ITAD BIR Ruling No. 316-14

November 24, 2014 ITAD BIR RULING NO. 316-14 Article 12, Philippines-Japan tax treaty, as amended Toyota Motor Philippines Corporation Toyota Special Economic Zone Santa Rosa, Tagaytay Highway Santa Rosa City, Laguna Attention: Mr. Davi Go, Ph.D Senior Executive Vice President Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on December 8, 2009 requesting confirmation that the royalty payments made by Toyota Motors Philippines Corporation ("Toyota") to Daihatsu Motor Co., Ltd. ("Daihatsu") are subject to the 10 percent preferential tax rate pursuant to Article 12 (2) (b) 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 ("Philippines-Japan tax treaty"), as amended. It is represented that Daihatsu, with address at 1-1, Daihatsu-Cho, Ikeda City, Osaka, Japan, is a corporation organized and existing under the laws of Japan as evidenced by the Certificate of Residence issued by the District Director of Toyono Tax Office dated October 16, 2009; that Daihatsu 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 October 23, 2009; and that, on the other hand, Toyota is a corporation duly organized and existing under the laws of the Philippines with principal place of business at Toyota Special Economic Zone, Santa Rosa, Tagaytay Highway, Santa Rosa City, Laguna. It is further represented, that on December 27, 2006, Daihatsu and Toyota entered into a Technical Assistance Agreement ("Agreement") effective on March 1, 2006 until February 28, 2011 automatically renewable for the successive term of one (1) year each, unless either of the parties give written notice of termination; and that the Agreement complies with the provisions of Sections 87 and 88, Chapter IX of the Intellectual Property Code of the Philippines (Republic Act No. 8293) on Voluntary Licensing under Certificate of Compliance No. 5-2006-00075 issued by the Intellectual Property Office on January 19, 2007. It is also represented that Daihatsu has been engaged in the manufacture of motor vehicles and component parts thereof and owns valuable technique and manufacturing know-how on motor vehicles and component parts thereof through research, development and experience for many years; that Daihatsu grants Toyota the manufacturing license for automotive parts and components and materials in the Philippines; that the license granted is non-exclusive, non-divisible, non-transferable and non-assignable and does not include any right to grant sublicenses; that the technical know-how, information, data, etc. to be furnished by Daihatsu to Toyota shall be the following: AcEIHC 1. For studying the feasibility of Local Parts 1 manufacturing a) Localization basic plan of bought-out parts b) Localization parts by steps c) (Trial) Production drawings of Local Parts d) Sample parts (1 set) 2. For manufacturing of Local Parts a) Local contents List b) Production drawings c) Request for design & development of parts (if any) d) CAD data e) Engineering change instructions f) Daihatsu engineering standards g) Technical instruction sheet h) Color combination instructions i) Color samples j) Grains Samples k) Sample parts (1 set) 3. For production preparation of Licensed Products- the portions (and only those portions) of the following know-how, information, data, etc. which then are or were used by Daihatsu and/or then in the hands of Daihatsu and which have not been developed, revised and/or modified by Daihatsu especially for Toyota: DIEAHc a) Quality Standards b) Inspection Standards c) KD Parts 2 specification sheet d) Contents of parts list e) KD Parts List (including Non-Licensed Parts 3 List) f) Disassembled form drawings In consideration of the royalty grants by Daihatsu to Toyota, it is represented that Toyota shall pay Daihatsu royalties equivalent to 6% of the "Local Value Added" of those Outgoing Licensed Parts or Local Parts and 3% "Local Value Added" for the Outgoing Licensed Parts or Local Parts sold; and that per Certification issued Toyota dated August 8, 2013, Toyota made remittances of royalties to Daihatsu through Metropolitan Bank and Trust Co. In reply, please be informed that royalties derived in the Philippines by a nonresident foreign corporation are, in general, covered by Section 28 (B) (1) of the National Internal Revenue Code ("Tax Code") of 1997, as amended. It provides: "Section 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 . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). aSTAcH xxx xxx xxx" However, Section 32 (B) (5) of the Tax Code of 1997, as amended, provides that: "Section 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. xxx xxx xxx" With respect to a treaty, what is being invoked for this purpose is Article 12 of the Philippines-Japan tax treaty, as amended. It 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; cDSaEH (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" Based on the Protocol amending the Philippines-Japan tax treaty which took effect on January 1, 2009, royalties derived in the Philippines by a resident of Japan will be taxed at a preferential rate of 15 percent if the same 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. In view thereof, since royalties paid by Daihatsu to Toyota are not paid in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, this Office hereby holds that said royalties shall be subject to income tax at the reduced rate of 10 percent of the gross amount thereof, pursuant to Article 12 (2) of the Philippines-Japan tax treaty, as amended. SDTaHc As regards the imposition of the VAT on the transfer of technical know-how of Daihatsu, 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 Daihatsu in the Philippines, such that on every payment of royalty fees, Toyota 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. DAaIEc 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. cTSDAH 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 Daihatsu by Toyota, 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. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner Bureau of Internal Revenue Footnotes 1. "Local Parts" means the parts, components and materials for the Outgoing Licensed Parts, which may be manufactured, or purchased from third parties, by the Licensee by using any technical know-how, information, data, etc. furnished by the Licensor to the Licensee hereunder and with the Licensor's prior written approval under Article 7 hereof. 2. "KD Parts" means the parts, components and materials in such knock-down or other form as separate prescribed by Licensor, which shall be supplied by it directly or indirectly to the Licensee for the manufacture of the Outgoing Licensed Parts or the Local Parts under the terms and conditions separate agreed upon between the parties concerned. 3. "Non-Licensed Parts" means the parts, components, which shall be purchased from third parties by the Licensee for the manufacture of the Outgoing Licensed Parts or the Local Parts without using any technical know-how, information, data etc. furnished by the Licensor to the Licensee hereunder. The scope of the Non-Licensed Parts shall be designated and may from time to time be change by the Licensor.