DA ITAD BIR Ruling No. 074-10

July 9, 2010 DA ITAD BIR RULING NO. 074-10 Article 12 Philippines-Japan tax treaty; BIR Ruling No. ITAD 11-10 Baniqued & Baniqued Attorneys at Law 8th Floor, Jollibee Centre San Miguel Avenue, Pasig City Attention: Atty. Laura Victoria A.S. Yuson-Layug Atty. Bernadette V. Quiroz Gentlemen : This refers to your letter dated August 19, 2009 requesting confirmation that royalties to be paid by Daikoku Electronics (Philippines), Inc. ("Daikoku Electronics") to Daikoku Electric Wire Company Ltd. ("Daikoku Electric") are subject to income tax in the Philippines at a rate not to exceed 10 percent based on the gross amount thereof pursuant to the Convention between the Republic of the Philippines and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Japan tax treaty") . 1 CAIaDT Basic Facts It is represented that Daikoku Electric is a foreign corporation organized and existing under the laws of Japan and is a resident of Japan based on the Certificate of Residence dated July 10, 2009 issued by the Otawara Tax Office in Japan; that the primary purpose of Daikoku Electric is to manufacture and sell electric wires and other related items, as well as electric machines and equipment, communication machines and equipment, electronic machines and equipment, general machines and equipment, and related parts thereof; that Daikoku Electric is situated at 767-90 Takawarabi, Aza, Hachisu, Ohtawara-shi, Tochigi Ken, Japan; that Daikoku Electric is not registered as a corporation or as a partnership in the Philippines based on a Certification of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission (SEC) dated July 1, 2009; that, on the other hand, Daikoku Electronics is a domestic corporation registered with the SEC under Registration No. A199816496 based on its Certificate of Incorporation issued by the SEC dated November 11, 1998; that Daikoku Electronics is also registered with the Philippine Economic Zone Authority ("PEZA") as an ecozone export enterprise at the Light Industry and Science Park of the Philippines I Special Economic Zone, based on its Certificate of Registration No. 98-071 dated December 22, 1998; and that Daikoku Electronics is situated at the Light Industry and Science Park 1, Barrio Diezmo, Cabuyao, Laguna, Philippines. It is also represented that on January 5, 2009, Daikoku Electronics and Daikoku Electric entered into a Technical Assistance Agreement where Daikoku Electric granted Daikoku Electronics a non-exclusive and non-assignable license to use its Know-how in the manufacture of coils for electric and electronic parts (the "Products" ) in the Philippines and in the use and sale of these coils worldwide; that Know-how refers to the knowledge, experience and information owned or controlled by Daikoku Electric relating to the manufacture of the Products and the latest manufacturing technology on the Products; that Daikoku Electric shall, within sixty days from the date of the effectivity of the Agreement, or January 1, 2009, furnish Daikoku Electronics all available materials relating to the Know-how and shall, during the effectivity of the Agreement and at the request of Daikoku Electronics , furnish the latter additional data, information and improvements relating to the Know-how; that Daikoku Electronics shall not use, attach or display any trademark or trade name owned by Daikoku Electric , particularly, the word "Daikoku", on the Products or their containers without the prior written consent of Daikoku Electric ; and that Daikoku Electric shall grant Daikoku Electronics continued access to improvements in techniques and processes related to the technology which shall be available during the period of the technology transfer arrangement. It is further represented that as consideration, Daikoku Electronics shall pay royalty to Daikoku Electric at rates to be computed based on the Net Selling Price of the Products manufactured and sold by Daikoku Electronics during the effectivity of the Agreement, with reference to the dates of commencement of production of the Products at the plant of Daikoku Electronics; that Net Selling Price means the gross selling price of the Products manufactured by Daikoku Electronics less packing charges, transportation charges, insurance fees, bobbin costs for stepping motor coils and other similar charges paid by Daikoku Electronics in dispatching the Products, and charges to customers; that the rates of the royalty are (a) 5 percent for the Products manufactured within a period of four years from the date of commencement of production, (b) 2 1/2 percent for the Products manufactured within a period of five to seven years from the date of commencement of production, and (c) zero percent or none for the Products manufactured within a period of more than seven years from the date of commencement of production; and that the royalty includes compensation for services rendered by Daikoku Electric in carrying out sales activities and technical negotiations with customers of Daikoku Electronics and the associated companies of these customers. It is further represented that the Agreement shall remain effective for one year and shall be renewed automatically for another one year unless terminated earlier by either party; and that based on Certificate of Compliance No. 5-2009-00052 issued by the Intellectual Property Office of the Philippines dated July 30, 2009, which is valid for one year from January 1 to December 31, 2009, the Agreement complies with the provisions of Sections 87 and 88 of Chapter IX, Part II of the Intellectual Property Code (Republic Act No. 8293) on Voluntary Licensing. It is finally represented based on a notarized certification by the Vice President of Daikoku Electronics , Mr. Hirofumi Yoshida, dated July 24, 2009, that the royalties subject of the application for tax treaty relief are not subject of an investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal. CaTSEA Ruling A. On income tax In reply, please be informed that a foreign corporation like Daikoku Electric, whether or not engaged in trade or business in the Philippines, is subject to income tax in the Philippines only with respect to income derived in the Philippines. Section 23 (F) of the National Internal Revenue Code of 1997 ("Tax Code of 1997") , as amended, provides: "SEC. 23. General Principles of Income Taxation in the Philippines. Except when otherwise provided in this Code: 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." However, any income derived by a foreign corporation may be exempt (or partially exempt if subject to a reduced rate only) if the same is so exempt (or partially exempt) to the extent required by any treaty obligation binding upon the Philippine Government. Section 32 (B) (5) of the Tax Code of 1997, as amended, provides: "SEC. 32. Gross Income. xxx xxx xxx (B) Exclusions from Gross Income. The following items shall not be included in gross income and shall be exempt from taxation under this Title: (5) Income Exempt under Treaty. Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines." With respect to a treaty, what is being invoked for this purpose is the Philippines-Japan tax treaty. Paragraphs 1, 2 and 3, Article 12 thereof provide as follows: "Article 12 1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State. 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 so 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. 3. Notwithstanding the provisions of paragraph 2, the amount of tax imposed by the Philippines on the royalties paid by a company, being a resident of 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 Japan, who is the beneficial owner of the royalties, shall not exceed 10 per cent of the gross amount of the royalties. EcICDT 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 including cinematograph films and films or tapes for radio or television broadcasting, any patent, trade mark, 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. xxx xxx xxx" The Protocol Amending the Convention between the Republic of the Philippines and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Amending Protocol") , signed on December 9, 2006, and effective January 1, 2009, amended Article 12 of the existing Philippines-Japan tax treaty as follows: "Article V Paragraph 2 of Article 12 of the Convention shall be deleted and replaced by the following: '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 so 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) 10 per cent of the gross amount of the royalties in all other cases.'" Under paragraphs 2 and 3, Article 10 of the Philippines-Japan tax treaty, as amended, royalties arising in the Philippines and paid to a resident of Japan may be taxed in the Philippines, but the rate of income tax that may be imposed thereon shall not exceed (a) 15 percent of the gross amount of the royalties if the royalties are paid in respect of the use or the right to use of cinematograph films and films or tapes for radio or television broadcasting; (b) 10 percent of the gross amount of the royalties if the royalties are paid by a company, being a resident of the Philippines, registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines; and (c) 25 percent (in the case of royalties paid or received before January 1, 2009) or 10 percent (in the case of royalties paid or received on January 1, 2009, and thereafter) in all other cases. Accordingly, with respect to royalties to be paid by Daikoku Electronics to Daikoku Electric beginning January 1, 2009, and thereafter, pursuant to the Technical Assistance Agreement dated January 5, 2009, such royalties shall be subject to income tax in the Philippines at the rate of 10 percent based on the gross amount, pursuant to paragraph 2, Article 10 of the Philippines-Japan tax treaty, as amended. (BIR Ruling No. ITAD 11-10 dated June 16, 2010) EITcaH B. On value-added tax In addition to income tax, the lease of the Know-how by Daikoku Electric to Daikoku Electronics pursuant to the Technical Assistance Agreement is subject to value-added tax (VAT). Section 108 (A) of the Tax Code of 1997, as amended, 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%) of gross receipts derived from the sale or exchange of services, including the use or lease of properties: Provided, that the President, upon the recommendation of the Secretary of Finance, shall, effective January 1, 2006, raise the rate of value-added tax to twelve percent (12%) . . ." However, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866 dated February 11, 2005), the Supreme Court ruled that: "Applying the special laws we have earlier discussed, respondent as an 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. Moreover, the exemption is both express and pervasive for the following reasons: First, 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. ADETca 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." Accordingly, since Daikoku Electronics is an enterprise registered with PEZA operating within an economic zone and as such is an exempt entity, it 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. Thus, the lease of the Know-how by Daikoku Electric to Daikoku Electronics is exempt from VAT. (Ibid.) This ruling is issued on the basis of the facts as represented. However, if upon investigation it shall be disclosed that the actual facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. Very truly yours, (SGD.) GREGORIO V. CABANTAC Deputy Commissioner Legal and Inspection Group Footnotes 1. Signed on February 13, 1980, and effective January 1, 1981.