ITAD BIR Ruling No. 033-11

January 28, 2011 ITAD BIR RULING NO. 033-11 Article 12, Philippines-Japan tax treaty; BIR Ruling No. ITAD 48-10; BIR Ruling No. ITAD 11-10 SyCip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: Atty. Jules E. Riego Principal, Tax Advisory and Advocacy Group Gentlemen : This refers to your letter dated 13 July 2009 on behalf of your client, Nikko Metals Philippines, Inc. (NMPH) (formerly known as, Nikko Materials Philippines, Inc.) , requesting confirmation of your opinion that the royalty payments by NMPH to Nippon Mining & Metals Co. Ltd. (NMMC) (formerly known as Nikko Materials Company Ltd.) under the Technology License Agreement beginning 1 January 2009, are subject to the 10% preferential withholding tax rate under Article 12 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") , as amended by a Protocol effective 1 January 2009. It is represented that NMMC, with office address at 10-1 Toranomon 2-chome, Minato-ku, Tokyo, Japan, is a corporation organized and existing under the laws of Japan, as shown in the Certificate dated 16 February 2009 issued by the Tokyo Legal Affairs Bureau in Japan; that NMMC is not registered as a corporation or as a partnership in the Philippines per certification issued by the Securities and Exchange Commission (SEC) dated 7 July 2009; that NMPH, with office address at 117 East Science Avenue, SEPZ, Laguna Technopark, Bian, Laguna, Philippines, is a domestic corporation registered with the SEC under Company Registration No. AS096-005640; and that NMPH is engaged in the business of manufacturing, importing, exporting, selling (on wholesale basis only) or otherwise dealing in copper foil and copper sulfate; and that NMPH is registered with the Philippine Economic Zone Authority (PEZA) as an ecozone export enterprise at the Laguna Technopark Special Economic Zone under amended Certificate of Registration No. 96-080 dated 2 April 2008. It is further represented that on 1 August 2003, NMPH and NMMC entered into a Technology License Agreement where NMMC granted NMPH a non-exclusive and non-transferable license, without the right to grant any sub-license, to manufacture treated rolled copper foils (the "Products") at its plant in Laguna, Philippines, and to use and sell the Products under NMMC's Patents and Technical Information and Know-How; that "Patents" means the patents (including patent applications) pertaining to the Products acquired by NMMC up to the date of the Agreement and patents which may be subsequently acquired by NMMC in relation to the Technical Information and Know-How; that "Technical Information and Know-How" means proprietary information, know-how, development or improvement, whether or not patentable, pertaining to the Products acquired by NMMC up to the date of the Agreement and during the term of the Agreement, to the extent NMMC shall have the right to grant licenses without violating any applicable law, or without breaching any contractual obligation to any third party; that in consideration, NMPH shall pay a running royalty to NMMC equivalent to five percent (5%) of the Net Sales Price of the Products manufactured and sold by NMPH less the cost of raw materials incurred by NMPH thereon; that the rate of the running royalty may be revised from time to time during the term of the Agreement by mutual agreement between the parties in the event NMMC provides major improvement to the Technical Information and Know-How; that the running royalty shall be calculated and paid on a semi-annual basis, and shall be paid in United States dollars by wire transfer to such bank account specified by NMMC; and that the Agreement shall take effect on 1 August 2003 and shall continue to be in effect until the tenth anniversary of the first date of payment of the running royalty, unless terminated earlier by the parties. It is finally represented that the royalty payment of the request for ruling is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings judicial appeal, based on the Sworn Certification issued by NMPH dated 17 April 2009. ESTDIA In reply, please be informed that royalty payments to a non resident 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 Corporation. 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 interests, 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 subparagraphs (c) and (d): Provided, That effective January 1, 1998, the rate of income tax shall be thirty-four percent (34%); effective January 1, 1999, the rate shall be thirty-three percent (33%); and, effective January 1, 2000 and thereafter, the rate shall be thirty-two percent (32%). However, under Section 32 (B) (5) of the Tax Code of 1997, as amended, such income derived by NMMC in the Philippines may be exempt or partially exempt from income tax to the extent required by any treaty obligation binding upon the Philippine Government, thus: "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." With respect to a treaty, what you invoke for this purpose is the Philippines-Japan tax treaty, as amended. Article 12 thereof provides: "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" As to royalties subject to 10% under paragraph 2 (b) of Article 12, these include specifically and pursuant to paragraph 4 of Article 12, royalties in respect of the use or the right to use any copyright of literary, artistic or scientific work (except 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 information concerning industrial, commercial or scientific experience, and payments in respect of the use of or the right to use, industrial, commercial or scientific equipment. TAECaD Accordingly, the running royalty to be paid by NMPH to NMMC under the Agreement beginning 1 January 2009, and thereafter, being essentially royalties in respect of the use or the right to use of patent and industrial, commercial or scientific experience ("know-how") , is subject to income tax at the rate of 10 percent of the gross amount thereof, pursuant to paragraph 2 (b), Article 12 of the Philippines-Japan tax treaty as amended. (BIR Ruling No. ITAD 48-10 dated 6 October 2010; BIR Ruling No. ITAD 11-10 dated 16 June 2010) With respect to value added tax (VAT), the running royalty, being payment for the use or lease of (intangible) properties in the Philippines is subject to VAT. Section 108 (A) of the Tax Code of 1997, as amended, provides: "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: 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%) . . ." 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. 1 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. ITSCED 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" Accordingly, and since NMPH is an enterprise registered with PEZA under Republic Act No. 7916, 2 as amended, operating within an economic zone and as such is an "exempt" entity, NMPH cannot 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 purchase of goods and services. Thus, the running royalty to be paid by NMPH to NMMC under the Agreement is 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. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337]. 2. 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 , effective 24 February 1995.