ITAD BIR Ruling No. 003-12

January 10, 2012 ITAD BIR RULING NO. 003-12 Article 12, Philippines-Japan tax treaty, as amended; BIR Ruling No. ITAD 37-11 J-Sys Philippines, Inc. JGC Philippines Building (Annex) 1606 Trade Street corner Investment Drive Madrigal Business Park, Ayala Alabang Muntinlupa City Attention: Mitsuharu Hamada President and General Manager Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on November 22, 2008 requesting confirmation that payments made by J-Sys Philippines, Inc. ("J-Sys Philippines") to JGC Information Systems Company Ltd. ("JGC Information") are subject to preferential tax under 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") , as amended by a Protocol 1 effective January 1, 2009 . EDcIAC Facts JGC Information is a foreign corporation organized and existing under the laws of Japan and is a resident thereof based on the Certification of Complete Records issued by the Yokohama Legal Affairs Bureau in Japan on April 18, 2008, and on the Residence Certificate issued by the Yokohama Naka Tax Office in Japan on November 17, 2008. JGC Information is situated at the 15th Floor, MM Park Building, 3-6-3 Minatomirai, Nishi-ku, Yokohama-shi, Kanagawa, Japan. JGC Information is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration issued by the Securities and Exchange Commission on May 8, 2008. On the other hand, J-Sys Philippines is a domestic corporation situated at 1606 Trade Street corner Investment Drive, Madrigal Business Park, Ayala Alabang, Muntinlupa City, Philippines. On March 1, 2008, JGC Information and J-Sys Philippines entered into a Software Distributorship Agreement where JGC Information granted J-Sys Philippines the right to market and distribute the e-Plantia Plant Maintenance Management System ("Software") developed by and belonging to JGC Information. JGC Information also granted J-Sys Philippines the right to use the documents relating to the Software and will provide related trainings and installation support services thereto. The copyright and other rights attached to the Software are owned by JGC Information before and after the delivery of the Software and such right may not be transferred to J-Sys Philippines or to any customer thereof. JGC Information will render maintenance support to the customers of J-Sys Philippines under the relevant maintenance contracts they entered with J-Sys Philippines, and JGC Information may also provide these customers, the relevant trainings, installation support, and development of related systems. The standard price of the Software and the related maintenance support thereto is equivalent to 40 percent of the invoice price of the Software and the support. J-Sys Philippines will pay JGC Information on the last day of the next calendar month following the date of delivery of the Software and such payment will be in United States dollars. J-Sys Philippines will market and distribute the software in any country worldwide except Japan. The Agreement took effect on March 1, 2008, and will continue to be in effect indefinitely. Ruling Relative thereto, please be informed that under Section III (2) of Revenue Memorandum Order No. 1-00 (Procedures for Processing Tax Treaty Relief Application) ("RMO 1-2000") , any availment of tax treaty relief (exemption from income tax or reduction of tax) shall be preceded by an application filed at the International Tax Affairs Division ("ITAD") of this Bureau at least 15 days before the intended transaction or payment of income, thus: "III. Policies: In order to achieve the above-mentioned objectives, the following policies shall be observed: xxx xxx xxx 2. Any availment of the tax treaty relief shall be preceded by an application by filing BIR Form No. 0901 (Application for Relief from Double Taxation) with ITAD at least 15 days before the transaction i.e., payment of dividends, royalties, etc., accompanied by supporting documents justifying the relief. . . " (Emphasis ours) This condition was emphasized by the Court of Tax Appeals in Mirant (Philippines) Operations Corporation vs. Commissioner of Internal Revenue (C.T.A. Case No. 6382 dated June 7, 2005) where it ruled: " However, it must be remembered that a foreign corporation wishing to avail of the benefits of the tax treaty should invoke the provisions of the tax treaty and prove that indeed the provisions of the tax treaty applies to it, before the benefits may be extended to such corporation. In other words, a resident or non-resident foreign corporation shall be taxed according to the provisions of the National Internal Revenue Code, unless it is shown, that the treaty provisions apply to the said corporation, and that, in cases the same are applicable, the option to avail of the tax benefits under the tax treaty has been successfully invoked. Under Revenue Memorandum Order 01-2000 of the Bureau of Internal Revenue, it is provided that the availment of a tax treaty provision must be preceded by an application for a tax treaty relief with its International Tax Affairs Division (ITAD). This is to prevent any erroneous interpretation and/or application of the treaty provisions with which the Philippines is a signatory to. The implementation of the said Revenue Memorandum Order is in harmony with the objectives of the contracting state to ensure that the granting of the benefits under the tax treaties are enjoyed by the persons or corporations duly entitled to the same. The Court notes that nowhere in the records of the case was it shown that petitioner indeed took the liberty of properly observing the provisions of the said order. Petitioner quotes various BIR, as well as ITAD, Rulings issued to several foreign corporations seeking for a tax relief from the office of the respondent. However, not any one of these rulings pertains to the petitioner: It must be stressed that BIR rulings are issued based on the facts and circumstances surrounding particular issue/issues in question and are resolved on a case-to-case basis. It would be thus erroneous to invoke the ruling of the respondent in specific cases, which have no bearing to the case of petitioner." (Emphasis ours) EATcHD This decision was upheld by the Supreme Court in a Resolution (G.R. No. 168531) dated February 18, 2008. Furthermore, the necessary requirement laid down in RMO 1-2000 is reiterated in subsequent rulings of the Court of Tax Appeals: Deutsche Bank AG Manila Branch vs. Commissioner of Internal Revenue (C.T.A. Case No. 456 dated May 29, 2009), CBK Power Company Ltd. vs. Commissioner of Internal Revenue (C.T.A. Case Nos. 6699, 6844 and 7166 dated March 29, 2010) and Manila North Tollways Corporation vs. Commissioner of Internal Revenue (C.T.A. Case No. 7864 dated April 12, 2011) . In view of the foregoing, since the subject Agreement took effect on March 1, 2008, and will continue to be in effect indefinitely, and the subject TTRA was filed only on November 22, 2008, this Office hereby DENIES relief on those payments made by J-Sys Philippines to JGC Information before the fifteenth day following the date of filing of the TTRA, or on December 7, 2008, pursuant to Section III (2) of RMO 1-2000. Accordingly, these payments shall be subject to income tax at the rate under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, to wit: "SEC. 28. Rates of Income Tax on Foreign Corporations. xxx xxx xxx (B) Tax on Nonresident Foreign Corporation. (1) In General. Except as otherwise provided in this Code, a foreign corporation not engaged in trade or business in the Philippines shall pay a tax equal to thirty-five percent (35%) of the gross income received during each taxable year from all sources within the Philippines, such as interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and capital gains, except capital gains subject to tax under subparagraph 5(c) and (d) above: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." On the other hand, payments made by J-Sys Philippines to JGC Information on December 7, 2008 and thereafter, being essentially royalties for the use of copyright of literary, artistic or scientific work, shall be subject to income tax at the rate of 25 percent (before January 1, 2009) and 10 percent (beginning January 1, 2009 and thereafter) pursuant to paragraph 2, in relation to paragraph 4, Article 12 of the Philippines-Japan tax treaty, to wit: "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 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 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." The Protocol amended paragraph 2 by reducing the rate in subparagraph (b) to 10 percent, thus: "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: xxx xxx xxx b) 10 per cent of the gross amount of the royalties in all other cases." (BIR Ruling No. ITAD 37-11 dated February 2, 2011) In connection with the use of copyright pertaining to software or computer program, the fact that under the Software Distributorship Agreement, J-Sys Philippines has the right to market and distribute to the public the e-Plantia Plant Maintenance Management System Software developed by and belonging to JGC Information deems J-Sys Philippines to utilize the copyrights or economic rights of the Software, as clearly mentioned in Section 5 (a) (v) of Revenue Memorandum Circular No. 44-2005 (Taxation of Payments for Software) , in relation to Section 177 of the Intellectual Property Code of the Philippines, to wit: CaAIES "Section 5. Characterization of Transactions. The character of payments received in a transaction involving the transfer of computer software depends on the nature of the rights that the transferee acquires under the particular arrangement regarding the use and exploitation of the program. a. Transfer of copyright rights. A transfer of software is classified as a transfer of a copyright right if, as a result of the transaction, a person acquires any one or more of the rights described below: i. The right to make copies of the software for purposes of distribution to the public by sale or other transfer of ownership, or by rental, lease or lending; ii. The right to prepare derivative computer programs based upon the copyrighted software; iii. The right to make a public performance of the software; iv. The right to publicly display the computer program or v. any other rights of the copyright owner, the exercise of which by another without his authority shall constitute infringement of said copyright . The determination of whether a transfer of a copyright right in a software is a sale or exchange of property is made on the basis of whether, taking into account all facts and circumstances, there has been a transfer of all substantial rights in the copyright. A transaction that does not constitute a sale or exchange because not all substantial rights have been transferred will be classified as a license generating royalty income. When only copyright rights are transferred, payments made in consideration therefor are royalties. On the other hand, when copyright ownership is transferred, payments made in consideration therefor are business income. "Section 177. Copyright or Economic Rights. Subject to the provisions of Chapter VIII, copyright or economic rights shall consist of the exclusive right to carry out, authorise or prevent the following acts: 177.1. Reproduction of the work or substantial portion of the work; 177.2. Dramatization, translation, adaptation, abridgment, arrangement or other transformation of the work; 177.3. The first public distribution of the original and each copy of the work by sale or other forms of transfer of ownership; 177.4. Rental of the original or a copy of an audiovisual or cinematographic work, a work embodied in a sound recording, a computer program, a compilation of data and other materials or a musical work in graphic form, irrespective of the ownership of the original or the copy which is the subject of the rental; 177.5. Public display of the original or a copy of the work; and SECcAI 177.6. Other communication to the public of the work. " (Emphasis ours) Finally, under Section 108 (A) of the Tax Code, the royalties at hand, being payments for the use of intangible property (copyright) in the Philippines, are subject to value-added tax ("VAT"), 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 or lease of properties 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, 2 raise the rate of value-added tax to twelve percent (12%), after any of the following conditions has been satisfied. . . " Relative thereto, J-Sys Philippines shall withhold VAT on the royalties at the rate of 12 percent before remitting them to JGC Information. J-Sys Philippines shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). If it is a VAT-registered taxpayer, the duly filed BIR Form No. 1600 and its accompanying proof of payment shall serve as documentary substantiation for J-Sys Philippines' claim of input tax on the royalties. Otherwise, J-Sys Philippines may treat such VAT as an asset or expense, whichever is applicable. VAT withheld shall be remitted within 10 days following the end of the month the withholding was made. 3 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.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. 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. 2. The VAT rate was increased to 12 percent 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. 3. Pursuant to Section 4.112-2 of Revenue Regulations No. 16-2005 (Consolidated Value-Added Tax Regulations of 2005), as amended by Revenue Regulations No. 4-2007 (Amending Certain Provisions of Revenue Regulations No. 16-2005, as Amended, Otherwise Known as the Consolidated Value-Added Tax Regulations of 2005) , which provides: "SEC 4.114-2. Withholding of VAT on Government Money Payments and Payments to Non-Residents. xxx xxx xxx (b) The government or any of its political subdivisions, instrumentalities or agencies including GOCCs, as well as private corporations, individuals, estates and trusts, whether large or non-large taxpayers, shall withhold twelve percent (12%) VAT, starting February 1, 2006, with respect to the following payments: (1) Lease or use of properties or property rights owned by non-residents; and (2) Services rendered to local insurance companies with respect to reinsurance premiums payable to non-residents; and (3) Other services rendered in the Philippines by non-residents. In remitting VAT withheld, the withholding agent shall use BIR Form No. 1600 Remittance Return of VAT and Other Percentage Taxes Withheld. VAT withheld and paid for the non-resident recipient (remitted using BIR Form No. 1600), which VAT is passed on to the resident withholding agent by the non-resident recipient of the income, may be claimed as input tax by said VAT-registered withholding agent upon filing his own VAT Return, subject to the rule on allocation of input tax among taxable sales, zero-rated sales and exempt sales. The duly filed BIR Form No. 1600 is the proof or documentary substantiation for the claimed input tax or input VAT. Nonetheless, if the resident withholding agent is a non-VAT taxpayer, said passed-on VAT by the non-resident recipient of the income, evidenced by the duly filed BIR Form No. 1600, shall form part of the cost of purchased services, which may be treated either as an 'asset' or 'expense', whichever is applicable, of the resident withholding agent. VAT withheld under this Section shall be remitted within ten (10) days following the end of the month the withholding was made."