ITAD BIR Ruling No. 056-14

June 9, 2014 ITAD BIR RULING NO. 056-14 Article 12; Philippines-Japan tax treaty, as amended Ogino Philippines Corporation 132 East Main Avenue Phase 5, Laguna Technopark Barrio Loma, Bian Laguna Attention: Mr. Ikuzou Kitamura President Gentlemen : This refers to your tax treaty relief application filed on October 24, 2008 requesting confirmation that royalties paid by Ogino Philippines Corporation ("Ogino Philippines") to Ogino Kogyo Company Ltd. ("Ogino Kogyo") are subject to preferential tax treatment 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 Protocol . 1 Facts Ogino Kogyo is a foreign corporation and a resident of Japan based on the Complete Certificate of Current Status issued by the Company Register in Kaita in Japan on September 18, 2008, and the Certificate of Status of Taxable Person issued by the Kaita Tax Office in Japan on September 2, 2008. Ogino Kogyo is located at 299-1 Hiradani, Kumano-cho, Aki-gun, Hiroshima, Japan. It is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission on September 16, 2008. On the other hand, Ogino Philippines is a domestic corporation located at 132 East Main Avenue, Phase 5, Laguna Technopark, Barrio Loma, Bian, Laguna, Philippines. It is registered with the Philippine Economic Zone Authority ("PEZA") as an ecozone export enterprise under Certificate of Registration No. 00-031 issued on April 4, 2000. aTICAc On April 30, 2001, Ogino Philippines and Ogino Kogyo entered into a Technical Assistance Agreement where Ogino Kogyo granted Ogino Philippines an exclusive right to manufacture in the Philippines, and a non-exclusive right to sell in the Philippines and in other territories, hard disk drives and related products, automotive parts, and other products by using the know-how developed by Ogino Kogyo . This know-how includes all proprietary information such as designs and manufacturing data required to manufacture the products. In consideration, Ogino Philippines will pay royalties to Ogino Kogyo equivalent to 10 percent of the gross selling price of the products manufactured and sold by Ogino Philippines . This rate is subsequently reduced to 5 percent in accordance with the letter issued by Ogino Philippines on December 4, 2004 as approved by Ogino Kogyo . The royalties are computed quarterly and payable within thirty days after each quarter. The Agreement took effect on April 30, 2001 for an initial term of ten years; thereafter the Agreement may be extended by mutual agreement of the parties. The Agreement complies with the provisions of the Intellectual Property Code on voluntary licensing under Certificate of Compliance No. 5-2001-00053 issued by the Intellectual Property Office on January 13, 2005 valid from July 23, 2001 to July 22, 2011. Ruling In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997, as amended ("Tax Code") , income payments including royalties made 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%)." aCASEH However, under Section 32 (B) (5) of the Tax Code, such payments 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: 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, paragraphs 1 and 2, Article 12 of the Philippines-Japan tax treaty provides relief to royalties arising in the Philippines and paid to a resident of Japan: "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. CTIEac 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 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." 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 , reduced the rate in subparagraph (b) to 10 percent beginning January 1, 2009: TcSCEa "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: xxx xxx xxx b) 10 per cent of the gross amount of the royalties in all other cases." Under Article 12, such royalties are subject to income tax at the rate of (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) before January 1, 2009, 25 percent, and beginning January 1, 2009, 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 Ogino Philippines to Ogino Kogyo under the Agreement are not for the use of cinematograph films and films or tapes for radio or television broadcasting, but for know-how in the manufacture of hard disk drives and related products, automotive parts, and other products, such royalties paid before January 1, 2009 are subject to income tax at the rate of 25 percent , and those paid on January 1, 2009 and onwards are subject to 10 percent , pursuant to paragraph 2 (b), Article 12 of Philippines-Japan tax treaty, as amended. Furthermore, under Section 108 (A) of the Tax Code, royalties for the use of intangible property in the Philippines are generally subject to value-added tax ("VAT"): SCEDaT "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 Ogino Philippines is a PEZA-registered enterprise and entitled to fiscal incentives pursuant to Republic Act No. 7916 , 3 the Supreme Court, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866 dated February 11, 2005) , ruled 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: TcADCI 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 Ogino Kogyo , the nonresident lessor of know-how, is not a VAT-registered taxpayer, such royalties paid to it by Ogino Philippines shall, for VAT purposes, be treated as exempt and not subject to zero percent VAT. In either case, no output VAT shall be shifted or passed-on to Ogino Philippines . 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 effective January 1, 2009 . 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 , as amended. 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." n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.