ITAD BIR Ruling No. 094-14

June 24, 2014 ITAD BIR RULING NO. 094-14 Article 12, Philippines-Japan tax treaty, as amended Isla Lipana and Co. 29th Floor, Philamlife Tower 8767 Paseo de Roxas Makati City Attention: Atty. Malou P. Lim Partner, Tax Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on February 20, 2012 requesting confirmation that royalties paid by Yokohama Tire Philippines, Inc. ("Yokohama Philippines") to Yokohama Rubber Company Ltd. ("Yokohama") are subject to a preferential income tax rate of 10 percent pursuant to Article 12 of 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") . 1 Facts Yokohama is a corporation organized and existing under the laws of Japan and is a resident thereof based on its Articles of Incorporation and Certificate of Status of Taxable Person issued by the Shiba Tax Office in Japan on August 19, 2011. Yokohama has principal address at 5-36-11 Shimbashi, Minato-ku, Tokyo, Japan. Yokohama is in the business of manufacturing and selling various kinds of tires, tubes, industrial rubber products and other rubber products, plastic products, and other chemical products. It is not registered either as a corporation or partnership in the Philippines based on the Certification of Non-Registration issued by the Securities and Exchange Commission on December 28, 2011. On the other hand, Yokohama Philippines is a corporation organized and existing under the laws of the Philippines and has principal address at Industrial Estate 5, Clark Freeport Zone, Clark Field, Pampanga, Philippines. Based on Certificate of Registration and Tax Exemption No. C2011-122 issued by Clark Development Corporation on April 1, 2011, Yokohama Philippines is registered with the Clark Development Corporation since June 13, 1996 as a Clark Freeport Zone. Yokohama Philippines is in the business of manufacturing and selling automobile, truck, and aircraft tires and tubes and other rubber products. Under RA 7227, as amended by RA 9400, Yokohama Philippines is subject to a tax of five percent (5%) of its gross income in lieu of national and local taxes. 2 HDacIT On January 1, 2010, Yokohama and Yokohama Philippines entered into a Technical Assistance and Trademarks License Agreement where Yokohama granted Yokohama Philippines a non-exclusive license to manufacture in the Philippines ground vehicle tires and other related rubber compounds with the brand 'YOKOHAMA' and to use and sell these products. In the process, Yokohama Philippines will use Yokohama 's licensed trademarks which consist of trade names, trademarks, brands, identification symbols and the like which Yokohama owns and controls or will own and control in connection with the sale and use of its tires and tire related products. Also, Yokohama will supply technical information to Yokohama Philippines which refer to all technical information, know-how, knowledge and data which are presently or will be in Yokohama 's possession and used by it in relation to the products, including details of the products construction, proper methods of the use of raw materials, intermediates, ingredients, processes, machinery and equipment for manufacturing and testing the products. In providing technical information, Yokohama will send its engineers, production representatives, consultants, and technical experts to Yokohama Philippines ' place of business in the Philippines, or will receive the latter's personnel to receive training in Japan at Yokohama 's facilities and plants in Japan. All related costs such as roundtrip airfare, accommodations, meal and domestic transportation will be borne by Yokohama Philippines . In consideration, Yokohama Philippines will pay royalties to Yokohama equivalent to 4 percent of the net sales of the products. The royalties will be paid semi-annually and within sixty days after the end of June and December of each calendar year. The royalties will be paid in US dollars. The Agreement took effect on January 1, 2010 for an initial term of five years; thereafter, the Agreement will be automatically renewed for another period or periods of five years. Based on the Certification issued by Mizuho Corporate Bank Ltd.-Manila Branch 3 on June 21, 2013, royalties together with reimbursement of travel expenses were remitted by Yokohama Philippines to Yokohama as follows: aDcHIS Nature of Payment Amount Date of Remittance (in US Dollars) Royalties 210,721.47 February 19, 2013 Travel Expenses 1,169.2 February 19, 2013 Total 211,890.67 ========= 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 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: * Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." DaAISH 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 derived by a resident of Japan from sources in the Philippines, 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. TECcHA 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. 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 Article 12, royalties arising in the Philippines and paid to a resident of Japan may be taxed in the Philippines at a rate not to exceed (a) 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 or television broadcasting, and (b) 10 percent in all other cases. The term 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") . cSDHEC Accordingly, since the royalties subject of the Agreement for the use of the licensed trademarks ( i.e. , trade names, trademarks, brands, identification symbols and the like) and the use of technical information ( i.e. , technical information, know-how, knowledge and data) are, primarily, in respect of trademark and know-how and not for cinematograph films and films or tapes for radio or television broadcasting, such royalties paid by Yokohama Philippines to Yokohama are subject to a preferential tax rate of 10 percent , pursuant to paragraph 2 (b), Article 12 of the Philippines-Japan tax treaty, as amended. Concerning value-added tax ("VAT"), the use in the Philippines of the abovementioned intangible properties are subject to VAT under Section 108 (A) of the Tax Code, as amended, 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: Provided, that the President, upon the recommendation of the Secretary of Finance, shall, effective January 1, 2006, 4 raise the rate of value-added tax to twelve percent (12%) . . ." However, pursuant to RA 7227, as amended, and considering that Yokohama Philippines is a Clark Freeport Zone enterprise and enjoys a special tax regime of 5 percent of its gross income in lieu of national and local taxes, Yokohama Philippines is entitled to the same VAT exemption given to enterprises registered with the Philippine Economic Zone Authority ("PEZA") under RA 7916. 5 HcDSaT In Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866 dated February 11, 2005), ("Seagate ruling") , the Supreme Court ruled that transactions entered into by PEZA-registered enterprises with VAT-registered taxpayers and non-VAT taxpayers like foreign suppliers of goods and services and lessors of properties continue to be exempt from VAT in keeping with the intention of RA 7916 that the 5 percent tax regime is in lieu of national internal revenue taxes . While it can be argued that VAT is imposed on the transaction, the fact that it can be passed-on or shifted to the person using the subject goods, services, and properties violates the spirit of RA 7916 when such person happens to be a PEZA-registered enterprise who indirectly borne the tax. The pertinent portion of the Seagate ruling reads: "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: 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. CDISAc 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 Yokohama , the lessor of the intangible properties, is a nonresident foreign person and is not a VAT-registered taxpayer, such royalties paid to it by Yokohama Philippines , a Clark Freeport Zone registered enterprise, shall, for VAT purposes, be treated as exempt and not subject to zero percent VAT. In either case, no output VAT is shifted or passed-on to Yokohama Philippines in the transaction. 6 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. As amended by 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 effective January 1, 2009 . 2. Republic Act No. 7227 entitled An Act Accelerating the Conversion of Military Reservations into Other Productive Uses, Creating the Bases Conversion and Development Authority for the Purpose, Providing Funds Therefore and for Other Purposes , as amended by Republic Act 9400 entitled An Act Amending Republic Act No. 7227, As Amended, Otherwise Known as the Bases Conversion and Development Act of 1992, and for Other Purposes . Section 15 thereof provides: " SEC. 15. Clark Special Economic Zone (CSEZ) and Clark Freeport Zone (CFZ) . . . . . . . The provisions of existing laws, rules and regulations to the contrary notwithstanding, no national and local taxes shall be imposed on registered business enterprises within the CFZ. In lieu of said taxes, a five percent (5%) tax on gross income earned shall be paid by all registered business enterprises within the CFZ and shall be directly remitted as follows: three percent (3%) to the National Government, and two percent (2%) to the treasurer's office of the municipality or city where they are located. " (Emphasis ours) 3. Located at 26th Floor, Citibank Tower, Valero Street corner Villar Street, Salcedo Village, Makati, Philippines. 4. The VAT rate was 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. 5. Republic Act No. 7916 entitled 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. 6. 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."