DA ITAD BIR Ruling No. 102-06

August 28, 2006 DA ITAD BIR RULING NO. 102-06 Article 11 & 12, Philippines-Japan tax treaty; BIR Ruling No. DA-ITAD-40-05; BIR Ruling No. DA-ITAD-92-05 Nihon Garter Philippines, Inc . Lot 12 Block 8, Cavite Economic Zone Rosario, 4106 Cavite, Philippines Attention: Mr. Tsunehiro Takami VP/General Manager Gentlemen : This refers to your letter dated April 19, 2005, requesting confirmation that the "Goodwill charges", which constitute royalties, and the interest payments made by your company to your parent company, Nihon Garter Co., Ltd. (Nikon-Japan), are subject to ten percent (10%) and fifteen percent (15%) income tax, respectively, pursuant to the Philippines-Japan tax treaty. It is represented that Nihon-Japan is a nonresident foreign corporation duly organized and existing under the laws of Japan with office address at 5-13, Imai 3-Chome, Ome-shi, Tokyo, Japan and is a resident of Japan within the meaning of the Tax Convention between Japan and the Philippines, as certified by the District Director of the Ome Tax Office on April 27, 2005; that it is not registered either as a corporation or as a partnership in the Philippines per certification issued by the Securities and Exchange Commission dated April 29, 2005; that Nihon Garter Philippines, Inc. (Nihon-Phil) is a corporation duly organized and existing under the laws of the Philippines with office address at Lot 12, Blk 8, Main Ave., Rosario, Cavite; that it was registered with the then Export Processing Zone Authority (EPZA), now Philippine Economic Zone Authority (PEZA) as a Zone Export Enterprise under Registration Certificate No. 89-024 dated June 30, 1989. It is further represented that on March 17, 2003, Nihon-Japan and Nihon-Phil entered into a Memorandum of Loan Agreement wherein Nihon-Japan and Nihon-Phil agreed that the balance of the trade credit of Nihon-Phil amounting to Seventy-Five Million Yen (Y75,000,000) be converted to Ten (10) Year Term Loan; that the said loan has interest rate of 3 percent (3%) per annum, payable in forty (40) equal quarterly amortizations and shall be paid per schedule of payment attached to the Agreement, with the first quarterly amortization commencing on May 31, 2003 and on or before the first day of the succeeding quarter for the year thereafter, until the loan shall have been fully paid. TDEASC In addition, it is represented that on March 2005, Nihon-Japan and Nihon-Phil entered into a Memorandum of Agreement wherein, upon written request of Nihon-Phil, Nihon-Japan shall provide Nihon-Phil the following marketing support services: (a) Souring of Slit PS Sheets, cover tapes and reels and manufacturing equipment; (b) Promotion of Nihon-Phil and its products (including embossed plastic carrier tapes) in world-wide trade chambers; (c) Providing business development and leads pertaining to potential customers in Asia, negotiation with buyers and suppliers; (d) Procuring materials, equipment and allied services needed by Nihon-Phil; and (e) Development and printing information materials, brochures, and other promotional materials; that Nihon-Japan shall provide the foregoing services outside the Philippines; that Nihon-Japan shall bill Nihon-Phil annually depending on the extent of the work to be performed at a rate mutually agreed upon prior to Nihon-Japan's performance of any marketing support services, provided that the amount shall not exceed to Y3,000,000.00 in each month; that the said Memorandum of Agreement shall take effect on April 1, 2005 and shall continue unless terminated by prior written sixty-day notice by one party to the other. In reply, please be informed that interest income and royalty payments received by Nihon-Japan are subject to Philippine income tax as follows: 1. One the Memorandum of Loan Agreement Article 11 of the Philippines-Japan tax treaty provides, viz : "Article 11 1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State. IDaCcS 2. However, such interest may also be taxed in the Contracting State in which it arises, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the interest the tax so charged shall not exceed: a) 10 percent of the gross amount of the interest if the interest is paid in respect of Government securities, or bonds or debentures; b) 15 per cent of the gross amount of the interest in all other cases. xxx xxx xxx 5. The term 'interest' as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and in particular, income from Government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. xxx xxx xxx" Based on the above, the preferential tax rate to be withheld by Nihon-Phil on its interest payments to Nihon-Japan under their Memorandum of Loan Agreement shall be fifteen percent (15%) of the gross amount of the interest since it is not paid in respect of Government securities or bonds and debentures. Moreover, file Memorandum Loan Agreement between Nihon-Japan and Nihon-Phil dated March 17, 2003 is subject to (a) documentary stamp tax imposed under Section 180 of the National Internal Revenue Code (NIRC) of 1997 at a rate of Thirty Centavos (P0.30) on each of Two Hundred Pesos (P200), or fractional part thereof, of the face value of such contract. 2. On the Memorandum of Agreement for services Article 12 of the Philippines-Japan tax treaty provides, viz : "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. AaITCH a) 15 percent 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 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 Investment 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. 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 cinematography 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" Based on the aforequoted provisions, royalties paid by a resident of the Philippines to a resident of Japan may be taxed at a rate not exceeding 10% of the gross amount of the royalties if the payor is a Board of Investments (BOI)-registered enterprise engaged in preferred pioneer areas of investment, 15% if it is paid in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, and 25% in all other cases. Such being the case, this Office is of the opinion and so holds that since Nihon-Phil is not a BOI-registered enterprise engaged in preferred pioneer areas of investment, and that 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, said royalty payments made by Nihon-Phil to Nihon-Japan under the above Agreement shall be subject to Philippine income tax at a rate of 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-40-05 dated May 9, 2005) As regards the imposition of the VAT on the rendition of services of Nihon-Japan, please be informed further that Section 108 of the NIRC 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%) of gross receipts derived from the sale or exchange of services, including the use of lease of properties. AHSEaD The phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration. . . . (Emphasis supplied). Thus, in general, the VAT should be imposed when Nihon-Japan provides the above services in the Philippines "for short durations and in no case shall exceed on aggregate of 3 months in any given calendar year" . Nihon-Phil shall then be 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. 2 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), not 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, nee 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 exeptis . An exception confirms the rule in cases not excepted; that is, a thing not being excepted must be regarded 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 the imposed indirectly. Quando aliquid prohibetur ex directo prohibetur et per obliquum . When anything is prohibited directly, it is also prohibited indirectly. THEcAS 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 NIRC of 1997 which provides VAT exemption for transactions that are exempt under specials laws, e.g., RA 7916 or EPZA Law], is particularly applicable, to the instant case. Such being the case, the payment by Nihon-Phil, a PEZA-registered enterprise, to Nihon-Japan, under the above 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 not 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. Referring to the old Section 109 (q) of the Tax Code of the 1997 [now Section 109(K), as amended by RA No. 9337].