DA ITAD BIR Ruling No. 148-06

December 7, 2006 DA ITAD BIR RULING NO. 148-06 Article 13, Philippines-Japan tax treaty; BIR Ruling No. DA-ITAD 042-06 Sycip Gorres Velayo & Co . 6760 Ayala Avenue 1226 Makati City Attention: Atty. R.C. Vinzon Tax Services Gentlemen : This refers to your application for relief from double taxation dated March 31, 2005, on behalf of your client, NEC Tokin Electronics (Philippines), Inc. (NEC Tokin), requesting confirmation that the fee paid to NEC Tokin Corporation (NTC) for the purchase of production and inventory control system is not subject to the Philippine income tax under Articles 5(6), 7(1) and 12(4) of the Philippines-Japan tax treaty. It is represented that NTC is a corporation duly organized and existing under the laws of Japan with office address at 6-7-1 Kooriyama, Futoshiro Ku, Sandai City, Miyagi Prefecture, Japan; that NTC is not registered either as a corporation or as a partnership in the Philippines per Certification of Non-Registration issued by the Securities and Exchange Commission dated April 5, 2005; that NEC Tokin is a corporation duly organized and existing under and by virtue of the laws of the Philippines with registered office and principal place of business at 1 Ring Road, Light Industry & Science Park (LISP) II, Barangay La Mesa, Calamba, Laguna; that on February 23, 2003, NEC Tokin purchased a production and inventory control system (system) under a Software Purchase Agreement (Agreement); that pursuant to such Agreement, NTC installed production and inventory control system that is customized for NEC Tokin's production and inventory process design for internal use only and will monitor and track the production of electro-mechanical devices, and record the current inventory of the said devices at any given time; that the system was purchased in a one-time transaction for which a lump-sum amount was paid and thereafter, NEC Tokin gained full ownership of the production inventory and control system; and that the employees of NTC will install the system in the Philippines and will stay for a few days only. It is your position that the payments made for the production and inventory control system purchased by NEC Tokin are not technically considered as software payments subject to royalties but are payments that represent business profits paid to NTC, which does not have a permanent establishment in the Philippines. cda2007tax In reply, please be informed as follows. Concerning software payments, the Bureau of Internal Revenue has issued two Revenue Memorandum Circulars (RMCs) that govern the taxation of software payments. The first Circular, RMC 77-2003 (Classification of Payments for Software for Income Tax Purposes), which covers software payments made from November 18, 2003 to September 7, 2005, generally treats software payments as royalties. It provides: "Definition of Royalties Includes Payments for the Use of Software: The term "royalties" as generally used means payment 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, or films or tapes used 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. The term "use" as contained herein shall include the reselling or distribution of software. HDTSIE Software is generally assimilated as a literary, artistic or scientific work protected by the copyright laws of various countries including the Philippines; thus payments in consideration for the use of, or the right to use, a copy or a copyrighted article relating to software are generally royalties." On the other hand, the second Circular, RMC 44-2005 (Taxation of Payments for Software), which covers software payments made from September 8, 2005 and thereafter, substantially amends the first Circular by treating software payments either as business income, royalties, rental income, or capital gains, depending on the nature of the transaction out of which such payments are made. Software payments are treated as royalties only if the transaction does not constitute a sale or exchange and not all substantial rights in the software have been transferred, but are merely for the transfer of copyright rights in the software. (BIR Ruling No. DA-ITAD-42-06 dated April 11, 2006) Accordingly, the fees paid for the purchase of production and inventory control system under the subject Agreement, from the effective date of the Agreement on February 24, 2003 up to September 7, 2005, which fees are treated as royalties under RMC 77-2003, are subject to the reduced tax rate under paragraph 2, Article 12 of the Philippines-Japan tax treaty, to wit: "Article 12 ROYALTIES 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. xxx xxx xxx 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 aforequoted provision, payments for the purchase of production and inventory control system under the SPA by NEC Tokin to NTC are subject to the reduced income tax of twenty five percent (25%) of the gross amount thereof. On the other hand, the fees paid for the purchase of production and inventory control system under the SPA payable to NTC by NEC Tokin from the effective date of RMC 44-2005 on September 8, 2005 and thereafter, which fees are treated as business profits under this RMC, are subject to income tax only if the same are attributable to a permanent establishment which NTC has in the Philippines, in accordance with paragraph 1, Article 7 of the Philippines-Japan tax treaty, to wit: "Article 7 1. The profits of an enterprise of a Contracting State shall be taxable only in that Contracting State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in that other Contracting State but only so much of them as is attributable to that permanent establishment. xxx xxx xxx" Moreover, Article 5 of the said treaty provides, viz: "Article 5 1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which the business of an enterprise is wholly or partly carried on. 2. The term "permanent establishment" includes especially: a) a store or other sales outlet; b) a branch; c) an office; d) a factory; e) a workshop; f) a warehouse; g) a mine, an oil or gas well, a quarry or other place of extraction of natural resources. 3. A building site or construction or installation project constitutes a permanent establishment only if it lasts more than six months. xxx xxx xxx 6. An enterprise of a Contracting State shall be deemed to have a permanent establishment in the other Contracting State if it furnishes in that other Contracting State consultancy services, or supervisory services in connection with a contract for building, construction or installation project through employees or other personnel other than an agent of an independent status to whom paragraph 7 applies provided that such activities continue (for the same project or two or more connected projects) for a period or periods aggregating more than six months within any taxable year. However, if the furnishing of such services is effected under all agreement between the Governments of the two Contracting States regarding economic or technical cooperation, that enterprise shall, notwithstanding any provisions of this Article, not be deemed to have a permanent establishment in that other Contracting State. HCEaDI xxx xxx xxx" Based on the foregoing, in order for any business profits derived by NTC from its transaction with NEC Tokin to be taxed in the Philippines, NTC must have a permanent establishment in the Philippines to which said profits must be attributed. Furthermore, a Japanese corporation may be deemed to have a permanent establishment in the Philippines, if among others, the furnishing of services by such corporation, through its employees or other personnel, in the same or connected project, continues within the Philippines for a period or periods aggregating more than six months within any taxable year. Since NTC, based on the documents submitted, does not appear to have in the Philippines a place of business at its disposal which is fixed or established at a distinct place, which has a certain degree of permanence, and through which it carries out its business considering that the employees of NTC shall perform the subject services in the Philippines for one hundred twenty (120) days only for the taxable year as evidenced by the certification issued by NEC Tokin, NTC is not deemed to have a permanent establishment in the Philippines to which its business profits may be attributed. Accordingly, this office is of the opinion and so holds that the fees paid for the purchase of production and inventory control system by NEC Tokin to NTC from September 8, 2005 and thereafter, under the subject agreement, are not subject to income tax. (BIR Ruling No. DA-ITAD 030-05 dated April 12, 2005) However, the fees paid for the purchase of production and inventory control system by NEC Tokin to NTC before February 1, 2006 are subject to VAT pursuant to Section 106(A) of the Tax Code of 1997 at the rate of 10% and beginning February 1, 2006 and thereafter are subject to VAT at the rate of 12%. With regard to the procedures for withholding and paying the VAT, Sections 4 and 6 of Revenue Regulations No. 4-2000, Section 3 of Revenue Regulations No. 8-2002, and Section 7 of Revenue Regulations No. 14-2002, provide that NEC Tokin shall be responsible for the withholding of the VAT on the license fees before remitting them to NTC. In remitting to the Bureau of Internal Revenue the VAT withheld on such fees, NEC Tokin shall use BIR Form No. 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld). If a VAT-registered taxpayer, NEC Tokin may use as documentary substantiation for its claim of input VAT the duly filed BIR Form No. 1600 and the proof of payment accompanying it. If a non-VAT-registered taxpayer, NEC Tokin may include as part of the cost of the copy of the software purchase agreement sold to it by NTC the VAT consequently shifted or passed on to it and may treat such VAT either as an expense or an asset, whichever is applicable. In addition, NEC Tokin is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies thereof to be given to NTC upon its request, and the fourth copy to be retained by NEC Tokin as its file copy. HESIcT This ruling is issued based on 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. Republic Act No. 9337 (An Act Amending Sections 27, 28, 34, 106, 107, 108, 109, 110, 111, 112, 113, 114, 116, 117, 119, 121, 148, 151, 151, 236, 237 And 288 Of The National Internal Revenue Code Of 1997, As Amended, And For Other Purposes), which was signed into law on May 24, 2005 and became effective on November 1, 2005, amended Section 106(A) to read as: "SEC. 106. Value-added Tax on Sale of Goods or Properties. (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 the goods or properties sold, bartered or exchanged, 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: (i) Value-added tax collection as a percentage of Gross Domestic Product (GDP) of the previous year exceeds one and one-half percent (1 1/2%); or (ii) National government deficit as a percentage of GDP of the previous year exceeds one and one-half percent (1 1/2%). xxx xxx xxx" The VAT rate was increased to 12% on February 1, 2006, in accordance with the Memorandum of the Executive Secretary to the Secretary of Finance dated January 31, 2006, as circularized by Revenue Memorandum Circular No. 7-2006 (Publishing the Full Text of the Memorandum from Executive Secretary Eduardo R. Ermita dated January 31, 2006 Approving the Recommendation of the Secretary of Finance to Increase the Value Added Tax Rate from Ten Percent to Twelve Percent) dated January 31, 2006.