ITAD BIR Ruling No. 150-13

June 13, 2013 ITAD BIR RULING NO. 150-13 Article 12, Philippines-Japan tax treaty, as amended MD Tech Phils., Inc. Main Avenue corner 3rd Street Cavite Economic Zone Rosario, Cavite Attention: Mr. Satoko Hashimoto Finance and Admin Manager Gentlemen : This refers to your tax treaty relief application filed on June 22, 2012 requesting that royalties to be paid by MD Tech Phils., Inc. ("MD Tech") to HDK Micro Devices Co. Ltd. ("HDK") 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. ACIESH It is represented that HDK is a corporation organized and existing under the laws of Japan and is a resident thereof based on the Residence Certificate issued by the Toyama Tax Office in Japan on May 22, 2012; that HDK is situated at 2-12-15, Shimo-Fugo, Toyama City, Toyama-Prefecture, Japan; that HDK 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 June 15, 2012; and that, on the other hand, MD Tech is a domestic corporation registered with the Philippine Economic Zone Authority ("PEZA") under Certificate of Registration No. 04-77 issued by PEZA on November 24, 2004 and is situated at Main Avenue corner 3rd Street, Cavite Economic Zone, Rosario, Cavite, Philippines. It is further represented that on March 26, 2012, HDK and MD Tech entered into a Contract of Technology Guidance Fee where HDK grants MD Tech the license to manufacture product and technology guidance from HDK. In consideration, MD Tech shall pay 41,402,860 Japanese Yen as annual amount of technology guidance fee for the use of HDK's trademark right, technology, and other confidential information which are used for sale of merchandise. The payment shall start from April 1, 2012 and pay in installments in accordance with the following terms and amounts: 1st Payment at the end of June 2012 by the amount of 23,402,860 2nd Payment July 2012 by the amount of 4,500,000 3rd Payment October 2012 by the amount of 4,500,000 4th Payment January 2013 by the amount of 4,500,000 5th Payment April 2013 by the amount of 4,500,000 The amount of 21,062,574 was remitted in favor of HDK by MD Tech on June 29, 2012 as shown in the Certification issued by Mizuho Corporate Bank, Ltd. Manila Branch on July 5, 2012. It is also represented that the Agreement shall take effect from April 2012 to March 31, 2013. 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 Affidavit issued by the Vice President of MD Tech on June 6, 2012. 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 HDK, 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: "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%). LLjur xxx xxx xxx" However, under Section 32 (B) (5) of the Code, such fees may be exempt from income tax or subject to a reduced rate to the extent required by any treaty obligation on the Philippines, thus: "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, as amended. 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." 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. AISHcD Accordingly, since MD Tech 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 MD Tech to HDK under the Agreement, 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 10 percent of the gross amount of the royalties. 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 . (Underscoring supplied) xxx xxx xxx" However, since MD Tech 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. 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, MD Tech , 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 HDK is a nonresident supplier of goods and services and not registered in the Philippines for VAT purposes, the royalties to be paid by MD Tech to HDK under the Agreement 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. DACTSa 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. 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].