ITAD BIR Ruling No. 098-11

March 21, 2011 ITAD BIR RULING NO. 098-11 Article 12, Philippines-Japan tax treaty, as amended; BIR Ruling No. ITAD-11-10 Romulo Mabanta Buenaventura Sayoc & De Los Angeles 30th Floor, Citibank Tower 8741 Paseo de Roxas Makati City Attention: Atty. Priscilla B. Valer Gentlemen : This refers to your letter dated November 5, 2009, on behalf of your client, Imasen Electric Industrial Co. Ltd. (hereinafter referred to as "Imasen Japan" ) requesting confirmation that the royalty payments by Imasen Philippine Manufacturing Corporation (hereinafter referred to as "Imasen Philippines" ) to Imasen Japan pursuant to a Technical Assistance Agreement are subject to 10 percent final tax under Article 12, paragraphs 2 and 3 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 (hereinafter referred to as the "Philippines-Japan tax treaty" ) as amended by its Protocol which took effect on January 1, 2009. It is represented that Imasen Japan is a nonresident corporation duly organized and existing under the laws of Japan with address at 1 Aza Kakihata, Inuyama, Aichi, Japan as evidenced by the Certificate of Entire Record of Corporate Registration issued by Inuyama District Office dated August 31, 2009; that it is not registered as a corporation nor as a partnership in the Philippines per a Certification of Non-Registration of Company issued by the Securities and Exchange Commission dated October 26, 2009; that, on the other hand, Imasen Philippines is a corporation duly organized and existing under Philippine laws with principal office at 101 East Main Avenue, Laguna Technopark, Bian, Laguna; and that Imasen is registered with the Philippine Economic Zone Authority (PEZA) under Certificate of Registration No. 96-114 issued on November 11, 1996, engaged in the manufacture and export of car components and accessories. It is further represented that on October 1, 2007, a TECHNICAL ASSISTANCE AGREEMENT (hereinafter referred to as "Agreement" ), covered by Certificate of Registration No. 5-2008-00096 issued by the Intellectual Property Office, was entered into by and between Imasen Japan and Imasen Philippines whereby Imasen Japan granted to Imasen Philippines the non-transferable and non-exclusive right to manufacture, assemble and sell the Licensed Products 1 using the Know-How 2 and the Industrial Property Rights; 3 that in consideration of the rights granted under the Agreement, Imasen Philippines shall pay Imasen Japan two percent (2%) of net sales 4 as royalty plus an initial fee to be paid within 30 days after receiving the drawing and other technical information; that Imasen Philippines shall have no right to sublicense the right and license granted by Imasen Japan to any third party but however, this provision does not restrict the manufacture of parts, molds and jigs by duly authorized sub-contractors; and that during the term of the Agreement, Imasen Japan shall dispatch Imasen Japan's trainers for technical guidance to Imasen Philippines, accept and train Imasen Philippines' trainees and provide Imasen Philippines with the Know-how. It is finally represented that the Agreement shall be for a term of five (5) years and shall remain effective beginning 1 January 2008 up to the end of December of the year 2013; and that the issue subject of the above request is not under any investigation or on-going audit, administrative protest, claim for refund or issuance of tax credit certificate, collection proceedings, or a judicial appeal. In reply, please be informed that royalty income derived by a nonresident foreign corporation is generally subject to tax as provided for under Section 28, (B) (1) of the National Internal Revenue Code of 1997 (Tax Code of 1997), as amended. It provides: "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 . . . royalties . . .: 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 same Tax Code provides as follows, 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: 5 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 relation thereto, Article 12 of the Philippines-Japan tax treaty which you invoked, may apply to the instant case. It provides, viz. : "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) 25 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." Based on the above provision, royalty income derived in the Philippines by a corporation which is a resident of Japan shall be taxed at a preferential rate of 10 percent if the payor company is BOI-registered engaged in preferred pioneer areas of investment; 15 percent if the payments are in respect of the use of or right to use cinematograph films and films or tapes for radio or television broadcasting; and 25 percent in all other cases. Considering that Imasen Philippines, the payor of the royalties, is not BOI-registered, the subject royalty payments to Imasen Japan from October 1, 2007 up to December 31, 2008 may not qualify for the 10 percent treaty rate being applied for. Instead of the 10 percent rate, the said payments merely qualify for a 25 percent preferential tax rate under Article 12 (2) [b] of the Philippines-Japan tax treaty. However, a Protocol amending the existing Philippines-Japan tax treaty took effect on January 1, 2009 whereby the aforementioned 25 percent tax rate was reduced to 10 percent. Accordingly, royalty income accruing on January 1, 2009 may qualify for the application of a 10 percent preferential tax rate pursuant to the Protocol. Article V of the said Protocol provides, viz. : "Paragraph (2) of Article 12 of the Convention shall be 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 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." (Emphasis supplied) In view of all of the foregoing, this Office is of the opinion and so holds that the subject royalty payments by Imasen Philippines to Imasen Japan under the Technical Assistance Agreement are subject to tax at a rate not exceeding 25 percent based on the gross amount of the royalty from October 1, 2007 up to December 31, 2008. However, the royalty payments accruing from January 1, 2009 and thereafter shall be subject to tax at a rate not exceeding 10 percent based on the gross amount of the royalty, pursuant to Article 12 of the Philippines-Japan tax treaty, as amended. (BIR Ruling No. ITAD-11-10 dated June 16, 2010) As regards the imposition of the VAT on the royalty fees to Imasen Japan, please be informed further that Section 108 of the Tax Code of 1997, as amended by Republic Act No. 9337, 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%) 6 of gross receipts derived from the sale or exchange of services, including the use or lease of properties: Provided, That the President, upon 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 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 percentage of GDP of the previous year exceeds one and one-half percent (1 1/2%). xxx xxx xxx '(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" Thus, in general, the VAT is imposed on the royalty payments made to Imasen Japan in the Philippines. On every payment of royalty fees, Imasen Philippines is 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. : "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" Such being the case, the payment of royalty fees by Imasen Philippines, being a PEZA-registered enterprise, to Imasen Japan under the above Agreement 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. Shall mean automobile parts designed, manufactured and sold by Imasen Japan. 2. Shall mean all materials and documents containing any technical information, know-how, data or knowledge including drawings, standards and specifications which are owned by Imasen Japan or for which Imasen Japan is entitled to grant a license to Imasen Philippines from time to time, necessary for; (1) manufacturing, assembling or selling the Licensed Product; (2) establishing and administering the manufacturing Factory of the Licensed Product. 3. Shall mean patent rights, design rights and other legal industrial property rights in respect of the Licensed Product which are owned by Imasen Japan or for which Imasen Japan is entitled to grant a license to Imasen Philippines from time to time. 4. Shall mean the gross sales of the Licensed Product after deducting; (1) returned Licensed Product (2) actual costs of parts purchased from Imasen Japan and import expenses and duties arising from the importation from Imasen Japan (3) cost of packing, transportation and insurance arising from the sales in the Territory. 5. TITLE II TAX ON INCOME. 6. 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.