ITAD BIR Ruling No. 216-11

August 18, 2011 ITAD BIR RULING NO. 216-11 Article 12, Philippines-Japan tax treaty, as amended; BIR Ruling No. ITAD 37-11 SB Flex Philippines, Inc. Lot 6B, Phase 1-A First Philippine Industrial Park Barangay Sta. Anastacia Sto. Tomas, Batangas Attention: Mr. Masaki Sasaki Director and General Manager Gentlemen : This refers to your letter dated August 15, 2007 requesting confirmation that royalties paid by SB Flex Philippines, Inc. ("SB Flex") to Sumitomo Bakelite Company Ltd. ("Sumitomo Bakelite") are subject to income tax at the rate of 25 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 Sumitomo Bakelite is a corporation organized and existing under the laws of Japan and is a resident of Japan based on the Certificate of Residence issued by the Shinagawa Tax Office in Japan on November 2, 2006; that Sumitomo Bakelite is situated at 5-8 Higashi Shinagawa 2-Chome, Shinagawa-Ku, Tokyo, Japan; that Sumitomo Bakelite is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission on June 22, 2006; that, on the other hand, SB Flex is a domestic corporation situated at Lot 6B, Phase 1-A, First Philippine Industrial Park, Barangay Sta. Anastacia, Sto. Tomas, Batangas, Philippines; and that SB Flex is registered with the Philippine Economic Zone Authority ("PEZA") as an ecozone export enterprise under Certificate of Registration No. 98-019 issued on March 4, 1998. HSCATc The Technical Assistance Agreement It is further represented that on January 1, 2006, SB Flex and Sumitomo Bakelite entered into a Technical Assistance Agreement where Sumitomo Bakelite granted SB Flex an exclusive and non-transferable right and license to use the Technical Documents and other technical information and knowledge relating to the manufacture of flexible printed wiring boards ( "Products" ) and a non-exclusive right to use and sell the Products in other countries and regions; that Technical Documents means technical information and data in documentary form available in the authorized file of Sumitomo Bakelite and used by it in its commercial production of the Products, and specifically, special manufacturing tool and die; manufacturing process sequence; preparation procedure; manufacturing technology for printed circuits: dimension of pattern width, pattern to pattern space width; inspection method and identification of failure; blanking: method of blanking; and Stiffener lamination: method of lamination and method of after treatment; that Products refers to flexible printed wiring boards using the technology of Sumitomo Bakelite; that in consideration, SB Flex will pay royalties to Sumitomo Bakelite equivalent to 5 percent of the Net Selling Price of the Products sold, leased, or otherwise disposed of by SB Flex to its customers; that Net Selling Price means the gross invoice price of the Products sold by SB Flex in its normal commercial transactions less the following items to the extent they are actually paid or allowed to be paid and they are included in the gross invoice price: a) Sales tax, special consumption tax, or value-added tax; b) Commercial discount; c) Expenses incurred in purchasing semi-products and kit parts from any sources and in subcontracting the assembly of the Products like transportation, charges, insurance, and taxes; and d) Expenses for carton boxes, packing, transportation, and advertisement. That the royalties will be paid in full in United States dollars and within sixty days from the end of each quarter; that the Agreement takes effect on the date it is approved by the competent authorities of the Government of the Philippines and will remain effective for a period of 10 years, and may be extended thereafter, unless terminated; and that the Agreement complies with the provisions of the Intellectual Property Code of the Philippines on Voluntary Licensing under Certificate of Compliance No. 5-2007-00022 issued by the Intellectual Property Office on July 10, 2007, valid for 10 years from that date until July 9, 2017. The Trademark License Agreement It is further represented that on January 1, 2006, SB Flex and Sumitomo Bakelite entered into a Trademark License Agreement where Sumitomo Bakelite granted SB Flex a non-exclusive and non-transferable license (but without a right to sublicense) to use the Sumilite Trademark ("Trademark") in connection with the manufacture and sale in the Philippines and in other countries and regions of flexible printed circuit boards bearing the Trademark ("Products"); that the Trademark is registered in the Philippines on October 17, 1988, under Registration No. 41344 and Class No. 17; that in consideration, SB Flex will pay royalties to Sumitomo Bakelite equivalent to 2 percent of the Net Selling Price of the Products sold, leased, or otherwise disposed of by SB Flex to its customers; that Net Selling Price means the gross invoice price of the Products sold by SB Flex in its normal commercial transactions less the following items to the extent they are actually paid or allowed to be paid and they are included in the gross invoice price: HIESTA a) Sales tax, special consumption tax, or value-added tax; b) Commercial discount; c) Expenses incurred in purchasing semi-products and kit parts from any sources and in subcontracting the assembly of the Products like transportation, charges, insurance, and taxes; and d) Expenses for carton boxes, packing, transportation, and advertisement. That SB Flex agrees to accept any increase in the amount of the royalties as demanded by Sumitomo Bakelite which might be due to the latter's adoption of new policies relating to the payment of such royalties; that the royalties will be paid in full in United States dollars and within sixty days from the end of each quarter; that the Agreement takes effect on July 10, 2007, and will remain effective for a period of 10 years, and may be extended thereafter, unless terminated; and that the Agreement complies with the provisions of the Intellectual Property Code of the Philippines on Voluntary Licensing under Certificate of Compliance No. 5-2007-00023 issued by the Intellectual Property Office on July 10, 2007, valid for 10 years from January 1, 2006 to December 31, 2015. It is finally represented that the royalties subject of this ruling are not under investigation, on-going audit, administrative protest, claims for refund or issuance of tax credit certificate, collection proceedings, or judicial appeal, based on the Affidavit issued by the Director and General Manager of SB Flex on February 18, 2008. 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, royalties paid to Sumitomo Bakelite are subject to income tax as follows: "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 subparagraph 5(c) and (d) above: Provided, That effective 1, 2009, the rate of income tax shall be thirty percent (30%)." However, under Section 32 (B) (5) of the Code, 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, 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: ECTIcS (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, you invoke the Philippines-Japan tax treaty, as amended. Paragraphs 1, 2, 3 and 4, Article 12 of this treaty 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) 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." Paragraph 2 of Article 12 is amended by the Protocol and now reads: "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." Under Article 12, 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 if the royalties are paid by a domestic company registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines; (b) 15 percent if the royalties are paid with respect to 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, and, 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 ( "know-how" ). ADCTac Accordingly, royalties paid by SB Flex to Sumitomo Bakelite under the Technical Assistance Agreement and the Trademark License Agreement for the use of the Technical Documents and the Trademark on the manufacture and sale of the Products, being essentially royalties for the use of know-how and trademark, are subject to income at the rate of 25 percent before January 1, 2009, and 10 percent beginning January 1, 2009, of the gross amount thereof. ( BIR Ruling No. ITAD 37-11 dated February 2, 2011 ) B. On value-added tax Furthermore, under Section 108 (A) of the Tax Code, as amended, the royalties mentioned, being payments for the use of intangible properties in the Philippines, are subject to value-added tax ("VAT"), thus: "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, 2 raise the rate of value-added tax to twelve percent (12%) . . . " However, since SB Flex is an enterprise registered with PEZA and covered by the provisions of Republic Act No. 7916, 3 the Supreme Court, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866 dated February 11, 2005), ruled that: "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. HICSTa Moreover, the exemption is both express and pervasive for the following reasons: First, 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." Accordingly, SB Flex, as an exempt entity, is not liable to VAT directly on its sale of goods or services to its customers, and indirectly on its purchase of goods or services from its suppliers. With respect to the supply of intangible properties by Sumitomo Bakelite, a nonresident foreign corporation not registered for VAT purposes, this transaction is considered exempt from VAT instead of being subject to VAT at 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. EcSCAD 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. The VAT rate was increased to 12 percent 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. 3. Entitled An Act Providing for the Legal Framework and Mechanism 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, as amended.