DA ITAD BIR Ruling No. 082-06

July 28, 2006 DA ITAD BIR RULING NO. 082-06 Art. 12, Philippines-Japan tax treaty; BIR Ruling No. DA-ITAD 20-04 Fernandez Aguja Law Firm CPA-LAWYERS Suite 5F JL Bldg., Don Jose Avila cor. Don Gil Garcia Streets, Cebu City Attention: Atty. Luna Mae F. Aguja Partner Gentlemen : This refers to your letter dated June 26, 2006 requesting for confirmation that the payments of Philippines Epson Optical, Inc. (EPSON-Phil.) to Pentax Corporation (PENTAX-Japan) under the Lease Agreement (Agreement) are subject to the preferential tax rate of 25% pursuant to Article 12 of the Philippines-Japan tax treaty and that the said payments are not subject to the value-added tax (VAT) under Section 109(K) of the National Internal Revenue Code of 1997, as amended, (Tax Code of 1997). It is represented that PENTAX-Japan is a nonresident foreign corporation organized and existing under the laws of Japan as evidenced by The Certificate of All of the Present Matters of Pentax Corporation and with principal office address at 2-36-9, Maeno-cho, Itabashi-ku, Tokyo 174-8639, Japan; that it is engaged in the business of manufacture and sale of cameras, optical machines and instruments and precision machines and instruments; measurement machines and instruments, equipment and material for medical use, products made of fine ceramics, lenses, rims and other products relating to glasses, computer-controlled automatic design and manufacturing systems, software, data processing machines and instruments and communication machines and instruments; that it is not registered either as a corporation or as a partnership in the Philippines as evidenced by the Certificate of Non-Registration dated June 6, 2006 issued by the Securities and Exchange Commission; on the other hand, EPSON-Phil. is a domestic corporation with principal office address located at Special Export Processing Zone, Gateway Business Park, Javalera General Trias, Cavite; that it is a PEZA-registered enterprise with Certificate of Registration No. 05-11; that its business activity as an Ecozone Export Enterprise consists in the manufacture of optical lenses and other optical related goods. AISHcD It is further represented that on April 1, 2005. PENTAX-Japan and EPSON-Phil. executed an Agreement whereby the former shall lease to the latter certain intangible assets (production/software equipment) for a fee of US$9,500 per month for a period of one (1) year (and may be extended by either party based on the notice to extend the Agreement in writing); and that on January 31, 2006, the parties amended the said Agreement extending its enforceability until March 31, 2006. In reply, please be informed that Article 12 of the Philippines-Japan tax treaty provides: "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 their 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. xxx xxx xxx 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 areas of 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. 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. EcDSHT xxx xxx xxx." Based on the foregoing, the royalty payments will be taxed at the preferential tax rate of 10 per cent (10%) if the payor is a Board of Investments (BOI)-registered enterprise and engaged in preferred pioneer area of investment, 15 per cent (15%) if the payments are in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, and in all other cases, 25 per cent (25%) of the gross amount of the royalties. The rental payments made by EPSON-Phil. to PENTAX-Japan for the lease of the assets (production/software equipment) are considered payments for the "use of or the right to use industrial, commercial or scientific experience" as defined under paragraph 4 of Article 12 of the Philippines-Japan tax treaty. Such being the case, this Office is of the opinion and so holds that since EPSON-Phil. is not a BOI-registered enterprise engaged in preferred pioneer areas of investment, and, the subject royalty payments 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, the said royalty payments by EPSON-Phil. to PENTAX-Japan under the said Agreement shall be subject to tax at the rate not exceeding 25% of the gross amount of the royalties pursuant to Article 12(2)(b) of the Philippines-Japan tax treaty. (BIR Ruling No. DA-ITAD 20-04 dated March 8, 2004) As regards the imposition of the VAT on the lease of properties (assets) of PENTAX-Japan, please be informed further that Section 108 of the Tax Code of 1997 1 provides as follows: "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 . (Emphasis supplied) xxx xxx xxx" Thus, in general, the VAT is imposed on lease of properties (assets) by PENTAX-Japan in the Philippines. On every payment of rental fees, EPSON-Phil. 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 : ITECSH "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 transaction 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. 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. DSETcC 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 and 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. Such being the case, the payment of rental fees by EPSON-Phil., being a PEZA-registered enterprise, to PENTAX under the Agreement should be, as it is hereby confirmed to be, exempt from 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. Very truly yours, Commissioner of Internal Revenue By: (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] .