ITAD BIR Ruling No. 183-11

June 29, 2011 ITAD BIR RULING NO. 183-11 Article 12, Philippines-Japan tax treaty, as amended; BIR Ruling No. ITAD 011-10; BIR Ruling No. DA-ITAD 074-10 Laguna Metts Corporation 118 East Science Avenue Special Export Processing Zone (SEPZ) Laguna Technopark Bian, Laguna Philippines Attention: Mr. Hiroyuki Miyaji President Ms. Zenaida Cajucom Finance & General Affairs Manager Gentlemen : This refers to your Tax Treaty Relief Application dated January 12, 2010, on behalf of Metts Corporation requesting confirmation that the royalty payments by Laguna Metts Corporation (Laguna Metts) to Metts Corporation under the License Technical Agreement beginning January 1, 2009 are subject to the 10 percent preferential withholding tax rate under Article 12 of 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 Metts Corporation, with office address at Sanritz Mitsuiseimei Building, 1-30-13 Narimasu, Itabashi-Ku, Tokyo, Japan, is a corporation organized and existing under the laws of Japan, as evidenced by the Residence Certificate issued on September 30, 2009 by the District Director of Itabashi Tax Office; that it is not registered either as a corporation or as a partnership in the Philippines per Certification of Non-Registration of Company issued by the Securities and Exchange Commission (SEC) dated September 2, 2009; that, on the other hand, Laguna Metts is a domestic corporation organized and existing under the laws of the Philippines with office address at 118 East Science Avenue, SEPZ, Laguna Technopark, Bian, Laguna; and that Laguna Metts is registered with the Philippine Economic Zone Authority ("PEZA") as an ecozone enterprise engaged in the business of manufacturing of automobile parts in the Philippines. It is further represented that Laguna Metts entered into a License Technical Agreement on January 4, 2005 with Metts Corporation in order to obtain technical assistance from Metts Corporation for the production, assembly, and manufacture of certain automatic parts and accessories in the Philippines; that Metts Corporation gave such technical assistance/support subject to the payment of the corresponding royalties and/or technical fees; that the Agreement shall become effective for a period of two (2) years from January 1, 2005 to December 31, 2006; that as consideration, Laguna Metts shall pay Metts Corporation a technical assistance fee or royalty in US Dollars which were billed on a monthly basis commencing January, 2005; that an Amendment to the said Technical Assistance Agreement dated September 12, 2009 was executed stating that the Amendment and its original agreement shall become effective from the date of signing thereof and shall remain in full force and effect for the period of five (5) years; that thereafter, the Agreement shall be automatically renewed from year to year; and that the issue or transaction subject of the above request for ruling is not under investigation neither is it subject of an on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings nor a judicial appeal based on the Affidavit executed by Laguna Metts dated September 12, 2009. ASTDCH In reply, please be informed that under Section 23 (F) of the National Internal Revenue Code of 1997 (Tax Code of 1997), as amended, a foreign corporation like Metts Corporation, whether or not engaged in trade or business in the Philippines, is taxable only on income derived from sources in the Philippines. Section 23 (F) provides: "SEC. 23. General Principles of Income Taxation in the Philippines. Except when otherwise provided in this Code: xxx xxx xxx (F) A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines." Income, therefore, derived by Metts Corporation from sources in the Philippines is generally subject to income tax at the rate prescribed under Section 28 (B) (1) of the Tax Code of 1997. It provides: "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-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 subparagraphs 5(c). Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." However, under Section 32 (B) (5) of the Tax Code of 1997, such income derived by Metts Corporation in the Philippines may be considered exempt or partially exempt from income tax. "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 that may be invoked by Metts Corporation and other residents of the Japan, there is the Philippines-Japan tax treaty. Prior to the amendment of the Philippines-Japan tax treaty, Article 12 thereof reads: "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. 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, royalties arising in the Philippines and derived by a resident of Japan may be taxed in the Philippines but the rate of income tax that may be imposed thereon will not exceed 10 percent if the payor is a Board of Investments (BOI)-registered enterprise and engaged in preferred pioneer areas of investment, 15 percent if the payments are in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, and in all other cases, 25 percent of the gross amount of the royalties. The aforequoted Article 12 of the Philippines-Japan tax treaty was amended by the 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, signed on December 9, 2006 and effective on January 1, 2009 provides. Article V of which reads: "ARTICLE V Paragraph (2) of Article 12 of the Convention shall be deleted and replaced by the following: '(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: cDCEHa (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, beginning January 1, 2009, the royalty payments will be taxed at the preferential tax rate of 15 percent if the payments are in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, and in all other cases, 10 percent of the gross amount of the royalties. Such being the case, this Office is of the opinion and so holds that since Laguna Metts is not a BOI-registered enterprise engaged in preferred pioneer areas of investment, and, since the subject royalty payments are not paid in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, the said royalty payments by Laguna Metts to Metts Corporation under the original Agreement, from January 1, 2005 until December 31, 2008, shall be subject to tax at a rate not exceeding 25 percent of the gross amount of the royalties, pursuant to Article 12 (2) (b) of the Philippines-Japan tax treaty. (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-06-06 dated May 30, 2006; BIR Ruling No. DA-ITAD-102-06 dated August 28, 2006; and BIR Ruling No. DA-ITAD-065-08 dated September 10, 2008) On the other hand, the royalty payments from January 1, 2009 up to September 12, 2014 under the Amendment to the Technical License Agreement shall be subject to 10 percent preferential tax rate pursuant to the Philippines-Japan tax treaty, as amended. (BIR Ruling No. ITAD 011-10 dated June 16, 2010) 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%) [now 12%] of gross receipts derived from the sale or exchange of services, including the use or lease of properties . . ." 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. 1 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. aCTcDS 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, since Laguna Metts is an enterprise registered with PEZA operating within an economic zone 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 Laguna Metts to Metts Corporation under the Agreement are 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. HScAEC Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337].