ITAD BIR Ruling No. 052-13

March 6, 2013 ITAD BIR RULING NO. 052-13 Article 12, Philippines-Japan tax treaty Regalado Bautista and Menzon Law Offices Lower Ground 18, City and Land Mega Plaza ADB Avenue corner Garnet Street Ortigas, Pasig City Attention: Atty. Edith C. Abana-Bautista Atty. Rhodora J. Corcuera-Menzon Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on February 9, 2010 requesting confirmation that royalty fees paid by Canon Information Technologies Philippines, Inc. ("Canon Philippines") to Canon, Inc. ("Canon") are in the nature of business profits and exempt from income tax 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") . 1 Facts Canon is a foreign corporation and a resident of Japan based on its amended Articles of Incorporation, on the Certificate of Registration issued by the Kamata Taxation Office in Japan on September 4, 2009, and on the Certification issued by the Tokyo Regional Taxation Bureau in Japan on April 25, 2007. Canon is located at 30-2, Shimomaruko 3 Cho-me, Ohta-ku, Tokyo, Japan. Canon is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration issued by the Securities and Exchange Commission on August 2, 2010. On the other hand, Canon Philippines is a domestic corporation located at 2nd Floor, Techno Plaza One Building, 18 Orchard Road Eastwood, Quezon City, Philippines. Canon Philippines is registered with the Philippine Economic Zone Authority ("PEZA") as an ecozone information technology enterprise under Certificate of Registration No. 08-26-IT issued on June 3, 2008. EICSDT On May 30, 2009, Canon Philippines and Canon entered into Supplement No. 5 to the Software License Base Agreement dated October 26, 2006 where Canon granted Canon Philippines a non-exclusive and non-transferable license, but without the right to sub-license, to use the following software: (1) Modelsim SE/Mix ; (2) Seamless CVE ; (3) MMAV2006 ; (4) Incisive Enterprise Simulator ; (5) Specman Elite ; (6) eVC for AHB ; (7) eVC for USB ; (8) eVC for PCI-Express End Point ; (9) eVC for PCI-Express Root Complete ; (10) eVC for PCI 2.2/2.3 ; (11) eVC for Ether ; (12) eVC for AXI; and (13) Incisive Enterprise Manager . In consideration, Canon Philippines will pay a royalty fee to Canon totaling 222,395,000.00. The Supplement took effect on January 1, 2009 for an initial period of one year. On May 30, 2009, Canon Philippines and Canon entered into Supplement No. 6 to the Software License Base Agreement where Canon granted Canon Philippines a non-exclusive and non-transferable license, but without the right to sub-license, to use the software Pure Spec-Any . In consideration, Canon Philippines will pay a royalty fee to Canon amounting 2,231,000.00. The Supplement took effect on January 8, 2009 for an initial period of six months. On November 12, 2009, Canon Philippines and Canon entered into Supplement No. 7 where Canon granted Canon Philippines continuous license to use the software Pure Spec-Any for another six months. In consideration, Canon Philippines will pay a royalty fee to Canon amounting 2,231,000.00. On September 25, 2009, Canon Philippines and Canon entered into a new Software License Base Agreement where Canon granted Canon Philippines continuous license to use the abovementioned software. The new Agreement took effect on January 1, 2008 for an initial period of one year; thereafter the Agreement will be renewed automatically for successive periods of one year. On September 25, 2009, Canon Philippines and Canon entered into Supplement No. 1 to the new Software License Base Agreement where Canon granted Canon Philippines a non-exclusive and non-transferable license, but without the right to sub-license, to use the software Model Designer and Platform Architect. In consideration, Canon Philippines will pay a royalty fee to Canon totaling 2,145,000.00. The Supplement took effect on January 1, 2008 for an initial period of one year. On September 25, 2009, Canon Philippines and Canon entered into Supplement No. 2 where Canon granted Canon Philippines continuous license to use the software Model Designer and Platform Architect for another one year. In consideration, Canon Philippines will pay a royalty fee to Canon totaling 2,075,000.00. cSATEH Based on the Sworn Statement issued by Canon Philippines on September 18, 2012, Canon Philippines had not yet paid royalty fees to Canon pending the issuance of a ruling by the Bureau of Internal Revenue on the matter. 2 Ruling Relative thereto, please be informed that in view of the special relationship between Canon Philippines to Canon as related companies, we consider the Software License Base Agreements and their Supplements concerning the grant to use certain software as contracts for the supply of know-how . The following commentaries in the Organisation for Economic Co-operation and Development ("OECD") Model Tax Convention on Income and on Capital (Condensed Version, July 22, 2010) mention that: "11.5 In the particular case of a contract involving the provision, by the supplier, of information concerning computer programming, as a general rule the payment will only be considered to be made in consideration for the provision of such information so as to constitute know-how where it is made to acquire information constituting ideas and principles underlying the program, such as logic, algorithms or programming languages or techniques, where this information is provided under the condition that the customer not disclose it without authorisation and where it is subject to any available trade secret protection." Under paragraph 4, Article 12 of the Philippines-Japan tax treaty, payments for the use, or the right to use of, know-how or information concerning industrial, commercial or scientific experience constitute royalties , to wit: "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 ." Hence, the fact that payments made by Canon Philippines to Canon under the contracts are termed as royalty simply reflects the intention of Canon to supply know-how or other exclusive information to Canon Philippines which are relevant to the latter as part of the Canon Group of Companies. On the taxation of royalties, paragraphs 1 and 2, Article 12 of the treaty provide: ITSaHC "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." 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 paid 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. Accordingly, since the royalties paid by Canon Philippines to Canon under the Software License Base Agreements and their Supplements are payments for the use of know-how as embedded in software, and not for the use of cinematograph films and films or tapes for radio or television broadcasting, such royalties paid to Canon on February 24, 2010 3 and thereafter shall be subject to income tax at the rate of 10 percent , pursuant to paragraph 2 (b), Article 12 of the Philippines-Japan tax treaty. Furthermore, under Section 108 (A) of the National Internal Revenue Code of 1997, as amended, the royalties paid to Canon 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: Provided, that the President, upon the recommendation of the Secretary of Finance, shall, effective January 1, 2006, 4 raise the rate of value-added tax to twelve percent (12%). . ." However, since Canon Philippines is registered with PEZA and entitled to fiscal incentives under Republic Act No. 7916 , 5 the Supreme Court, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866 dated February 11, 2005) , ruled that: DSEaHT "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: 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 Canon , the nonresident lessor of know-how, is not a VAT registered taxpayer, such royalties paid to it by Canon Philippines shall, for purposes of VAT, be exempt from VAT and not subject to zero-percent VAT; in either case, no output VAT is shifted or passed-on to Canon Philippines . 6 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. CHDAEc Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. As amended by the 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 effective January 1, 2009. 2. Since the relevant TTRA was filed on February 9, 2010 and Canon Philippines will pay royalty fees to Canon after the issuance of a ruling by the Bureau of Internal Revenue, all fees paid to Canon shall be subject to relief (exemption from income tax or reduction of tax) under Section III (2) of Revenue Memorandum Order No. 1-00 (Procedures for Processing Tax Treaty Relief Application) , to wit: "III. Policies: In order to achieve the above-mentioned objectives, the following policies shall be observed: xxx xxx xxx 2. Any availment of the tax treaty relief shall be preceded by an application by filing BIR Form No. 0901 (Application for Relief from Double Taxation) with ITAD at least 15 days before the transaction i.e., payment of dividends, royalties, etc., accompanied by supporting documents justifying the relief . . ." (Emphasis ours) 3. February 24, 2010 is the fifteenth day after the filing of the TTRA on February 9, 2010 . 4. The VAT rate was increased to 12 percent beginning 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. 5. 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 . 6. 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."