ITAD BIR Ruling No. 171-15

June 2, 2015 ITAD BIR RULING NO. 171-15 Article 12, Philippines-Japan tax treaty Isla Lipana & Co. 29th Floor, Philamlife Tower 8767 Paseo de Roxas 1226 Makati City, Philippines Attention: Alexander B. Cabrera Authorized Representative Gentlemen : This refers to your application for tax treaty relief application (TTRA) filed on 19 February 2013, requesting confirmation of your opinion that the royalty payments made by Muramoto Audio-Visual Philippines, Inc. ("MAPLE") to Muramoto Industry Co. Ltd. ("MIC"), are subject to 10 percent preferential tax rate pursuant to Article 12 (2) of 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 "). Facts It is represented that MIC is a foreign corporation organized and existing under the laws of Japan, with business address at No. 3-1-56 Chome, Takatsukadai, Nishi-ku, Kobe City, Japan as evidenced by the Certificate of Residence dated 22 January 2013, which was authenticated by the Vice Consul of the Republic of the Philippines, in and for Osaka, Japan dated 24 January 2013; that MIC is not registered as a corporation or partnership in the Philippines based on the Certificate issued by the Securities and Exchange Commission (SEC) on 31 January 2013; that, on the other hand, MAPLE is duly organized and existing under the laws of the Philippines, with business address at Mactan Economic Zone (MEZ) 1, Lapulapu City, Cebu; and that MAPLE is registered with the Philippine Economic Zone Authority (PEZA) with Registration Certificate No. 90-08, which was not yet cancelled at the time of the subject transaction, as evidenced by the sworn statement executed by the Financial Affairs Assistant Department Manager of MAPLE, on 07 November 2013. It is further represented that MAPLE and MIC entered into a Technical Advisory Agreement (" Agreement ") on 01 October 2011, for the following services: 1. MIC shall provide MAPLE the right to use all technical advice and design cooperation which the former has developed in order to expand MAPLE's capacity to meet increased market demand and sales target; and 2. MIC shall exclusively provide MAPLE access to MIC's worldwide intelligence system for least-cost sourcing raw materials and packaging supplies, testing procedures and standards including laboratory analysis services. 2 It is further represented that MAPLE shall pay MIC annually, royalty fees not exceeding 3% of MAPLE's total sales for each fiscal year. 3 It is further represented that the royalty fees for fiscal year 2012 were paid by MAPLE to MIC, through the Bank of Philippine Islands ("BPI") in the amount of Four Hundred Ninety Two Thousand One Hundred Three and 16/100 US Dollars (USD492,103.16) on 21 March 2013, as evidenced by the Certification issued by BPI executed on 21 March 2013. It is finally represented that the royalty fee subject of this TTRA is not subject of investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Sworn Statement issued for MAPLE, executed on 18 January 2013. Ruling A. On Income Tax In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997 (" Tax Code "), as amended, the royalty fees paid to MIC is subject to income tax at the rate of 30 percent, thus: "SEC. 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 percent (30%) 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 " However, under Section 32 (B) (5) of the Tax Code, such royalty 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: "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: 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." With respect to a treaty, MIC invoked the Philippines-Japan tax treaty, Article 12 thereof, as amended by Article 5 of the Protocol provides: "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 Article 12, royalty fees 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% of the gross amount of the royalties if the royalties are paid in respect of the use of or right to use cinematograph films and films or tapes for radio or television broadcasting; and (b) 10% of the gross amount of the royalties in all other cases. In the instant case, the fees represent payment for technical advice and access to worldwide intelligence system which are considered as technical know-how. Accordingly, royalty fees paid to MIC by MAPLE are subject to income tax at the rate of 10 percent of the gross amount thereof, pursuant to paragraph 2 (b), Article 12 of the Philippines-Japan tax treaty. B. On value-added tax The royalty fees paid to MIC, being payment for the use or lease of (intangible) property in the Philippines, are subject to value-added tax (VAT) 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 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, raise the rate of value-added tax to twelve percent (12%). . . xxx xxx xxx The phrase "sale or exchange of services" means the performance if 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: xxx xxx xxx (3) The supply of scientific, technical, industrial or commercial knowledge or information; Thus, in general, the VAT is imposed on the royalty fees by MIC in the Philippines, such that on every payment of the royalty fees, MAPLE is generally required to withhold such VAT and treat the same as a "passed on" VAT, pursuant to Section 4.110-3 (b) of Revenue Regulations No. 7-95 as amended [now Section 4.114-2 (b) of Revenue Regulations No. 16-05]. 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. 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" Based on the foregoing, sale of goods and/or services including the use of or lease of properties, to person or entities exempt from VAT by reason of PD 66 and 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 special laws, e.g. , Republic Act No. 7916 or PEZA Law, is particularly applicable to the instant case. Hence, the royalties paid by MAPLE being a PEZA registered enterprise, to MIC under the Agreement 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. Date of effectivity, January 1, 2009. 2. Article 2 Scope of Services. 3. Article 4 Royalty Fees. 4. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337]. n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.