ITAD BIR Ruling No. 227-12

June 5, 2012 ITAD BIR RULING NO. 227-12 Article 12, Philippines-Japan tax treaty, as amended Sycip Gorres Velayo & Co . 6760 Ayala Avenue 1226 Makati City Attention: Atty. Luis Jose P. Ferrer Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on May 26, 2010, on behalf of NITTETSU MICROMETAL CORPORATION PHILIPPINES ("Nittetsu") , requesting confirmation that the royalty payments made by Nittetsu to NIPPON MICROMETAL CORPORATION ("Nippon") are subject to the preferential tax rate of 10 percent pursuant to Article 12 (2) (b) 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 Nippon, with office address at 158-1, Sayamagahara Iruma City, Saitama 358-0032, Japan, is a corporation duly organized and existing under the laws of Japan, and is a resident of Japan within the meaning of Article 4 of the Philippines-Japan tax treaty, as evidenced by the Certificate of Status of Taxable Person issued by the Tokorozawa Tax Office dated March 8, 2010; that it is not registered either as a corporation or as a partnership in the Philippines per Certification of Non-Registration issued by the Securities and Exchange Commission dated March 15, 2010; that, on the other hand, Nittetsu is a corporation organized and existing under the laws of the Philippines, with principal office address at First Philippine Industrial Park, Sta. Anastacia, Sto. Tomas, Batangas; and that it is registered with the Philippine Economic Zone Authority ("PEZA") as an Ecozone Export Enterprise under Certificate of Registration No. 00-096 dated November 27, 2000. It is also represented that on August 31, 2001, Nippon and Nittetsu entered into a Royalty Agreement ("Agreement"), whereby Nippon grants Nittetsu the license to use Nippon's patent and know-how relating to Bonding Wire; that, in consideration for the grant of license, Nittetsu shall pay Nippon royalty fees in the amount corresponding to: a.) three percent (3%) of the aggregate Processing Cost of the Target Wire on Patent 1 manufactured by Nittetsu for its customers, and b.) two percent (2%) of the aggregate Processing Cost of the Target Wire on Know-how 2 manufactured by Nittetsu for its customers; that the royalty fees shall be paid semi-annually based on the aggregate Processing Costs stated in each Semi-Annual Report; 3 that the Agreement shall be in full force and effect for an initial period of three years, commencing on September 1, 2001, and shall be automatically renewed and continued from year to year unless Nippon or Nittetsu gives to the other party a written notice to terminate the Agreement. DSITEH It is further represented 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 Certification of Nittetsu dated May 11, 2010. It is finally represented that pursuant to BIR Ruling No. DA-ITAD-054-03 dated April 15, 2003, the Bureau of Internal Revenue confirmed that the royalty payments under the same Agreement are subject to the preferential tax rate of 25 percent of the gross amount of the royalties pursuant to Article 12 (2) of the Philippines-Japan tax treaty; and, that in light of the Protocol amending the Philippines-Japan tax treaty which took effect on January 1, 2009 thereby lowering the preferential tax rate from 25 percent to 10 percent, you are now requesting confirmation that the royalty payments under the same Agreement from the date the Protocol took effect on January 1, 2009 are now subject to 10 percent, pursuant to the Philippines-Japan tax treaty, as amended. In reply, please be informed that 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 (Amending Protocol), signed on December 9, 2006, and effective January 1, 2009. Pursuant to Article V of the Amending Protocol, the Article 12 of the Philippines-Japan tax treaty (Royalties) is amended as follows: "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: (a) 15 percent 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 percent of the gross amount of the royalties in all other cases. . . ." TacESD Prior to the amendment of the Philippines-Japan tax treaty, royalty payments are taxed at a preferential rate of 10 percent if the payor is a BOI-registered enterprise and engaged in preferred areas of investment under the investment incentives laws of the Philippines; 15 percent if the royalty payments are in respect of the use of or 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. Under the Amending Protocol to the tax treaty, beginning January 1, 2009, royalty paid to a resident of Japan will be taxed at a preferential rate of 15 percent 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 and 10 percent in all other cases. As confirmed in BIR Ruling No. DA-ITAD-054-03, Nittetsu's payments to Nippon under the Agreement are not in respect of the use or right to use cinematograph films and films or tapes for radio or television broadcasting, and hence, were subject to 25 percent preferential tax rate. In view of the effectivity of the Amending Protocol, the rate of tax is changed to 10 percent, and as such, all royalty payments of Nittetsu to Nippon accruing from January 1, 2009 are hereby confirmed to be subject to income tax at a preferential rate of 10 percent of the gross amount thereof, pursuant to paragraph 2 (b), 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. 4 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%) 5 of gross receipts derived from the sale or exchange of services, including the use or lease of properties. The phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for others for a fee, . . . . 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; . . ." 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. 6 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. IDAESH 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. . . ." DCaSHI 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 Nittetsu, being a PEZA-registered enterprise, to Nippon 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. "Target Wire on Patent" shall mean the wire products under the patents listed in the Agreement that Nippon hereby grants license to Nittetsu to use, which at the present time consist of the wire series L3, T3, K3, NT5, R1 and G1. 2. "Target Wire on Know-How" shall mean the wire products manufactured or sold under the know-how listed in the Agreement that Nippon grants license to Nittetsu to use, which at present consist of the wire series B, F, G, H, K, L, M, NHJ, NYT, R, RT, S, T and UC. 3. "Semi-Annual Report" shall refer to the report to be submitted by Nittetsu to Nippon on a semi-annual basis stating the product type, selling quantity and processing cost of each contract entered into by Nittetsu with each customer and such other data as may be required by Nippon. 4. Section 108 was amended by Republic Act No. 9337 (An Act Amending Sections 27, 28, 34, 106, 107, 108, 109, 110, 111, 112, 113, 114, 116, 117, 119, 121, 148, 151, 236, 237 And 288 Of The National Internal Revenue Code Of 1997, As Amended, And For Other Purposes), which was signed into law on May 24, 2005 and became effective on November 1, 2005, to read as: "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 selling price or gross value in money of the goods or properties sold, bartered or exchanged, such tax to be paid by the seller or transferor: 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 one and one-half percent (1 1/2%); 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 5. 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. 6. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337].