ITAD BIR Ruling No. 031-14

April 14, 2014 ITAD BIR RULING NO. 031-14 Articles 12 (Royalties) Philippines-Japan tax treaty Sapalo Velez Bundang & Bulilan Law Offices 11th Floor, Security Bank Centre 6776 Ayala Avenue Makati City Attention: Atty. Romeo H. Duran Authorized Representative Gentlemen : This refers to your tax treaty relief application dated March 21, 2013 involving royalties to be paid by JGC Philippines, Inc. ("JPHIL") to JGC Corporation ("JGC") 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"). JGC is a non-resident foreign corporation organized and existing under the laws of Japan with business address at 2-1, Ohtemachi 2-Chome, Chiyoda-Ku, Tokyo, Japan per certificate of fiscal residence issued on April 27, 2012 at 1-1-15 Kudanminami Chiyoda-ku, Tokyo, Japan by the District Director of Kojimachi Taxation Office. 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 March 6, 2013. On the other hand, JPHIL is a domestic corporation organized and existing under the laws of the Philippines with principal address at JPHIL Bldg., 2109 Prime MBP Park, Ayala Alabang, Muntinlupa City. It is a PEZA registered enterprise per certificate of registration no. 07-14-IT. It is represented that on April 1, 2012, JGC and JPHIL entered into a Trademark Licensing Agreement ("Agreement") ; that under the Agreement , JGC granted and assigned to JPHIL the non-exclusive use of JGC's trademark in all of JPHIL's business transactions, sales promotion and project execution in the Philippines and abroad; that JGC shall lend its technical expertise and know-how in the area of engineering design, determination and procurement of the appropriate materials for used in a specified project, equipment selection and maintenance and the construction and commission of projects; that JGC shall have full control over the manner in which JPHIL uses the business name together with the products, technology and services associated with the trademark; that a separate Technical Consultancy and Service Agreement shall govern the assignment of technical personnel by JGC to JPHIL's office or project sites for the purpose of providing technical assistance for JPHIL's specific projects; that for and consideration of the use of JGC's trademark, know how, expertise in engineering, procurement and construction technology, products and services and goodwill associated with the trademark, JPHIL shall pay JGC a Royalty Fee of USD350,000 for the year 2012; and that on April 5, 2013 JPHIL paid JGC through Mizuho Corporate Bank, Ltd-Manila branch the amount of Three Hundred Fifteen Thousand US Dollars (USD315,000.00) for the Royalty period April 2012 to March 2013 per certification issued by Mizuho Corporate Bank, Ltd-Manila branch on April 16, 2013. DISHEA It is finally represented that, per sworn statement issued by Corporate Administration Division Manager of JPHIL on March 14, 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) xxx xxx xxx" 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: STcDIE "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 JPHIL to JGC 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, know how, expertise in engineering, procurement and construction technology, products and services and goodwill 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. EDIHSC Considering that a separate Technical Consultancy and Service Agreement will govern the technical assistance that will be provided by JGC to JPHIL, the imposition of VAT under this ruling is limited only to the VAT on royalties paid to JGC, please be informed 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; . . ." xxx xxx xxx Thus, in general, VAT is imposed on the fees earned by JGC for services rendered within the Philippines, such that on every payment of the fees, JPHIL 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. 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, 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 JPHIL, being a PEZA registered enterprise, to JGC 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.