Manabat Sanagustin & Co., CPAs

March 25, 2015 ITAD BIR RULING NO. 080-15 Article 12 (2) (b), Philippines-Japan tax treaty, as amended Manabat Sanagustin & Co., CPAs The KPMG Center 9/F 6787 Ayala Avenue Makati City 1226 Attention: Maria Carmela M. Peralta Principal, Tax Gentlemen : This refers to your tax treaty relief application filed on October 25, 2012, on behalf of Senju Metal Industry Co., Ltd. ("Senju-Japan"), requesting confirmation that the royalty payments by Senju Solder (Phils.), Inc. ("Senju-Phil") to Senju-Japan are subject to 10 percent preferential final withholding tax rate pursuant to Article 12 of 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 Senju-Japan is a corporation organized and existing under the laws of Japan with principal address at 23 Senju-Hashidocho, Adachi-ku, Tokyo, Japan, and is a resident thereof within the meaning of Philippines-Japan tax treaty based on the Certificate of Residence issued on October 3, 2012 by the District Director of Adachi Tax Office; that it is not registered either as a corporation or as a partnership in the Philippines per Certification of Non-Registration of Company issued by the Securities and Exchange Commission dated September 17, 2012; and that, on the other hand, Senju-Phil is a corporation organized and existing under the laws of the Philippines, and is registered with the Philippine Economic Zone Authority ("PEZA") under Certificate of Registration No. 95-143 issued on December 14, 1995, with principal address at Block 9 Lot 6 Phase 1, PEZA, Rosario, Cavite. It is further represented that on January 1, 2011, Senju-Phil and Senju-Japan entered into a Comprehensive Licensing Agreement on Manufacturing and Sales Right ("Agreement") where Senju-Japan grants to Senju-Phil a non-exclusive license without sub-licensing and assignable right of all or part of the Intellectual Property Rights held by Senju-Japan to the extent necessary for Senju-Phil to manufacture and sell the Subject Goods with Senju-Japan's brands; that in consideration thereof, Senju-Phil shall pay to Senju-Japan the amount multiplying the base amount of the licensing rate as royalties, which is the amount deducting the amount equal to the raw materials and purchased goods consumed for sale of the Subject Goods in respective subject periods from the total sales amount of the Subject Goods in respective subject periods under the Agreement; that the period of payments of royalties shall be divided into two as the first half beginning as of January 1 every year and ending as of June 30 ("First Half") and the second half beginning as of July 1 every year and ending as of December 31 ("Second Half"); and that, based on a proof of bank's telegraphic transfer, an amount of US$76,806.90 was remitted by Senju-Phil to Senju-Japan on October 30, 2012. 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 royalties derived in the Philippines by a nonresident foreign corporation. It provides: "Section 28. Rates of Income Tax on Foreign Corporations. (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 interest, 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%)." HICcSA However, Section 32 (B) (5) of the Tax Code of 1997, as amended, provides: "Section 32. Gross Income. (B) Exclusions from Gross Income. The following items shall not be included in gross income and shall be exempt from taxation under this Title: (5) Income Exempt under Treaty. Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines. " Thus, Article 12 of the Philippines-Japan tax treaty, as amended, which you invoke, may apply to the instant case. It provides: "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. 3. Notwithstanding the provisions of paragraph 2, the amount of tax imposed by the Philippines on the royalties paid by a company, being a resident of the Philippines, registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines to a resident of Japan, who is the beneficial owner of the royalties, shall not exceed 10 per cent of the gross amount of the royalties. 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. 5. The provisions of paragraphs 1, 2 and 3 shall not apply if the beneficial owner of the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties arise, through a permanent establishment situated therein, or performs in that other Contracting State independent personal services from a fixed base situated therein, and the right or property in respect of which the royalties are paid is effectively connected with such permanent establishment or fixed base. In such case the provisions of Article 7 or Article 14, as the case may be, shall apply. . . . " Based on the aforequoted provisions, the Philippines may tax the royalties paid by a resident thereof to a company which is a resident of Japan at a rate not exceeding 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 and television broadcasting; and 10 percent of the gross amount of royalties in all other cases. In view thereof and considering that Senju-Japan is a resident company in Japan, and that the royalties paid by Senju-Phil to Senju-Japan are not in respect of the use of, or the right to use, cinematograph films and films or tapes for radio and television broadcasting, but for the provision of technical information to improve the quality of the Contract Product being manufactured by Senju-Phil, such royalty fees are subject to the 10 percent final withholding tax rate pursuant to Article 12 (2) (b) of the Philippines-Japan tax treaty, as amended. As regards the imposition of the VAT on royalties paid to Senju-Japan, please be informed further that Section 108 of the Tax Code of 1997 1 provides as follows: "SEC. 108. Value-added Tax on Sale of Services and Use or Lease of Properties. aTEHCc (A) Rate and Base of Tax. There shall be levied, assessed and collected, a value-added tax equivalent to ten percent (10%) 2 of gross receipts derived from the sale or exchange of services, including the use or lease of properties. 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 (2) The supply of scientific, technical or commercial knowledge information; xxx xxx xxx" Thus, in general, the VAT is imposed on the royalties paid to Senju-Japan in the Philippines, such that on every payment of the royalties, Senju-Phil 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. 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. 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, sale of goods and/or services including the use of or lease of properties, to person or entities 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 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 special laws, e.g. , Republic Act No. 7916 or PEZA Law, is particularly applicable to the instant case. HDAECI Such being the case, the royalties paid by Senju-Phil, being a PEZA registered enterprise, to Senju-Japan under the Agreement should be, as it is hereby confirmed to be, exempt from VAT. This ruling is issued on the basis of the foregoing 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. 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. 2. Effective February 1, 2006, the rate shall be 12%. 3. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337].