ITAD BIR Ruling No. 011-16

March 4, 2016 ITAD BIR RULING NO. 011-16 Article 12 (Royalties), Philippines-Japan tax treaty Sycip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: Reynante M. Marcelo Partner, Tax Services Gentlemen : This refers to your tax treaty relief application dated April 16, 2013 involving royalties to be paid by Yamaha Motor Philippines, Inc. ("YMPI") to Yamaha Motor Co., Ltd. ("YMC") pursuant to the Convention between the Government of the Republic of the Philippines and the Government of Japan with respect to Taxes on Income, as amended by the 2009 Protocol ("Philippines-Japan tax treaty") . It is represented that YMC is a non-resident foreign corporation organized and existing under the laws of Japan per certificate of tax resident status issued on February 4, 2013 by the District Director of the Iwata Tax Office at 112-4 Nakaizumi Iwata-Shi, Shizuoka, Japan; that it is not registered as a corporation or a partnership in the Philippines per certification of non-registration issued by the Securities and Exchange Commission on December 18, 2012; and that on the other hand, YMPI is a domestic corporation organized and existing under the laws of the Philippines; that it is a PEZA registered enterprise based on its Certificate of Registration dated September 5, 2007. HTcADC It is represented that on January 1, 2013, YMPI and YMC entered into a Technical Collaboration Agreement ("Agreement") ; that under the Agreement , YMC grants and assigns to YMPI the exclusive non-transferable and indivisible license, without any right to sublicense to any person, to use Technical Information and Trademark for the purpose of doing the following within the Philippines during the term of the Agreement : (a) To manufacture or process locally manufactured parts at the factory for incorporation into products and/or sale as replacement parts or accessories for products; (b) To have locally manufactured parts manufactured or processed in the Philippines by Subcontractors approved by YMC in accordance with Article 12 on Subcontract of the Agreement for incorporation into products and/or sale as replacement parts or accessories for Products; (c) To procure locally procured parts for incorporation into products and/or sale as replacement parts or accessories for products; (d) To import other imported parts for incorporation into products and/or sale as replacement parts or accessories for products; (e) To assemble parts or accessories for products; (f) To sell, distribute or transfer products and parts as replacement parts or accessories for products; (g) To export products and parts subject to the guideline under the Agreement ; (h) To use Trademark, subject to Article 6 hereof, on and in connection with products and parts. It is agreed that YMPI shall not use Technical Information or Trademark within the Philippines for any purpose other than those specified above; that YMPI shall give prior written notice to YMC of its intention to sell, deliver or distribute the products or parts outside the Philippines; that YMC shall be entitled to withhold its consent to YMPI's proposed export of products and/or parts in case YMC has a good reason, including but not limited to, the existence in the territory in question of an exclusive licensee or distributor for products or parts and failure of the products and parts or their packaging to conform to the standards, which are and will be established by YMC from time to time. It is also agreed that upon request by YMPI, YMCI shall provide technical instruction and training to the technical personnel of YMPI at the factory and/or factory of YMC or its subsidiaries, in order to make them understand and become familiar with the Technical Information; that YMPI may use the Trademark, and except as otherwise provided herein, shall not use any other marks, on locally manufactured parts and on products and, if YMC has consented to the use of Trademark on locally procured parts or other imported parts, YMPI may so use the Trademark; that YMPI shall not remove or alter any trademark, service mark, symbol, brand or abbreviation thereof attached to YMC imported parts or add any mark of any kind thereto, except as may be mutually agreed in writing by the parties. It is further agreed that in consideration of the continuing use by YMPI of the products and parts of YMC, YMPI shall pay to YMC a lump sum initial fee and running royalty as specified below: a) An initial fee for each model of Motorcycle towards the cost and expenses of the development, the amount to be paid and payment schedule of which shall be separately agreed by the parties in writing; b) Running royalty in the amount equal to the aggregate of five percent of the net sales price on all products and parts sold during each annual period ending on December 31st (Annual Period). The payment of the running royalty shall be made within 90 days after the end of each Annual Period; and that on May 23, 2013 YMPI paid the amount of JPY44,597,081 to YMC. It is finally represented that, per sworn statement issued by Administration & Corporate Planning Director of YMPI on March 6, 2013, that the issue or transaction subject of this request for ruling is not under investigation, on-going audit, administrative protest, claims for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended, applies, in general, to royalties derived in the Philippines by a nonresident foreign corporation. It provides: " 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 interest, 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): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). . . (Emphasis supplied)" aScITE However, said income derived by a nonresident foreign corporation may be exempt or partially exempt from income tax pursuant to a treaty obligation to which the Philippine government is bound. Thus, Section 32 (B) (5) of the Tax Code of 1997, as amended provides, viz. : "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. 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 determining whether these payments for royalties are subject to relief under the Philippine-Japan tax treaty, we refer to Article 12 of the treaty: "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) 10 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-quoted provisions, the Philippines may tax the royalties paid by a resident thereof to a company which is a resident of Japan at a rate not exceeding 15 percent if the royalties are paid in respect of the use of or the right to use cinematograph films and films or tapes for radio and television broadcasting; and 10 percent of the gross amount of royalties in all other cases. In view thereof and considering that the royalties paid by YMPI to YMC are not in respect of the use of, or the right to use, cinematograph films and films or tapes for radio and television broadcasting, but represent consideration for the use of trademark together with the technical assistance and know how associated with the trademark, such royalty fees are subject to the 10 percent final withholding tax rate pursuant to Article 12 (2) (b) of the Philippines-Japan tax treaty, as amended. As regards the imposition of the VAT on royalties paid to YMC, please be informed further that Section 108 of the Tax Code of 1997, as amended, provides as follows: "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%) 1 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 1) The lease or the use of or the right or privilege to use any copyright, patent, design or model plan, secret formula or process, goodwill, trademark, trade brand or other like property or right. . ." Thus, in general, VAT is imposed on the fees earned by YMC for services rendered within the Philippines, such that on every payment of the fees, YMPI is generally required to withhold such VAT and treat the same as a "passed-on" VAT, pursuant to Section 4.110-3 (b) of Revenue Regulations No. 7-95 as amended [now Section 4.114-2 (b) of Revenue Regulations No. 16-05]. However, in Commissioner of Internal Revenue vs. Seagate Technology, 2 the Supreme Court held, viz. : "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. HEITAD 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. . ." Based on the foregoing, sale of goods and/or services including the use of or lease of properties to person or entities 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 nonresident suppliers, the provision for exempt transactions under Section 109 (K) of the Tax Code of 1997 which provides VAT exemption for transactions that are exempt under special laws, e.g. , Republic Act No. 7916 or PEZA Law, is particularly applicable to the instant case. Such being the case, the royalties paid by YMPI, being a PEZA registered enterprise, to YMC under the Agreement should be, as it is hereby confirmed to be, exempt from VAT. This ruling is issued on the basis of the foregoing 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. Effective February 1, 2006 the rate shall be 12%. 2. G.R. No. 153866, February 11, 2005.