BIR Ruling [DA-581-06]

September 26, 2006 BIR RULING [DA-581-06] VAT Ruling 025-02, BIR Ruling No. DA-168-98 Article 12, RP-Japan Tax Treaty Aranas Consunji Barleta Law Offices Unit 106 G/F Le Metropole Building 326 Tordesillas cor. De la Costa Streets Salcedo Village, Makati City Attention: Atty. Jesus Clint O. Aranas Gentlemen : This refers to your letter dated September 6, 2006 requesting on behalf of your client, Seiko Epson Corporation Japan (hereinafter "SEC"), confirmation of your opinion that: 1. The royalties paid by Epson Precisions Philippines, Inc., Philippines Epson Optical Inc., Sanyo Epson Imaging Devices (Phils) Inc. and Epson Software Engineering (Phils) Inc. (hereinafter "The Epson Group") under various licensing agreements entered into in their behalf by SEC with Microsoft Operations Pte. Ltd., Symantec Japan Inc., and SSA Global Japan KK (hereinafter "The Licensors") are exempted from the value added tax; and 2. The royalties paid by The Epson Group are subject to a final withholding tax on royalties equivalent to 25% of the gross amount of such royalty payments pursuant to the provisions of the RP-Japan Tax Treaty. It is represented that Epson Precision (Philippines), Inc. is a corporation duly organized and existing under the laws of the Philippines with business address at Special Economic Zone, Lima Technology Center, Lipa City, Batangas and registered as an Ecozone Export Enterprise under Philippine Economic Zone Authority (PEZA) Certificate of Registration No. 95-18; that Sanyo Epson Imaging Devices (Phils.) Inc., is a corporation organized and existing under the laws of the Philippines with business address at Integrated Microelectronics Inc., 2nd Floor Bldg. I, North Science Avenue, Special Economic Processing Zone, Laguna Technopark, Bian, Laguna and registered as an Ecozone Export Enterprise under PEZA Certificate of Registration No. 05-07; that Philippines Epson Optical Inc. is a corporation organized and existing under the laws of the Philippines with business address at Special Export Processing Zone, Gateway Business Park, Javalera, General Trias, Cavite, and registered as an Ecozone Export Enterprise under PEZA Certificate of Registration No. 05-011; that EPSON Software Engineering (Phils.) Inc. is a corporation organized and existing under the laws of the Philippines with business address at Module 7A, E-Office Asiatown I.T. Park, Apas, Cebu City and registered as an Ecozone I.T. Enterprise under PEZA Certificate of Registration No. 06-09-IT; that the foregoing companies (hereinafter "The Epson Group") are all PEZA registered companies enjoying the Income Tax Holiday Scheme (ITH); that all the foregoing entities are 100% export oriented manufacturing firms; that Seiko Epson Corporation Japan (SEC) entered into licensing agreements with Microsoft Operations Pte. Ltd., Symantec Japan Inc., and SSA Global Japan KK (hereinafter "The Licensors"); that under the said agreements, The Epson Group, as affiliates of SEC, are granted the license to use and implement the software owned respectively by The Licensors; that The Epson Group was made a party to the Licensing Agreements entered into by and between SEC and The Licensors; and that in consideration for the use and implementation of the software, The Epson Group shall pay fees to The Licensors in ratable portion, and such payments are coursed and remitted through SEC. In reply thereto, please be informed that the Philippine VAT System adopts the destination principle wherein imports are taxed while exports are given total immunity. This system of taxation, when applied to goods crossing borders, is designed to make our local products competitive in the foreign market. In line with this principle, the royalties paid by EPPI, for the right to use and implement a software program developed by SEC are exempted from the value added tax, whether at the time it enjoys income tax holiday or at the time that it is subject to the 5% commutation tax. The foregoing position is in consonance with VAT Ruling 025-02, dated April 25, 2002, where the BIR ruled that: "In reply thereto, please be informed that the Philippine VAT System adopts the destination principle wherein imports are taxed while exports are given total immunity. This system of taxation, when applied to goods crossing borders, is designed to make our local products competitive in the foreign market. In line with this principle which is the backbone of the Philippine VAT System, the royalty payments by TIEPI to Toshiba are exempt from VAT whether at the time it enjoys income tax holiday or at the time that it is subject to the 5% commutation tax . Otherwise, TIEPI will be required to shoulder the VAT on inputs, which will be added-up to the export cost of its products. As a matter of fact, the local sale of VAT suppliers to PEZA registered enterprises were declared zero-rated to afford full immunity to the export producer. (RMC 74-99) It is on this principle that the royalty payments by TIEPI to Toshiba shall be exempt from VAT so that the PEZA locator would be truly relieved from the burden of indirect tax consonant with the "Cross Border Doctrine" thereby ensuring that the export price of the commodities has no VAT component. (VAT Ruling No. 63-2001)." (emphasis supplied). The VAT exemption notwithstanding, the royalties paid by EPPI remain subject to the 25% income tax on royalties pursuant to Article 12 subparagraph (2) of the RP-Japan Tax Treaty, to wit: Article 12 "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 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." Since EPPI is not a BOI registered company engaged in pioneer areas of investment and the royalties involved in this case 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, then the said royalties are subject to income/withholding tax equivalent to 25% of the gross amount of such royalty payments pursuant to the provisions of the RP-Japan Tax Treaty. The foregoing position is supported by BIR Ruling No. DA-168-98, where the BIR ruled that: "Such being the case, since the activities conducted by NEC-Phils. does not fall squarely to the circumstances set forth under paragraph (2)(a) of Article 12 of the RP-JapanTaxTreaty nor under paragraph 3 thereof, this Office believes therefore, that NEC-Phils. royalty payments to its parent company, NEC-Japan, shall be subject to the 25% income tax on royalties set forth under paragraph (2)(b) of Article 12 of the Tax Treaty which is imposed on all other cases of royalty payments other than those mentioned above, i.e., 10% tax rate on royalty payments." HDCAaS 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 from that represented, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service