ITAD BIR Ruling No. 228-12

June 5, 2012 ITAD BIR RULING NO. 228-12 Articles 5 & 7, Philippines-Japan tax treaty, as amended Quisumbing Torres 12th Floor, Net One Center, 26th Street corner 3rd Avenue Crescent Park West, Bonifacio Global City Taguig City Attention: Atty. Jose Jaime V. Cruz Atty. Maria Ana Camila C. Jacinto Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on April 15, 2010, requesting confirmation that the service fees received by TDK CORPORATION ("TDK") from TDK PHILIPPINES CORPORATION ("TDK Phil") are not in the nature of royalties but business profits and as such, service fees for services performed outside the Philippines are exempt from Philippine income tax pursuant to Article 7, in relation to Article 5, 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 TDK is a nonresident foreign corporation, organized and existing under the laws of Japan, with business address at 13-1 Nihonbashi 1-chome, Chuo-ku, Tokyo, Japan based on the Certificate of Status of Taxable Person issued by the District Director of the Nihonbashi Tax Office in Japan dated March 15, 2010; that TDK is in the business of manufacturing electronics components and recording media and that it is registered as a taxable person under Tax Reference No. 00389099; that based on the Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission ("SEC") dated September 2, 2010, the petition for withdrawal of license to transact business in the Philippines of TDK (with SEC Registration No. AF095-134) was approved by the SEC on September 26, 2002, and that to date, no new registration of TDK either as a corporation or as a partnership has been approved by the SEC; that on the other hand, TDK Phil is a domestic corporation, registered with the Philippine Economic Zone Authority ("PEZA") as an ecozone export enterprise under Certificate of Registration No. 97-020 dated June 19, 2009; and that, TDK Phil's office address is at 119 East Science Avenue Special Export Processing Zone, Laguna Technopark, Bian, Laguna, Philippines. HSATIC It is also represented that on October 1, 2009, TDK and TDK Phil entered into a Management Services Agreement ("Agreement") , where TDK agreed to provide the following services ("Services") to TDK Phil in order to develop the latter's business and to maintain the soundness of its management: a) Quality assurance assistance including, but not limited to, providing support to establish and maintain a quality assurance system; b) Accounting and finance assistance including, but not limited to, providing support with respect to budgeting, closing accounting, finance, cash management and tax; c) General administration assistance including, but not limited to, providing support with respect to secretarial services, public and government relations, and advising on matters relating to corporate governance; d) General corporate planning assistance; and, e) Such other assistance that may be reasonably requested by TDK Phil and agreed to be provided by TDK. that in calculating fees for the services to be charged to TDK Phil, a profit mark-up of 5% shall be added to the cost base which shall include all direct and indirect costs incurred by TDK in rendering the Services, in particular, but not limited to, personnel, travel and equipment purchase, all third parties expense and all overhead cost; that TDK shall invoice TDK Phil for fees for the Services (the amount of which shall be separately determined by agreement between the parties) in arrears at least five days prior to the end of March, June, September and December of each calendar year; that TDK Phil shall pay the total amount invoiced by transfer of funds in Japanese Yen or such other currency as the parties may mutually agree to the bank account designated by TDK within thirty days from the receipt of such invoice by TDK Phil or on the day separately agreed upon by the parties; that unless otherwise earlier terminated, the Agreement shall take effect on October 1, 2009, up to September 30, 2010; and that if neither party expresses in writing its intention not to renew the Agreement at least one month prior to the expiration of the same, the Agreement shall be automatically extended for one year, and thereafter. It is further represented that on March 15, 2010, TDK and TDK Phil entered into an Addendum to the Agreement ("Addendum") to lay down the conditions for the performance of the Services under the Agreement; that under the Addendum, TDK shall, to the extent possible, perform the Services entirely in Japan; that if it will be necessary for TDK to send its employees or other personnel to the Philippines, TDK will ensure that its personnel will stay in the Philippines for only a short period or periods which in no case shall exceed an aggregate of six months; that TDK shall perform the Services only for the purpose of assisting TDK Phil to develop its business and maintain the soundness of its management, which shall consist solely of such assistance or other ancillary or secondary services as may be required by TDK Phil to achieve such purpose; and that based on the Certification by TDK Phil dated May 31, 2010, TDK, as of that date, has not sent, and does not intend to send, any of its personnel to the Philippines to perform services to TDK Phil in order to carry out its obligations to TDK Phil under the Agreement. aSADIC It is finally represented that the issue or transaction subject of the application for tax treaty relief is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings or judicial appeal, as confirmed by TDK Phil in its certification dated April 12, 2010. In reply, please be informed as follows: A. On income tax 1. On whether the service fees are not in the nature of royalties under Article 12 of the Philippines-Japan tax treaty, as amended Paragraph 4, Article 12 of the Philippines-Japan tax treaty, as amended, defines the term "royalties" as follows: "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." Relative thereto, to distinguish between payments for the supply of services (as business profits) and payments for know-how (as royalties), the following commentaries of the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention on Income and on Capital (Condensed Version, July 21, 2010) mention: "11.1. In the know-how contract, one of the parties agrees to impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public. It is recognized that the grantor is not required to play any part himself in the application of the formulas granted to the licensee and that he does not guarantee the result thereof. 11.2. This type of contract thus differs from contracts for the provision of services, in which one of the parties undertakes to use the customary skills of his calling to execute work himself for the other party. Payments made under the latter contracts generally fall under Article 7. 11.3. The need to distinguish these two types of payments, i.e. , payments for the supply of know-how and payments for the provision of services, sometimes gives rise to practical difficulties. The following criteria are relevant for the purpose of making that distinction: - Contracts for the supply of know-how concern information of that kind described in paragraph 11 that already exists or concern the supply of that type of information after its development or creation and include specific provisions concerning the confidentiality of that information. ASEIDH - In the case of contracts for the provision of services, the supplier undertakes to perform services which may require the use, by that supplier, of special knowledge, skill and expertise but not the transfer of such special knowledge, skill or expertise to the other party. - In most cases involving the supply of know-how, there would generally be very little more which needs to be done by the supplier under the contract other than to supply existing information or reproduce existing material. On the other hand, a contract for the performance of services would, in the majority of cases, involve a very much greater level of expenditure by the supplier in order to perform his contractual obligations. For instance, the supplier, depending on the nature of the services to be rendered, may have to incur salaries and wages for employees engaged in researching, designing, testing, drawing and other associated activities or payments to sub-contractors for the performance of similar services. 11.4. Examples of payments which should therefore not be considered to be received as consideration for the provision of know-how but, rather, for the provision of services, include: payments obtained as consideration for after-sales service, payments for services rendered by a seller to the purchaser under a guarantee, payments for pure technical assistance, payments for a list of potential customers, when such a list is developed specifically for the payer out of generally available information (a payment for the confidential list of customers to which the payee has provided a particular product or service would, however, constitute a payment for know-how as it would relate to the commercial experience of the payee in dealing with these customers), payments for an opinion given by an engineer, an advocate or an accountant, and payments for advice provided electronically, for electronic communications with technicians or for accessing, through computer networks, a trouble-shooting database such as a database that provides users of software with non-confidential information in response to frequently asked questions or common problems that arise frequently." Applying the above commentaries, the service fees to be paid by TDK Phil to TDK pursuant to the Agreement and its Addendum are in the nature of business profits and not royalties by reason of the following: cCAaHD 1. The Agreement and its Addendum concern solely with the supply of services by TDK to TDK Phil to develop the latter's business and maintain the soundness of its management (which shall consist solely of such assistance or other ancillary or secondary services as may be required by TDK Phil to achieve such purpose), and not with the supply of information concerning industrial, commercial or scientific experience ("know-how") or any other intangible property that already exists or that is in its stage of development by TDK. 2. Under the Agreement and its Addendum, TDK undertakes to perform such services to TDK Phil, which merely require the use by TDK of its special knowledge, skill and expertise on the subject and not the transfer of such special knowledge, skill or expertise to TDK Phil. 3. To perform its contractual obligations to TDK Phil, TDK will perform different types of services to TDK Phil and not simply supply existing information or material to TDK Phil. Specifically, these services are: a) Quality assurance assistance including, but not limited to, providing support to establish and maintain a quality assurance system; b) Accounting and finance assistance including, but not limited to, providing support with respect to budgeting, closing accounting, finance, cash management and tax; c) General administration assistance including, but not limited to, providing support with respect to secretarial services, public and government relations, and advising on matters relating to corporate governance; d) General corporate planning assistance; and, e) Such other assistance that may be reasonably requested by TDK Phil and agreed to be provided by TDK; This being so, the service fees are not royalties but business profits and taxable as such. (BIR Ruling No. ITAD 15-09 dated May 18, 2009) . 2. On whether the service fees received by TDK from TDK Phil for services performed outside the Philippines are exempt from Philippine income tax pursuant to Article 7 in relation to Article 5 of the Philippines-Japan tax treaty, as amended Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended, applies, in general, to income derived in the Philippines by a nonresident foreign corporation. It 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 . . . , profits and income, . . . : Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, Section 32 (B) (5) of the Tax Code of 1997, as amended, provides: "Section 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: ECTHIA 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. xxx xxx xxx" In this particular case, the treaty involved is the Philippines-Japan tax treaty, as amended, which, in its Article 7, provides: "Article 7 1. The profits of an enterprise of a Contracting State shall be taxable only in that Contracting State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in that other Contracting State but only so much of them as is attributable to that permanent establishment." Based on the foregoing, the profits of a Japanese enterprise shall be taxable only in Japan unless such enterprise carries on business in the Philippines through a permanent establishment situated therein. If the Japanese enterprise carries on business as aforesaid, the profits of such enterprise may be taxed in the Philippines but only so much of them as are attributable to that permanent establishment. Applying this to the instant case, the service fees received by TDK for the services rendered in the Philippines shall be taxable in the Philippines only if it has a permanent establishment in the Philippines in connection with the activities giving rise to such income. In relation thereto, Article 5 of the Philippines-Japan tax treaty, as amended, provides: "Article 5 1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business through which the business of an enterprise is wholly or partly carried on. 2. The term 'permanent establishment' includes especially: a) a store or other sales outlet; b) a branch; c) an office; d) a factory; e) a workshop; f) a warehouse; g) a mine, an oil or gas well, a quarry or other place of extraction of natural resources. xxx xxx xxx 6. An enterprise of a Contracting State shall be deemed to have a permanent establishment in the other Contracting State if it furnishes in that other Contracting State consultancy services, or supervisory services in connection with a contract for a building, construction or installation project through employees or other personnel other than an agent of an independent status to whom paragraph 7 applies provided that such activities continue (for the same project or two or more connected projects) for a period or periods aggregating more than six months within any twelve-month period. However, if the furnishing of such services is effected under an agreement between the Governments of the two Contracting States regarding economic or technical cooperation, that enterprise shall, notwithstanding any provisions of this Article, not be deemed to have a permanent establishment in that other Contracting State." cCaDSA Under paragraphs 1 and 2 of Article 5, the term "permanent establishment" means a fixed place of business through which the business of an enterprise is wholly or partly carried on, and includes, for example a store or other sales outlet, a branch, an office, a factory, and a workshop. Under paragraph 6 of the same article, a permanent establishment is deemed to arise if an enterprise furnishes consultancy services, or supervisory services in connection with a contract for a building, construction or installation project, through employees or other personnel, where such activities continue (for the same project or two or more connected projects) for a period or periods aggregating more than six months within any twelve-month period. Relative thereto, please be informed that under Section III (2) of Revenue Memorandum Order No. 1-00 (Procedures for Processing Tax Treaty Relief Application) ("RMO 1-2000") , any availment of tax treaty relief (exemption from income tax or reduction of tax) shall be preceded by an application filed at the International Tax Affairs Division ("ITAD") of this Bureau at least 15 days before the intended transaction or payment of income, thus: "III. Policies: In order to achieve the above-mentioned objectives, the following policies shall be observed: xxx xxx xxx 2. Any availment of the tax treaty relief shall be preceded by an application by filing BIR Form No. 0901 (Application for Relief from Double Taxation) with ITAD at least 15 days before the transaction i.e. , payment of dividends, royalties, etc., accompanied by supporting documents justifying the relief . . ." (Underscoring ours) This condition was emphasized by the Court of Tax Appeals in Mirant (Philippines) Operations Corporation vs. Commissioner of Internal Revenue (C.T.A. Case No. 6382 dated June 7, 2005) where it ruled: " However, it must be remembered that a foreign corporation wishing to avail of the benefits of the tax treaty should invoke the provisions of the tax treaty and prove that indeed the provisions of the tax treaty applies to it, before the benefits may be extended to such corporation . In other words, a resident or non-resident foreign corporation shall be taxed according to the provisions of the National Internal Revenue Code, unless it is shown that the treaty provisions apply to the said corporation, and that, in cases the same are applicable, the option to avail of the tax benefits under the tax treaty has been successfully invoked. Under Revenue Memorandum Order 01-2000 of the Bureau of Internal Revenue, it is provided that the availment of a tax treaty provision must be preceded by an application for a tax treaty relief with its International Tax Affairs Division (ITAD). This is to prevent any erroneous interpretation and/or application of the treaty provisions with which the Philippines is a signatory to. The implementation of the said Revenue Memorandum Order is in harmony with the objectives of the contracting state to ensure that the granting of the benefits under the tax treaties are enjoyed by the persons or corporations duly entitled to the same . SCADIT The Court notes that nowhere in the records of the case was it shown that petitioner indeed took the liberty of properly observing the provisions of the said order. Petitioner quotes various BIR, as well as ITAD, Rulings issued to several foreign corporations seeking for a tax relief from the office of the respondent. However, not any one of these rulings pertains to the petitioner. It must be stressed that BIR rulings are issued based on the facts and circumstances surrounding particular issue/issues in question and are resolved on a case-to-case basis. It would be thus erroneous to invoke the ruling of the respondent in specific cases, which have no bearing to the case of petitioner." (Underscoring ours) This decision was also upheld by the Supreme Court in a Resolution (G.R. No. 168531) dated February 18, 2008. Furthermore, the necessary requirement laid down in RMO 1-2000 is reiterated in subsequent rulings of the Court of Tax Appeals: Deutsche Bank AG Manila Branch vs. Commissioner of Internal Revenue (C.T.A. Case No. EB 456 dated May 29, 2009), CBK Power Company Ltd. vs. Commissioner of Internal Revenue (C.T.A. Case Nos. 6699, 6844 and 7166 dated March 29, 2010) and Manila North Tollways Corporation vs. Commissioner of Internal Revenue (C.T.A. Case No. 7864 dated April 12, 2011) . In view of the foregoing, this Office hereby DENIES relief on the service fees paid by TDK Phil to TDK before April 30, 2010 since the TTRA was filed beyond the 15-day period prescribed by the RMO. Accordingly, said fees shall be subject to income tax at 30 percent as provided for under Section 28 (B) (1) of the Tax Code of 1997 cited above. On the other hand, considering that TDK is not engaged in trade or business in the Philippines, and that under the March 15, 2010 Addendum, TDK will perform the services to TDK Phil entirely in Japan, and that, as of May 31, 2010, it has not sent any employees or other personnel thereof to the Philippines to perform the services, TDK is not deemed to have a permanent establishment in the Philippines. Accordingly, and for as long as no TDK personnel will perform services in the Philippines which will exceed for a period of 6 months, the service fees by TDK Phil to TDK for Services rendered by the latter, under the March 15, 2010 Addendum, made on April 30, 2010 and thereafter, are hereby GRANTED relief, and the same shall not be subject to Philippine income tax pursuant to Article 7 in relation to Article 5 of the Philippines-Japan tax treaty, as amended. B. On Value-Added Tax As regards the imposition of the value-added tax ("VAT"), 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 twelve percent (12%) of gross receipts derived from the sale or exchange of services, including the use or lease of properties. cCTAIE xxx xxx xxx The phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for others for a fee, remuneration of consideration . . ." Section 108 (A) clearly states that the sale or exchange of services subject to VAT include only those services that are performed in the Philippines. Hence, the service fees to be paid by TDK Phil to TDK, for services rendered under the March 15, 2010 Addendum, to the extent that the subject services are not performed in the Philippines, 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