ITAD BIR Ruling No. 369-15

December 23, 2015 ITAD BIR RULING NO. 369-15 Article 12, Philippines-Korea tax treaty HHIC Phil., Inc. Green Beach 1, Redondo Peninsula Sitio Agusuhin Brgy. Cawag Subic Bay Freeport Zone Attention: Hwangeun Chung Managing Director Gentlemen : This refers to your Tax Treaty Relief Application filed on May 3, 2012, on behalf of Hanjin Heavy Industries & Construction Co., Ltd. ("Hanjin") , requesting confirmation that the royalty payments by HHIC Phil., Inc. ("HHIC") to Hanjin are subject to a preferential tax rate of 10 percent, pursuant to Article 12 of the Convention between the Republic of the Philippines and the Republic of Korea for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Korea tax treaty") . It is represented that Hanjin is a resident of Korea within the meaning of the Philippines-Korea tax treaty, based on the Certificate of Residence issued by the Jungbusan District Tax Office dated September 25, 2012; that Hanjin 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 April 10, 2012; than Hanjin is engaged in the shipbuilding and construction businesses that on the other hand, HHIC is a domestic corporation duly organized and existing under Philippine laws and registered with Subic Bay Freeport Enterprise; and that HHIC is a steel shipbuilding company, focuses on large container ships, LNG carriers, tankers, and bulk carriers. It is further represented that Hanjin , and HHIC entered into a Service Agreement ("Agreement") effective January 1, 2012 to December 31, 2012 and shall automatically be renewed every year; that the purpose of the Agreement is to improve the effectiveness of HHIC in shipbuilding and ship repairing business in the Philippines by providing Hanjin 's management know-how and technology support; that under the Agreement Hanjin shall provide HHIC with any necessary assistance and support regarding HHIC's shipyard management including management and other know-how, technology and manufacturing information acquired and developed by Hanjin in the operation of ship building and ship repairing business of HHIC; that HHIC shall pay a royalty of 3.25% of its turnover amount to Hanjin for the fee of transferring know-how regarding shipbuilding; that HHIC shall request Hanjin 25% of royalty amount by end of March, June and September respectively based on the planned turnover amount, and the balance shall be requested for payment by HHIC after the turnover for the year is confirmed; and Hanjin shall request HHIC's payment after quarter-end settlement of accounts is confirmed. Furthermore, it is represented that based on the Sworn Certification issued on May 17, 2012 by HHIC, no payment of royalties have been made yet to Hanjin as of said date. It is finally represented, based on the March 29, 2012 Sworn Statement by HHIC, that the transaction subject of the request for ruling is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal of the taxpayer/s involved. 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%). 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" In relation thereto, Article 12 of the Philippines-Korea tax treaty which you invoked may apply to the herein case. It provides: "Article 12 Royalties 1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State if such resident is the beneficial owner of the royalties. 2. However, such royalties may be taxed in the Contracting State in which they arise, and according to the laws of that State, but if the recipient is the beneficial owner of the royalties the tax so charged shall not exceed 15 per cent of the gross amount of the royalties. 3. Notwithstanding the provisions of paragraph 2 hereof, 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 Korea, 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 right to use, any copyright of literary, artistic or scientific work, any patent, trademark, 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, and includes payments of any kind in respect of motion picture films and works on films or videotapes for use in connection with television or tapes for the use of radio broadcasting. 5. The provisions of paragraphs 1, 2 and 3 shall not apply if the beneficial owner of the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties arise, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the right or property in respect of which the royalties are paid is effectively connected with such permanent establishment or fixed base. In such a case, the provisions of Article 7 (Business Profits) or Article 14 (Independent Personal Services), as the case may be, shall apply. xxx xxx xxx" Based on the foregoing, royalty payments to a resident of Korea arising in the Philippines may be taxed at the preferential tax rate of 15 percent of the gross amount of the royalties and 10 percent of the gross amount of the royalties if the royalties are 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. Hence, since Hanjin is a resident of Korea with no fixed place of business in the Philippines, and HHIC is a BOI-registered enterprise engaged in preferred pioneer areas of investment, this Office hereby GRANTS relief on the royalty payments by HHIC to Hanjin under the said Agreement which consist of the 3.25% of its turnover amount of HHIC for the fee of transferring know-how regarding shipbuilding. Accordingly, said payment shall be subject to a preferential tax rate of 10 percent of the gross amount thereof, pursuant to Article 12 (2) (b) of the Philippines-Korea tax treaty. Furthermore, under Section 108 (A) of the Tax Code, the said royalties for the use of intangible properties (know-how and process) are 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, 3 raise the rate of value-added tax to twelve percent (12%). . ." However, 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. 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 Hanjin , the lessor of the intangible property, is a nonresident foreign person and is not a VAT-registered taxpayer, such royalties paid to it by HHIC, a Subic Bay Freeport Enterprise-registered entity enjoying fiscal incentives under Republic Act No. 7227, shall, for VAT purposes, be treated as exempt and not subject to zero percent VAT. In either case, no output VAT is shifted or passed-on to HHIC in the transaction. 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