ITAD BIR Ruling No. 090-15

March 25, 2015 ITAD BIR RULING NO. 090-15 Article 12, Philippines-Japan tax treaty, as amended Pilipinas Kao, Inc. 7th Floor, Tower One and Exchange Plaza Ayala Triangle, Ayala Avenue Makati City Attention: Mr. Reynaldo M. Ganal Vice President Finance and Administration Gentlemen : This refers to your tax treaty relief application filed on October 30, 2009 requesting confirmation that royalties paid by Pilipinas Kao, Inc. ("Pilipinas Kao") to Kao Corporation ("Kao") 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") , as amended. 1 Facts Kao is a foreign corporation and a resident of Japan based on its Certification of Corporate Residence for Tax Purposes issued by the Nihonbashi Tax Office on May 12, 2010. It is engaged in the research, manufacture and sale of products on beauty care, human health care, and fabric and home care, and chemicals. It is located at 14-10, Nihonbashi Kayabacho 1-chome, Chuo-ku, Tokyo, Japan. Kao 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 October 23, 2009. On the other hand, Pilipinas Kao is a domestic corporation with office head office at Jasaan Misamis Oriental Ecozone, 9003 Jasaan, Misamis Oriental, and liaison office at 7th Floor, Tower One and Exchange Plaza, Ayala Triangle, Ayala Avenue, Makati City, in the Philippines. It is registered with the Philippine Economic Zone Authority ("PEZA") as an ecozone export enterprise under Certificate of Registration No. 01-30 issued on April 26, 2001. Kao Pilipinas is engaged in the manufacture and distribution of oleochemicals using coconut oil as main raw material. HDCAaS On January 1, 2008, Pilipinas Kao and Kao entered into a License, Technological, and Other Business Agreement where Kao granted Pilipinas Kao a non-exclusive and nontransferable license to use certain know-how, patents, and trademarks to manufacture and distribute chemical products such as surfactants, polyurethane, oleo, tertiary amine, aroma chemical and compound, toner and toner binder, and akypo. These intangible properties are developed by and belong to Kao . In consideration, Pilipinas Kao will pay royalties to Kao based on the net sales of the products or equivalent to 1.5 percent for surfactants, polyurethane, and oleo, and 3.0 percent for tertiary amine, aroma chemical and compound, toner and toner binder, and akypo. The royalties are calculated and payable semiannually and due within two months after each semester. The royalties are payable in Philippine pesos or in foreign currency specified by Kao at the time of payment. The Agreement took effect on January 1, 2008 for an initial term of three years or until December 31, 2010. Afterwards, the agreement is deemed renewed automatically for successive periods of three years. Ruling In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997, as amended ("Tax Code") , royalties and other forms of income derived in the Philippines by a foreign corporation not engaged in trade or business are subject to income tax at the general rate of 30 percent, to wit: IESDCH "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 Tax Code, such income is 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: IDaCcS 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." For this purpose, Article 12 of the amended Philippines-Japan tax treaty provides relief to royalties paid to a resident of Japan, to wit: "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. EDACSa 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, the royalties may be taxed in the Philippines at a rate not to exceed (a) 15 percent if the royalties are for 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. Intangible properties within item (b) are copyright of literary, artistic or scientific work (except including cinematograph films and films or tapes for radio or television broadcasting); patent; trade mark; design or model; plan; secret formula or process; industrial, commercial or scientific equipment; and information concerning industrial, commercial or scientific experience ("know-how") . Accordingly, since royalties paid by Pilipinas Kao to Kao for the use of know-how, patents, and trademarks to manufacture and distribute chemical products do not pertain to cinematograph films and films or tapes for radio or television broadcasting, such royalties paid to Kao on are subject to income tax at the rate of 10 percent, pursuant to paragraph 2 (b), Article 12 of the amended Philippines-Japan tax treaty. CADacT Furthermore, under Section 108 (A) of the amended Tax Code, the royalties in question for the use or lease of certain intangible properties are generally 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 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, 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. EcAISC 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 Kao , the licensor of the intangible properties, is a nonresident foreign person and is not a VAT-registered taxpayer, royalties paid to it by Pilipinas Kao , a PEZA-registered entity, are treated as VAT-exempt transaction and not as VAT zero-rated transaction. In either case, no output VAT is shifted or passed-on to Pilipinas Kao in the payment of royalties. 3 TAEDcS 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 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. 3. 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.