ITAD BIR Ruling No. 055-13

March 13, 2013 ITAD BIR RULING NO. 055-13 Article 12, Philippines-Japan tax treaty, as amended Isla Lipana & Co 29th Floor, Philamlife Tower 8767 Paseo de Roxas, 1226 Makati City Attention: Atty. Maria Ysidra May Y. Kintanar Authorized Representative Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on September 12, 2011, on behalf of F-Tech, Inc. ( "F-Tech Japan" ), requesting confirmation that the royalty payments to F-Tech Japan by F-Tech Philippines Manufacturing, Inc. ( "F-Tech Phils" ) are subject to 10 percent preferential tax rate pursuant to the amended 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" ). It is represented that F-Tech Japan, with address at 19 Showanuma, Shobu-cho, Kuki-city, Saitama Pref, Japan, is a corporation organized and existing under the laws of Japan and is a resident of Japan per the Certificate of Residence issued by the Kasukabe District Tax Office on August 1, 2011; that F-Tech Japan is not registered either as a corporation or as a partnership in the Philippines as shown in the Certification of Non-Registration of Company issued by the Securities and Exchange Commission (SEC) dated September 12, 2011; and that, on the other hand, F-Tech Phils is a domestic corporation duly organized and existing under the laws of the Philippines and is duly registered with the Philippine Economic Zone Authority (PEZA) with office address located at 118 North Science Avenue, Laguna Technopark, Bian, Laguna. It is also represented that on January 1, 2001, F-Tech Japan and F-Tech Phils entered into a Technical Assistance Agreement ( "Agreement" ) that shall be valid for five (5) years from January 1, 2001 and shall be deemed renewed for another successive period of five (5) years which was amended by a Supplemental Agreement wherein the Agreement was renewed indefinitely effective January 1, 2011; that F-Tech Japan granted F-Tech Phils an indivisible and non-transferable non-exclusive right and license, without the right to grant sublicenses, to manufacture, assemble and sell the Products 1 and to manufacture, assemble and install the Manufacturing Assists 2 within the Territory 3 under the Industrial Property Rights 4 and by using the Know-how, subject to the provision of the Agreement; that F-Tech Japan shall provide the following technical assistance with regard to the manufacture, assembly and sale of F-Tech Phils of the Products in the Territory: IScaAE 1. Know-how shall be effected from time to time at the time when F-Tech Japan deems it necessary to do so or as promptly as possible after the date of receipt by F-Tech Japan of F-Tech Phils' request with regard to the Know-how coming to exist after such effectuation; 2. Furnishing of advice regarding the method of operation of the Manufacturing Assists; 3. Technical guidance by dispatching of F-Tech Phils technical personnel of F-Tech Japan in accordance with the "Agreement for Dispatching Technicians" which may be separately entered into between F-Tech Japan and F-Tech Phils ; and 4. Technical training of F-Tech Phils' technicians at a factory or factories of F-Tech Japan in accordance with the "Agreement for Accepting of Trainees" which may be separately entered into between F-Tech Japan and F-Tech Phils . That in consideration of the rights and licenses granted to F-Tech Phils by F-Tech Japan, F-Tech Phils shall pay F-Tech Japan royalty in US dollars calculated by multiplying the Net Sale 5 at the rate of (3%) for each unit of all the Products sold by F-Tech Phils and the total royalty shall be payable within thirty (30) days after receipt of an invoice made by F-Tech Japan . It is further represented that the issue or transaction subject of the above request for ruling is not under investigation neither is it subject of an on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings nor a judicial appeal based on the Sworn Statement of F-Tech Phils dated June 29, 2011. It is finally represented that pursuant to BIR Ruling No. DA-ITAD-217-02 dated December 27, 2002, the Bureau of Internal Revenue confirmed that the royalty payments under the same Agreement are subject to the preferential tax rate of 25 percent of the gross amount of the royalties pursuant to Article 12 (2) of the Philippines-Japan tax treaty; and, that in light of the Protocol amending the Philippines-Japan tax treaty which took effect on January 1, 2009 thereby lowering the preferential tax rate from 25 percent to 10 percent, you are now requesting confirmation that the royalty payments under the same Agreement from the date the Protocol took effect on January 1, 2009 are now subject to 10 percent, pursuant to the Philippines-Japan tax treaty, as amended. HEcaIC In reply, please be informed that the Philippines-Japan tax treaty, was 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 (Amending Protocol), signed on December 9, 2006, and effective January 1, 2009. Pursuant to Article V of the Amending Protocol, the Article 12 of the Philippines-Japan tax treaty (Royalties) is amended as follows: "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. . . . " Prior to the amendment of the Philippines-Japan tax treaty, royalty payments are taxed at a preferential rate of 10 percent if the payor is a BOI-registered enterprise and engaged in preferred areas of investment under the investment incentives laws of the Philippines; 15 percent if the royalty payments are in respect of the use of or right to use cinematograph films and films or tapes for radio or television broadcasting; and in all other cases, 25 percent of the gross amount of the royalties. Under the Amending Protocol to the tax treaty, beginning January 1, 2009, royalty paid to a resident of Japan will be taxed at a preferential rate of 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 or television broadcasting and 10 percent in all other cases. HSTaEC As confirmed in BIR Ruling No. DA-ITAD-217-02, F-Tech Phils payments to F-Tech Japan under the Agreement are not in respect of the use or right to use cinematograph films and films or tapes for radio or television broadcasting, and hence, were subject to 25 percent preferential tax rate. In view of the effectivity of the Amending Protocol, the rate of tax is changed to 10 percent, and as such, all royalty payments of F-Tech Phils to F-Tech Japan accruing from January 1, 2009 are qualified for the preferential tax rate of 10 percent. Hence, all royalty payments of F-Tech Phils to F-Tech Japan accruing from January 1, 2009 are hereby confirmed to be subject to income tax at a preferential 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. 037-11 dated February 2, 2011) As regards the imposition of VAT on royalties, Section 108 of the Tax Code of 1997, as amended provides that: "SEC. 108. 6 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. TcEaAS 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 (3) The supply of scientific, technical, industrial or commercial knowledge or information; . . ." 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. ICESTA 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. aDACcH 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. . . ." Based on the foregoing, transactions exempt from VAT by reason of Presidential Decree No. 66 and Republic Act No. (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 (q) [now Section 109 (K)] of the Tax Code of 1997 which provides VAT exemption for transactions that are exempt under specials laws, e.g., RA 7916 or PEZA Law, is particularly applicable to the instant case. Such being the case, the royalty payment of F-Tech Phils, being a PEZA-registered enterprise, to F-Tech Japan under the subject 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. "Products" shall mean such parts for automobiles, motorcycles and power products as pedal bracket, front beam, center beam, rear beam, rear beam, * rear-suspension cross beam, trailing arm, rear upper arm and other parts, including parts for repair or replacement, to be decided from time to time upon agreement by both the parties hereto. 2. "Manufacturing Assists" means jigs, tools, dies, machinery and equipment which F-Tech Japan uses for the manufacture, assemble, testing, inspection, maintenance and servicing of the Products. 3. "Territory" shall mean the Philippines and such other countries as may be decided hereafter upon agreement in writing by both the parties hereto. 4. "Industrial Property Rights" means any and all patents, trademarks, service marks, copyrights, designs and other statutory industrial property rights, which F-Tech Japan from time to time owns or is entitled to grant license to F-Tech Phils, relating to the Products and the Manufacturing Assists. 5. "Net Sale" means the amount of price of the sale at the term end of each unit of all the products sold by and F-Tech Phils in the Philippines minus: a) Trade, quality or cash discounts and broker's or agent's commissions, if any; b) Return credits and allowances; c) Tax, excise or other government charges; d) Freight, insurance and packaging cost, and total prices of the purchase of each unit of the parts supplied by customers. 6. Section 108 was amended by Republic Act No. 9337 (An Act Amending Sections 27, 28, 34, 106, 107, 108, 109, 110, 111, 112, 113, 114, 116, 117, 119, 121, 148, 151, 236, 237 and 288 of the National Internal Revenue Code of 1997, as Amended, and for Other Purposes), which was signed into law on May 24, 2005 and became effective on November 1, 2005, to read as: "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, raise the rate of value-added tax to twelve percent (12%), after any of the following conditions has been satisfied: (i) Value-added tax collection as a percentage of Gross Domestic Product (GDP) of the previous year exceeds one and one-half percent (1 1/2%); or (ii) National government deficit as a percentage of GDP of the previous year exceeds one and one half percent (1 1/2%). xxx xxx xxx 7. The VAT rate was increased to 12% 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. 8. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337].