ITAD BIR Ruling No. 010-11

January 19, 2011 ITAD BIR RULING NO. 010-11 Article 12, Philippines-Japan tax treaty, as amended; BIR Ruling No. ITAD-011-10 JGLaw SOL Building, 112 Amorsolo Street Legaspi Village 1229 Makati City Attention: Atty. Norina Aileen C. Sanchez Atty. Jennifer E. Laygo Gentlemen : This refers to your letter dated July 15, 2009, on behalf of DAI-ICHI SEIKO CO. LTD. (hereinafter referred to as "DIS"), requesting confirmation that the royalties paid to it by LAGUNA DAI-ICHI, INC. (hereinafter referred to as "LDI") under a Royalty Agreement entered into by and between them are subject to a 25 percent or 10 percent preferential tax rate effective January 1, 2009, pursuant to the provisions of 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"). THcaDA It is represented that DIS is a resident corporation of Japan with Tax ID No. 00300179 as evidenced by a Certification by the Tax Authorities of the Country of Residence issued by the District Director, Fushimi Tax Office dated February 18, 2009; that it is duly organized and existing under the laws of Japan for the main purpose of manufacturing molding dies, plastic parts and stamping metal pressed parts and various industrial product, with office address at No. 12-4, Negoro, Momoyama-cho, Fushimi-ku, Kyoto 612-8024 Japan; that it is not registered as a corporation or as a partnership in the Philippines per a Certification of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission dated June 01, 2009; that, on the other hand, LDI is a corporation duly organized and existing under Philippine laws with principal office at 103 North Science Avenue, Laguna Techno Park, Phase I, SEPZ, Bian, Laguna; that it is an ecozone export enterprise registered with the Export Processing Zone Authority (EPZA, now Philippine Economic Zone Authority [PEZA]) under Certificate of Registration No. 94-10 dated February 18, 1994; and that it is engaged in the manufacture of molding dies, plastic parts and stamping metal pressed parts and in the export of such articles from the Philippines. It is further represented that DIS and LDI entered into a Royalty Agreement (hereinafter referred to as "Agreement") effective initially for a period of one (1) year from November 04, 2004, unless sooner terminated, whereby DIS undertakes the following: Continued access to improvements in techniques and processes related to the technology shall be made to LDI during the period of the Agreement; Should DIS and LDI deem it necessary or desirable to arrange trial runs of the process for evaluation of quality, packaging and economic limits of the arrangements hereof, such trial runs shall be conducted without delay and all data hereon made available to the other parties. In the absence of other agreement the costs of such trial shall be borne by DIS; DIS shall arrange for the attendance at LDI's plant of suitable qualified technicians who shall advise and guide those employees of LDI so far as is necessary in or relating to the use and application of the Know-how for the production of the Products; 1 DIS warrants that the Know-how is the property of DIS based upon DIS's own research and experiment and is not based upon any information obtained from any other person; DIS shall provide LDI with all necessary information for ensuring that LDI's laboratory facilities are adequate for testing, sampling and control of the raw materials to be used in the manufacture of the Products and LDI shall take all necessary steps to comply with the requirements thereof. It is also represented that in consideration of the above rights, licenses and assistance of DIS, LDI shall pay to DIS as from effective date, a remuneration/royalty fee equivalent to five percent (5%) of the gross sales of the Products payable every quarter; that the Agreement complies with the provisions of Sections 87 and 88 of Chapter IX, Part II of the Intellectual Property Code on Voluntary Licensing, as evidenced by Certificate of Compliance No. 5-2009-00042 issued by the Intellectual Property Office issued on June 17, 2009; and that the issue subject of the above request is not under any investigation or on-going audit, administrative protest, claim for refund or issuance of tax credit certificate, collection proceedings, or a judicial appeal. TSADaI In reply, please be informed that royalty income derived by a nonresident foreign corporation is generally subject to tax as provided for under Section 28, (B) [1] of the National Internal Revenue Code of 1997 (Tax Code of 1997), as amended, thus: "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 . . . royalties . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, Section 32 (B) (5) of the same Tax Code provides as follows: "SEC. 32. Gross Income. xxx xxx xxx (B) Exclusions from Gross Income. The following items shall not be included in gross income and shall be exempt from taxation under this Title: 2 xxx xxx xxx (5) Income Exempt under Treaty. Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines." In relation thereto, Article 12 the Philippines-Japan tax treaty which you invoked, may apply to the instant case. It 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: 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 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." Based on the above provision, royalty income derived in the Philippines by a corporation which is a resident of Japan shall be taxed at a preferential rate of 10 percent if the payor company is BOI-registered engaged in preferred pioneer areas of investment; 15 percent 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 25 percent in all other cases. EHDCAI Considering that LDI, the payor of the dividends, is not BOI-registered, the subject royalty payments to DIS may not qualify for the 10 percent treaty rate being applied for. Instead of the 10 percent rate, the said payments merely qualify for a 25 percent preferential tax rate under Article 12 (2) [b] of the Philippines-Japan tax treaty. However, a Protocol amending the existing Philippines-Japan tax treaty took effect on January 1, 2009 whereby the aforementioned 25 percent tax rate was reduced to 10 percent. Accordingly, royalty income accruing on January 1, 2009 may qualify for the application of a 10 percent preferential tax rate pursuant to the Protocol. Article V of the said Protocol provides, viz. : "Paragraph (2) of Article 12 of the Convention shall be deleted and replaced by the following: "(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) 10 per cent of the gross amount of the royalties in all other cases. " (Emphasis supplied) In view of all of the foregoing, this Office is of the opinion and so holds that the subject royalty payments by LDI to DIS under the Royalty Agreement between them from November 2004 until December 31, 2008 are subject to tax at a rate not exceeding 25 percent based on the gross amount of the royalty. However, the royalty payments accruing from January 1, 2009 and thereafter shall be subject to tax at a rate not exceeding 10 percent based on the gross amount of the royalty, pursuant to the Article 12 of the Philippines-Japan tax treaty, as amended. As regards the imposition of VAT on royalties, Section 108 of the Tax Code of 1997, as amended provides that: "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%) 3 of gross receipts derived from the sale or exchange of services, including the use or lease of properties. The phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for others for a fee, . . . . The phrase 'sale or exchange of services' shall likewise include: xxx xxx xxx (3) The supply of scientific, technical, industrial or commercial knowledge or information; . . . 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. 4 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. STcADa 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. Such being the case, the royalty payment of LDI being an enterprise registered with EPZA (now PEZA), to DIS 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, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. "Products" refers to the molding dies, plastic parts and stamping metal presses parts and various industrial plastic products made according to the Process, descriptions of which are set forth below. 2. TITLE II TAX ON INCOME. 3. 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. 4. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337].