ITAD BIR Ruling No. 038-13

February 28, 2013 ITAD BIR RULING NO. 038-13 Article 12, Philippines-Japan tax treaty; BIR Ruling No. ITAD 160-12 Sycip Gorres Velayo and Co. 6760 Ayala Avenue 1226 Makati City Attention: Fabian K. delos Santos Partner, Tax Services Gentlemen : This refers to your tax treaty relief application filed on December 23, 2011 requesting confirmation that royalties paid by Sanwa Electric Philippines, Inc. ("Sanwa Electric Philippines") to Sanwa Electric Company Ltd. ("Sanwa Electric") are subject to income tax at the rate of 10 percent pursuant to 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 1 effective January 1, 2009. Facts Sanwa Electric is a foreign corporation and a resident of Japan based on its Business Registration issued by the Company Register in Maebashi in Japan on November 15, 2011, and on the Certificate of Residence issued by the Tatebayashi Tax Office in Japan on October 5, 2011. Sanwa Electric is located at 2479 Yoshida, Oizumi-machi, Ora-gun, Gunma, Japan. It is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission on July 22, 2011. On the other hand, Sanwa Electric Philippines is a domestic corporation located at Block 2, Lots 1 and 2, First Cavite Industrial Estate, Dasmarias, Cavite, Philippines. It is registered with the then Export Processing Zone Authority as an export enterprise under Certificate of Registration No. 95-67 issued on June 9, 1995. On July 1, 2011, Sanwa Electric Philippines and Sanwa Electric entered into a Technical Assistance Agreement where Sanwa Electric granted Sanwa Electric Philippines a non-exclusive right and license to use certain technical information in connection with the manufacture and assembly in the Philippines of small type motors and other products. This technical information includes design of the products (drawings, specification, parts list, materials standards and test standards); manufacture engineering of the products (equipment specification, tool die drawings, and measurement machinery specifications); quality of the products (process quality standards, finished good inspection standards, and quality inspection flowcharts); production of the products (parts inspection standards and working guidance manuals); and other information necessary for the manufacture of the products. These products may be sold by Sanwa Electric Philippines in the Philippines and other territories except Japan. In consideration, Sanwa Electric Philippines will pay royalties to Sanwa Electric consisting of (a) a running royalty equivalent to 1 percent of the ex-factory price of the products sold to Sanwa Electric and 1.5 percent of the ex-factory price of the products sold to third parties, and (b) a management guidance royalty equivalent to 500,000.00 every month. The royalties are computed and payable every month and due within fifteen days following the receipt by Sanwa Electric Philippines of the invoice for the royalties. The Agreement took effect on July 1, 2011 and will remain in effect for a period of five years thereafter. AIHTEa Ruling In reply, please be informed that under Section 14 of Revenue Memorandum Order No. 72-2010 (Guidelines on the Processing of Tax Treaty Relief Applications (TTRA) Pursuant to Existing Philippine Tax Treaties) ("RMO 72-2010") , which covers income derived or which accrued on November 4, 2010 and thereafter, any availment of tax treaty relief (exemption from income tax or reduction of tax) shall be preceded by an application filed at the International Tax Affairs Division ("ITAD") of this Bureau before the first taxable event subject of the TTRA, to wit: "SEC. 14. When and Where to File the TTRA. All tax treaty relief applications (updated BIR Forms No. 0901-D, 0901-I, 0901-R, 0901-P, 0901-S, 0901-T, 0901-O and 0901-C) relative to the implementation and interpretation of the provisions of Philippine tax treaties shall only be submitted to and received by the International Tax Affairs Division (ITAD). If the forms or any necessary documents are submitted to any other BIR Office, the application shall be considered as improperly filed. Filing should always be made BEFORE the transaction. Transaction for purposes of filing the TTRA shall mean before the occurrence of the first taxable event . Failure to properly file the TTRA with ITAD within the period prescribed herein shall have the effect of disqualifying the TTRA under this RMO ." (Emphasis ours) In view of the foregoing, since the Agreement that gives rise to the royalties has been in effect on July 1, 2011, but the TTRA for this purpose was filed only on December 23, 2011, this Office hereby DENIES relief on all royalties paid by Sanwa Electric Philippines to Sanwa Electric on and before such date of filing , pursuant to Section 14 of RMO 72-2010. Accordingly, said royalties shall be subject to income tax at the rate of 30 percent under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, to wit: DEAaIS "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 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 subparagraph 5(c) and (d) above: * Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." On the other hand, the royalties paid to Sanwa Electric on December 24, 2011 and thereafter are subject to a reduced rate of income tax under paragraphs 1, 2 and 4, Article 12 of the amended Philippines-Japan tax treaty, to wit: "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: SaETCI 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. xxx xxx xxx 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." Under Article 12, royalties arising in the Philippines and paid to a resident of Japan may be taxed in the Philippines at a rate not to exceed (a) 15 percent if the royalties are in respect of the use or the right to use of cinematograph films and films or tapes for radio or television broadcasting, and (b) 10 percent in all other cases. Royalties 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 ("know-how") . Accordingly, since the royalties paid by Sanwa Electric Philippines to Sanwa Electric under the Agreement for the use of technical information or know-how on the manufacture and assembly of small type motors and other products are not royalties for the use of cinematograph films and films or tapes for radio or television broadcasting, such royalties paid to Sanwa Electric on December 24, 2011 and thereafter shall be subject to income tax at the rate of 10 percent, pursuant to paragraph 2 (b), Article 12 of the amended Philippines-Japan tax treaty. (BIR Ruling No. ITAD 160-12 dated April 16, 2012) ITSCED Furthermore, under Section 108 (A) of the Tax Code, the royalties in question, being payments for the use of an intangible property (know-how) in the Philippines, are subject to value-added tax ("VAT"), to wit: "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, 2 raise the rate of value-added tax to twelve percent (12%) . . ." However, since Sanwa Electric Philippines, originally an enterprise registered with the then Export Processing Zone Authority, is likewise entitled to the same fiscal incentives available to enterprises registered with and administered by the present Philippine Economic Zone Authority ("PEZA") pursuant to Republic Act No. 7916, 3 the Supreme Court ruled, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866 dated February 11, 2005) , that: "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: TICAcD First, 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." Accordingly, since Sanwa Electric, the nonresident lessor of know-how, is not a VAT-registered taxpayer, such royalties paid to it by Sanwa Electric Philippines shall, for VAT purposes, be treated as exempt and not subject to zero percent VAT. In either case, no output VAT is shifted or passed-on to Sanwa Electric Philippines in the process. 4 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. Protocol Amending 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. 2. The VAT rate is increased to twelve percent 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. 3. 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 . Section 11 thereof provides: "CHAPTER II Governing Structures SEC. 11. The Philippine Economic Zone Authority (PEZA) Board. There is hereby created a body corporate to be known as the Philippine Economic Zone Authority (PEZA) attached to the Department of Trade and Industry. . . The existing Export Processing Zone Authority (EPZA) created under Presidential Decree No. 66 shall evolve into the PEZA in accordance with the guidelines and regulations set forth in an executive order issued for this purpose." 4. Revenue Regulations No. 16-2005 (Consolidated Value-Added Tax Regulations of 2005) , as amended, provides: "SEC. 4.106-5. Zero-Rated Sales of Goods or Properties . A zero-rated sale of goods or properties (by a VAT-registered person) is a taxable transaction for VAT purposes, but shall not result in any output tax. However, the input tax on purchases of goods, properties or services related to such zero-rated sale, shall be available as tax credit or refund in accordance with these Regulations." "SEC. 4.109-1. VAT-Exempt Transactions. (A) In general. 'VAT-exempt transactions' refer to the sale of goods or properties and/or services and the use or lease of properties that is not subject to VAT (output tax) and the seller is not allowed any tax credit of VAT (input tax) on purchases. The person making the exempt sale of goods, properties or services shall not bill any output tax to his customers because the said transaction is not subject to VAT."