ITAD BIR Ruling No. 147-15

May 4, 2015 ITAD BIR RULING NO. 147-15 Article 12, Philippines-Japan tax treaty, as amended MSM Cebu, Inc. 5th Street, Mactan Economic Zone (MEZ 1) Pusok, Lapu-lapu City Mactan Island, Cebu City Attention: Ms. Edna L. Flores Office Manager Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on February 19, 2013, on behalf of Mitsubishi Steel Manufacturing Co., Ltd. ("Mitsubishi Steel") , requesting confirmation that the royalty payments of MSM Cebu, Inc. ("MSM Cebu") are subject to 10 percent preferential tax rate pursuant to the amended 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 Mitsubishi Steel , with address at 2-22, Harumi 3 chome, Chuo-ku, Tokyo, 104-8550, Japan, is a corporation organized and existing under the laws of Japan and is a resident of Japan per Application for Certification of Residence issued by the Kyobashi District Tax Office on July 25, 2012; that Mitsubishi Steel 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 March 30, 2012; that Mitsubishi Steel is engaged in the business of manufacturing and selling various kind of precision springs with its related products and assembled products; on the other hand, MSM Cebu is a domestic corporation engaged in manufacturing of flat springs, tension springs, torsion springs, compression spring for industrial purpose with principal office address located at 5th Street, Mactan Economic Zone (MEZ 1), Pusok, Lapu-lapu City, Mactan Island, Cebu City; and that it is registered with the Philippine Economic Zone Authority (PEZA) under Certificate of Registration No. 94-70 dated September 19, 1994 per certification issued by PEZA dated May 17, 2012. It is also represented that Mitsubishi Steel and MSM Cebu entered into a Technical Assistance Agreement ("Agreement") , which took effect on April 1, 2011 until the expiration of a period of three (3) years, and shall be renewable for further three (3) year term under the Agreement; that Mitsubishi Steel grants a non-exclusive license to use management, sales and marketing and technical information, knowledge, know-how, methods, design, experience and all documents including drawings, manuals and instructions as have heretofore been developed and acquired by Mitsubishi Steel with respect to manufacture and sale of precision springs with its related products as shall be manufactured by Mitsubishi Steel ; that MSM Cebu shall pay Mitsubishi Steel a running royalty at the rate of four percent (4%) of Net Sales Price; that the payment of royalty shall be made within one month from the end of March, June, September and December respectively each year of the preceding three month period royalty; that MSM Cebu issued sworn certification showing payment of royalties for the Agreement from July 22, 2011 until January 23, 2013; and that MSM Cebu remitted the royalty payments to Mitsubishi Steel on July 24, 2012, October 23, 2012 and January 23, 2013, as evidenced by Certificate of Remittance issued by Bank of Tokyo-Mitsubishi UFJ-Manila Branch. 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 MSM Cebu dated February 5, 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. xxx xxx xxx" With respect to a treaty, what is being invoked for this purpose is Article 12 of the Philippines-Japan tax treaty, as amended. 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. 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. 5. The provisions of paragraphs 1, 2 and 3 shall not apply if the beneficial owner of the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties arise, through a permanent establishment situated therein, or performs in that other Contracting State independent personal services from a fixed base situated therein, and the right or property in respect of which the royalties are paid is effectively connected with such permanent establishment or fixed base. In such case the provisions of Article 7 or Article 14, as the case may be, shall apply. xxx xxx xxx" Based on the Protocol amending the Philippines-Japan tax treaty which took effect on January 1, 2009, royalties derived in the Philippines by a resident of Japan will be taxed at a preferential rate of 15 percent if the same 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, since the royalties paid by MSM Cebu to Mitsubishi Steel , which is a resident of Japan, are not paid in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, said royalties are subject to income tax at the reduced rate of 10 percent of the gross amount thereof, pursuant to Article 12 (2) of the Philippines-Japan tax treaty, as amended. Finally, such license fees, being payments for the use or lease of (intangible) properties in the Philippines, are generally subject to value-added tax ("VAT"). Section 108 (A) of the Tax Code of 1997, as amended, 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 MSM Cebu , being a PEZA-registered enterprise, to Mitsubishi Steel under the subject contracts 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].