ITAD BIR Ruling No. 131-14

July 22, 2014 ITAD BIR RULING NO. 131-14 Article 12, Philippines-Japan tax treaty, as amended Chaves Hechanova & Lim Law Offices Unit 7D, 7th Floor, Corinthian Plaza Condominium 121 Paseo de Roxas cor Gamboa Sts. Makati City 1229 Attention: Atty. Alfredo C. Lim Partner Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on December 13, 2011 requesting confirmation that the royalty payments made by Itabashi Seiki Philippines, Inc. ("Itabashi Phil") to Itabashi Seiki Co., Ltd. ("Itabashi Japan") are subject to the 10 percent preferential tax rate pursuant to Article 12 (2) (b) 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, as amended by "Protocol" 1 ("Philippines-Japan tax treaty, as amended"). It is represented that Itabashi Japan , with address at 4-45-17 Ikebukuro-honcho. Toshima-ku, Tokyo, Japan, is a corporation organized and existing under the laws of Japan and is a resident of Japan within the meaning of the Philippines-Japan tax treaty as evidenced by the Residence Certificate issued by the District Director of Toshima Tax Office dated November 22, 2011; that Itabashi 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 on September 22, 2011; that, on the other hand, Itabashi Phil is a corporation duly organized and existing under the laws of the Philippines with principal place of business at Lots 1, 1A, 3 & 5 Block 16, Phase 4, Cavite Export Processing Zone, Rosario, Cavite; and that Itabashi Phil is registered with the then Export Processing Zone Authority, now Philippine Economic Zone Authority (PEZA) with Certificate of Registration No. 95-06 issued on January 2, 1995; and that the PEZA registration of Itabashi Phil remains in full force and effect and has not been cancelled to date. HSCcTD It is further represented that on July 6, 2011, Itabashi Japan and Itabashi Phil entered into a Technological Transfer and Assistance Agreement (" Agreement ") which shall be effective for a period of three (3) years to commence on August 1, 2011 and to expire on July 31, 2014 unless sooner terminated by agreement of the parties; and that the Agreement complies to the provisions of Sections 87 and 88, Chapter IX of the Intellectual Property Code of the Philippines (Republic Act No. 8293) on Voluntary Licensing under the Certificate of Compliance No. 5-211-0051 issued by the Intellectual Property Office on July 22, 2011. It is also represented that pursuant to the Agreement, Itabashi Japan shall provide technology transfer and assistance as follows: a) Carry out appropriate guidance with regard to the improvement of defective boards rate and quality of printed wiring boards produced by Itabashi Phil ; b) Advice Itabashi Phil with regard to its sales activities with the end in view of increasing sales; c) Counsel and advise Itabashi Phil with regard to managing Itabashi Phil' business. As consideration for the furnishing of technical and assistance service by Itabashi Japan , it is represented that Itabashi Phil shall pay Itabashi Japan in U.S. Dollar ($) in the calculation formula of Basic fee rate: Single-sided product sales amount ($) x 2%. It is moreover represented, based on a notarized certification by Itabashi Phil dated December 30, 2011, that the transaction subject of the application for tax treaty relief is not subject of an investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal. HTcDEa It is finally represented that Itabashi Phil paid the technical guidance fee to Itabashi Japan for the period from January 2012 to September 2012 a total amount of US$43,686.00 on September 27, 2012 as evidenced by Sworn Certification of Itabashi Phil dated August 6, 2013. In reply, please be informed that royalties derived in the Philippines by a nonresident foreign corporation are, in general, covered by Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended. It provides: "Section 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 Tax Code of 1997, as amended, provides that: "Section 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. ASaTHc xxx xxx xxx" With respect to a treaty, what is being invoked for this purpose is Article 12 of the amended Philippines-Japan tax treaty. It provides as follows: "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. . . ." Based on the foregoing, royalty derived in the Philippines by a resident of Japan will be taxed at a preferential rate of 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, 10 percent in all other cases. Accordingly, said payments by Itabashi Phil to Itabashi Japan being essentially royalties for the use or the right to use technical information and intellectual rights are hereby subject to income tax at the preferential rate of 10 percent of the gross amount thereof, pursuant to paragraph 2, Article 12 of the Philippines-Japan tax treaty, as amended. As regards the imposition of the VAT on the transfer of technical know-how of Itabashi Japan , please be informed further that Section 108 of the Tax Code of 1997 provides as follows: CTSAaH "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 . (Emphasis supplied) xxx xxx xxx" Thus, in general, the VAT is imposed on the transfer of technical know-how by Itabashi Japan in the Philippines, such that on every payment of royalty fees, Itabashi 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. However, the Tax Code provides that those falling under PD 66 are not. P.D. 66 is the precursor of R.A. 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 P.D. 66 and R.A. 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. cETDIA 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: . . ., R.A. 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 R.A. 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. cAECST xxx xxx xxx" Based on the foregoing, transactions exempt from VAT by reason of P.D. 66 and R.A. 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. Such being the case, the subject royalty payments to Itabashi Japan by Itabashi Phil , being a PEZA-registered enterprise, under the 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. 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.