ITAD BIR Ruling No. 064-11

February 25, 2011 ITAD BIR RULING NO. 064-11 Article 12, Philippines-France Tax Treaty; BIR Ruling No. ITAD-005-09 Atty. Zenaida P. Alcantara, CPA Unit 4G Pacopandana, 1845 Paz M. Guazon St. Paco, Manila Madam : This refers to your letter dated January 15, 2010 requesting confirmation of your opinion that the royalty fees to be paid by Optodev, Inc. (Optodev) to Essilor International (Compagnie Generale d' Optique) S.A. (Essilor) are subject to a preferential tax rate of 15 percent pursuant to Article 12 of the Convention between the Government of the Republic of the Philippines and the Government of the French Republic for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-France tax treaty"). aDCIHE It is represented that Essilor is a nonresident corporation organized and existing under the laws of France as evidenced by its Articles of Association; that its principal office is at 147 rue de Paris, 94220 Charenton-Le-Pont (Val de Marne) Cedex, France; 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 May 19, 2009 issued by the Securities and Exchange Commission; that Optodev is a domestic corporation with principal office address at B2 L2 Corner Star Avenue and Interstar Streets, LIIP-SEPZ, Mamplasan, Bian, Laguna; that it is a Philippine Economic Zone Authority (PEZA) registered enterprise as shown in a Certificate of Registration No. 97-051 dated July 10, 1997 engaged in the manufacture of plastic ophthalmic lenses. It is further represented that on January 1, 1999 Optodev entered into a Technology License Agreement (First Agreement) with Essilor; that on January 1, 2000 they entered into another separate Technology License Agreement (Second Agreement); that under the First Agreement, Essilor grants Optodev a non-exclusive license of the Technology 1 to use the Technology in the Territory 2 and sell the Licensed Products 3 throughout the world; that the parties acknowledged and agreed that all right, title and interest in and to the Technology shall not be transferred and shall at all time remain in, and belong to, Essilor except to the extent provided in the First Agreement; that to enable Optodev to use the Technology for the treatment of the Licensed Products, Essilor shall disclose to Optodev the technical information related to the Technology which will be sufficient to enable Optodev to carry out the treatment of the Licensed Products; that technical information shall include, inventions, and know-how, whether or not patentable including chemical engineering, scientific and practical information, reports and formulae; manufacturing data, practices and procedures; equipment and system specifications, operating, maintenance and safety instructions, analytical procedures, machinery, plant and equipment designs; computer software and other machine readable data and information, and information contained on drawings, blueprints and in specifications, technical reports and other writings; that Essilor shall provide Optodev with the services and technical advice of skilled personnel; that in consideration for the license granted by Essilor, Optodev shall pay to Essilor a royalty of three percent (3%) of the selling price of the Licensed Products; that the First Agreement shall enter into effect on January 1, 1999 and shall continue for a period of ten (10) years, unless one of the parties terminated the First Agreement in the conditions of Article 13.2; that under the Second Agreement, Essilor grants Optodev a non-exclusive License of the Technology Rights 4 in order to use the Technology 5 for the manufacture of Products 6 to be produced in the Philippines; that Optodev shall not have the right grant sub-licenses of the Technology Rights without prior written approval of Essilor; that in consideration for the license granted by Essilor, Optodev shall pay Essilor a royalty equal to two percent (2%) of the Net Turnover made by Optodev with the sales of the Products; 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 Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended, applies in general to royalty payments received by nonresident foreign corporations. 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, the rate of income tax shall be thirty percent (30%). CSTEHI 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, the provisions of the Philippines-France tax treaty may apply to your request for relief particularly its Article 12, which provides: "Article 12 ROYALTIES 1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. 2. However, such royalties may be taxed in the Contracting State in which they arise, and according to the law of that State. However, the tax so charged shall, provided that the royalties are taxable in the other Contracting State, not exceed: a) in the case of the Philippines, 15 per cent of the gross amount of the royalties: (i) paid by an enterprise registered with the Philippines Board of Investments and engaged in preferred areas of activities, or (ii) paid in respect of cinematographic films or of works recorded for broadcasting or television; b) in all other cases, 25 per cent of the gross amount of the royalties. 3. 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 cinematographic films and works recorded for broadcasting or television, 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." Under paragraph 2, Article 12 of the Philippines-France tax treaty, the royalty payments will be taxed at the preferential tax rate of 15 percent if the payor is a Board of Investments (BOI)-registered enterprise and engaged in preferred pioneer areas of activities or paid in respect of cinematographic films or of works recorded for broadcasting or television, and in all other cases, 25 percent of the gross amount of the royalties. However, Article 6 of the Protocol amending the foregoing provisions, which took effect on January 1, 2000, reads as follows: "Article 6 Paragraph 2 of Article 12 of the Convention is 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 State, but if the beneficial owner of the royalties is a resident of the other Contracting State, the tax so charged shall not exceed 15 percent of the gross amount of the royalties.'" Based on the foregoing, this Office is of the opinion and so holds that said royalty payments by Optodev to Essilor from the period January 1, 1999 to December 31, 1999 under the First Agreement shall be subject to a 25 percent preferential tax rate while royalty payments under the First and Second Agreements from January 1, 2000 onward shall be subject to a 15 percent preferential tax rate on the gross amount thereof pursuant to Article 12 (2) of the Philippines-France tax treaty, as amended. (BIR Ruling No. ITAD 005-09 dated February 12, 2009) AHECcT As regards the imposition of the value-added tax (VAT) on the transfer of technology by Essilor, please be informed further that Section 108 of the Tax Code of 1997 7 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%) 8 of gross receipts derived from the sale or exchange of services, including the use or lease of properties . (Emphasis supplied) xxx xxx xxx" Thus, in general, VAT is imposed on the transfer of technology by Essilor in the Philippines, such that on every payment of royalty fees, Optodev 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]. 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. 9 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. EaSCAH 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 Optodev , being a PEZA-registered enterprise, to Essilor under the agreements 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. Technology means the technology consisting in a vacuum deposition process used on ophthalmic lens substrates to provide anti-reflective properties to the lens. 2. Territory means the national territory of the Philippines. 3. Licensed Products means the ophthalmic spectacle lenses incorporating the technology. 4. "Technology Rights" means intellectual property rights owned by Essilor relating to the Molding Process including, but not limited to, patent rights, processes, techniques, know-how, technical information and trade secrets. 5. "Technology" means the Molding Process. 6. "Products" means organic spectacle lenses manufactured in accordance with the Technology. 7. 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. 8. Effective February 1, 2006, the rate shall be 12%. 9. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337].