ITAD BIR Ruling No. 371-12

November 5, 2012 ITAD BIR RULING NO. 371-12 Article 12, Philippines-Japan tax treaty EDS Manufacturing, Inc. PET Building 2900 Faraday Street Barangay San Isidro Makati City Attention: Mr. Masao Fukuda Managing Director Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on April 8, 2010 requesting confirmation that royalties paid by EDS Manufacturing, Inc. ("EDS Manufacturing") to Yazaki Corporation ("Yazaki") are subject to a reduced rate of income tax 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") . Facts Yazaki is a foreign corporation and a resident of Japan based on the Certificate of Status of Taxable Person issued by the Shiba Tax Office in Japan on July 17, 2009. Yazaki is located at 1-4-28 Mita Minato-ku, Tokyo, Japan. Based on the Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission ("SEC") on October 19, 2009, Yazaki was licensed previously by the SEC to establish a regional or area headquarters in the Philippines under SEC F-430 but such license has been cancelled already on October 2, 1997. On the other hand, EDS Manufacturing is a domestic corporation with liaison office located at PET Building, 2900 Faraday Street, Barangay San Isidro, Makati City, Philippines, and with factory located at Barangay Anabu II, Imus, Cavite, Philippines. It is registered with the Philippine Economic Zone Authority ("PEZA") as an ecozone export enterprise under Certificate of Registration No. 02-066 issued on November 25, 2002. On January 1, 2006, EDS Manufacturing and Yazaki entered into a Technical Assistance Agreement where Yazaki granted EDS Manufacturing a non-exclusive license to use in the Philippines, technical information, know-how, engineering data and other information relating to the manufacture, sale, and use of automotive wiring harnesses and their components and parts, including those relating to preliminary arrangements for manufacturing, manufacturing program, inspection and storage of materials, semi-finished and finished products, working standards and manufacturing process. In consideration, EDS Manufacturing will pay royalties to Yazaki equivalent to three percent of its gross sales of automotive wiring harnesses and their components and parts. The royalties are calculated quarterly and payable within thirty days after each quarter. The royalties are payable in United States dollars. The Agreement took effect on January 1, 2006 and had an initial term of five years up to December 31, 2010. The Agreement is automatically renewed thereafter for another period of five years, from January 1, 2011 to December 31, 2015. CTacSE Based on the submitted Monthly Remittance Returns of Final Income Taxes Withheld (BIR Form No. 1601-F) and their corresponding payment confirmation through the Electronic Filing and Payment System, EDS Manufacturing had paid royalties to Yazaki beginning January 2006 up to present, to wit: Date of Payment Amount of Date of Payment Amount of Rate of Income of Royalties Royalties of Income Tax Income Tax Tax Applied (in Pesos) on Royalties Paid (in Pesos) January 2006 68,235,343.44 Feb. 15, 2006 17,058,835.86 25 percent March 2006 63,393,151.92 Apr. 10, 2006 15,848,287.98 25 percent July 2006 55,409,323.08 Aug. 12, 2006 13,852,330.77 25 percent October 2006 89,623,887.28 Nov. 9, 2006 22,405,971.82 25 percent January 2007 80,887,091.68 Feb. 15, 2007 20,221,772.92 25 percent March 2007 71,360,605.12 Apr. 12, 2007 17,840,151.28 25 percent April 2007 2,626.84 May 15, 2007 656.71 25 percent July 2007 66,844,642.20 Aug. 9, 2007 16,711,160.55 25 percent October 2007 80,035,630.96 Nov. 15, 2007 20,008,907.74 25 percent January 2008 66,278,309.48 Feb. 15, 2008 16,569,577.37 25 percent March 2008 61,992,186.92 Apr. 15, 2008 15,498,046.73 25 percent July 2008 58,471,970.32 Aug. 15, 2008 14,617,992.58 25 percent October 2008 67,095,214.40 Nov. 13, 2008 16,773,803.60 25 percent January 2009 34,458,280.20 Feb. 12, 2009 8,614,570.05 25 percent March 2009 21,338,734.68 Apr. 15, 2009 5,334,683.67 25 percent July 2009 42,794,533.72 Aug. 17, 2009 10,698,633.43 25 percent October 2009 61,490,810.12 Nov. 13, 2009 15,372,702.53 25 percent January 2010 84,819,641.20 Feb. 15, 2010 21,204,910.30 25 percent March 2010 86,456,822.30 Apr. 15, 2010 8,645,682.23 10 percent July 2010 76,855,258.80 Aug. 13, 2010 7,685,525.88 10 percent October 2010 84,887,188.40 Nov. 12, 2010 8,488,718.84 10 percent January 2011 99,707,352.00 Feb. 14, 2011 9,970,735.20 10 percent March 2011 90,767,550.00 Apr. 15, 2011 9,076,755.00 10 percent July 2011 71,440,684.40 Aug. 12, 2011 7,144,068.44 10 percent October 2011 97,251,712.20 Nov. 14, 2011 9,725,171.22 10 percent January 2012 98,900,138.50 Feb. 14, 2012 9,890,013.85 10 percent March 2012 97,230,299.20 Apr. 13, 2012 9,723,029.92 10 percent Ruling Relative thereto, please be informed that under Section III (2) of Revenue Memorandum Order No. 1-00 (Procedures for Processing Tax Treaty Relief Application) ("RMO 1-2000") , any availment of tax treaty relief (exemption from income tax or reduction of tax) shall be preceded by an application filed at the International Tax Affairs Division ("ITAD") of this Bureau at least fifteen days before the intended transaction or payment of income, thus: cHCIDE "III. Policies: In order to achieve the above-mentioned objectives, the following policies shall be observed: xxx xxx xxx 2. Any availment of the tax treaty relief shall be preceded by an application by filing BIR Form No. 0901 (Application for Relief from Double Taxation) with ITAD at least 15 days before the transaction i.e., payment of dividends, royalties, etc., accompanied by supporting documents justifying the relief . . . " (Emphasis ours) This condition is emphasized by the Court of Tax Appeals in Mirant (Philippines) Operations Corporation vs. Commissioner of Internal Revenue (C.T.A. Case No. 6382 dated June 7, 2005) where it ruled: " However, it must be remembered that a foreign corporation wishing to avail of the benefits of the tax treaty should invoke the provisions of the tax treaty and prove that indeed the provisions of the tax treaty applies to it, before the benefits may be extended to such corporation . In other words, a resident or non-resident foreign corporation shall be taxed according to the provisions of the National Internal Revenue Code, unless it is shown that the treaty provisions apply to the said corporation, and that, in cases the same are applicable, the option to avail of the tax benefits under the tax treaty has been successfully invoked. Under Revenue Memorandum Order 01-2000 of the Bureau of Internal Revenue, it is provided that the availment of a tax treaty provision must be preceded by an application for a tax treaty relief with its International Tax Affairs Division (ITAD). This is to prevent any erroneous interpretation and/or application of the treaty provisions with which the Philippines is a signatory to. The implementation of the said Revenue Memorandum Order is in harmony with the objectives of the contracting state to ensure that the granting of the benefits under the tax treaties are enjoyed by the persons or corporations duly entitled to the same . The Court notes that nowhere in the records of the case was it shown that petitioner indeed took the liberty of properly observing the provisions of the said order. Petitioner quotes various BIR, as well as ITAD, Rulings issued to several foreign corporations seeking for a tax relief from the office of the respondent. However, not any one of these rulings pertains to the petitioner. It must be stressed that BIR rulings are issued based on the facts and circumstances surrounding particular issue/issues in question and are resolved on a case-to-case basis. It would be thus erroneous to invoke the ruling of the respondent in specific cases, which have no bearing to the case of petitioner." (Emphasis ours) This decision of the Court of Tax Appeals is upheld by the Supreme Court in Resolution G.R. No. 168531 on February 18, 2008. Furthermore, the requirement laid down in RMO 1-2000 is reiterated in subsequent rulings of the Court of Tax Appeals: Deutsche Bank AG Manila Branch vs. Commissioner of Internal Revenue (C.T.A. Case No. EB 456 dated May 29, 2009), CBK Power Company Ltd. vs. Commissioner of Internal Revenue (C.T.A. Case Nos. 6699, 6844 and 7166 dated March 29, 2010) and Manila North Tollways Corporation vs. Commissioner of Internal Revenue (C.T.A. Case No. 7864 dated April 12, 2011) . In view of the foregoing, since the Technical Assistance Agreement that gives rise to the royalties has been in effect since January 1, 2006 , but the relevant TTRA was filed only on April 8, 2010 , this Office hereby DENIES relief on all royalties paid by EDS Manufacturing to Yazaki before April 23, 2010 , 1 pursuant to Section III (2) of RMO 1-2000. Accordingly, said royalties shall be subject to income tax under Section 28 (B) (1) of the National Internal Revenue Code of 1997 (" Tax Code "), as amended, 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: * Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." SDAcaT Relative thereto, EDS Manufacturing shall be subject to deficiency income tax on royalties it paid from January 2006 to March 2010 where it applied a preferential rate of 25 percent (from January 2006 to January 2010) and 10 percent (in March 2010) even if it has not filed a TTRA at any of those times. The deficiency income tax is computed as follows: Date of Amount of Preferential Regular Difference Amount of Payment of Royalties Rate of Rate of Deficiency Royalties (in Pesos) Income Tax Income Tax Income Tax Applied (in Pesos) January 2006 68,235,343.44 25 percent 35 percent 10 percent 6,823,534.34 March 2006 63,393,151.92 25 percent 35 percent 10 percent 6,339,315.19 July 2006 55,409,323.08 25 percent 35 percent 10 percent 5,540,932.31 October 2006 89,623,887.28 25 percent 35 percent 10 percent 8,962,388.73 January 2007 80,887,091.68 25 percent 35 percent 10 percent 8,088,709.17 March 2007 71,360,605.12 25 percent 35 percent 10 percent 7,136,060.51 April 2007 2,626.84 25 percent 35 percent 10 percent 262.68 July 2007 66,844,642.20 25 percent 35 percent 10 percent 6,684,464.22 October 2007 80,035,630.96 25 percent 35 percent 10 percent 8,003,563.10 January 2008 66,278,309.48 25 percent 35 percent 10 percent 6,627,830.95 March 2008 61,992,186.92 25 percent 35 percent 10 percent 6,199,218.69 July 2008 58,471,970.32 25 percent 35 percent 10 percent 5,847,197.03 October 2008 67,095,214.40 25 percent 35 percent 10 percent 6,709,521.44 January 2009 34,458,280.20 25 percent 30 percent 10 percent 3,445,828.02 March 2009 21,338,734.68 25 percent 30 percent 10 percent 2,133,873.47 July 2009 42,794,533.72 25 percent 30 percent 10 percent 4,279,453.37 October 2009 61,490,810.12 25 percent 30 percent 10 percent 6,149,081.01 January 2010 84,819,641.20 25 percent 30 percent 10 percent 8,481,964.12 March 2010 86,456,822.30 10 percent 30 percent 20 percent 17,291,364.46 Total 124,744,562.81 =========== On the other hand, royalties paid to Yazaki on April 23, 2010 and thereafter are subject to a reduced rate of income tax under paragraphs 1, 2 and 4, Article 12 of the Philippines-Japan tax treaty, 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 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) 25 per cent of the gross amount of the royalties in all other cases. 2 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, 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 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. 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 "). Accordingly, since royalties paid by EDS Manufacturing to Yazaki under the Agreement for the use of technical information, know-how, engineering data and other information relating to the manufacture, sale, and use of automotive wiring harnesses and their components and parts are payments or royalties for the use of know-how , and not for the use of cinematograph films and films or tapes for radio or television broadcasting, such royalties paid to Yazaki on April 23, 2010 and thereafter shall be subject to income tax at the rate of 10 percent , pursuant to paragraph 2 (b), Article 12 of the Philippines-Japan tax treaty. Furthermore, under Section 108 (A) of the Tax Code, the said royalties for the use of know-how in the Philippines 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. CIETDc (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 EDS Manufacturing is registered with PEZA and entitled to fiscal incentives under Republic Act No. 7916 , 4 the Supreme Court, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866 dated February 11, 2005) , ruled 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 Yazaki , the nonresident lessor of the subject know-how, is not a VAT registered taxpayer, royalties paid by EDS Manufacturing to Yazaki shall for purposes of VAT be treated as exempt from VAT and not subject to zero percent VAT; in either case, no output VAT is shifted or passed-on to EDS Manufacturing. 5 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. CaAIES Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. April 23, 2010 is the fifteenth day after the filing of the TTRA on April 8, 2010. 2. 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 , effective January 1, 2009 , reduced the rate of income tax on royalties in subparagraph (b) to 10 percent from the original rate of 25 percent. 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. Entitled 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. 5. 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."