ITAD BIR Ruling No. 267-12

June 22, 2012 ITAD BIR RULING NO. 267-12 Article 12, Philippines-Japan tax treaty, as amended; BIR Ruling No. ITAD-011-10; BIR Ruling No. ITAD-048-10; BIR Ruling No. ITAD-010-11 Agan & Montenegro Law Offices Unit J-3, 7th Floor, Electra House Bldg. Esteban St. Legaspi Village Makati City Attention: Atty. J. Carlito M. Montenegro Authorized Representative Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on October 23, 2009 requesting confirmation that the royalty payments made by Isuzu Autoparts Manufacturing Corp. ("IAMC") to Isuzu Motors Limited ("IML") are subject to the 10 percent preferential tax rate pursuant to Article 12 (2) (b) 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 ("Philippines-Japan tax treaty") , as amended. It is represented that IML, with address at 26-1, Minami-oi-6-chome, Shinagawa-ku, Tokyo, 140-8722 Japan, is a corporation organized and existing under the laws of Japan as evidenced by the Certificate of Status of Taxable Person issued by the District Director of Shinagawa Tax Office dated July 16, 2009; that IML is not registered either as a corporation or as a partnership in the Philippines as shown in the Certification of Non-Registration of Company issued by the Securities and Exchange Commission on September 17, 2009; that, on the other hand, IAMC is a corporation duly organized and existing under the laws of the Philippines with principal place of business at 114 North Main Avenue, Phase III, Special Economic Zone, Laguna Technopark, Bian, Laguna; and that IAMC is registered with the Philippine Economic Zone Authority (PEZA) with Certificate of Registration No. 97-015. It is further represented on November 1, 2001, IML and IAMC entered into Supplemental Agreements to the Technical Assistance Agreement ("Agreement") whereby IML grants to IAMC the following: 1. Technical Information 1 A non-exclusive right to use the Technical Information in order for IAMC to assemble Licensed Transmission 2 and to manufacture Licensed Components 3 in the Philippines and to sell Licensed Transmission and Licensed Components in the Philippines and throughout the world unless justified for the protection of the legitimate interest of IML such as exports to countries where exclusive licenses to manufacture and/or distribute the products licensed under the Agreement has already been granted; 2. Technical Assistance During the Technical Cooperation Period, IML shall, upon mutual agreement of the parties, send to IAMC's facilities in the Philippines such number IML's employees on matters concerning the manufacture and assembly of Licensed Transmissions and Licensed Components and shall train at IML's facilities such member of IAMC's employees on matters concerning the manufacture and assembly of Licensed Transmissions and Licensed Components. As to the consideration of the furnishing of Technical Information by IML, it is represented that IAMC shall pay IML in Japanese Yen a "Running Royalty" (which excludes value-added tax) payable to IML during the Royalty Period: 4 ScCDET (i) For each Licensed Transmission sold by IAMC, an amount equivalent to three percent (3%) of the Net Selling Price of such Licensed Transmission, and (ii) For each Licensed Component sold by IAMC to customers as repair service parts, an amount equivalent to three percent (3%) of the Net Selling Price of such Licensed Component. It is further represented that the Agreement and its Supplemental and Amending Agreement are duly registered under the Intellectual Property Office with Certificate of Compliance No. 5-2006-00133; and that the transaction subject of the herein request for ruling is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or a judicial appeal of the taxpayers involved. It is finally represented that pursuant to BIR Ruling No. ITAD-041-01 dated April 10, 2001 and BIR Ruling No. ITAD-196-02 dated November 7, 2002, 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 Article 12 of the Philippines-Japan tax treaty, as amended by Article V of 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 , provides as follows: "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. . . ." Prior to the amendment of the Philippines-Japan tax treaty, royalty payments were 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 derived in the Philippines by 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. ITAD-041-01 dated April 10, 2001 and BIR Ruling No. ITAD-196-02 dated November 7, 2002, IAMC's payments to IML 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 IAMC to IML 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 the VAT on the transfer of technical know-how of IML, please be informed further that Section 108 of the Tax Code of 1997 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%) 2 of gross receipts derived from the sale or exchange of services, including the use or lease of properties . (Emphasis supplied) xxx xxx xxx" Thus, in general, the VAT is imposed on the transfer of technical know-how by IML in the Philippines, such that on every payment of royalty fees, IAMC is generally 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. : "Special laws may certainly exempt transactions from the VAT. 3 However, the Tax Code provides that those falling under PD 66 are not. P.D. 66 is the precursor of R.A. 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. 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 P.D. 66 and R.A. 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: . . ., R.A. 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 R.A. 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" Based on the foregoing, transactions exempt from VAT by reason of P.D. 66 and R.A. 7916 are effectively zero-rated. However, instead of zero-rating which is not available to non-resident 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 special laws, e.g. , Republic Act No. 7916 or PEZA Law, is particularly applicable to the instant case. Such being the case, the subject royalty payments to IML by IAMC, being a PEZA-registered enterprise, under the 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. DIESaC Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. "Technical Information" means the following documentary technical information: (i) The technical documents, set out in attached Exhibit B, that ISUZU owns, possesses or has the right to grant licenses hereunder and utilizes, at the time of ISUZU's delivery of such documents to IAMC under Section 2, for the manufacture and assembly, by ISUZU or other party or parties under ISUZU's license, of the Model Transmission and of the Model Component, and (ii) Such revision, changes, improvements, modifications and updated versions to the technical documents described in the preceding paragraph (i) as are subsequently made or acquired by ISUZU from time to time during the Technical Cooperation Period. 2. "Licensed Transmission" means any transmission that IAMC manufactures or assembles in accordance with ISUZU's design of and specifications for the Model Transmission corresponding to such transmission, utilizing all or any portion of the Technical Information furnished to IAMC by ISUZU under Section 2. 3. "Licensed Component" means any transmission part or assembly manufactured or assembled by IAMC in the Republic of the Philippines for repair and services for Licensed Transmission, utilizing all or any portion of the Technical Information furnished to IAMC by ISUZU under Section 2. 4. "Royalty Period" means, for the payment of royalty for any model of the Licensed Transmission and any Licensed Component therefor, the period commencing on the date of IAMC's first sale and delivery of a unit of the Licensed Transmission to the customers and terminating upon the expiration of five (5) years thereafter.