ITAD BIR Ruling No. 055-14

May 29, 2014 ITAD BIR RULING NO. 055-14 Article 12, Philippines-Japan tax treaty Sycip Gorres Velayo and Co. 6760 Ayala Avenue 1226 Makati City Attention: Atty. Carolina A. Racelis Principal, Tax Services Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on March 23, 2012 requesting confirmation that royalties paid by Sakamoto Orient Chemicals Corporation ("Sakamoto Orient") to Sakamoto Yakuhin Kogyo Company Ltd. ("Sakamoto Yakuhin") 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") . 1 Facts Sakamoto Yakuhin is a foreign corporation and a resident of Japan based on its amended Articles of Incorporation and Certificate of Residence issued by the Higashi Tax Office in Japan on December 7, 2011. Sakamoto Yakuhin is located at 2-6, Awaji-machi 1-chome, Chuo-ku, Osaka, 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 January 11, 2012. On the other hand, Sakamoto Orient is a domestic corporation located at 903 Liberty Center Building, 104 H.V. dela Costa, Makati City, Philippines. It is registered with the Philippine Economic Zone Authority ("PEZA") as an ecozone export enterprise under Certificate of Registration No. 99-012 issued on March 11, 1999. On February 28, 2012, Sakamoto Orient and Sakamoto Yakuhin entered into a Royalty Agreement where Sakamoto Yakuhin granted Sakamoto Orient license to use technical information and know-how in connection with the production of chemicals, particularly, poly-glycerin and refined glycerin, as well as continuous access to improvements in techniques and processes pertaining thereto. In consideration, Sakamoto Orient will pay royalties to Sakamoto Yakuhin equivalent to 2 percent of the total sales of these chemicals. The period covered is from April 1, 2012 to September 30, 2012 for poly-glycerin, and from April 1, 2012 to September 30, 2017 for refined glycerin. The royalties will be remitted by telegraphic transfer to Sakamoto Yakuhin 's designated bank account in Japan. The royalties are computed quarterly and payable on or before the fifteenth day of the month after the end of each quarter. The first payment of royalties will be on July 15, 2012. The Agreement took effect on April 1, 2012 and will be in effect up to September 30, 2017; thereafter, the parties may agree to renew the Agreement. TCAHES Based on the Certificate of Remittance issued by the Bank of Tokyo-Mitsubishi UFJ Manila Branch 2 on February 26, 2013, the first payment of royalties were made by Sakamoto Orient to Sakamoto Yakuhin as follows: Date of Amount Remitting Bank Reference Receiving Bank Remittance Number Sept. 27, 2012 2,401,825.00 Bank of Tokyo- 69TTS077194 Bank of Tokyo- Mitsubishi UFJ Mitsubishi UFJ Manila Branch Osaka-chuo Branch Ruling In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997 (" Tax Code "), as amended, royalties paid to a foreign corporation not engaged in trade or business in the Philippines are subject to income tax at the rate of 30 percent, to wit: "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. n Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." However, under Section 32 (B) (5) of the same Tax Code, such royalties are exempt or partially exempt to the extent required by any treaty obligation on the Philippines, to wit: "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: aICHEc 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." In this regard, Article 12 of the Philippines-Japan tax treaty provides relief to royalties as follows: "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. 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 this article, 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 of or the right to use cinematograph films and films or tapes for radio or television broadcasting, and (b) 10 percent in all other cases. The term 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. aICcHA Accordingly, since royalties paid by Sakamoto Orient to Sakamoto Yakuhin for the use of technical information and know-how in connection with the production of poly-glycerin and refined glycerin, as well as continuous access to improvements in techniques and processes pertaining thereto, are royalties for the use of information concerning industrial, commercial or scientific experience ("know-how") and process and not for cinematograph films and films or tapes for radio or television broadcasting , such royalties 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 Tax Code, the said royalties for the use of intangible properties (know-how and process) 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, 3 raise the rate of value-added tax to twelve percent (12%). . ." However, 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: 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 Sakamoto Yakuhin , the lessor of the intangible property, is a nonresident foreign person and is not a VAT-registered taxpayer, such royalties paid to it by Sakamoto Orient , a PEZA-registered entity enjoying fiscal incentives under Republic Act No. 7916 , 4 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 Sakamoto Orient in the transaction. 5 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. 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. Located at 15th Floor, 6788 Ayala Avenue, Makati City, Philippines. 3. 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. 4. 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 , as amended. 5. 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." n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.