ITAD BIR Ruling No. 371-15

December 23, 2015 ITAD BIR RULING NO. 371-15 Article 12, Philippines-Japan tax treaty as amended Mitsuwa Philippines, Inc . Lots 4, 6 and 8, Block 22, Phase IV Cavite Economic Zone Rosario, Cavite Attention: Ms. Josefina H. Maravillas Director and Senior Department Manager-Accounting and Finance Gentlemen : This refers to your tax treaty relief application filed on May 26, 2009 requesting confirmation that royalties paid by Mitsuwa Philippines, Inc. (now Mitsuwa Chemical Philippines, Inc .) ("Mitsuwa Philippines") to Mitsuwa Chemical Company Ltd . ("Mitsuwa") are subject to income tax at the 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 ("Philippines-Japan tax treaty") , as amended by protocol. 1 Facts Mitsuwa is a foreign corporation organized and existing under the laws of Japan and a resident thereof based on its Certificate of Residence issued by the Hiratsuka Tax Office on May 11, 2009. Mitsuwa 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 January 20, 2009. On the other hand, Mitsuwa Philippines is a domestic corporation organized and existing under the laws of the Philippines. It is registered with the then Export Processing Zone Authority ("EPZA") as an export enterprise. Based on the 2015 General Information Sheet of Mitsuwa Philippines , 75% of its shares are held by Mitsuwa . On August 23, 2007, Mitsuwa Philippines and Mitsuwa entered into a Technological Transfer and Assistance Agreement where Mitsuwa granted Mitsuwa Philippines the right to use and acquire technology and technical information in the manufacture and assembly of plastic parts for car audio equipment and accessories, particularly, Sanyo, Alpine, Clarion, Fujitsu and Kenwood, and of plastic injection moulds, jigs and other tools employed in or related in the manufacture of the plastic parts. These plastic parts include escutcheon assemblies, buttons, illumi plates and assemblies, CD magazines, acryl panel, panel escutcheon assy, and CD changer cartridge. In consideration, Mitsuwa Philippines will pay royalties to Mitsuwa amounting to 3 percent of the 'cost insurance freight' of the manufactured plastic parts. Cost insurance freight means the cost of the products including freight and insurance but excluding all other charges like taxes and other government charges; other related sales/shipping costs like packaging, bank charges, brokers' and agents' commissions and other similar charges which are billed separately or as a separate item in the invoice. The Agreement took effect on August 23, 2007 for an initial term of two years or until August 22, 2009; thereafter, the Agreement will be automatically renewed. The Agreement complies with the provisions of the Intellectual Property Code on voluntarily licensing under a Certificate of Compliance issued by the Intellectual Property Office on July 6, 2007, valid from August 23, 2007 to August 22, 2009. Ruling Relative thereto, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997, as amended ("Tax Code") , royalties derived by Mitsuwa , a foreign corporation, 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: "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, paragraphs 1 and 2, Article 12 of the Philippines-Japan tax treaty provides relief to royalties arising in the Philippines and paid to a resident of Japan: "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. 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, such royalties are subject to a reduced rate of (a) 15 percent if the royalties are 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 the royalties paid by Mitsuwa Philippines to Mitsuwa for the use of the relevant technology and technical information in the manufacture and assembly of plastic parts for car audio equipment and accessories, and of plastic injection moulds, jigs and other tools employed in or related in the manufacture of these parts, constitute payments for know-how (and not cinematograph films and films or tapes for radio or television broadcasting), such royalties paid to Mitsuwa are 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 . (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, 2 raise the rate of value-added tax to twelve percent (12%). . ." However, since Mitsuwa Philippines is an enterprise registered with the then EPZA, which is now succeeded by the Philippine Economic Zone Authority ("PEZA"), and that PEZA-registered enterprises enjoy fiscal incentives under the provisions of Republic Act No. 7916 ("RA 7916"), 3 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." In that ruling, the Court declared that no VAT, directly or indirectly , shall be imposed on enterprises operating within ecozones and covered by RA 7916. This being so where Mitsuwa , the nonresident lessor of the know-how, is not a VAT registered taxpayer, such royalties paid to it by Mitsuwa Philippines shall, for VAT purposes, be treated as VAT exempt rather than subject to VAT zero rating; in either case, no output VAT on the transaction shall be shifted or passed-on to Mitsuwa 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 of Internal Revenue Footnotes 1. As amended by 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 . 2. 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. 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 . Section 11 of this Act provides: "CHAPTER II Governing Structures SECTION 11. The Philippine Economic Zone Authority (PEZA) Board. There is hereby created a body corporate to be known as the Philippine Economic Zone Authority (PEZA) attached to the Department of Trade and Industry. . . The existing Export Processing Zone Authority (EPZA) created under Presidential Decree No. 66 shall evolve into the PEZA in accordance with the guidelines and regulations set forth in an executive order issued for this purpose." 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.