ITAD BIR Ruling No. 150-11

May 16, 2011 ITAD BIR RULING NO. 150-11 Article 12, Philippines-Japan tax treaty, as amended; BIR Ruling No. 096-81; BIR Ruling No. DA-ITAD-98-05; BIR Ruling No. DA-ITAD-60-06; BIR Ruling No. DA-ITAD-102-06; BIR Ruling No. DA-ITAD-65-08; BIR Ruling No. ITAD-011-10 MKP, Inc. Lot 14 Block 18, Phase IV Cavite Economic Zone Rosario, Cavite Attention: Mr. Shigeaki Oya General Manager Gentlemen : This refers to your letter dated August 9, 2010 requesting that the royalties to be paid by MKP, INC. ("MKP") to MURAKI LTD. ("Muraki") are subject to preferential tax rate under 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 by a Protocol 1 effective January 1, 2009. It is represented that Muraki is a corporation organized and existing under the laws of Japan and is a resident of Japan based on the Residence Certificate issued by the Nihonbashi Tax Office in Japan on July 7, 2010; that Muraki is located at 9-10 Nihonbashi, 3-Chome Chuo-ku, Tokyo, Japan; that Muraki is not registered as a corporation or partnership in the Philippines based on the Certificate of Non-Registration of Company issued by the Securities and Exchange Commission on July 19, 2010; that, on the other hand, MKP is a domestic corporation located at Lot 14, Block 18, Phase IV, Cavite Economic Zone, Rosario, Cavite, Philippines; and that MKP is registered with the Philippine Economic Zone Authority ("PEZA") under Certificate of Registration No. 00-078 issued by PEZA on September 26, 2000. It is further represented that on August 28, 2008, MKP and Muraki entered into a Technical Support Agreement where Muraki grants MKP the right to engage in manufacturing activities using Muraki's technical data and information, which consist of know-how technology and other technological or business information necessary for such manufacturing activities; that specifically, Muraki will undertake the following activities for MKP: 1. Muraki will transfer technical processes and procedures to MKP for its manufacturing activities; SAHaTc 2. Muraki will, upon written request of MKP or at the discretion of Muraki , send its employees to MKP for a certain period which it deems necessary to provide technical sessions and new-technology updates to MKP; 3. Muraki may consign necessary resources and equipment to MKP; 4. Muraki will assist MKP in looking for machinery and equipment for its tapping, champering, annealing and wasting activities; 5. Muraki will assist MKP in evaluating its products for quality control; 6. Muraki will assist MKP in evaluating machinery breakdown, diagnosing such problems, recommending optimum solutions, and implementing such solutions. It is further represented that Muraki assures that the technical information are suitable for tapping, champering, annealing and washing of various parts relating to MKP's manufacturing activities; that in consideration, MKP will pay technical support fees (royalties) to Muraki amounting to 100,000,000.00, for the one-year term of the Agreement; that conversion of the royalties from the Philippine peso to Japanese yen will be done at prevailing official market exchange rates on the last day of the effectivity of the Agreement; that MKP will pay the royalties through bank remittance at the designated account of Muraki ; that the Agreement was effective for one year from September 1, 2008 to August 31, 2009; and that the Agreement was registered with the Intellectual Property Office ("IPO") under Certificate of Compliance No. 5-2008-00086 issued on October 13, 2008, valid for one year from September 1, 2008 to August 31, 2009. It is further represented that on August 25, 2009, MKP and Muraki entered into another Technical Support Agreement under the same terms and conditions as the first Agreement except that the amount of the support fees (royalties) was reduced to 50,000,000.00 for the half-year term of the renewed Agreement, which was effective from September 1, 2009 to February 28, 2010; and that the Agreement was also registered with the IPO under Certificate of Compliance No. 5-2009-00067 issued also on August 28, 2009, valid from September 1, 2009 to February 28, 2010. It is finally represented that the royalties subject of the application are not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Certification issued by the General Manager of MKP on August 3, 2010. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code ("Tax Code") of 1997, as amended, provides that royalties paid to Muraki , being a foreign corporation not engaged in trade or business in the Philippines, are subject to income tax in the Philippines at the rate of 30 percent, thus: IDCScA "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 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): 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 the royalties may be exempt or partially exempt (if subject to reduced rate only) to the extent required by any treaty obligation on the Philippines, viz. : "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 you invoke is the Philippines-Japan tax treaty. 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) 25 per cent of the gross amount of the royalties in all other cases. AHaDSI xxx xxx xxx 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" The Protocol amended paragraph 2 as follows: "(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 provisions, 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) 10 percent of the gross amount of the royalties if the company paying the royalties is registered with the Board of Investments ("BOI") and engaged in preferred areas of investments under the investment incentive laws of the Philippines; (b) 15 percent of the gross amount of the royalties if they 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 (c) before January 1, 2009, 25 percent of the gross amount of the royalties in all other cases, and beginning January 1, 2009, 10 percent of the gross amount of the royalties in all other cases. 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. Accordingly, since MKP is not registered with the BOI, and since the royalties in question are not in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, such royalties to be paid by MKP to Muraki under the Agreements, being essentially royalties for the use of, or the right to use, information concerning industrial, commercial or scientific experience ("know-how") , are subject to income tax at the rate of (a) before January 1, 2009, 25 percent of the gross amount of the royalties, and (b) beginning January 1, 2009, and thereafter, 10 percent of the gross amount of the royalties. (BIR Ruling No. 096-81 dated June 11, 1981; BIR Ruling No. DA-ITAD-98-05 dated September 7, 2005; BIR Ruling No. DA-ITAD-60-06 dated May 30, 2006; BIR Ruling No. DA-ITAD-102-06 dated August 28, 2006; BIR Ruling No. DA-ITAD 065-08 dated September 10, 2008; BIR Ruling No. ITAD-011-10 dated June 16, 2010) aSITDC Furthermore, the royalties in question, being payments for the use or lease of (intangible) properties in the Philippines are 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%) 2 of gross receipts derived from the sale or exchange of services, including the use or lease of properties . (Emphasis supplied) xxx xxx xxx" However, since MKP is registered with PEZA and covered by the provisions of Republic Act No. 7916, 3 as amended, the Supreme Court, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866, February 11, 2005), held, viz. : "Special laws may certainly exempt transactions from the VAT. 4 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 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. caAICE 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" Accordingly, MKP, being an "exempt" entity, cannot be directly charged for VAT on its sales of goods and services nor indirectly made to bear, as added cost to such sales, the equivalent VAT on its purchase of goods and services when such purchase is subject to VAT. Therefore, since Muraki is a nonresident supplier of goods and services and not registered in the Philippines for VAT purposes, the royalties to be paid by MKP to Muraki under the two Agreements for the use or lease of certain intangible properties in the Philippines are, instead of being subject to VAT at zero percent, 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. aEIADT 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. 2. Effective February 1, 2006, the rate shall be 12%. 3. An Act Providing for the Legal Framework and Mechanisms for the Creation, Operation, Administration, and Coordination of Special Economic Zones in the Philippines, Creating for this Purpose, the Philippine Economic Zone Authority (PEZA), and for other Purposes. 4. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337].