DA ITAD BIR Ruling No. 115-06

September 27, 2006 DA ITAD BIR RULING NO. 115-06 Article 12, Philippines-Japan tax treaty Section 109 (K) National Internal Revenue Code of 1997, as amended; BIR Ruling No. DA-ITAD-82-06 Fernandez Aguja Law Firm CPA-Lawyers Suite 5F JL Building Don Jose Avila cor. Don Gil Garcia Streets Cebu City, Philippines 6000 Attention: Atty. Rita A.S. Fernandez Partner Gentlemen : This refers to your letter dated September 4, 2006 on behalf of your client, Yamashin Cebu Filter Manufacturing Corporation (Yamashin Philippines), requesting confirmation that its payments to Yamashin-Filter Corporation, formerly Yamashin Filter Manufacturing Corporation of Japan, are royalties subject to the 25% preferential tax rate, pursuant to Article 12 of the Philippines-Japan tax treaty, and that the said royalty payments are not subject to 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 Yamashin-Filter Corporation (Yamashin Japan) is a nonresident foreign corporation duly organized and existing under the laws of Japan, with office address at 1-11-5 Nishi-kanagawa, Kanagawa-ku, Yokohama, Japan; that is not registered either as a corporation or as a partnership in the Philippines per certification issued by the Securities and Exchange Commission dated August 22, 2006; that Yamashin Philippines is a domestic corporation with office address at Mactan Economic Zone II, Lapulapu City, Philippines; that it is registered with the Export Processing Zone Authority under Certificate of Registration No. 89-014 dated April 14, 1989 and is enjoying the tax regime of 5% in lieu of all taxes. It is further represented that on October 15, 2001, Yamashin Philippines and Yamashin Japan entered into a Technical Support and Service Agreement which provides that since Yamashin Japan has developed and holds certain technology and expertise involving the designing, development, manufacture and production of advanced and state of the filters for industrial and other uses, and through its years of experience and reputations, has built-up goodwill and markets for its products which it intends and plans to transfer to exclusive right in the Philippines for the latter's technical advice, design cooperation, information, experience, quality control, and business support for Yamashin Japan's own products which it produces in the Philippines for export to Japan and other parts of the world; that by virtue thereof, Yamashin Japan agrees to provide to Yamashin Philippines the following: 1. Full assistance and furnishing of its recent technical advise, design cooperation, and business support for the production and development of filters; 2. Provide and accept access to its Japanese and worldwide intelligence system to carry out and effect its production of up to date and state of the art filters and applications acceptable to the market; 3. Allow and accept the availment of the following: a. Training the production, quality control and administrative employees. b. Seminars and conferences for training of Yamashin Philippines' employees AaHcIT c. Materials for training d. Engineers and professional who are experts in all disciplines necessary in the implementation of advice to Yamashin Philippines as regards filter manufacture, development and application, design development, and business support. That, moreover, in consideration for the services under the Agreement, Yamashin Philippines shall pay to Yamashin Japan a fee equivalent to Four Million Philippine Pesos (P4,000,000.00) each fiscal year effective October 1, 2001 up to September 30, 2006. In reply, please be informed that Article 12 of the Philippines-Japan tax treaty provides 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 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. 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" Based on the above provision, royalty payments will be taxed at a preferential rate of ten percent (10%), if the payor is a BOI-registered enterprise and engaged in preferred areas of investment; fifteen percent (15) if the payments are in respect of the use of or right to use cinematograph films and films or tapes for radio or television broadcasting; and in all other cases, twenty-five (25%) of the gross amount of the royalties. Considering that Yamashin Philippines is not a BOI-registered enterprise engaged in preferred pioneer areas of investment and the subject royalties are not payments in respect of the use or right to use cinematograph films and films or tapes for radio or television broadcasting, this Office is of the opinion and so holds that the said payments are royalty payments in consideration for information concerning industrial, commercial or scientific experience and as such are subject to the preferential tax rate of 25% of the gross amount of royalties pursuant to Article 12(2)(b) of the Philippines-Japan tax treaty. (BIR Ruling No. DA-ITAD-82-05 dated July 28, 2006) As regards the imposition of VAT on royalties, Section 106 of the Tax Code of 1997, provides that: "SEC. 106. 1 "(A) Rate and Based of Tax. There shall be levied, assessed and collected on every sale, barter or exchange of goods or properties, a value-added tax equivalent to ten percent (10%) of the gross selling price or gross value in money of the goods or properties sold, bartered or exchange, such tax to be paid by the seller or transferor. "(1) The term 'goods or properties' shall mean all tangible and intangible objects which are capable of pecuniary estimation and shall include: xxx xxx xxx "(b) The right or the privilege to use patent, copyright, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or right; HTSAEa xxx xxx xxx 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), 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. 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. AIECSD Such being the case, the royalty payment of Yamashin Philippines, being an EPZA-registered enterprise, now PEZA, to Yamashin Japan under the subject 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 actual 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. Amended by Republic Act No. 9337, effective November 1, 2005, to read as follows: "SEC. 106. Value-added Tax on Sale of Goods or Properties. xxx xxx xxx "(A) Rate and Base of Tax. There shall be levied, assessed and collected on every sale, barter or exchange of goods or properties, a value-added tax equivalent to ten percent (10%) of the gross selling price or gross value in money of goods or properties sold, bartered or exchange, such tax to be paid by the seller or transferor: 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%), after any of the following conditions has been satisfied: xxx xxx xxx "(1) The term 'goods or properties' shall mean all tangible and intangible objects which are capable of pecuniary estimation and shall include: xxx xxx xxx "(b) The right or the privilege to use patent, copyright, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or right; xxx xxx xxx 2. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109(K), as amended by RA No. 9337].