ITAD BIR Ruling No. 148-15

May 4, 2015 ITAD BIR RULING NO. 148-15 Article 12, Philippines-Japan tax treaty; Section 28 (B) (1) in relation to Section 32 (B) (5) of the Tax Code of 1997, as amended Fernandez Aguja Law Firm Suite 5F JL Building, Don Jose Avila corner Don Gil Garcia Streets, Cebu City Attention: Atty. Luna Mae F. Aguja Gentlemen : This refers to your tax treaty relief application filed on March 8, 2013 requesting confirmation that the royalty payments made to Kyocera Crystal Device Corporation ("Kyocera JP") by Kyocera Crystal Device Philippines, Inc. ("Kyocera PH") are subject to preferential tax rate of 10 percent 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 as amended by a Protocol 1 ("Philippines-Japan tax treaty") . It is represented that Kyocera JP is a resident of Japan with address at No. 8-1, 1 chome, Izumi-honcho, Komae-shi, Tokyo, Japan, based on the Certificate of Residence dated July 13, 2012, issued by the tax authority of Japan; that Kyocera JP is not registered as a corporation or as a partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission dated February 11, 2013; that on the other hand, Kyocera PH is a domestic corporation with address at New Cebu Township One, Special Economic Zone, Barangay Cantaoan, Naga, Cebu; and that Kyocera PH is registered with the Philippine Economic Zone Authority (PEZA) under Amended Certificate of Registration No. 97-016 dated February 22, 2012. It is further represented that on April 1, 2013, Kyocera JP and Kyocera PH entered into a Technical Support and Service Agreement ("Agreement") whereby Kyocera JP permitted Kyocera PH to receive and use exclusively in the Philippines such technical advice, design, cooperation, information, quality control, project evaluation, experience and production support for the production of its products and the improvement and/or increase in production and manufacture of such products; that for and in consideration of such permit, Kyocera PH shall pay Kyocera JP a royalty equivalent to one percent of Kyocera PH's total sales revenue for the products; that the royalty payments shall be made in US$ within ninety days after the monthly closing date based on operating calendar; and that the first payment was made on July 26, 2013 based on the Certification issued by Bank of the Philippine Islands, Cebu Mez 1 Branch on July 29, 2013. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code of 1997 (" Tax Code "), as amended, provides: "SEC. 28. Rates of Income Tax on Foreign Corporations . (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: n Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." However, such royalties may be exempt or subject to a reduced rate to the extent required by any treaty obligation on the Philippines. Section 32 (B) (5) of the Code provides: "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) Income Exempt under Treaty . Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines." Thus, you invoke the Philippines-Japan tax treaty. With respect to royalties, Paragraphs 1, 2, 3 and 4, Article 12 thereof provide: "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" Under paragraphs 2 and 3 of Article 12 of the Philippines-Japan tax treaty, 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 of the gross amount of the royalties if they are paid in respect of the use or the right to use of 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; (c) 10 percent of the gross amount of the royalties if they are paid by a domestic company registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines. Under paragraph 4 of Article 12, 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"). In this case, payments for the use of the Product are treated as payments for information concerning industrial, commercial or scientific experience, specifically, knowhow in the production of hairpieces of all kinds and nature. Thus, this Office is of the opinion and so holds that royalty payments made by Kyocera PH to Kyocera JP shall be treated as royalties subject to 10 percent of the gross amount thereof . As regards the imposition of the VAT on royalties paid to Kyocera JP , please be informed further that Section 108 of the Tax Code of 1997 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 twelve percent (12%) of gross receipts derived from the sale or exchange of services, including the use or lease of properties. The phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for others for a fee, . . . The phrase 'sale or exchange of services' shall likewise include: xxx xxx xxx (2) The supply of scientific, technical or commercial knowledge information; xxx xxx xxx" In Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866 dated February 11, 2005), the Supreme Court ruled that: "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. 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 Kyocera PH is an enterprise registered with the PEZA and as such is an exempt entity, it can neither be directly charged with VAT nor indirectly made to bear, as added cost, the equivalent VAT. Thus, the royalty fees to be paid by Kyocera PH to Kyocera JP under the Agreement as consideration for the transfer of Know-how are 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 effective January 1, 2009. n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.