DA ITAD BIR Ruling No. 063-06

June 1, 2006 DA ITAD BIR RULING NO. 063-06 Articles 5 & 8 of the Philippines-United States tax treaty; BIR Ruling No. 025-87; BIR Ruling No. ITAD-13-06 SGV & Co . 6/F Ayala Life-FGU Center Mindanao Avenue cor. Biliran Road Cebu Business Park, Cebu City Attention: Ms. Rita A.S. Fernandez Tax Services Gentlemen : This refers to your letter dated September 19, 2005, on behalf of your client, NKC Manufacturing Philippines Corporation (NKC-Phils) requesting confirmation of your opinion that the rental payments made by NKC-Phils to Nakanishi Manufacturing Corporation (NMC) for the lease of the latter's machinery are not subject to Philippine income tax and value-added tax (VAT) pursuant to the Philippines-United States of America tax treaty (Philippine-United States tax treaty). It is represented that NMC is a nonresident foreign corporation duly organized and existing under the laws of the United States of America with principal address at 1225 Voyles Rd., Winterville, Georgia 30683, USA; that it is not registered as either corporation or as a partnership in the Philippines per certification issued by the Securities and Exchange Commission dated July 18, 2005; that NKC-Phils is a corporation duly organized and existing under the laws of the Philippines with principal address at Lot 6-8, Block 2, Mactan Export Processing Zone II, Basak, Lapu-lapu City, Cebu; that it is duly registered with the Philippine Economic Zone Authority (PEZA) under Certificate of Registration No. 97-031 dated April 8, 1997 as an Ecozone Enterprise on a non-pioneer status engaged in the manufacture of parts for roller bearings, conveyor systems, sash rollers, rubber seals, metal core plates and other hearing related products; that it is currently subject to the 5% preferential tax rate under Section 24 of Republic Act (R.A.) 7916 otherwise known as the Special Economic Zone Act of 1995; that NKC-Phils and NMC entered into two (2) Contracts of lease (Agreements) dated April 1, 2005 and May 24, 2005, and involving annual rental fees of US$470,400 and US$311,360, respectively; and that under the Agreements, NMC leases to NKC-Phils Property ( i.e ., machinery described in the Annex of the Agreements, copy of which is attached hereto) under the following conditions with respect to the use and maintenance of the Property: (1) that NKC-Phils shall use the Property in good and safe custody, solely for performing the operation for which it was designated and made, and only in the conduct of its ordinary and usual business, and all the time in compliance with the laws and regulations pertaining to the Property or the operation or maintenance thereof; (2) that until the return of the Property NKC-Phils shall, in any cases, at its own costs and expenses furnish, repair and replace any and all parts and accessories required for aforesaid purpose and shall, whether from time to time and periodically, inspect all the Property and furnish all maintenance works and labor to keep in good repair, condition and working order. If and when the insurance proceeds may have been received by NMC under the Agreement, NKC-Phils shall be exempted insofar as NMC may have received, from aforesaid obligation to pay or bear costs and expenses of repair or replacement; (3) that NKC-Phils shall, as and if required by NMC, make a contract for maintenance of the Property with a competent person or corporation as prior approved by NMC. NKC-Phils shall thereupon submit to NMC a copy of such contract; SEHACI (4) that NMC agrees to be liable for and to pay, satisfy and settle every claim, demand, action and liability arising from loss, damage to injury to any person or property of any character whatsoever arising out of or occasioned by or through selection, possession, leasing, renting, operation, handling, control, use, maintenance, transportation, delivery and/or return of the property and hold NMC free and harmless of any and all claims and demands which may arise from or be occasioned by any causes whatsoever of like nature. In reply, please be informed that considering that the parties in this case ( i.e . NMC and NKC-Phils) are resident corporations of the Philippines and the United States, respectively, the provisions of the Philippines-United States tax treaty should be applied. In connection thereto, paragraphs 1 and 6 of Article 8 of the said treaty provide as follows: "Article 8 BUSINESS PROFITS (1) Business profits of a resident of one of the Contracting States shall be taxable only in that State unless the resident has a permanent establishment in the other Contracting State. If the resident has a permanent establishment in that other Contracting State, tax may be imposed by that other Contracting State on the business profits of the resident but only on so much of them as are attributable to the permanent establishment. xxx xxx xxx (6) The term 'business profits' means income derived from any trade or business whether carried on by an individual, corporation or any other person, or group of persons, including the rental of tangible personal (movable) property. In relation thereto, Article 5(1) and (2) of the said treaty provides, viz : "Article 5 PERMANENT ESTABLISHMENT (1) For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which a resident of one of the Contracting States engages in a trade or business. (2) The term 'fixed place of business' includes but is not limited to: (a) A seat of management; (b) A branch; (c) An office; (d) A store or other sales outlet; (e) A factory; (f) A workshop; (g) A warehouse; (h) A mine, quarry, or other place of extraction of natural resources; (i) A building site or construction or assembly project or supervisory activities in connection therewith, provided such site, project or activity continues for a period of more than 183 days; and (j) The furnishing of services, including consultancy services, by a resident of one of the Contracting States through employees or other personnel, provided activities of that nature continue (for the same or a connected project) within the other Contracting State for a period or periods aggregating more than 183 days." Considering that in the present case, NMC, the foreign lessor, does not have a permanent establishment in the Philippines as contemplated in the provisions of the Philippines-United States tax treaty, the said rental fees paid by NKC-Phils to NMC pursuant to their Agreement are considered as "business profits" taxable only in the United States, where NMC is a resident and has its fixed place of business, and as such are, not subject to the 7 1/2% final withholding tax imposed under Section 25(b)(4) of the National Internal Revenue Code (Tax Code) of 1997 as amended. (BIR Ruling No. 025-87 dated January 28, 1987) As regards the imposition of the VAT on the above rental fees, please be informed further that Section 108 of the Tax Code of 1997 1 provides as follows, to wit: "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%) 2 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: TAcSaC xxx xxx xxx (2) 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, in general, be imposed on the said rental fees to be paid by NKC-Phils to NMC. Accordingly, NKC-Phils 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. 3 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 all 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. AIHECa 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) Such being the case, the payment of the rental fees by NKC-Phils, being a PEZA-registered enterprise, to NMC, under the above Agreement, should be as it is hereby confirmed to be exempt from VAT. However, upon the importation of the subject machineries to be leased by NKC-Phils from NMC, such importation is subject to VAT. Section 107 of the Tax Code of 1997 4 which provides as follows, viz : Sec. 107. Value-added Tax on Importation of Goods . (A) In General. There shall be levied, assessed and collected on every importation of goods a value-added tax equivalent to ten percent (10%) 5 based on the total value used by the Bureau of Customs in determining tariff and customs duties, plus customs duties, excise taxes, if any, and other charges, such tax to be paid by the importer prior to the release of such goods from custody : Provided, That where the customs duties are determined on the basis the quantity or volume of the goods, the value-added tax shall be based on the landed cost plus excise taxes, if any. (emphasis supplied) xxx xxx xxx For purposes of the VAT law, the term "importer" refers to any person who brings goods into the Philippines, whether or not in the course of his trade or business [Section 4.107-1(b), Revenue Regulations No. 16-05]. In this case, NMC is deemed the importer of the machineries since it undertook to deliver the same to NKC-Phils. Thus, in accordance with the aforequoted, NMC is liable to pay the VAT on the importation. To recapitulate, this Office is of the opinion as it hereby holds that: (1) The rental fees to be paid by NKC to NMC are considered "business profits" taxable only in the United States, and as such are not subject to the 7 1/2 % final withholding tax imposed under Section 25(b)(4) of the tax Code of 1997, as amended. (2) Such rental fees are exempt from VAT. (3) The importation of the subject machineries .are subject to VAT. This ruling is issued on the basis of the facts as represented. However, if upon investigation it shall be disclosed that the facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. cEDaTS Very truly yours, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. 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. 2. Effective February 1, 2006, the rate shall be 12%. 3. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109(K)], as amended by RA No. 9337] . 4. 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. 5. 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.