ITAD BIR Ruling No. 270-12

June 27, 2012 ITAD BIR RULING NO. 270-12 Articles 12, 7 and 5, Philippines-Japan tax treaty, as amended; BIR Ruling No. ITAD-011-10 MAHLE Filter Systems Philippines Corporation Block 8 Lots 5, 6 & 7 PEZA Drive First Cavite Industrial Estate Brgy. Langkaan, Dasmarias, Cavite Attention: Ms. Eleonor F. Ledesma Department Head General Accounting and Tax Gentlemen : This refers to your letters dated June 30, 2009 and September 15, 2010, on behalf of MAHLE Filter Systems Phil's Corporation ("MFSP") , requesting for an applicable tax treaty rate on the royalty fee paid by MFSP to MAHLE Filter Systems Japan Corporation ("MFSJ") based on 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 MFSJ (formerly MAHLE Tennex Corporation), with Corporate Register Number: 0133-01-007523, is a company duly established on July 31, 1945 under the laws of Japan for the purpose, among others, of designing, manufacturing, repairing and selling of filters, heat exchangers, exhaust gas cleaning devises, air conditioners, silencers, home electrical appliances, office equipment, and small electric motors, with head office at 1-2, Ikebukuro 3-chome, Toshima Ward, Tokyo, per the duly consularized Certificate of All Company Matters Registered Hitherto as certified by the Registrar, Toshima Branch of Tokyo Legal Affairs Bureau dated June 24, 2009; that it is not registered as a corporation nor as a partnership in the Philippines per Certification of Non-Registration of Company issued by the Securities and Exchange Commission (SEC) dated June 24, 2009; that, on the other hand, MFSP (formerly MAHLE Tennex Philippines Corporation) is a Philippine Economic Zone Authority (PEZA)-registered Ecozone Export enterprise with Registration Certificate No. 96-067 dated June 3, 1996 as amended on December 5, 2005, duly incorporated for the primary purpose of manufacturing air filter elements and other automotive products. Moreover, it is represented that on January 1, 2009, MFSJ and MFSP entered into a License and Service Agreement ("LSA") , superseding any and existing license agreement between the two parties; that under the LSA, MFSJ grants MFSP the non-exclusive and right to use the current and future technology, know-how and intellectual rights for the manufacture and sale of modules and components for filtration engine peripheral ("Contractual Products"); that MFSJ also agrees to provide MFSP additional related development services; that other features of the LSA are described as follows: 1. LICENSE a. Type and Scope Non-exclusive and revocable right to use MFSJ's current and future technology, know-how and intellectual property rights for the manufacture, the use and the sale of Contractual Products. Rights granted herein shall not be transferable to any third party. Any sublicenses to subsidiaries of MFSP may, however, be granted after prior written approval by MFSJ. For the production of the Contractual Products, MFSJ shall provide all relevant documents, patents, drawings, quality standards, drafts and descriptions. MFSJ shall retain title to all documents and information provided. EHSCcT MFSJ agrees to disclose all new and further developments of Contractual Products and the production processes thereof regarding the Contractual Products throughout the term of the LSA, but retains title to all documents provided and reserves the right to request return thereof upon termination of the LSA. MFSP, at all times mutually agreed upon, shall send suitable qualified personnel for training at MFSJ's premises in the design, manufacture and marketing of Contractual Products, under certain conditions provided for in the LSA. b. Compensation For the grant of right to use technology, know-how and intellectual property rights of MFSJ, MFSP shall pay MFSJ a license fee of 2% on all Net Turnover 1 with Contractual Products produced and sold by MFSP shall pay MFSJ. With regard to any 'relocation of production' from MFSJ to MFSP (types which are first developed by MFSJ and were produced or foreseen for production there), the development costs, as far as not already amortized, and further profit elements shall be compensated by an additional license fee to MFSJ, beyond the aforementioned 2%, of 3% on all Net Turnover with Contractual Products produced by MFSP. The license fee shall be paid to MFSJ's bank account on a quarterly basis based on Group's standard intercompany terms applicable on the respective payment date and according to the conditions established in the LSA. 2. DEVELOPMENT SERVICES a. MFSJ shall be prepared to render additional services such as: Development tasks for design and components testing, damage analyses, calculations and the corresponding optimization, as well as materials testing; Delegation of specialists at the request of MFSP; Technical sales promotion; As well as additional services which may be requested by MFSP; b. Development costs shall be determined based on: The costs resulting from salary expenses of the employees who perform the Development Services and its connected operating costs, The costs of services performed by subcontractors, if any, and Travel expenses, accommodation, car-rental, meals and other current expenditures of MFSJ employees or subcontractors ('current expenses') shall be covered by MFSP, provided that they have been incurred solely in connection with the provision of the Development Services and are documented in accordance with the international standards and to the court of law having jurisdiction over the head office of MFSJ; c. Consideration for the Services: MFSJ shall determine the Development Costs based on: o The costs resulting from salary expenses of the employees who perform the Development Services and its connected operating costs, o The costs of services performed by subcontractors, if any, and o Travel expenses, accommodation, car-rental, meals and other current expenditures of MFSJ employees or subcontractors ("current expenses") shall be covered by MFSP, provided that they have been incurred solely in connection with the provision of the Development Services and are documented in accordance with the international standards and to the court of law having jurisdiction over the head office of MFSJ. ISDCHA Following the arms length principle a reasonable profit needs to be incorporated in the charges. In consideration of the provision of the Development Services, MFSP agrees to pay MFSJ all Development Costs due for the Development Services. MFSJ shall invoice MFSP at the end of each calendar month for Development Services performed by MFSP in that month. The development cost obligation shall be paid in the currency determined by the MAHLE Group Financial Guideline Risk Policy. 3. TRADEMARKS MFSJ grants MFSP a non-exclusive license to use the trademarks of MFSJ and/or sub-license to use any other trademarks which are used by MFSJ legitimately. 4. TERM and TERMINATION The LSA, made for unlimited period, comes into force as of the date when it is signed by both parties, effective as of January 1, 2009. Based on the foregoing, you now request for ruling on the license fee and other technical support services charges paid by MFSP to MFSJ under the LSA pursuant to the Philippines-Japan tax treaty, as amended. In reply, please be informed that subject license and service fees derived by MFSJ, a nonresident foreign corporation, are generally subject to tax as provided for under Section 28, (B) [1] of the National Internal Revenue Code of 1997 (Tax Code of 1997), as amended. It provides: "SEC. 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 . . . royalties . . . profits and income: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). . . ." However, Section 32 (B) (5) of the same Tax Code provides as follows, to wit: "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: 2 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." In relation thereto, Article 12 the Philippines-Japan tax treaty hereto invoked, may apply to the instant case. It 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. 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 literacy, 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." IAcTaC Based on the above provision, royalty income derived in the Philippines by a corporation which is a resident of Japan shall be taxed at a preferential rate of 10 percent if the payor company is BOI-registered engaged in preferred pioneer areas of investment; 15 percent if the payments are in respect of the use of or right to use cinematograph films and films or tapes for radio or television broadcasting; and 10 percent in all other cases. Considering that the payments are not in respect of the use of or right to use cinematograph films and films or tapes for radio or television broadcasting, the subject royalty payments to MFSJ may not qualify for the 15 percent treaty rate. However, although the payor of the royalties, MFSP, is not BOI-registered, the subject transaction may still qualify for the 10 percent preferential tax rate under Article 12 (2) [b] of the Philippines-Japan tax treaty, as amended. 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. 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 royalty payments of MFSP to MFSJ, under the LSA, before September 4, 2009 since the TTRA was filed beyond the 15-day period prescribed by the RMO. Accordingly, said royalties shall be subject to income tax at the rate provided for in the above-cited Section 28 (B) (1) of the Tax Code of 1997, as amended. However, this Office GRANTS relief on the royalty payments of MFSP to MFSJ under the LSA on September 4, 2009 and thereafter, and are subject to tax at a reduced rate of 10 percent based on the gross amount of the royalty, pursuant to the Article 12 (2) (b) of the Philippines-Japan tax treaty, as amended. (BIR Ruling No. ITAD-011-10 dated June 16, 2010) With regard to the fees derived by MFSJ as consideration for its Development Services rendered to MFSP under the LSA, the same shall be governed by Article 7, in relation to Article 5, of the Philippines-Japan tax treaty, as amended, to wit : ScCDET "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." "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. 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 taxable year. 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." Based on the foregoing, the development services fees of MFSJ to MFSP shall not be subject to Philippine income tax if MFSJ, being a resident of Japan, does not have a fixed place of business in the Philippines; or if it has such a fixed place, said fees are not attributable to such fixed place. However, should employees of MFSJ be required to render services in the Philippines and such furnishing of services continue within the Philippines for a period or periods aggregating more than six months within any taxable year, such shall be deemed to constitute as a permanent establishment of MFSJ in the Philippines. Accordingly, such service fees shall be subject to Philippine income tax. Considering that MFSJ does not have a fixed place of business in the Philippines, as indicated in the issued SEC Certification of Non-Registration of Company, and that the personnel of MFSJ, should their presence in the Philippines be required in the rendition of development services for MFSP under the LSA, shall not stay in the Philippines for a period or periods aggregating more than 6 months within any taxable year, then MFSP is not deemed to have a permanent establishment in the Philippines to which such payment of service fees may be attributed. In view thereof, this Office DENIES relief on the development service fees paid by MFSP to MFSJ under the LSA before the filing of the TTRA on August 20, 2009 since the TTRA was filed beyond the 15-day period prescribed by the RMO. Accordingly, said fees shall be subject to income tax at the rate provided for in the above-cited Section 28 (B) (1) of the Tax Code of 1997, as amended. However, relief is hereby GRANTED on the development service fees paid by MFSJ to MFSP under the LSA after 15 days from the date of the filing of this TTRA and the said fees 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. As regards the imposition of VAT on royalties and services fees for services rendered in the Philippines, Section 108 of the Tax Code of 1997, as amended provides that: "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%) 3 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: ETDHSa 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. 4 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. 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. xxx xxx xxx" Based on the foregoing, transactions exempt from VAT by reason of PD 66 and RA 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 specials laws, e.g. , Republic Act No. 7916 or PEZA Law, is particularly applicable to the instant case. Such being the case, the royalty payment and services fees of MFSP being PEZA-registered enterprise, to MFSJ under the subject LSA 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. TcHEaI Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Net Turnover = Sales minus Inter-company Purchases. 2. TITLE II TAX ON INCOME. 3. 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. 4. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337].