ITAD BIR Ruling No. 164-15

June 2, 2015 ITAD BIR RULING NO. 164-15 Article 12, Philippines-Japan tax treaty HKT Philippines, Inc. Carmelray Industrial Park II Brgy. Punta, Calamba City Laguna Attention: Mr. Anthony D. Torres President Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on May 24, 2011, on behalf of HKT Corporation ("HKT Co.") , requesting confirmation that the royalty payments to HKT Co. by HKT Philippines, Inc. ("HKT Phils") 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 HKT Co. is a corporation organized and existing under the laws of Japan and is a resident of Japan per Certificate of Status of Taxable Person issued by the District Director of Hachioji Tax Office on November 16, 2010; that HKT Co. 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 dated December 10, 2010; that, on the other hand, HKT Phils is a domestic corporation duly organized and existing under the laws of the Philippines; and that HKT Phils is a Philippine Economic Zone Authority (PEZA)-registered enterprise pursuant to the provisions of Republic Act No. 7916. It is also represented HKT Co. has engaged in the manufacture and sale of automotive parts throughout the world and has, through its research and development, acquired certain confidential proprietary technical information and intellectual property rights such as trademarks and patents; that on January 7, 2009, HKT Co. and HKT Phils entered into Technical Assistance and Licensing Agreement ("Agreement") whereby HKT Co. and HKT Phils agree to use such technical information and intellectual property rights in order to manufacture and sell the automotive products; that the Agreement has a validity of three (3) years from the date of execution, in the absence of any prior written notice by either party for the termination the Agreement, shall be automatically extended for one more year; that HKT Phils shall pay HKT Co. , as compensation for the use of the technical information and the trademark and patent rights, the amount of one and a half percent (1.5%) based on total sales; and that royalty fee shall be paid semi-annually at the end of September and at the end of March of each year. It is also represented based on a notarized certification by HKT Phils dated December 30, 2010, 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. 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 the amended Philippines-Japan tax treaty. Its Article 12 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" Under Article 12 of the Philippines-Japan tax treaty, as amended, royalties arising in the Philippines and paid to a resident of Japan may be taxed in the Philippines, but the rate of income tax that may be imposed thereon shall not exceed (a) 15 percent of the gross amount of the royalties if the royalties 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 percent of the gross amount of the royalties if the royalties are 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; and (c) 10 percent in all other cases. Accordingly, since HKT Co. is a resident of corporation of Japan and has no fixed place of business in the Philippines, and since the royalties being paid is for the use or the right to use of trademark, patent, design, and 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 VAT on royalties, Section 108 of the Tax Code of 1997, as amended provides that: "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%) 1 of gross receipts derived from the sale or exchange of services, including the use or lease of properties. xxx xxx xxx (3) The supply of scientific, technical, industrial or commercial knowledge or information; xxx xxx xxx" 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 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. . . ." Based on the foregoing, transactions exempt from VAT by reason of Presidential Decree No. 66 and Republic Act No. (RA) 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 specials laws, e.g. , RA 7916 or PEZA Law, is particularly applicable to the instant case. Such being the case, the royalty payment of HKT Phils , being an enterprise registered with EPZA, now PEZA, to HKT Co. under the subject 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. The VAT rate was increased to 12% on 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].