ITAD BIR Ruling No. 339-13

December 6, 2013 ITAD BIR RULING NO. 339-13 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 Futaba Corporation of the Philippines 120 North Science Avenue, Laguna Technopark SEPZ, Bian, Laguna Attention: Mr. Hiroshi Sekigawa President Gentlemen : This refers to your tax treaty relief application filed on January 31, 2013 requesting confirmation that the royalty payments made to Futaba Corporation-Japan ("Futaba Japan") by Futaba Corporation of the Philippines ("Futaba 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") . aDIHTE It is represented that Futaba Japan is a resident of Japan with address at 629 Oshiba, Mobara, Chiba, Japan, based on the Certificate of Residence dated July 6, 2012, issued by the District Director of Mobara Tax Office, Noboru Ueno, Japan; that Futaba 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 October 10, 2012; that on the other hand, Futaba Phil is a domestic corporation with address at 120 North Science Avenue, Laguna Technopark SEPZ, Bian, Laguna; and that Futaba Phil is registered with the Philippine Economic Zone Authority (PEZA) under Certification No. 2013-0181 based on the Certification issued by PEZA on December 20, 2012. It is further represented that on July 1, 2006, Futaba Japan and Futaba Phil entered into a Technical Assistance and License Agreement ("Agreement") whereby Futaba Japan granted Futaba Phil the following: (1) a non-exclusive license to manufacture the Products using the Manufacturing Technology and Patents; and, (2) a non-exclusive license to sell the Products which were manufactured using the Manufacturing Technology and Patents with the Trademarks; that Futaba Japan shall provide Futaba Phil with the Manufacturing Technology to the extent that Futaba Phil needs to manufacture the Products; that for and in consideration of the foregoing, Futaba Phil shall pay Futaba Japan (1) a Patents Royalty of two percent of the net sales of products sold by Futaba Phil and, (2) a Trademarks Royalty of one percent of the sales of products sold by Futaba Phil; that the total royalties is three percent of the sales of products sold by Futaba Phil; that in order to receive the Manufacturing Technology, Futaba Japan shall enter into a separate individual agreements with Futaba Phil in order to dispatch engineers; that the scope of the services shall be as follows: a) Technical assistance during the factory construction such as determination, manufacturing, transfer, launch, repair or modification of factory layout, manufacturing equipment, utility facility, and specification of dies, negotiation with manufacturing corporations, various meetings and on-site presence, etc.; b) Lay-out of manufacturing premise, recovery, adjustment and trial run of equipment, guidance on manufacturing technology, guidance on factory work, and training of workforce during the transfer of new technology, new process, or new products; c) Guidance regarding the designing and making specifications for Products; d) Assistance regarding the quality system, production management system and information management system; e) Services regarding the maintenance of equipment, software and systems; f) Settlement of troubles in factory administration, manufacturing process, quality, or yield ratio which are not attributable to Futaba Japan ; g) Settlement of troubles in equipment and software which are not attributable to Futaba Japan ;and, h) Human resource development of Futaba Phil or instruction or training on know-how which Futaba Japan has disclosed. HCEcaT That Futaba Phil shall pay Futaba Japan the royalty fees within 30 days after the submission of the report of the Net Sales; Futaba Phil shall make the payment in US Dollars based on the exchange rate prevailing on the last day of the preceding month of the payment; that Futaba Phil remitted royalty fees to Futaba Japan on May 23, 2013 based on the Certificate of Remittance issued by Bank of Tokyo-Mitsubishi UFJ on June 3, 2013. In reply, please be informed that Section 14 of Revenue Memorandum Order No. (RMO) 72-2010 2 which took effect on November 4, 2010, provides that: "SEC. 14. When and Where to File the TTRA . All tax treaty relief applications (updated BIR Forms No. 0901-D, 0901-I, 0901-R, 0901-P, 0901-S, 0901-T, 0901-O and 0901-C) relative to the implementation and interpretation of the provisions of Philippine tax treaties shall only be submitted to and received by the International Tax Affairs Division (ITAD). If the forms or any necessary documents are submitted to any other BIR Office, the application shall be considered as improperly filed. Filing should always be made BEFORE the transaction. Transaction for purposes of filing the TTRA shall mean before the occurrence of the first taxable event. Failure to properly file the TTRA with ITAD within the period prescribed herein shall have the effect of disqualifying the TTRA under this RMO ." (emphasis supplied) Relative thereto, Section 13 (4) of the same RMO defines the first taxable event for purposes of filing the TTRA, to wit: "SEC. 13. Definitions . xxx xxx xxx 4. First taxable event for purposes of filing the Tax Treaty Relief Application (TTRA),shall mean the first or the only time when the income payor is required to withhold the income tax thereon or should have withheld taxes thereon had the transaction been subjected to tax; and for 0901-C applications, before the due date of the Documentary Stamp Tax (DST) on the sale of the shares of stock." (emphasis supplied) In this case, the TTRA was filed only on January 31, 2013 covering the Agreement dated July 1, 2006. Thus, royalty payments made on or before January 31, 2013, if any , shall be subject to 30 percent pursuant to Section 28 (B) (1) of the National Internal Revenue Code of 1997 (" Tax Code "),as amended, which 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%)." aATESD However, for royalty payments made on February 1, 2013 and thereafter , 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: "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; 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. ETISAc 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. 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. DHITcS 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) 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 Futaba 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 Futaba 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 per cent of the gross amount of the royalties in all other cases; (c) 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. 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"). SaDICE In this case, payments for the license to manufacture the Products and license to sell the Products which were manufactured using the Manufacturing Technology and Patents with the Trademarks are treated as payments for information concerning industrial, commercial or scientific experience. Thus, this Office is of the opinion and so holds that royalty payments made by Futaba PH to Futaba Japan on February 1, 2013 and thereafter shall be treated as royalties subject to 10 percent of the gross amount thereof. As regards the imposition of the VAT on royalties paid to Futaba Japan , 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 twelve percent (12%) 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: xxx xxx xxx (2) The supply of scientific, technical or commercial knowledge information; xxx xxx xxx" In this case, since Futaba PH is a PEZA-registered entity availing of the Income Tax Holiday, payments made shall be subject to 12 percent VAT under above-quoted provision. Futaba PH shall withhold VAT at the rate of 12 percent on royalties payable to Futaba Japan using BIR Form No. 1600. Futaba PH may use the VAT withheld as input tax if it is a VAT-registered taxpayer, or may treat the VAT as an expense or asset if Futaba PH is not a VAT-registered taxpayer. Section 4.112-2 of Revenue Regulations No. 16-2005, 3 as amended, provides: "Withholding of VAT on Government Money Payments and Payments to Non-Residents. xxx xxx xxx (b) The government or any of its political subdivisions, instrumentalities or agencies including GOCCs, as well as private corporation, individuals, estates and trust, whether large or non-large taxpayers, shall withhold twelve percent (12%) VAT, starting February 1, 2006, with respect to the following payments: (1) Lease or use of properties or property rights owned by non-residents; and, (2) Other services rendered in the Philippines by non-residents. In remitting VAT withheld, the withholding agent shall use BIR Form No. 1600 Remittance Return of VAT and Other Percentage Taxes Withheld. AcICHD VAT withheld and paid for the non-resident recipient (remitted using BIR Form No. 1600),which VAT is passed on to the resident withholding agent by the non-resident recipient of the income, may be claimed as input tax by said VAT-registered withholding agent upon filing his own VAT Return, subject to the rule on allocation of input tax among taxable sales, zero-rated sales and exempt sales. The duly filed BIR Form No. 1600 is the proof or documentary substantiation for the claimed input tax or input VAT. Nonetheless, if the resident withholding agent is a non-VAT taxpayer, said passed-on VAT by the non-resident recipient of the income, evidenced by the duly filed BIR Form No. 1600, shall form part of the cost of purchased services, which may be treated either as an 'expense' or 'asset',whichever is applicable, of the resident withholding agent. VAT withheld under this Section shall be remitted within ten (10) days following the end of the month the withholding was made." 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. 2. Guidelines on the Processing Tax Treaty Relief Applications (TTRA) Pursuant to Existing Philippine Tax Treaties. 3. Entitled, "Consolidated Value-Added Tax Regulations of 2005".