Samsung Electronics Philippines Manufacturing Corporation

April 30, 2008 BIR RULING [DA-273-08] 23 (F); 42 (C) (3); 108; 109 (K); DA 108-07; DA-ITAD 042-06 Samsung Electronics Philippines Manufacturing Corporation Block 6, Calamba Premiere International Park, Barangay Batino, Calamba City, Laguna Attention: Mr. Sang Ho Park Chief Financial Officer Gentlemen : This refers to your letter dated April 21, 2008 requesting confirmation that: 1) the license fees to be made by Samsung Electronics Philippines Manufacturing Corporation (SEPHIL) to Samsung Electronic Co. Ltd. (SECL) pursuant to the JungUm Global License Agreement (Agreement) are not subject to value added tax (VAT); 2) the license fees to be paid by SEPHIL under the Agreement effective September 8, 2005 are ordinary business profits and not royalties; and 3) the license fees effective September 8, 2005 are income of SECL derived from sources outside the Philippines and, therefore, exempt from Philippine income tax. It is represented that SEPHIL [formerly Philippines Samsung Electronics Corporation (PSEC)] is a corporation duly organized and existing under Philippine laws with office address at the Calamba Premiere International Park-Special Economic Zone. It is registered with the Philippine Economic Zone Authority (PEZA) as an Ecozone Export Enterprise under Registration Certificate No. 01-011 dated February 9, 2001 and is entitled to a 5% special tax on gross income in lieu of payment of all national and local taxes and Income Tax Holiday on other registered activities with Supplemental Agreements dated December 22, 2004 and January 9, 2008 under Resolutions No. 04-0436 and 08-030. It is also represented that SECL is a nonresident foreign corporation duly organized and existing under the laws of Korea with business address at 416 Maetan 3-dong, Paldal-ku, Suwon-City Kyungki-Do, Korea 442-742. It has a representative office in the Philippines, the activities of which are limited to the conduct of market survey of electronics products, household appliances and other related products to find out the feasibility of undertaking a joint venture agreement in the Philippines; to act as communication link between its head office and the customers in the country; and to conduct such other activities which are purely coordination work. SECL has not engaged in any business activity in the Philippines. CaTcSA It is finally represented that SEPHIL is one of the ten entities comprising the Samsung Electronics Southeast Asia (SEAHQ). On June 22, 2005, SEAHQ entered into an agreement with SECL for use of the JungUm Global License for a period of three years, from June 22, 2005 to June 21, 2008. Under the Agreement, SEAHQ's entities are granted the non-exclusive right to use the JungUm Global License, in exchange for which SECL bills the SEAHQ entities individually for use of the software. Pursuant thereto, SEPHIL shall pay SECL annual license fees in US dollars equivalent to 177,000 won. Based on the foregoing, you now request confirmation of your opinion that 1) the license fees to be paid by SEPHIL are not subject to value added-tax; 2) the license fees to be paid by SEPHIL under the Agreement effective September 8, 2005 are ordinary business profits and not royalties; 3) the license fees effective September 8, 2005 are income of SECL derived from sources outside the Philippines and, therefore, exempt from Philippine income tax. In reply, please be informed that as a general rule, the sale of services to be rendered in the Philippines is subject to twelve percent (12%) VAT. Section 108 (A) of 1997 Tax Code, as amended by R.A. 9337, provides as follows: "Section 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%) [now 12%] of gross receipts derived from the sale or exchange of services, including the use or lease of properties. "The phrase ' sale or exchange of services' means the performance of all kinds of services in the Philippines for a fee, remuneration or consideration . . . (emphasis added) aSTECI However, Section 109 (q) of the same Tax Code exempts from VAT transactions which are exempt under international agreements or under special laws, to wit: "SEC. 109. Exempt Transactions . The following shall be exempt from the value-added tax: "xxx xxx xxx" "(q) Transactions which are exempt under international agreements to which the Philippines is a signatory or under special laws, except those under Presidential Decree Nos. 66, 529 and 1590; "xxx xxx xxx" Concerning special laws relevant to SEPHIL and other PEZA-registered enterprises, Section 24 of Republic Act No. 7916 (An Act Providing for the Legal Framework and Mechanism for the Creation, Operation, Administration, and Coordination of Special Economic Zones in the Philippines, Creating for this Purpose, the Philippine Economic Zone Authority (PEZA), and for Other Purposes) is worth mentioning, thus: "Section 24. Exemption from Taxes under the National Internal Revenue Code . Any provision of existing laws, rules and regulations to the contrary, notwithstanding, no taxes, local and national, shall be imposed on business establishments operating within the ECOZONE. In lieu of paying taxes, five percent of the gross income earned by all business and enterprises within the ECOZONE shall be remitted to the national government. . ." As a PEZA-registered enterprise enjoying a 5% preferential tax rate, SEPHIL is subject to a different tax regime and excluded from the VAT system. This is because the ecozone within which it is registered is managed and operated as a separate customs territory or a foreign territory created by legal fiction. Considering that SEPHIL is transacting with a non-resident foreign corporation which is likewise not covered by the VAT system, there may be no instance where VAT may be imposed on SEPHIL's transactions. As such, it may not be passed on with nor claim input VAT on the license fees, nor can it be obliged to shoulder the payment of VAT on the fees. Accordingly, the payment of license fees by SEPHIL to SECL is exempt from VAT. This position finds support in VAT Ruling No. 100-99 dated September 16, 1999, as reiterated in BIR Ruling Nos. DA-ITAD 62-05 dated June 27, 2005 and DA-ITAD 112-05 dated September 30, 2005, where the BIR held that the payment of royalties by a PEZA-registered export enterprise to a non-resident owner is exempt from VAT. TcAECH With respect to the income tax implications of the subject payment to SECL, please be informed that there are two Revenue Memorandum Circulars (RMCs) governing the taxation of software payments as explained in BIR Ruling DA-ITAD-042-06. The first Circular, RMC 77-2003 (Classification of Payments for Software for Income Tax Purposes), which covers software payments made from November 18, 2003 to September 7, 2005, generally treats software payments as royalties. On the other hand, the second Circular, RMC 44-2005 (Taxation of Payments for Software), which covers software payments made from September 8, 2005 and thereafter, substantially amends the first Circular by treating software payments either as business income, royalties, rental income, or capital gains, depending on the nature of the transaction out of which such payments are made. Software payments are treated as royalties only if the transaction does not constitute a sale or exchange and not all substantial rights in the software have been transferred, but are merely for the transfer of copyright rights in the software. It was also stated in the ruling that license fees paid for the right to access and use a licensed software but without the right to market or exploit the same would render the payment of such fees as business income. DcSEHT Based on the foregoing, the license fees paid by SEPHIL for its use of the JungUm Licensed Software from the effective date of the Agreement on June 22, 2005 up to September 7, 2005, are treated as royalties under RMC 77-2003, and are therefore subject to the reduced tax rate under Article 12 of the RP-Korea Tax Treaty which provides thus: "Article 12 Royalty 1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State if such resident is the beneficial owner of the royalties. 2. However, such royalties may be taxed in the Contracting State in which they arise, and according to the laws of that State, but if the recipient is the beneficial owner of the royalties the tax so charged shall not exceed 15 per cent of the gross amount of the royalties. 3. Notwithstanding the provisions of paragraph 2 hereof, the amount of tax imposed by 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 Korea, 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, any patent, trademark, 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, and includes payments of any kind in respect of motion picture films and works on films or videotapes for use in connection with television or tapes for the use of radio broadcasting. xxx xxx xxx" On the other hand, the license fees paid by SEPHIL for the its use of the Licensed Software from the effective date of RMC 44-2005 on September 8, 2005 and thereafter, which fees are treated as business profits under this RMC, are subject to income tax only if the same are attributable to a permanent establishment of SECL in the Philippines, in accordance with Article 5, in relation to Article 7 of the Philippines-Korea tax treaty, quoted as follows: DaIAcC "Article 5 PERMANENT ESTABLISHMENT (1) For the purposes of this Convention, the term "permanent establishment" means a fixed place of business through which the business of an enterprise is wholly or partly carried on. (2) The term "permanent establishment" includes especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources; g) premises used as a sales outlet; and h) a warehouse, in relation to a person providing storage facilities for others. xxx xxx xxx (4) Notwithstanding the preceding provisions of this Article, the term "permanent establishment" shall be deemed not to include: xxx xxx xxx d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise; e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character; and f) the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs (a) to (e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character. "xxx xxx xxx" "Article 7 Business Profits 1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment. HaTISE xxx xxx xxx" Considering the foregoing, and inasmuch as SECL's representative office acts exclusively for information collection and dissemination on its behalf and for other activities which are preparatory and auxiliary in character, it is clear that said representative office is not a permanent establishment of SECL in the Philippines. Accordingly, SECL is not deemed to have permanent establishment in the Philippines to which the royalty payment may be attributed. Hence, the license fees paid effective September 8, 2005 are considered income derived from sources outside the Philippines. In this regard, Section 23 (F), in relation to 42 (C) (3) of the Tax Code, provides: "Sec. 23. General Principles of Income Taxation in the Philippines. xxx xxx xxx F) A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines." "Sec. 42. Gross Income from Sources Without the Philippines . xxx xxx xxx (3) Compensation for labor or personal services performed without the Philippines." Since the license fees are considered income derived from sources outside the Philippines, the payments made by SEPHIL to SECL pursuant to the JungUm Agreement effective September 8, 2005 are not subject to Philippine income tax and consequently to withholding tax. 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. cHaICD Very truly yours, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service