ITAD BIR Ruling No. 109-15

April 14, 2015 ITAD BIR RULING NO. 109-15 Article 12, Philippines-Japan tax treaty Isla Lipana & Co. 29th Floor, Philamlife Tower 8767 Paseo de Roxas 1226 Makati City Attention: Ms. Malou P. Lim Partner, Tax Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on February 9, 2012, on behalf of Toshiba Corporation ("Toshiba Japan") , requesting confirmation that the royalty payments to Toshiba Japan by Toshiba Information Equipment (Philippines), Inc. ("Toshiba Phil.") are subject to 10 percent preferential tax rate 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") . It is represented that Toshiba Japan , with address at 1-1, Shibaura 1-Chome, Minato-Ku, Tokyo 105-8001, Japan, is a corporation organized and existing under the laws of Japan and is a resident of Japan per Certificate of Status of Taxable Person issued by the Shiba District Tax Office on February 24, 2012; that Toshiba Japan is not registered either as a corporation or as a partnership in the Philippines as shown in the Certification of Non-Registration of Company issued by the Securities and Exchange Commission (SEC) dated February 8, 2012; on the other hand, Toshiba Phil. is a domestic corporation with principal office address located at 103 East Main Avenue, SEPZ, Laguna Technopark, Bian, Laguna; and that it is registered with the Philippine Economic Zone Authority (PEZA) under Certificate of Registration No. 95-99. It is also represented that Toshiba Japan and Toshiba-Phil . entered into a Technical Collaboration Agreement ("Original Agreement") on June 13, 1996 where the former agreed to provide the latter a non-exclusive license to use Toshiba's Patents and Technical Information for the manufacture of hard disk drives, optical disk drives and printed circuit brands of personal computers in the Philippines; that the Original Agreement was valid from June 13, 2001 to October 1, 2006; that the Agreement was renewed for another 5 years, from October 1, 2006 to September 30, 2011 with the amendment that only hard disk drives are to be manufactured in the Philippines; and that BIR Ruling No. ITAD 011-10 dated June 6, 2010 was issued to Toshiba Japan confirming that Royalty payments under the Agreement are subject to the 25 percent tax rate from October 1, 2006 to December 31, 2008 and to the amended treaty rate of 10 percent beginning January 1, 2009, when the Protocol Amending the Philippines-Japan tax treaty took effect. It is further represented that on October 1, 2011, Toshiba Japan and Toshiba Phil. agreed to renew the Agreement for another 5 years from October 1, 2011 to September 30, 2016; and that parties executed an agreement entitled "Amendment No. 9" to effect the renewal and to set royalty payments at this formula: number of hard disk drives x 3.02 x net sales ; that payment shall be made quarterly within 60 days after the end of March, June, September and December of each year. Moreover, it is represented that the transaction subject of the herein request for ruling is not under investigation, on going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or a judicial appeal of the taxpayers involved per the Sworn Statement issued by Toshiba Phil. dated January 18, 2012. You now request for confirmation that royalty payments under the Agreement, as amended by Amendment No. 9, are subject to income tax at a preferential rate of 10 percent of the gross amount thereof, pursuant to paragraph 2 (b), Article 12 of the Philippines-Japan tax treaty, as amended. "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." xxx xxx xxx" Since license fees represent payments for the use or lease of (intangible) properties in the Philippines, they are subject to value-added tax ("VAT") under Section 108 (A) of the National Internal Revenue Code ("Tax Code") of 1997, as amended which provides: " 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, 1 raise the rate of value-added tax to twelve percent (12%). . . The phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration. . . 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 Lease of properties shall be subject to the tax herein imposed irrespective of the place where the contract of lease or licensing agreement was executed if the property is leased or used in the Philippines . The term 'gross receipts' means the total amount of money or its equivalent representing the contract price, compensation, service fee, rental or royalty, including the amount charged for materials supplied with the services and deposits and advanced payments actually or constructively received during the taxable quarter for the services performed or to be performed for another person, excluding value-added tax." (Emphasis ours) 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. 2 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 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, the sale of goods and services to persons or entities exempt from VAT, by reason of PD 66 and RA 7916, is effectively zero-rated. However, instead of zero-rating which is not available to nonresident suppliers, the provision for exempt transactions under Section 109 (K) of the Tax Code of 1997, 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. Such being the case, the payment of royalty fees by Toshiba Phil., being a PEZA-registered enterprise, to Toshiba Japan under the Original Agreement, as amended 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 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. 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. 2. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337].