ITAD BIR Ruling No. 256-12

June 8, 2012 ITAD BIR RULING NO. 256-12 Article 12, Philippines-Japan tax treaty, as amended Flexo Manufacturing Corporation 275 A, Mabini St., Caloocan City 1400 Metro Manila Attention: Mr. Ricardo C. Leong President Gentlemen : This refers to your letter dated July 13, 2009, requesting confirmation of your opinion that the royalty payments of your company, Flexo Manufacturing Corporation (hereinafter referred to as " Flexo ") to Hosokawa Yoko Co., Ltd. (hereinafter referred to as "HYCL") pursuant to a License Agreement are subject to 10 percent final tax under Article 12, paragraphs 2 and 3 of 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 ("Philippines-Japan tax treaty") . It is represented that HYCL is a foreign corporation duly organized and existing under the laws of Japan with address at 11-5, Nibancho, Chiyoda-ku, Tokyo, Japan and is a resident thereof as evidenced by the Residence Certificate issued by the District Director of Kojimachi Tax Office dated September 12, 2008; 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 August 5, 2008; on the other hand, Flexo is a corporation duly organized and existing under Philippine laws. It is further represented that HYCL entered into a License Agreement with Flexo whereby HYCL, as the Licensor, granted Flexo the exclusive right to use HYCL's Industrial Property Rights, 1 Trademarks 2 and other information and know-how relating to the manufacture and sale of the products owned or controlled by Flexo as of August 18, 1989 (date when the License Agreement was executed between Flexo and HYCL) inside the Philippines, and Hong Kong (later in March 9, 1992 the date the Amendment Agreement was executed), provided Flexo agrees as follows: 1) It is expressly agreed that the Industrial Information 3 and the Improvements are proprietary information and constitute the trade secrets of HYCL. Accordingly, the Industrial Information and the Improvements shall be held in strict confidence by Flexo and shall not be disclosed to any third party without the prior written consent of HYCL. DaTEIc 2) Flexo shall not itself sell, lease, transfer, export or otherwise dispose of its Products 4 outside the Philippines and Hong Kong or to any third party in the Territory who Flexo knows or should reasonably know intends to sell, lease, transfer, export or otherwise dispose of the products in the form of bare packages without contents outside the Territory. 5 3) HYCL hereby grants to Flexo an exclusive license to use the Industrial Information during the term of the Agreement solely in connection with the manufacture and sale of the Products in the Territory, and Flexo hereby accepts such grant, all on the terms and conditions hereinafter set forth. 4) Flexo shall not, without HYCL's prior written consent, be entitled to grant sublicenses of the Industrial Information. It is also represented that for and in consideration of the license granted to Flexo by HYCL pursuant to the License Agreement executed on August 18, 1989, Flexo shall pay HYCL: (a) An initial royalty fee in the amount of Nine Million Five Hundred Thousand Japanese Yen (9,500,000.00), divided into three (3) installments as follows: (1) Five Million Five Hundred Thousand Japanese Yen (5,500,000.00) within twenty (20) days after August 18, 1989; (2) Two Million Japanese Yen (2,000,000.00) within one (1) year after August 18, 1989; (3) Two Million Japanese Yen (2,000,000.00) within two (2) years after August 18, 1989; and (b) Flexo shall pay HYCL a yearly royalty, irrespective of the sales amount of the Products by Flexo , with respect to each Contract Year 6 (prorated for any period which is less than a full Contract Year) as follows: (1) First (1st) Contract Year 500,000.00 (2) Second (2nd) Contract Year 500,000.00 (3) Third (3rd) Contract Year 1,000,000.00 (4) Fourth (4th) Contract Year 1,000,000.00 (5) Fifth (5th) Contract Year 1,000,000.00 (6) Sixth (6th) Contract Year 2,000,000.00 (7) Seventh (7th) Contract Year 2,000,000.00 (8) Eighth (8th) Contract Year 2,000,000.00 (9) Ninth (9th) Contract Year 2,000,000.00 (10) Tenth (10th) Contract Year 2,000,000.00 (11) Eleventh (11th) Contract Year 2,000,000.00 (12) Twelfth (12th) Contract Year 2,000,000.00 It is further represented that the License Agreement was effective on August 18, 1989 and shall, unless earlier terminated, continue for an initial term of twelve (12) years; that thereafter, shall be automatically extended for additional periods of one (1) year each unless one party informs the other party of its intention to terminate the License Agreement at least sixty (60) days prior to initial term or any extension thereof; that in the event of automatic extension of the License Agreement, any change in the yearly royalty applicable to such extended period shall be determined by the parties on the basis of mutual discussions at least sixty (60) days prior to the expiration of the effective term of the License Agreement. DEICHc It is finally represented that for and in consideration of the right granted to Flexo by HYCL pursuant to the Amendment Agreement executed on March 9, 1992, Flexo shall pay HYCL a running royalty equal to 4% of the aggregate Net Selling Price 7 of the Products sold in Hong Kong; that the running royalty shall be calculated every six (6) months commencing on March 9, 1992 and shall be paid within sixty (60) days after the end of each six (6)-month period; and that the issues or transactions subject of the above request are not under any investigation or on-going audit, administrative protest, claim for refund or issuance of tax credit certificate, collection proceedings, or a judicial appeal. In reply, 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 . . ." (Emphasis ours) In view of the foregoing, considering that the Agreement was entered into on August 18, 1989 but the subject TTRA was filed only on July 13, 2009, in violation of the 15-day period prescribed by RMO 1-2000, this Office hereby DENIES relief on such payments paid prior to July 28, 2009. Accordingly, said payments paid prior to July 28, 2009 shall be subject to income tax at the rates provided under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, 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: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." aSCHIT However, with respect to payments made beginning July 28, 2009, this Office hereby GRANTS relief on the payments pursuant to the Philippines-Japan tax treaty which, in its Article 12, as amended, provides, viz. : "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." (Underscoring supplied) In view of all of the foregoing, this Office is of the opinion and so holds that the subject royalty payments by Flexo to HYCL under the License Agreement and the Amendment Agreement beginning July 28, 2009 are subject to tax at a preferential rate of 10 percent based on the gross amount of the royalty, pursuant to Article 12 of the Philippines-Japan tax treaty, as amended. As regards the imposition of the VAT on the royalty fees to HYCL, please be informed further that Section 108 of the Tax Code of 1997, as amended by Republic Act No. 9337, provides as follows: "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 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 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 percentage of GDP of the previous year exceeds one and one-half percent (1 1/2%). xxx xxx xxx '(1) The lease or the use of or the right or privilege to use any copyright, patent, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or right; EACIaT xxx xxx xxx" Thus, in general, the VAT is imposed on the royalty payments made to HYCL in the Philippines. On every payment of royalty fees, Flexo is required to withhold such VAT and treat the same as a "passed on" VAT, pursuant to Section 4.110-3 (b) of Revenue Regulations No. 7-95 as amended [now Section 4.114-2 (b) of Revenue Regulations No. 16-05]. However, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866, February 11, 2005), the Supreme Court held, viz. : "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. xxx xxx xxx" Such being the case, the payment of royalty fees by Flexo, being a PEZA-registered enterprise, to HYCL under the License Agreement and the Amendment 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. caTESD Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Shall mean all patents, utility models, designs and other industrial property rights relating to the manufacture of the Products owned or controlled by HYCL. 2. Shall mean all trade names and trademarks relating to the Products owned or controlled by HYCL. 3. Shall mean all industrial property rights, trademarks and other information and know-how relating to the manufacture and sale of the products owned or controlled by HYCL including but not limited to, drawings, specification plans, models, designs, charts, processes and formulae. 4. Shall mean drink packaging known as "Cheer Pack". 5. Shall mean the Philippines and Hong Kong. 6. Shall mean each consecutive twelve (12)-month period during the term of the Agreement commencing on August 18, 1989 or each subsequent anniversary thereof as the case may be, and ending on the day immediately preceding each anniversary date thereof. 7. Shall mean the invoice price billed by Flexo to its customers less (a) sales, use, excise and other similar taxes: (b) transportation and insurance charges on delivery; (c) trade or quantity discounts; and (d) credits for returns.