ITAD BIR Ruling No. 027-13

February 18, 2013 ITAD BIR RULING NO. 027-13 Article 12, Philippines-Japan tax treaty, as amended Honda Parts Manufacturing Corporation 101 North Science Avenue LTI II, Bian, Laguna Attention: Akira Ishida President/Gen. Manager Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on January 19, 2012, on behalf of Honda Motors Co., Ltd. ("Honda Japan") , requesting confirmation that the royalty payments to Honda Japan by Honda Parts Manufacturing Corporation ("HPMC") are subject to 10 percent preferential tax rate pursuant to the amended 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") . TIEHSA It is represented that Honda , with address at 1-1, 2-Chome, Minami-aoyama, Minato-ku, Tokyo, Japan, is a corporation organized and existing under the laws of Japan and is a resident of Japan per Tax Residence Certificate issued by the Azabu District Tax Office on December 12, 2011; that Honda is not registered either as a corporation or as a partnership in the Philippines as shown in the Certification of Non-Registration of Company issued by the Securities and Exchange Commission dated December 15, 2011; that, on the other hand, HPMC, an registered, is a domestic corporation duly organized and existing under the laws of the Philippines, registered with the Export Processing Zone Authority (EPZA), now Philippine Economic Zone Authority ("PEZA"), with office address at 101 North Science Avenue, LTI Phase II , Bian, Laguna. It is also represented that on December 19, 2011, Honda and HPMC entered into a License and Technical Assistance Agreement ("Agreement") which shall continue in full force and effect for a period of one (1) year, and shall thereafter be automatically renewed for successive one (1) year period and may be terminated by either party at the end of the initial one (1) year; that Honda granted HPMC an indivisible and non-transferable non-exclusive right and license under the Intellectual Property Rights 1 and by using the Technical Information: 2 (a) To manufacture and assemble in the Territory 3 the Product 4 for supply to any purchasers approved by Honda ; and (b) To manufacture and to have manufactured for it by third parties on a subcontract basis the Licensed Parts for supply to any purchasers approved by Honda. That in consideration of the right and license granted to HPMC and for the furnishing of the Technical information, HPMC shall pay to Honda an initial fee and a running royalty in the currency of U.S. Dollars by bank transfer remittance not later than sixty (60) days after the close of each six (6) month period ending on the last day of June and December every year, as follows: (a) Three percent (3%) of the summation of the local value added of the Products and the License Parts; and (b) Three percent (3%) of the summation of the price of each of the Service Products and License Parts invoiced to any purchases approved by Honda times the number of units of the relevant Service Products and License Parts manufactured and sold by HPMC. It is further represented that the issue or transaction subject of the above request for ruling is not under investigation neither is it subject of an on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings nor a judicial appeal based on the Sworn Statement of HPMC dated January 17, 2012. In reply, please be informed that royalties derived in the Philippines by a nonresident foreign corporation are, in general, covered by Section 28 (B) (1) of the National Internal Revenue Code ("Tax Code") of 1997, as amended. It provides: "Section 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 Tax Code of 1997, as amended, provides that: "Section 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. EcSCHD xxx xxx xxx" With respect to a treaty, what is being invoked for this purpose is Article 12 of the Philippines-Japan tax treaty, as amended. It provides as follows: "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. xxx xxx xxx" Based on the Protocol amending the Philippines-Japan tax treaty which took effect on January 1, 2009, royalties derived in the Philippines by a resident of Japan will be taxed at a preferential rate of 15 percent if the same are paid in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, and, 10 percent in all other cases. In view thereof, this Office hereby DENIES relief on those royalties paid by HPMC to Honda before January 20, 2012 . 5 Said royalties shall be subject to income tax at 30 percent as provided under Section 28 (B) (1) of the Tax Code of 1997. However, relief is hereby GRANTED to royalties paid by HPMC to Honda from January 20, 2012 and thereafter. Accordingly, said royalties shall be subject to income tax at the reduced rate of 10 percent of the gross amount thereof, pursuant to Article 12 (2) 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. 6 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%) 7 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; . . ." HAICTD 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. 8 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. 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. . . ." Based on the foregoing, transactions exempt from VAT by reason of Presidential Decree No. 66 and Republic Act No. (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 (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. , RA 7916 or PEZA Law, is particularly applicable to the instant case. Such being the case, the royalty payment of HPMC, being an enterprise registered with EPZA, now PEZA, to Honda 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. HCaEAT Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. "Intellectual Property Rights" shall mean any and all secret technical information (except for the Intellectual Property Rights), whether in writing or not, including but not limited to drawings, standards, specifications, material lists, process manuals and directions maps, which directly relates to the Products or the Licensed Parts themselves or is necessary for the manufacture of the Products or the Licensed Parts and which HONDA owns the time of execution of this Agreement or may own from time to time during the term of this Agreement or under which HONDA is entitled to grant a license to HPMC. 2. "Technical Information" shall mean (i) the Know-How, and (ii) any technical information, not included in the Know-How, such as JIS (Japanese Industrial Standard), whether in writing or not, which directly relates to the Products or the Licensed Parts or is necessary for the manufacture of the Products or the Licensed Parts and which HONDA owns at the time of execution of the Agreement or may own from time to time during the term of this Agreement or under which HONDA is entitled to grant a license to HPMC. 3. "Territory" shall mean the Republic of the Philippines. 4. "Product" shall mean (a) built-up manual transmission to be installed in Honda branded automobiles, such models and types of which shall, from time to time, be agreed upon by the parties hereto in writing, (b) such products which are used for repair and replacement thereof (service application) (the "Service Products"), and (c) such additional type or kind of automotive products as may, from time to time, be decided by mutual agreement of the parties hereto in writing after the execution of the Agreement. 5. January 20, 2012 is the day following the filing date of the TTRA on January 19, 2012. 6. Section 108 was amended by 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, to read as: "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, 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 7. 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. 8. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337].