ITAD BIR Ruling No. 074-14

June 10, 2014 ITAD BIR RULING NO. 074-14 Article 12, Philippines-Italy tax treaty Draka Philippines Incorporated Mactan Ecozone 2 Basak, Lapu-lapu City, Cebu Attention: Ms. Clarita P. Cacayan Authorized Representative Gentlemen : This refers to your tax treaty relief application filed on April 24, 2013, requesting confirmation that royalties received by Prysmian Cavi e Sisteme S.r.l. ("Prysmian") from Draka Philippines Incorporated ("Draka") are subject to income tax at 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 Republic of Italy for the Avoidance of Double Taxation with Respect to Taxes on Income and to Prevent Fiscal Evasion ("Philippines-Italy tax treaty") . cHaDIA Facts It is represented that Prysmian is a corporation organized and existing under the laws of Italy and is a resident of thereof based on the Tax Residence Certificate issued by the Agenzia Entrate in Italy on February 15, 2013; that Prysmian is situated at Viale Sarca, 222, 20126 Milan, Italy; that Prysmian is not registered as corporation or partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission on February 5, 2013; and that Draka is a Philippine Economic Zone Authority (PEZA) registered enterprise with Certificate of Registration No. 97-061 situated at Mactan Ecozone 2, Basak, Lapu-lapu City, Philippines. It is further represented that on January 7, 2013, Prysmian and Draka entered into the following agreements: Trademark and Name License Agreement and Patent and Know-How License Agreement effective January 1, 2012; that pursuant to the Agreements Prysmian grants Draka a non-exclusive license to use the Prysmian trademark, the Draka trade mark, and the name and the exclusive right to license or sub-license the Prysmian trade mark, the Draka trade mark and the name in the field Mark; that in consideration for the right to use the trademark, patent and know-how under the Agreements, Draka shall pay to Prysmian a royalty fee of 1 percent of the Sales Value of the Products 1 per agreement. Draka shall, within 30 days after the last day of each calendar quarter (namely March 31st, June 30th, September 30th and December 31st), deliver to Prysmian a detailed statement showing the sales of and/or revenues from the Products made by Draka during such quarter and, concurrently therewith, shall pay in Euro the royalties due to Prysmian pursuant to Article 13. The payment of the aggregate amount of royalties for 2012 in the amount of US$1,467,156.61 has been remitted by Draka to Prysmian on May 10, 2013 as shown in the attached documents ( i.e., Receipt of Payment Confirmation by BIR eFPS, Payment Confirmation, Remittance Advice, etc.). Also the Audited Financial Statements (December 31, 2012 and 2011) of Draka has shown that no payment for royalties under the said agreements are made by Draka to Prysmian for 2012. It is further represented that both agreements are effective and enforceable until terminated by the parties. It is finally represented that the royalties subject of this ruling are not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Sworn Statement issued by the Plant Manager of Draka on April 19, 2013. Ruling In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code of 1997 (" Tax Code "), as amended, provides that gains derived by Prysmian , being a foreign corporation not engaged in trade or business in the Philippines, are subject to income tax in the Philippines at the rate of 30 percent, thus: SECATH "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%). xxx xxx xxx" However, Section 32 (B) (5) of the Code provides that the gains may be exempt from income tax or subject to a reduced rate to the extent required by any treaty obligation on the Philippines, viz. : "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" For this purpose, you invoke the provisions of the Philippines-Italy tax treaty. Paragraphs 1, 2, and 3, Article 12 thereof provide: "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. cTADCH 2. However, such royalties may be taxed in the Contracting State in which they arise, and according to the law of that State, but, if the recipient is the beneficial owner of the royalties, the tax so charged shall not exceed: a) in the case of the Philippines, 15 per cent of the gross amount of the royalties, where the royalties are paid by an enterprise registered with the Philippine Board of Investments and engaged in preferred areas of activities and also royalties in respect of cinematographic films or tapes for television or broadcasting; 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 cinematograph films, or tapes for television or broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience. xxx xxx xxx." Based on the foregoing provisions, royalties arising in the Philippines and paid to a resident of Italy may be taxed in the Philippines at a rate not to exceed (a) 15 percent of the gross amount of the royalties where the enterprise paying the royalties is registered with the Board of Investment and engaged in preferred areas of activities and also royalties in respect of cinematograph films or tapes for television and broadcasting; and (b) 25 percent of the gross amount of the royalties, in all other cases. Such being the case, this Office is of the opinion and so holds that since Draka is not registered with the Board of Investment, and since the subject royalties are not paid in respect of the use of cinematograph films or tapes for television and broadcasting, royalties paid by Draka to Prysmian in both Agreements are subject to income tax at the rate of 25 percent of the gross amount of the royalties . Furthermore, royalties, being payments for the use or lease of intangible properties in the Philippines, are subject to value-added tax ("VAT"). Section 108 (A) of the Tax Code, as amended, provides: HSaIDc "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 two and four-fifth percent (2 4/5%); 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 The phrase 'sale or exchange of services shall likewise include : (1) The lease or the use of or the right or privilege to use any copyright, patent, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or right; xxx xxx xxx" 2 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. 3 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. HEAcDC 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. 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, as amended, 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. cDCSET Such being the case, royalties paid by Draka , being a PEZA-registered enterprise, to Prysmian under both 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. "Sales Value" means the gross invoiced sales of the Products manufactured by the Licensee (or by any Contractor on behalf of the Licensee) and sold or leased by Licensee, less (i) allowances for the defective Products, (ii) normal quantity and trade discounts, (iii) freight, insurance, packing expenses, and (iv) any taxes levied on the manufacture and trade of the Products which are included in the invoice price. With respect to such Products manufactured by the Licensee and sold or transferred by the Licensee for other than cash only, the Sales Value shall be the quantity of such Products multiplied by the weighted average of the unit price derived from the Sales Value for the same Products sold in the same calendar quarter for cash only. 2. 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. 3. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337].