by Toshiba-Philippines pertaining to Toshiba-Japan shall be subject to the preferential tax rate of 10 percent of the gross amount of the dividends pursuant to Article 10 (2) (a) of the Philippines-Japan tax treaty. (BIR Ruling No. ITAD-087-83 dated May 17, 1983; BIR Ruling No. ITAD-008-99 dated July 20, 1999; ITAD Ruling No. 020-99 dated August 18, 1999; BIR Ruling No. DA-ITAD-041-99 dated November 3, 1999; BIR Ruling No. DA-ITAD 047-99 dated December 9, 1999) As regards the imposition of the VAT on the transfer of technical know-how of Toshiba-Japan , please be informed further that Section 108 of the Tax Code of 1997 2 provides as follows: "SEC. 108. Value-added Tax on Sale of Services and Use or Lease of Properties . (A) Rate and Base of Tax. There shall be levied, assessed and collected, a value-added tax equivalent to ten percent (10%) 3 of gross receipts derived from the sale or exchange of services, including the use or lease of properties . (Emphasis supplied) xxx xxx xxx" Thus, in general, the VAT is imposed on the transfer of technical know-how by Toshiba-Japan in the Philippines, such that on every payment of royalty fees, Toshiba-Philippines is generally required to withhold such VAT and treat the same as a "passed on" VAT, pursuant to Section 4.110-3 (b) of Revenue Regulations No. 7-95 as amended [now Section 4.114-2 (b) of Revenue Regulations No. 16-05] . However, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866, February 11, 2005), the Supreme Court held, viz. : " Special laws may certainly exempt transactions from the VAT. 4 However, the Tax Code provides that those falling under PD 66 are not. PD 66 is the precursor of RA 7916 the special law under which respondent was registered. The purchase transactions it entered into are, therefore, not VAT-exempt. These are subject to the VAT; respondent is required to register. xxx xxx xxx Since the purchases of respondent are not exempt from the VAT, the rate to be applied is zero. Its exemption under both PD 66 and RA 7916 effectively subjects such transactions to a zero rate, because the ecozone within which it is registered is managed and operated by the PEZA as a separate customs territory. This means that in such zone is created the legal fiction of foreign territory. Under the cross-border principle of the VAT system being enforced by the Bureau of Internal Revenue (BIR), no VAT shall be imposed to form part of the cost of goods destined for consumption outside of the territorial border of the taxing authority. If exports of goods and services from the Philippines to a foreign country are free of the VAT, then the same rule holds for such exports from the national territory except specifically declared areas to an ecozone. xxx xxx xxx Applying the special laws we have earlier discussed, respondent as an entity is exempt from internal revenue laws and regulations. This exemption covers both direct and indirect taxes, stemming from the very nature of the VAT as a tax on consumption, for which the direct liability is imposed on one person but the indirect burden is passed on to another. Respondent, as an exempt entity, can neither be directly charged for the VAT on its sales nor indirectly made to bear, as added cost to such sales, the equivalent VAT on its purchases. Ubi lex non distinguit, nec nos distinguere debemus. Where the law does not distinguish, we ought not to distinguish. Moreover, the exemption is both express and pervasive for the following reasons: . . ., RA 7916 states that 'no taxes, local and national, shall be imposed on business establishments operating within the ecozone.' Since this law does not exclude the VAT from the prohibition, it is deemed included. Exceptio firmat regulam in casibus non exceptis. An exception confirms the rule in cases not excepted; that is, a thing not being excepted must be regarded as coming within the purview of the general rule. Moreover, even though the VAT is not imposed on the entity but on the transaction, it may still be passed on and, therefore, indirectly imposed on the same entity a patent circumvention of the law. That no VAT shall be imposed directly upon business establishments operating within the ecozone under RA 7916 also means that no VAT may be passed on and imposed indirectly. Quando aliquid prohibetur ex directo prohibetur et per obliquum. When anything is prohibited directly, it is also prohibited indirectly. xxx xxx xxx" Based on the foregoing, transactions exempt from VAT by reason of PD 66 and RA 7916 are effectively zero-rated. However, instead of zero-rating which is not available to non-resident suppliers, the provision for exempt transactions under Section 109 (q) [now Section 109 (K)] of the Tax Code of 1997 which provides VAT exemption for transactions that are exempt under special laws, e.g. , Republic Act No. 7916 or PEZA Law, is particularly applicable to the instant case. Such being the case, the payment of royalty fees by Toshiba-Philippines , being a PEZA-registered enterprise, to Toshiba-Japan under the Agreement should be, as it is hereby confirmed to be, exempt from VAT. This ruling is issued on the basis of the facts as represented and shall only apply insofar as the royalty aspect is concerned. However, if upon investigation it shall be disclosed that the actual facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. Very truly yours, (SGD.) JOEL L. TAN-TORRES Commissioner of Internal Revenue Footnotes 1. "Contract Products" means hard disk drives, optical disk drives and printed circuit boards for personal computers. 2. Please note that this cited provision has been retained by Republic Act (RA) No. 9337, although with the modification as to the applicable rate when the circumstances so warrant. 3. Effective February 1, 2006, the rate shall be 12%. 4. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337].