ITAD BIR Ruling No. 288-13

October 1, 2013 ITAD BIR RULING NO. 288-13 Article 12, Philippines-Japan tax treaty; Section 28 (B) (1) in relation to Section 32 (B) (5) of the Tax Code of 1997, as amended Salvador & Associates 815-816 Tower One & Exchange Plaza Ayala Triangle, Ayala Avenue, Makati City Attention: Atty. Gerardo V. Francisco Authorized Representative Gentlemen : This refers to your tax treaty relief application filed on June 29, 2012 requesting confirmation that the royalty payments made to Lotte Co., Ltd. ("Lotte Japan'') by Lotte Confectionery Pilipinas Corporation ("Lotte Phil") are subject to preferential tax 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 Lotte Japan is a Japanese corporation with address at 20-1 Nishi-Shinjuku 3-Chome, Shinjuku-ku, Tokyo, Japan, based on the Declaration of Residence dated March 26, 2012, issued by the Shinjuku Tax Office of Japan; that Lotte Japan is not registered as a corporation or as a partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission dated July 9, 2012; and that on the other hand, Lotte Phil is a domestic corporation with address at Unit 1702, Hanson Square Building, No. 17 San Miguel Avenue, Ortigas Center, Pasig City. It is further represented that on April 1, 2012, Lotte Japan and Lotte Phil entered into a License Agreement ("Agreement") whereby Lotte Japan granted Lotte Phil a license to manufacture and sell certain confectionary products in the Philippines by using certain formulation and technology (" Know-how ") for manufacturing and selling the products under Lotte Japan 's trademarks; that for and in consideration of such license, Lotte Phil shall pay Lotte Japan 1.0% of net ex-factory sales less sales commissions, volume discounts, and the sales for the specified companies specified by Lotte Japan , actually granted (Net Sales) accrued for each such category during such calendar-half-year as the license fee, payable within 30 days after the end of each calendar-half-year during the term of the Agreement ; that any such payment shall be made exclusive of any bank charges; and that royalty payments were made on August 17, 2012 based on the Certificate of Remittance issued by the Bank of Tokyo-Mitsubishi UFJ on November 8, 2012. SCHcaT It is finally represented that the subject income payments are not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or a judicial appeal based on the Certification issued by Lotte Japan on May 8, 2012. In reply, please be informed that royalties payable to Lotte Japan , being a foreign corporation not engaged in trade or business in the Philippines, are subject to income tax at a rate of 30 percent Section 28 (B) (1) of the National Internal Revenue Code of 1997 (" Tax Code "), as amended, provides: "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%)." However, such royalties 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: ScTIAH "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." Thus, you invoke the Philippines-Japan tax treaty. With respect to royalties, Paragraphs 1, 2, 3 and 4, Article 12 thereof provide: "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; aETAHD 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. xxx xxx xxx" 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. IEcDCa 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. HSATIC 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 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) DAHCaI In this case, payments under the Agreement concern information of that kind described in paragraph 11 quoted above which 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 and that there would generally be very little more which needs to be done by Lotte Japan under the contract other than to supply existing information or reproduce existing material and will not involve a very much greater level of expenditure by Lotte Japan in order to perform his contractual obligations. Under paragraphs 2 and 3 of Article 12 of the Philippines-Japan tax treaty, royalties arising in the Philippines and paid to a resident of Japan may be taxed in the Philippines at a rate not to exceed (a) 15 percent of the gross amount of the royalties if they are paid in respect of the use or the right to use of cinematograph films and films or tapes for radio or television broadcasting; (b) 10 percent of the gross amount of the royalties if they are paid by a domestic company registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines; and (c) before January 1, 2009, 25 percent of the gross amount of the royalties in all other cases and beginning January 1, 2009, 10 percent of the gross amount of the royalties in all other cases. Under paragraph 4 of Article 12, the term Royalties 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 ("Know-how"). Considering that Lotte Phil is not a BOI-registered enterprise engaged in preferred pioneer areas of investment and the subject royalties are not payments in respect of the use or right to use cinematograph films and films or tapes for radio or television broadcasting, this Office of the opinion and so holds that the said payments by Lotte Phil to Lotte Japan under the Agreement are royalty payments in consideration for the right to use of any patent, trade mark, design or model, plan, secret formula or process, and as such are subject to the preferential tax rate of 10 percent of the gross amount of royalties pursuant to Article 12 (2) (b) of the Philippines-Japan tax treaty. Furthermore, the royalty payments made by Lotte Phil are subject to the 12% value-added tax (VAT) pursuant to Section 108 of the National Internal Revenue Code of 1997, as amended. Accordingly, Lotte Phil, being the payor in control of the payment shall be responsible for the withholding of VAT on the said royalty payments on behalf of Lotte Japan by filing a separate VAT return for and on behalf of Toyota 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 Lotte Phil, if it is a VAT registered taxpayer. In case Lotte Phil 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, Lotte Phil 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 Lotte Japan upon its request, and the fourth copy to be retained by Lotte Phil 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)] DIETcC 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.