BIR Ruling [DA-067-05]

February 28, 2005 BIR RULING [DA-067-05] R.A. 7916 DA-147-2004 Dae Kying Phils., Co., Inc . Philippine Economic Zone Authority Lot No. 1-6, Block 20. Phase 4, Main Avenue Rosario Cavite 4106, Philippines Attention: Ms. Merilinda C. Fajardo Accounting Asst. Manager Gentlemen : This refers to your letter dated December 15, 2004 requesting for an opinion that royalty payments made by Dae Kyung Phils. Co. Inc. (DKP) relative to the transfer of technology by Radix Electron, Inc. (Radix) are deductible from the gross revenues for purposes of computing its taxable income. It is represented that DKP is a Philippine Corporation registered with the Export Processing Zone Authority (EPZA), now PEZA as a Zone Export Enterprise under Certificate of Registration No. 93-26 dated June, 03, 1993, to engage in the 1) manufacture of satellite video receiver (SVR tuners and other components/subcomponents of the telecommunication industry, 2) manufacture of transformers, 3) manufacture of tuner for cable modem and 4) manufacture of Low Noise Block (LNB); that DKP is now subject to the 5% preferential tax rate, in; lieu of other taxes, under the PEZA law; that DKP entered into a Technical License Agreement with Radix Electron, Inc., a corporation organized and existing under the laws of the Republic of Korea; that Radix agreed to furnish DKP with all available technical information on the design, drawings, data and materials relating to technical know-how in the manufacturing of products; and that the aforesaid Technical License Agreement has been registered with the Intellectual Property Office (IPO) and has been issued Certificate of Compliance No. 5-2004-00031 dated February 27, 2004. In reply; please be informed that Section 2, Rule 1 of the Rules and Regulations to Implement Republic Act No. 7916 (the PEZA Law), otherwise known as "The Special Economic Zone Act of 1995," (the PEZA Rules) defines gross income as follows: "Gross Income for purposes of computing the special tax due under Section 24 of the Act refers to gross sales or gross revenues derived from business activity within the ECOZONE, net of sales discounts, sales returns and allowances and minus costs of sales or direct costs but before any deduction is made for administrative expenses or incidental losses during a given taxable period. The allowable deductions from "gross income" are specifically enumerated under Section 2, Rule XX of these Rules." Moreover, Section 3 of BIR Revenue Regulations No. 16-99 provides that firms established under Republic Act No. 7227 are allowed to deduct royalty payments when. calculating gross income subject to the 5% final tax. The same Section 3 of Revenue Regulations No. 16-99 governing enterprises registered with the Subic Bay Metropolitan Authority (SBMA), modifies the definition of gross income earned to read as follows: "o. Gross Income Earned refers to gross sales or gross revenues derived tom the business activity within the zone, net of sales discounts and sales returns and allowances and minus costs of sales or direct costs but before any deduction for administrative expenses or incidental losses during a given taxable period. For financial enterprises, gross income shall include interest income, gains from sales, and other income, net of allowable deductions The following deductions shall be allowable for the calculation of gross income earned for specific types of enterprises: Trading and manufacturing enterprises Direct salaries Production supervision salaries Raw materials used in the manufacture of products Good in process (Intermediate goods) Finished goods Supplies and fuels used in production Toll manufacturing fees Commission expenses Distribution expenses Depreciation of machineries and equipment used in production and building owned and/or constructed by SBMA-registered enterprise Equipment lease payments Rent and utility charges associated with building, equipment and warehouses, or handling of goods Financing charges associated with-fixed assets Corporate Management salaries Administrative salaries Marketing and sales salaries Advertising Research and development Royalty Fees Travel expense Communication Expenses Outside Professional Services Interest and financial charges on working capital Loss on foreign exchange translation Loss on disposal of merchandise inventory . . ." (Emphasis ours.) Based on the above Revenue Regulations, SBMA-registered trading and manufacturing enterprises are entitled to deduct Royalty Fees when calculating their gross income earned. By virtue of R.A. 7916 (PEZA Law), these SBMA privileges are also extended to PEZA firms as follows: "51. Ipso-Facto Clause. All privileges, benefits, advantages or exemptions wanted to special economic zones under Republic Act No. 7227, shell ipso-facto be accorded to special economic zones already created or to be created under this Act. The free port status shall not be vested upon the new special economic zones." (Section 51 of the PEZA Law) DHTECc IN VIEW OF THE FOREGOING, this Office holds that royalties arising from the Technical License Agreement relating to know-how in the manufacturing of the company's products should be deductible in computing the gross income subject to the 5% preferential tax rate as defined under Section 2, Rule 1 of the PEZA Rules and as extended to PEZA registered firms as mandated by Sec. 51 of RA 7916. This ruling is being 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. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group