ITAD BIR Ruling No. 008-13

January 21, 2013 ITAD BIR RULING NO. 008-13 Article 12 Philippines-Japan tax treaty Asia Pacific Business Legal Consulting 2nd Floor, Building B, Mactan Marina Mall Mactan Economic Zone 1 Barangay Ibo, Lapulapu City Cebu Attention: Lauris L. dela Pea Managing Partner Gentlemen : This refers to your tax treaty relief application filed on August 5, 2011 requesting confirmation that royalties paid by Cozo Filters Philippines Corporation ("Cozo Filters Philippines") to Cozo Filters Corporation ("Cozo Filters") are subject to income tax at the rate of 10 percent pursuant to 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. Facts Cozo Filters is a foreign corporation and a resident of Japan based on its Articles of Incorporation and its Residence Certificate issued by the Shiba Tax Office in Japan on June 17, 2011. Cozo Filters is located at 3-16-15 Shirokanedai, Minatoku, Tokyo, Japan. It is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission on June 28, 2011. On the other hand, Cozo Filters Philippines is a domestic corporation located at Mactan Economic Zone 1, Barangay Ibo, Lapu-Lapu City, Cebu, Philippines. Cozo Filters Philippines is registered with the Philippine Economic Zone Authority ("PEZA") as an ecozone export enterprise under Certificate of Registration No. 95-47 issued on April 17, 1995. On August 1, 2011, Cozo Filters Philippines and Cozo Filters entered into a Technical Assistance Agreement where Cozo Filters granted Cozo Filters Philippines a non-exclusive right and an implementation right to use in the Philippines, certain know-how and industrial property pertaining to the manufacture and sale of optical glass filters and other optical component parts. Pursuant thereto, Cozo Filters will supply the following to Cozo Filters Philippines : a) Layouts, drawings, manuals, instructions and specifications for plant, machinery and equipment (including molds, jigs, tools, dies, measurement instruments), systems, procedures, practices, methods of production control and management for the manufacture of optical products. b) Process control sheet and work standard sheet for every manufacturing process. cTIESD c) Quality inspection standard and quality check sheet at the manufacturing process. In consideration, Cozo Filters Philippines will pay royalties to Cozo Filters equivalent to five percent (5%) of its gross sales of the optical products through the scheme of offsetting. Under the said scheme, royalty payments are being offset against Cozo Filters Philippines ' outstanding trade receivables from Cozo Filters ; hence, payment of royalties does not involve actual remittance to Cozo Filters . Royalties for the quarter sales covering July to September 2011 are payable on or before October 30, 2011, while royalties for subsequent months' sales beginning October 31, 2011 and monthly thereafter are payable on or before the thirtieth of the following month. The Agreement has a term of five years from July 1, 2011 to June 30, 2016. Ruling Relative thereto, please be informed that paragraphs 1, 2 and 4, Article 12 of the Philippines-Japan tax treaty, as amended, provide: "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; TIcAaH b) 10 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." Under Article 12, royalties arising in the Philippines and paid to a resident of Japan may be taxed in the Philippines at a rate not to exceed (a) 15 percent if the royalties are paid in respect of the use or the right to use of cinematograph films and films or tapes for radio or television broadcasting, and (b) 10 percent in all other cases. The term royalties 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 ("know-how") . Accordingly, since the royalties paid by Cozo Filters Philippines to Cozo Filters for the use of know-how and other industrial property relating to the manufacture and sale of optical products in the Philippines are essentially royalties for the use of know-how, and not for cinematograph films and films or tapes for radio or television broadcasting, such royalties paid to Cozo Filters in October 2011 and subsequent months shall be subject to income tax at the rate of 10 percent, pursuant to paragraph 2 (b), Article 12 of the Philippines-Japan tax treaty. Finally, under Section 108 (A) of the Tax Code, payments for the use of the subject know-how and industrial property in the Philippines are generally 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%) . . ." EHCcIT However, since Cozo Filters Philippines is registered with PEZA and entitled to fiscal incentives under Republic Act No. 7916 , 3 the Supreme Court ruled, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866 dated February 11, 2005) , that: "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: First, 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." AcEIHC Accordingly, since Cozo Filters , the nonresident lessor of the know-how and industrial property, is not a VAT registered taxpayer, royalties paid to it by Cozo Filters Philippines shall be treated as exempt from VAT and not subject to VAT at zero percent. In either case, no output VAT is shifted or passed-on to Cozo Filters Philippines in the transaction. 4 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 is increased to twelve 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. Entitled An Act Providing for the Legal Framework and Mechanism for the Creation, Operation, Administration, and Coordination of Special Economic Zones in the Philippines, Creating for this Purpose, the Philippine Economic Zone Authority (PEZA), and for Other Purposes . 4. Revenue Regulations No. 16-2005 (Consolidated Value-Added Tax Regulations of 2005) , as amended, provides: "SEC. 4.106-5. Zero-Rated Sales of Goods or Properties . A zero-rated sale of goods or properties (by a VAT-registered person) is a taxable transaction for VAT purposes, but shall not result in any output tax. However, the input tax on purchases of goods, properties or services related to such zero-rated sale, shall be available as tax credit or refund in accordance with these Regulations." "SEC. 4.109-1. VAT-Exempt Transactions . (A) In general ' VAT-exempt transactions ' refer to the sale of goods or properties and/or services and the use or lease of properties that is not subject to VAT (output tax) and the seller is not allowed any tax credit of VAT (input tax) on purchases. The person making the exempt sale of goods, properties or services shall not bill any output tax to his customers because the said transaction is not subject to VAT."