ITAD BIR Ruling No. 307-14

October 16, 2014 ITAD BIR RULING NO. 307-14 Article 12 Philippines-Japan tax treaty, as amended Gotoh Philippines Corporation 118 Excellence Avenue corner Competence Drive Carmelray Industrial Park I Canlubang, Calamba Laguna Attention: Mr. Mitsuyuki Terui Managing Director Ms. Aileene Reyes Accounting Manager Gentlemen : This refers to your tax treaty relief application filed on May 25, 2010 requesting confirmation that royalties paid by Gotoh Philippines Corporation ("Gotoh Philippines") to Gotoh Manufacturing Company Ltd. ("Gotoh") are subject to preferential treatment 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 ("Philippines-Japan tax treaty"), as amended by protocol. 1 Facts Gotoh is a foreign corporation which is a resident of Japan based on its Certificate of Residence issued by the Shinagawa Tax Office on August 12, 2010. Gotoh is located at Gotenyama Trust Tower, 4-7-35 Kita-Shinagawa, Shinagawa-ku, Tokyo, Japan. It is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission on February 22, 2010. On the other hand, Gotoh Philippines is a domestic corporation located at 118 Excellence Avenue corner Competence Drive, Carmelray Industrial Park I, Canlubang, Calamba, Laguna, Philippines. Based on the certification issued by the Philippine Economic Zone Authority ("PEZA") on December 12, 2013, Gotoh Philippines is engaged in the manufacture of lead frames; it is registered originally with the Export Processing Zone Authority under Certificate of Registration No. 95-31 dated March 17, 1995; and is entitled to a special tax rate of 5 percent final income tax on its gross income in lieu of national and local taxes under Republic Act No. 7916 2 as is usually available to PEZA-registered enterprises. On December 1, 2009, Gotoh Philippines and Gotoh entered into a Technical Support Agreement where Gotoh agreed to furnish Gotoh Philippines set of technical information and documents, such as product drawings, specifications, design standards, manufacturing process and quality control manuals, all being intellectual property relating to the manufacture of lead frames in the Philippines. Gotoh will provide also technical assistance by introducing newly developed technical information to assist in the sourcing of materials, machines and equipment for the manufacture of lead frames. In consideration, Gotoh Philippines will pay Gotoh a service fee equivalent to 5 percent of its total annual sales of the manufactured lead frames less the cost of raw materials used in production. The fee is payable every six months on or before February 28 (for the period July 1 to December 31) and August 31 (for January 1 to June 30). The Agreement took effect retroactively on July 1, 2009 for an initial term of one year or up to June 30, 2010; thereafter, the agreement continues to be in effect on a yearly basis. HICATc Ruling In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997, as amended ("Tax Code"), income derived in the Philippines by a foreign corporation not engaged in trade or business is subject to income tax at the rate of 30 percent, to wit: "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 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, under Section 32 (B) (5) of the Tax Code, such income is exempt or partially exempt to the extent required by any treaty obligation on the Philippines, 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: 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." cTECIA In this regard, paragraphs 1 and 2, Article 12 of the amended Philippines-Japan tax treaty provides relief to royalties arising in the Philippines and paid to a resident of Japan: "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. xxx xxx xxx 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." Under Article 12, such royalties are subject to a reduced rate of income tax of (a) 15 percent if the royalties are in respect of the use or the right to use of cinematograph films and films or tapes for radio or television broadcasting, and (b) 10 percent in all other cases. 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"). EATCcI Accordingly, since payments made by Gotoh Philippines to Gotoh under the Agreement, although nominally termed as service fees, are actually for the use by Gotoh Philippines of such set of technical information and documents (product drawings, specifications, design standards, manufacturing process and quality control manuals) and for the provision of the necessary technical assistance for the manufacture of lead frames, these payments are royalties within the meaning described in paragraph 3, Article 12 of the Philippines-Japan tax treaty. Particularly, they are payments for the use of know-how and design or model. Therefore, such payments, which are not for the use of cinematograph films and films or tapes for radio or television broadcasting, made to Gotoh are subject to income tax at the rate of 10 percent, pursuant to paragraph 2 (b), Article 12 of the treaty. Furthermore, under Section 108 (A) of the Tax Code, the payments for the use of intangible properties in the Philippines are subject to value-added tax ("VAT"): "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 selling price or gross value in money of the goods or properties sold, bartered or exchanged, such tax to be paid by the seller or transferor: Provided, that the President, upon the recommendation of the Secretary of Finance, shall, effective January 1, 2006, 3 raise the rate of value-added tax to twelve percent (12%) . . ." However, since Gotoh Philippines is a PEZA-registered enterprise and entitled to fiscal incentives pursuant to Republic Act No. 7916, the Supreme Court, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866 dated February 11, 2005), ruled that: IEaATD "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: First, 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." Accordingly, since Gotoh, the nonresident lessor of the properties, is not a VAT-registered taxpayer, payments made to it by Gotoh Philippines are, for VAT purposes, treated as exempt and not subject to zero-rated VAT. In either case, no output VAT is shifted or passed-on to Gotoh Philippines. 4 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. DCISAE Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner Bureau 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. 2. An Act Providing for the Legal Framework and Mechanism for the Creation, Operation, Administration, and Coordination of Special Economic Zones in the Philippines, Creating for this Purpose, the Philippine Economic Zone Authority (PEZA), and for Other Purposes, as amended. 3. The VAT rate is increased to twelve percent 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. Revenue Regulations No. 16-2005 (Consolidated Value-Added Tax Regulations of 2005), as amended, provides: "SEC. 4.106-5. Zero-Rated Sales of Goods or Properties. A zero-rated sale of goods or properties (by a VAT-registered person) is a taxable transaction for VAT purposes, but shall not result in any output tax. However, the input tax on purchases of goods, properties or services related to such zero-rated sale, shall be available as tax credit or refund in accordance with these Regulations." "SEC. 4.109-1. VAT-Exempt Transactions. (A) In general. 'VAT-exempt transactions' refer to the sale of goods or properties and/or services and the use or lease of properties that is not subject to VAT (output tax) and the seller is not allowed any tax credit of VAT (input tax) on purchases The person making the exempt sale of goods, properties or services shall not bill any output tax to his customers because the said transaction is not subject to VAT." n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.