ITAD BIR Ruling No. 048-10

October 6, 2010 ITAD BIR RULING NO. 048-10 Article 12, Philippines-Japan Tax Treaty; BIR Ruling No. 096-81; BIR Ruling No. DA-ITAD-98-05; BIR Ruling No. DA-ITAD-60-06; BIR Ruling No. DA-ITAD-102-06; BIR Ruling No. DA-ITAD-65-08 FCC (Philippines) Corp. 106 North Science Avenue Laguna Technopark, Bian, Laguna Attention: Ms. Susan C. Lansangan Accounting Manager Gentlemen : This refers to your letter dated April 16, 2009 applying for the 10% preferential tax rate on the royalty payment of FCC Philippines Corporation (FCC-Philippines) to F.C.C. Co. Ltd. (F.C.C.-Japan) pursuant to Article 12 of the Philippines-Japan tax treaty. EDcIAC It is represented that F.C.C.-Japan is a resident of Japan as evidenced by the Residence Certificate dated April 2, 2009 issued by the District Director of Hamamatsunishi Tax Office, Japan; that its principal office is located at 7000-36 Nakagawa, Hosoe-Cho, Kita-ku, Hamamatsu-City, Shizuoka-Pref, Japan; that it is not registered either as a corporation or as a partnership in the Philippines as evidenced by the Certificate of Non-Registration of Corporation/Partnership dated March 30, 2009 issued by the Securities and Exchange Commission; on the other hand, FCC-Philippines is a domestic corporation with principal office address located at 106 North Science Avenue, Laguna Technopark, Bian, Laguna; that it is registered with the Philippine Economic Zone Authority (PEZA) under Certificate of Registration No. 93-55; that FCC-Philippines is engaged in the manufacture of clutch parts for motorcycles and automobiles. It is further represented that FCC-Philippines entered into a License Agreement with F.C.C.-Japan on November 4, 1994 under which F.C.C.-Japan grants FCC-Philippines a non-exclusive and non-transferable right and license to use the Industrial Property Rights 1 and Technical Information 2 in order to manufacture and sell the Products 3 and Parts 4 in the Territory; 5 that during the term of this Agreement, F.C.C.-Japan shall, at FCC-Philippines' sole expense, furnish to FCC-Philippines the following: 1) Technical Information and continued access to improvements in techniques and processes related to such Technical Information. 2) Advice with respect to the following: i) Construction of the factory; ii) Manufacturing facilities; iii) Plan of processing; 3) Engineer of F.C.C.-Japan for technical guidance. 4) Technical training of engineers of FCC-Philippines at F.C.C.-Japan's factory. That in consideration of the right to manufacture and sell the Products under the Industrial Property Rights and Technical Information provided by F.C.C.-Japan pursuant to the Agreement, FCC-Philippines shall pay to the former the following royalties: Three percent (3%) of the difference between the net sales price actually charged by the Licensee to purchasers of the Products sold by the Licensee and the gross sales price actually charged by the Licensor to the Licensee for the Parts sold by the Licensor. EHTSCD That the Agreement shall be effective for a period of ten (10) years from the effective date confirmed in accordance with the provision of Paragraph 1 of this Article; that on April 1, 2003, FCC-Philippines and F.C.C.-Japan executed an Addendum in regard to amendment of the Consideration stated in the License Agreement, stated as follows: "In consideration of the right to manufacture and sell the Products under the Industrial Property Rights and Technical Information provided by the Licensor pursuant to this Agreement, the Licensee shall pay to the Licensor the following royalties: Five percent (5%) of the difference between the net sales prices actually charged by the Licensee to purchasers of the Products sold by the Licensee and the gross sales price actually charged by the Licensor to the Licensee for the Parts sold by the Licensor. The five percent can be changeable. However, when calculating the above royalties, any taxes imposed in regard to the sale of the Products shall be excluded." And that the issue or transaction subject of the above application is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or a judicial appeal. In reply, please be informed that the Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997 as amended, applies in general. 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 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): Provided, That effective January 1, 2009, at the rate of income tax shall be thirty percent (30%). HADTEC xxx xxx xxx However, Section 32 (B) (5) of the Tax Code of 1997, as amended provides: "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. xxx xxx xxx" In relation thereto, there is the Philippines-Japan tax treaty which may be invoked in the instant case. Its Article 12 provides, 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: 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) 25 per cent of the gross amount of the royalties in all other cases. xxx xxx xxx 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. CDScaT 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 foregoing, the royalty payments will be taxed on the preferential tax rate of 10 percent (10%) if the payor is a Board of Investments (BOI)-registered enterprise and engaged in preferred pioneer areas of investment, 15 percent (15%) if the payments are in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, and in all other cases, 25 percent (25%) of the gross amount of the royalties. However, there is the Protocol amending the Philippines-Japan tax treaty which took effect on January 1, 2009. It provides: "ARTICLE V Paragraph (2) of Article 12 of the Convention shall be deleted and replaced by the following: (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." Based on the foregoing provisions, the royalty payments will be taxed on the preferential tax rate of 15 percent (15%) if the payments are in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, and in all other cases, 10 percent (10%) of the gross amount of the royalties. EAcHCI Such being the case, this Office is of the opinion and so holds that since FCC-Philippines is not a BOI-registered enterprise engaged in preferred pioneer areas of investment, and, since the subject royalty payments are not paid in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, the said royalty payments by FCC-Philippines to F.C.C.-Japan from November 4, 1994 until December 31, 2008 under the said Agreement shall be subject to tax at the rate not exceeding 25% of the gross amount of the royalties, pursuant to Article 12 (2) (b) of the Philippines-Japan tax treaty. (BIR Ruling No. 096-81 dated June 11, 1981; BIR Ruling No. DA-ITAD-98-05 dated September 7, 2005; BIR Ruling No. DA-ITAD-60-06 dated May 30, 2006; BIR Ruling No. DA-ITAD-102-06 dated August 28, 2006; BIR Ruling No. DA-ITAD 065-08 dated September 10, 2008) On the other hand, the royalty income that would be derived by F.C.C.-Japan in the Philippines from January 1, 2009 onward, shall be subject to 10% preferential tax rate pursuant to Article IV (2) of the Protocol amending the Philippines-Japan tax treaty. As regards the imposition of the VAT on the transfer of Technical Property Rights and Technical Information of F.C.C.-Japan , please be informed further that Section 108 of the Tax Code of 1997 6 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%) 7 of gross receipts derived from the sale or exchange of services, including the use or lease of properties . (Underscoring supplied) xxx xxx xxx" Thus, in general, the VAT is imposed on the transfer of Technical Property Rights and Technical Information by F.C.C.-Japan in the Philippines, such that on every payment of royalty fees, FCC-Philippines 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]. HCaDET 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. TaHDAS 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, transactions 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 non-resident 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 special laws, e.g. , Republic Act No. 7916 or PEZA Law, is particularly applicable to the instant case. Such being the case, the payment of royalty fees by FCC-Philippines , being a PEZA-registered enterprise, to F.C.C.-Japan under the License 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. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. The term "Industrial Property Rights" means patents, utility models, designs, trademarks, service marks, symbols, abbreviations thereof and brands relating to the products which Licensor now or hereafter owns. 2. The term "Technical Information" means any technical know-how, designs, drawings, standards, specifications and all other technical data relating to the Products and Parts and all other technical knowledge necessary for the manufacture of the Products and Parts which Licensor now owns, and all documents whether originals or copies containing any such designs, drawings, standards, specifications, technical data or technical knowledge. 3. The term "Products" means such clutches for motorcycles and automobiles as may from time to time be designated by mutual agreement of the parties hereto, and stipulated by separate agreement between the parties hereto. 4. The term "Parts" means such kinds of component and peripheral parts, including parts for repair or replacement, of the Products as may from time to time be designated by mutual agreement of the parties hereto, and stipulated by separate agreement between the parties hereto. 5. The term "Territory" means the Philippines. 6. Please note that this cited provision has been retained by Republic Act (RA) No. 9337, although with the modification as to the applicable rate when the circumstances so warrant. 7. Effective February 1, 2006, the rate shall be 12%. 8. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337].