ITAD BIR Ruling No. 325-14

December 18, 2014 ITAD BIR RULING NO. 325-14 Article 12, Philippines-Japan tax treaty, as amended Masuda Philippines, Inc. 108 North Science Avenue Laguna Technopark Bian, Laguna Attention: Mr. Yoshiharu Nakano President Gentlemen : This refers to your tax treaty relief application filed on April 2, 2009 requesting confirmation that royalties paid by Masuda Philippines, Inc. ("Masuda Philippines") to MSD Company Ltd. ("MSD") 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. 1 Facts MSD is a foreign corporation resident of Japan based on its Residence Certificate issued by the Hamamatshigashi Taxation Office on May 23, 2008. It is engaged in the business of development, manufacture and sale of certain motorcycle parts. MSD is located at 1500 Watagashima Tenryu-shi, Shizuoka-ken, Japan. It is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission on April 8, 2009. On the other hand, Masuda Philippines is a domestic corporation located at 108 North Science Avenue, Laguna Technopark, Bian, Laguna, Philippines. It is registered with the Philippine Economic Zone Authority ("PEZA") as an export enterprise engaged in the manufacture and sale of precision frame body parts (cross-pipes, step arm assembly, side frame and pivots) for large motorcycles (250 cc to 750cc) and other types of vehicles and engine head covers and engine fan covers made of steel alloys and components made basically of steel; of caster wheel parts and motorcycle stand center complete and carrier complete; of metal crates and automotive parts (engine parts, aircon parts and seat frame parts); and of swing arm and other motorcycle parts such as head comp, main comp, down comp, upper comp, L/R sub pipe comp, pipe sub cross, stay comp and HD/LT upper cowl. DCTSEA On August 1, 2001, Masuda Philippines and MSD entered into a License and Technical Assistance Agreement where MSD granted Masuda Philippines an indivisible, nontransferable and nonexclusive right and license to manufacture, assemble, and sell motorcycle parts for manufacturers of motorcycles like Honda Italia Industriale S.p.A. and Honda Spain by using know-how developed by and belonging to MSD. In consideration, Masuda Philippines will pay royalties to MSD equivalent to 3 percent of the net selling price of the products. The royalties are computed every month and payable beginning on the tenth day up to the last day of the following month. The Agreement took effect on August 1, 2001 with an initial term of five years. Thereafter, the Agreement will be renewed automatically every year but subject to approval by the Technology Transfer Bureau of the Philippines. The Agreement was amended on September 1, 2003 for the purpose of increasing the rate of royalties to 5 percent, and on September 5, 2007 for the purpose of extending the term of the Agreement until July 31, 2011. Ruling In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997, as amended (" Tax Code "), royalties derived in the Philippines by a foreign corporation not engaged in trade or business in the Philippines are 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: ECTSDa "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." For this purpose, paragraph 2, Article 12 of the amended Philippines-Japan tax treaty provides relief to such royalties paid to a resident of Japan, to wit: "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 percent 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 percent 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." HcTSDa Under this article, such royalties are subject to income tax at a rate not to exceed (a) 15 percent if the royalties are paid 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. 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 "). Accordingly, since the intangible property subject of the Agreement between Masuda Philippines and MSD is in the form of know-how, specifically for the manufacture, assembly, and sale of motorcycle parts, and not copyright on cinematograph films and films or tapes for radio or television broadcasting, such royalties paid by Masuda Philippines to MSD are subject to income tax at the rate of 10 percent, pursuant to paragraph 2 (b), Article 12 of the amended Philippines-Japan tax treaty. Furthermore, under Section 108 (A) of the Tax Code, the royalties are generally subject to value-added tax ("VAT"), to wit: "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: Provided, that the President, upon the recommendation of the Secretary of Finance, shall, effective January 1, 2006, 2 raise the rate of value-added tax to twelve percent (12%). . ." However, since Masuda Philippines is a PEZA-registered enterprise and entitled to fiscal incentives under Republic Act No. 7916, 3 as amended, the Supreme Court ruled, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866 dated February 11, 2005), that: "Applying the special laws we have earlier discussed, respondent as an entity is exempt from internal revenue laws and regulations. CTHaSD 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 MSD, the nonresident lessor of know-how, is not a VAT-registered taxpayer, such royalties paid to it by Masuda Philippines are treated as VAT exempt instead of being subject to zero-rated VAT. In either case, no output VAT shifted or passed-on to Masuda 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. 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. The VAT rate was increased to 12 percent beginning 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. 3. 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. 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.