ITAD BIR Ruling No. 189-11

July 7, 2011 ITAD BIR RULING NO. 189-11 Article 12, Philippines-Japan tax treaty, as amended; BIR Ruling No. ITAD 074-10; BIR Ruling No. ITAD 011-10 JGLaw SOL Building, Amorsolo Street Legaspi Village, Makati City Attention: Jose V.E. Jimenez Richelle Mae G. Atos Gentlemen : This refers to your application for tax treaty relief dated March 18, 2011 requesting confirmation that royalties paid by Mactan Steel Center, Inc. ("Mactan Steel") (formerly JS Steel Cebu Corporation ) to NS Fellows Corporation ("NS Fellows") are subject to income tax at a preferential rate of 10 percent pursuant to 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. Basic Facts It is represented that NS Fellows is a foreign corporation organized and existing under the laws of Japan based on the Certificate of Complete Historical Records issued by the Yokohama District Legal Affairs Bureau in Asahi, Japan, on February 23, 2011, and on the Certificate of Status of Taxable Person issued by the Hodogaya Tax Office in Japan on February 16, 2011; that NS Fellows is situated at 2-26-32 Hongo, Seya-ku, Yokohama City, Karagawa, Japan; that NS Fellows is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission on February 24, 2011; that, on the other hand, Mactan Steel is a domestic corporation situated at Mactan Economic Zone 1, Lapu-Lapu City, Cebu, Philippines; and that Mactan Steel is registered with the Philippine Economic Zone Authority ("PEZA") under Certificate of Registration issued on February 28, 2011. It is further represented that on October 1, 2010, NS Fellows and Mactan Steel entered into a Technical Assistance Agreement where NS Fellows agreed to provide the following technical assistance to Mactan Steel: 1. Information and assistance on factory management, production control, quality control and other dairy management and operations; 2. Information and assistance on general maintenance, repair and amendment of machinery equipment; 3. Information and assistance on equipment, fast moving spare parts, and so on; 4. Information and assistance to deal with and to solve quality claims. that in consideration Mactan Steel will pay royalties to NS Fellows in the amount of 2,000,000 to be paid on or before March 31, 2011, for the period October 1, 2010 to March 31, 2011, and on or before September 30, 2011, for the period April 1-September 30, 2011; and that the Agreement shall take effect on October 1, 2010 and shall continue in full force and effect until September 30, 2011. ICAcTa It is finally represented that the royalties subject of this ruling are 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 by the Finance and Administration Manager of Mactan Steel on February 22, 2011. Ruling A. On income tax In reply, please be informed that royalties paid to NS Fellows , a foreign corporation not engaged in trade or business in the Philippines, are subject to income tax at the rate of 30 percent beginning January 1, 2009. Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, 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 . . ., dividends, . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, such royalties may be exempt from income tax or subject to a reduced rate to the extent required by any treaty obligation on the Philippines. Section 32 (B) (5) of the Code provides: "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: (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, 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. CIAHaT 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 paragraphs 2 and 3 of Article 12, royalties arising in the Philippines and paid to a resident of Japan may be taxed in the Philippines at a reduced rate of (a) 10 percent if the domestic company paying the royalties is registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentive laws of the Philippines; (b) 15 percent if the royalties are paid in respect of the use of or the right to use cinematograph films or tapes for radio or television broadcasting and (c) beginning January 1, 2009, 10 percent 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, royalties to be paid by Mactan Steel to NS Fellows under the Agreement for the provision of information and assistance on certain matters, being essentially royalties for the use of or the right to use information concerning industrial, commercial of scientific experience ("know-how"), beginning March 1, 2011, 2 are subject to income tax at the rate of 10 percent of the gross amount thereof. (BIR Ruling No. ITAD 011-10 dated June 16, 2010; BIR Ruling No. DA ITAD 074-10 dated July 9, 2010) . B. On value-added tax As regards the imposition of value-added tax ("VAT"), such royalties payable to NS Fellows are generally subject to VAT at the rate of 12 percent. 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%) 3 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%), after any of the following conditions has been satisfied: (i) Value-added tax collection as a percentage of Gross Domestic Product (GDP) of the previous year exceeds two and four-fifth percent (2 4/5%); or (ii) National government deficit as a percentage of GDP of the previous year exceeds one and one half percent (1 1/2%). xxx xxx xxx" However, since Mactan Steel is registered with PEZA and covered by the provisions of Republic Act No. 7916, 4 the Supreme Court ruled in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866, February 11, 2005) that: "Special laws may certainly exempt transactions from the VAT. 5 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. TIESCA 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 prohibetur et per obliquum. When anything is prohibited directly, it is also prohibited indirectly. xxx xxx xxx" Such being the case, the royalties paid by Mactan Steel to NS Fellows under the Agreement are exempt from VAT instead of being subject to VAT at the rate of zero percent. 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. AaCcST 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. Pursuant to Revenue Memorandum Order No. 72-2010 (Prescribing Guidelines on the Processing of Tax Treaty Relief Applications (TTRA) pursuant to existing Philippine Tax Treaties). 3. 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. 4. 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 Zones in the Philippines. 5. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337].