DA ITAD BIR Ruling No. 061-06

June 1, 2006 DA ITAD BIR RULING NO. 061-06 Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337; BIR Ruling No. ITAD 13-06 Sycip Gorres Velayo & Co . 6760 Ayala Avenue Attention: R.C. Vinzon Tax Services Gentlemen : This refers to your letter dated November 23, 2005, requesting to amend DA-ITAD Ruling No. ITAD-131-05 dated November 14, 2005 so that your royalty payments to Samsung Electronics Co., Ltd. (SECL) be declared exempt from value-added tax, in view of the additional representation that Samsung Electronics Philippines Manufacturing Corporation (SEPHIL) is duly registered with Philippine Economic Zone Authority (PEZA); that it is still enjoying an extension of income tax holiday; and that it is not yet under the 5% preferential tax on gross income regime. It is 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; that SECL 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; that SECL has not engaged in any business activity in the Philippines; that SEPHIL is a domestic corporation duly organized and existing under Philippine laws and is duly registered with the Philippine Economic Zone Authority (PEZA) under Certificate of Registration No. 01-11 dated July 31, 2002, with principal office address at Block 6, Calamba Premiere International Park, Batino, Calamba, Laguna; that SEPHIL is engaged in the design manufacture and sale of electronic products including, but not limited to, optical disk drive products, their components and parts; that on January 1, 2000, SEPHIL entered into an Optical Disc Drive License Agreement (Agreement) with SECL; that under the Agreement, SECL grants to SEPHIL, during the term of the Agreement, the non-exclusive rights to use the Technical Information 1 furnished by SECL to manufacture products in the Philippines and to use, sell or otherwise dispose of the products in all countries of the world; that SEPHIL shall pay SECL royalties on Licensed Products 2 which are manufactured, used, sold, leased and disposed by SEPHIL; that the royalty on technical information and knowledge shall be paid at the rate of four percent (4%) of Net Selling Price which shall be remitted to SECL within 60 days after each calendar quarter ending with the last day of March, June, September and December; and that the Agreement shall be fully effective for one (1) year from January 1, 2002, and annually prolonged with the option that SECL and SEPHIL can renew the Agreement for another year. It is further represented further and clarified that SEPHIL was still enjoying an income tax holiday and was not yet under the 5% preferential tax on gross income regime when the request for ruling was filed; that SEPHIL's commercial operations started last November 5, 2001 and its income tax holiday is effective for four years from the start of its commercial operation; that it was granted by PEZA a one-year extension of its income tax holiday from November 1, 2005 to October 31, 2006 per Notice of ITH Extension Approval No. 06-003 issued by PEZA dated January 9, 2006; and that it is your contention that SEPHIL is still exempt from withholding and remitting the 10% VAT on its payment and remittances of royalties paid to SECL at the time it enjoys its income tax holiday. aHSTID In reply, please be informed that, in general, under Section 108(A)[(1) and (5)] of the Tax Code, "the use of certain 'know-how' formulations and technical informations" and "the supply of services by a nonresident person or his employee in connection with the use of property or rights belonging to the nonresident person" both fall within the definition of sale or exchange of services subject to ten percent (10%) value-added tax (VAT). Section 108 of the Tax Code of 1997 3 provides: "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%) 4 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 ' shall likewise include: xxx xxx xxx (1) The lease or the use of, or the right to use any industrial, commercial or scientific equipment; xxx xxx xxx" Based on the foregoing, the VAT should be generally imposed on the said royalties to be paid by SEPHIL to SECL. SEPHIL is 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. 5 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. HcDaAI 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 specials laws, e.g., Republic Act No. 7916 or PEZA Law, is particularly applicable to the instant case. ( BIR Ruling No. ITAD 13-06 dated February 20, 2006 ) In view of all the above and the additional representation that SEPHIL is a PEZA-registered enterprise under an income tax holiday, and which is not yet under the 5% preferential tax on gross income regime, this Office is of the opinion and so holds that the subject royalty payments by SEPHIL to SECL are not subject to VAT. This ruling is deemed incorporated in DA-ITAD Ruling No. 131-05 to the extent that the herein VAT exemption applies to the royalty payments of SEPHIL. This ruling 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.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. "Technical Information" means all the technical knowledge, know-how, data and information which are available in the authorized file of Licensor and are used by Licensor for manufacturing products. (Section 1.04, Optical Disk Drive License Agreement) 2. "Licensed Product" means optical disc drive such as CD-ROM, CD-RW which shall be manufactured and sold by Licensee in accordance with Licensor's technical information and assistance. (Section 1.03, ibid ) 3. 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. 4. Effective February 1, 2006, the rate shall be 12%. 5. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109(K)], as amended by RA No. 9337].