ITAD BIR Ruling No. 245-15

August 28, 2015 ITAD BIR RULING NO. 245-15 Articles 5, 7, 12 and 22 Philippines-Japan tax treaty, as amended Honda Philippines, Inc. Head Office & Manufacturing Plant Lot 34 Phase 1-B Road 3 First Philippine Industrial Park Tanauan City, Batangas Attention: Ms. Ma. Beth S. Alejandro Assistant Vice President for Finance Gentlemen : This refers to your application for tax treaty relief filed with the Law Division on March 16, 2012, and indorsed to the International Tax Affairs Division on April 16, 2012, requesting confirmation that the fees paid by HONDA PHILIPPINES, INC. ("Honda PH") to HONDA MOTOR CO., LTD. ("Honda Japan") are subject to the 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 as amended by a Protocol 1 ("Philippines-Japan tax treaty") . It is represented that HONDA JAPAN is a corporation organized and existing under the laws of Japan and a resident thereof with address at No. 1-1, 2-Chome, Minamiaoyama, Minato-ku, Tokyo, Japan based on the Certificate of Status of Taxable Person issued by the District Director of Azabu Tax Office dated February 15, 2012; that it is not registered as a corporation nor as a partnership in the Philippines per a Certification of Non-Registration of Company issued by the Securities and Exchange Commission dated February 14, 2012; that on the other hand, Honda PH is a domestic corporation with principal address at Lot 34 Phase 1-B, Road 3, First Philippine Industrial Park, Tanauan City, Batangas; and that Honda PH is registered with the Board of Investments (BOI) under: (1) Certificate of Registration No. DP 2005-120, (2) Certificate of Registration. No. 2001-271 and (3) Certificate of Registration No. 2011-271 based on the corresponding Certificates of Registration issued by the BOI on August 25, 2005, December 16, 2011 and December 16, 2011, respectively. It is further represented that on April 1, 2012, Honda Japan and Honda PH entered into the following Agreements : CAIHTE (1) License and Technical Assistance Agreement ("Agreement") whereby: (a) Honda Japan granted Honda PH an indivisible and non-transferable exclusive right and license, without the right to grant sublicenses, to manufacture, use and sell the Products themselves and the Licensed Parts for the Products within the Philippines; that Honda Japan shall, during the term of the Agreement , furnish Honda PH Technical Information to the extent deemed necessary by Honda Japan , by disclosing it in documentary form, and/or by dispatching Honda Japan 's and/or its designee's technical experts to the Philippines and/or countries located outside the Philippines designated by Honda PH , and/or accepting Honda PH 's engineers or associates at Honda Japan 's and its designee's facilities to instruct and advise them; that for and in consideration of the right and license granted to Honda PH and of the furnishing of the Technical Information, Honda PH shall pay Honda Japan a running royalty equal to the amount calculated by the product of (a) running royalty rate which is seven percent and (b) the aggregate base amount which shall mean the aggregate invoiced prices of the Products to dealers, less (i) aggregate credits and allowances for returned goods; (ii) aggregate trade, quantity or cash discount, if any; (iii) transportation costs, insurances, if any; (iv) selling and general administrative expenses (except for manufacturing overhead); (v) the aggregate procurement cost by Honda PH of the supply parts and the subsidiary supply parts; and (vi) operating profit; that if Honda PH fails to make any payment on the due date, Honda PH agrees to pay a late payment fee in the amount equivalent to twelve percent per annum calculated on the basis of a 365-day year; and that the Agreement shall be effective on the effective date and shall continue in full force and effect for a period of three years, and shall thereafter be automatically renewed for successive one year periods each. (b) Upon the request of Honda PH , Honda Japan shall sell the supply parts and the manufacturing facilities to Honda PH or any purchasing agency designated by it at reasonable price and in accordance with a Memorandum on Supply of Parts ; (2) Memorandum on Exchange of Technicians ("MET") whereby Honda Japan shall dispatch its and/or its designee's technical expert/s to the Philippines and/or to the countries located outside the Philippines designated by Honda PH and Honda Japan shall accept and shall have Honda PH 's engineers or associates; and, (3) Support Services Agreement ("SSA") whereby Honda Japan shall furnish, provide and supply the Support Services to Honda PH , upon approval of Honda Japan of the request made by Honda PH ; that the Support Services shall consist of off-site services and on-site services; that off-site services to Honda PH refers to those rendered at the regular country of business for the Experts (in this case, Japan), while on-site refers to support services rendered by dispatching a certain member of Experts to Honda PH in the Philippines; that as of May 23, 2012, Honda Japan and Honda PH have not yet agreed on any support service to be performed on an on-site basis based on the letter issued by the Assistant Vice President for Finance of Honda PH on even date. It is finally represented that the following payments were made under the Agreements on the following dates: Royalties Support Services 5/30/12 4/7/12 8/29/12 5/9/12 11/29/12 5/9/12 5/30/12 6/28/12 7/27/12 8/29/12 9/27/12 10/30/12 1/29/13 based on the Certifications issued by the Bank of Philippine Islands n on February 7, 2013 and the Metropolitan Bank and Trust Company on February 14, 2013. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, provides, to wit: "SEC. 28. Rates of Income Tax on Foreign Corporations . . . . (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: n Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." However, such income may be exempt 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: DETACa "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." In this case, we apply the Philippines-Japan tax treaty. A. As to payments made under the Agreement and MET Article 12 of the Philippines-Japan tax treaty provides: "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 . 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 . HEITAD 5. The provisions of paragraphs 1, 2 and 3 shall not apply if the beneficial owner of the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties arise, through a permanent establishment situated therein, or performs in that other Contracting State independent personal services from a fixed base situated therein, and the right or property in respect of which the royalties are paid is effectively connected with such permanent establishment or fixed base. In such case the provisions of Article 7 or Article 14, as the case may be, shall apply. 6. Royalties shall be deemed to arise in a Contracting State when the payer is that Contracting State itself, a political subdivision or a local authority thereof or a resident of that Contracting State. Where, however, the person paying the royalties, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base in connection with which the liability to pay the royalties was incurred, and such royalties are borne by such permanent establishment or fixed base, then such royalties shall be deemed to arise in the Contracting State in which the permanent establishment or fixed base is situated. 7. Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the royalties, having regard to the use, right or information for which they are paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case, the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this Convention." (underscoring supplied) In this case, payments under the Agreement are treated as payments for information concerning industrial, commercial or scientific experience. Thus, this Office is of the opinion and so holds that payments made by Honda PH to Honda Japan shall be treated as royalties pursuant to Article 12 (3) of the Philippines-Japan tax treaty. Honda PH , being BOI-registered, the said royalty payments shall be subject to 10 per cent of the gross amount of the royalties . In addition, the royalty payments and payments for services rendered in the Philippines under the MET made by Honda PH to Honda Japan are subject to the 12 percent VAT pursuant to Section 108 of the National Internal Revenue Code of 1997, as amended. Accordingly, Honda PH , being the payor in control of the payment shall be responsible for the withholding of VAT on the said royalty payments on behalf of Honda Japan by filing a separate VAT return for and on behalf of Honda Japan using BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form 1600 and proof of payment thereof shall serve as sufficient basis for the claim of input tax to be applied against the output tax that may be due from Honda PH , if it is a VAT registered taxpayer. In case Honda PH is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased or treated as an "expense" or an "asset", whichever is applicable. In addition, Honda PH is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies thereof to be given to Honda Japan upon its request, and the fourth copy to be retained by Honda PH as its copy. [Section 4.110.3 (b), Revenue Regulations No. (RR) 7-95, as amended by RR 08-02 (now Section 4.114-2, RR 16-05, as amended by RR 04-07)] Furthermore, under Article 6 of the Agreement , a Memorandum for Supply of Parts may be entered into by the Honda Japan and Honda PH . Article 7 of the Philippines-Japan tax treaty 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. 2. Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment." Under the Agreement , upon the request of Honda PH , Honda Japan shall sell or supply parts and the manufacturing facilities to Honda PH or any purchasing agency designated by it at reasonable price and in accordance with a Memorandum on Supply of Parts . Since it is within the business framework of Honda Japan to manufacture and sell parts and supplies based on Honda Japan 's Articles of Incorporation, said profits derived from such sales shall be considered as business profits. As such, as a general rule, said payments shall be exempt from income tax pursuant to Article 7 of the Philippines-Japan tax treaty. However, as to the determination of the existence of a permanent establishment, since this is a future contingency, this Offices declines to rule thereon since the parties not having had entered into a Memorandum on Supply of Parts yet. But this is without prejudice to the filing of Honda Japan of the requisite TTRA in the future. B. Payments made under the SSA Under the SSA, Honda Japan shall provide and supply the Support Services to Honda PH , which shall be distinct and separate from the intellectual property rights and technical information furnished or supplied under the Agreement . Under Article 2 of the SSA, the term "Support Services" shall mean services such as but not limited to the following areas: ATICcS (1) the designing of manufacturing and assembly line and other preparations or processes for production; (2) the method, technique, process or system for the efficient and effective purchase, installation and operation of manufacturing and inspection facilities; (3) the planning or production quality management system; (4) the organization of production parts and products logistics system or system; (5) the introduction of computerized systems, including computer softwares, for production control and assembly line control; (6) the plant engineering management and facility maintenance services; (7) the improvement of administrative and accounting management system commensurate to, and/or aligned with expanded production capacity; (8) other support services as the parties may so mutually agree upon. Article 7 of the Philippines-Japan tax treaty 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. 2. Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment." In relation thereto, Article 5 of the Philippines-Japan tax treaty 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. 3. A building site or construction or installation project constitutes a permanent establishment only if it lasts more than six months. 4. Notwithstanding the preceding provisions of this Article, the term "permanent establishment" shall be deemed not to include: a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise; e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character; f) the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs (a) to (e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character. 5. Where a person other than an agent of an independent status to whom paragraph 7 applies is acting in a Contracting State on behalf of an enterprise of the other Contracting State, that enterprise shall be deemed to have a permanent establishment in the first-mentioned Contracting State in respect of any activities which that person undertakes for the enterprise, if: TIADCc a) that person has, and habitually exercises in the first-mentioned Contracting State, an authority to conclude contracts in the name of the enterprise, unless his activities are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph; or b) that person regularly secures orders in the first-mentioned Contracting State wholly or almost wholly for the enterprise itself or for the enterprise and other enterprises which control or are controlled by that enterprise; or c) that person maintains in the first-mentioned Contracting State a stock of goods or merchandise belonging to the enterprise from which he regularly fills orders on behalf of the enterprise. 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." Under tax treaties, payments for the supply of services are treated as business profits, unless they are otherwise treated as royalties when they concern the use of know-how or any other intangible property (copyright, patent, trademark, design or model, plan, secret formula or process design). To distinguish between payments for the supply of services and payments for know-how, the following commentaries of the Organisation for Economic Co-operation and Development ("OECD") Model Tax Convention on Income and on Capital (Condensed Version, July 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. 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 warranty, 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 AIDSTE 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." (Pages 225-226) Based on the above-quoted provision, payments made to Honda Japan by Honda PH under the SSA are considered business profits and shall be exempt from income tax unless the personnel sent to the Philippines: (1) has a fixed base regularly available to him in the Philippines, or (2) undertakes any of the following: (i) an authority to conclude contracts in the name of Honda Japan; (ii) regularly secures orders in the Philippines wholly or almost wholly for Honda Japan or other enterprises which control or are controlled by Honda Japan; (iii) maintains in the Philippines a stock of goods or merchandise belonging to the enterprise from which he regularly fills orders on behalf of the enterprise In this case, since Honda Japan and Honda PH has not yet sent any support service to be performed on an on-site basis based on the letter dated May 23, 2012, issued by the Assistant Vice President for Finance of Honda PH , this Office is of the opinion and so holds that the payments for off-site services under the MET and SSA , or those rendered outside the Philippines, shall be exempt from income tax, which are as follows: (1) the designing of manufacturing and assembly line and other preparations or processes for production, which is separate and distinct from the intellectual property rights and technical information under the Agreement ; (2) the method, technique, process or system for the efficient and effective purchase, installation and operation of manufacturing and inspection facilities; (3) the planning or production quality management system; (4) the organization of production parts and products logistics system or system; (5) the introduction of computerized systems, including computer softwares, for production control and assembly line control; (6) the plant engineering management and facility maintenance services; (7) the improvement of administrative and accounting management system commensurate to, and/or aligned with expanded production capacity; (8) other support services as the parties may so mutually agree upon. 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. 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 effective January 1, 2009. n Note from the Publisher: Written as "Bank of Philippine Islands" in the original document. n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.