ITAD BIR Ruling No. 410-12

December 26, 2012 ITAD BIR RULING NO. 410-12 Article 12 (2) (b), Philippines-Japan tax treaty, as amended; BIR Ruling No. ITAD-65-10 Rohm Electronics Phils., Inc. People's Technology Complex Special Economic Zone Barangay Maduya, Carmona Cavite 4116 Attention: Kunihiko Tsuru President Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on November 11, 2011 , on behalf of your client, Rohm Electronics Phil., Inc. ("Rohm-Phil") , requesting confirmation that royalties paid to Rohm Company Limited ("Rohm-Japan") by Rohm-Phil are subject to 10 percent preferential final withholding tax rate pursuant to Article 12 of the amended 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") . It is represented that Rohm-Japan is a corporation organized and existing under the laws of Japan with principal address at 21 Saiin Mizosaki-cho Ukyo-ku, Kyoto 615-8585, Tokyo, Japan and is a resident thereof within the meaning of Philippines-Japan tax treaty based on a Certificate of Registration as Taxpayer issued on September 21, 2011 by the District Director of Ukyo Tax Office; that it is not registered either as a corporation or as a partnership in the Philippines per Certification of Non-Registration of Company issued by the Securities and Exchange Commission dated July 4, 2011; and that, on the other hand, Rohm-Phil is a corporation organized and existing under the laws of the Philippines, and is registered with the Philippine Economic Zone Authority ("PEZA") under Certificate of Registration No. 00-081 issued on October 9, 2000, with principal address at People's Technology Complex-Special Economic Zone, Barangay Maduya, Carmona, Cavite 4116. It is further represented that on October 1, 2011, Rohm-Japan and Rohm-Phil entered into a Technical and Managing Service Agreement ("Agreement") whereby Rohm-Japan shall provide Rohm-Phil certain technical and managing service such as: (1) Product Manufacturing; (2) Installment and Maintenance of Manufacturing Equipment; (3) Providing technical know-how; (4) Administration of organization; (5) Operation and management of business; and (6) other necessary items; that Rohm-Japan shall send its employee or other company's employee designated by Rohm-Japan to Rohm-Phil upon the latter's request in order to carry out the services; that as compensation for the Service provided by Rohm-Japan under the Agreement, Rohm-Phil shall pay Rohm-Japan service fees equivalent to Rohm-Phil 's sales amount multiplied by 4%; that the payment of the Service fees shall be made within 60 days from the end of each month; and that the said Agreement shall be in effect from October 1, 2011 to March 31, 2012 and shall continue in full force and effect, commencing with the effective date and shall automatically renew thereafter for additional periods of one year each unless either party gives notice to the other of its intent not to renew. CHDTIS It is finally represented, per the Sworn Statement issued by Rohm-Phil , that the issue or transaction subject of this request for ruling is not under investigation, on-going audit, administrative protest, claims for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended, applies, in general, to royalties derived in the Philippines by a nonresident foreign corporation. It provides: "Section 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 interest, 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): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." However, Section 32 (B) (5) of the Tax Code of 1997, as amended, provides: "Section 32. Gross Income . (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." With respect to a treaty that may be invoked by Rohm-Japan and other residents of Japan, there is the Philippines-Japan tax treaty. Since tax treaties follow the principal method of classification and assignment in mitigating the effects of double taxation of income derived by a resident of a Contracting State from sources in the other Contracting State, it is important to know how income derived by Rohm-Japan under the Agreement is classified for purposes of the Philippines-Japan tax treaty. IcCDAS Payments for services to be made by Rohm-Phil to Rohm-Japan are generally treated as business profits unless otherwise proven as royalties such as if the activity involves the grant to use or the right to use an intangible property like know-how (information concerning industrial, commercial or scientific experience). To distinguish between payments for the supply of services and payments for the supply of know-how, the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention on Income and on Capital (Condensed Version, July 15, 2005) made the following commentaries on the subject, thus: "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. HCITAS 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. 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 guarantee, payments for pure technical assistance, 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 181-182) DCHIAS As a basic difference, contracts for the supply of know-how concern information that already exists or concern the supply of that type of information after its development or creation and generally include specific provisions concerning the confidentiality of that information. Also, 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. In the subject Agreement, Rohm-Japan will not merely perform technical support and provide administrative services but will impart technical know-how to Rohm-Phil . The provision of the know-how requires divulging special knowledge or experience to Rohm-Phil . Thus, applying the characterization made by OECD, the payments arising from the Agreement between Rohm-Japan and Rohm-Phil give rise to royalties. Article 12 of the Philippines-Japan tax treaty, as amended, reads as follows: "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. IADCES 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. . . ." Based on the aforequoted provisions, the Philippines may tax the royalties paid by a resident thereof to a company which is a resident of Japan at a rate not exceeding 15 percent if the royalties are paid in respect of the use of or the right to use cinematograph films and films or tapes for radio and television broadcasting; and 10 percent of the gross amount of royalties in all other cases. In view thereof and considering that the royalties paid by Rohm-Phil to Rohm-Japan are not in respect of the use of, or the right to use, cinematograph films and films or tapes for radio and television broadcasting, but represent consideration for information concerning industrial, commercial or scientific experience, i.e., provision of know-how, such royalty fees are subject to the 10 percent final withholding tax rate pursuant to Article 12 (2) (b) of the Philippines-Japan tax treaty, as amended. (BIR Ruling No. ITAD-65-10 dated November 30, 2010) As regards the imposition of the VAT on royalties paid to Rohm-Japan , please be informed further that Section 108 of the Tax Code of 1997 1 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 ten percent (10%) 2 of gross receipts derived from the sale or exchange of services, including the use or lease of properties . aACEID 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" Thus, in general, the VAT is imposed on the service fees by Rohm-Japan in the Philippines, such that on every payment of the service fees, Rohm-Phil is generally required to withhold such VAT and treat the same as a "passed on" VAT, pursuant to Section 4.110-3 (b) of Revenue Regulations No. 7-95 as amended [now Section 4.114-2 (b) of Revenue Regulations No. 16-05] . However, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866, February 11, 2005), the Supreme Court held, viz. : "Special laws may certainly exempt transactions from the VAT. 3 However, the Tax Code provides that those falling under PD 66 are not. PD 66 is the precursor of RA 7916 the special law under which respondent was registered. The purchase transactions it entered into are, therefore, not VAT-exempt. These are subject to the VAT; respondent is required to register. xxx xxx xxx Since the purchases of respondent are not exempt from the VAT, the rate to be applied is zero. Its exemption under both PD 66 and RA 7916 effectively subjects such transactions to a zero rate, because the ecozone within which it is registered is managed and operated by the PEZA as a separate customs territory. This means that in such zone is created the legal fiction of foreign territory. Under the cross-border principle of the VAT system being enforced by the Bureau of Internal Revenue (BIR), no VAT shall be imposed to form part of the cost of goods destined for consumption outside of the territorial border of the taxing authority. If exports of goods and services from the Philippines to a foreign country are free of the VAT, then the same rule holds for such exports from the national territory except specifically declared areas to an ecozone. IESAac xxx xxx xxx 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: . . ., 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. xxx xxx xxx" Based on the foregoing, sale of goods and/or services including the use of or lease of properties, to person or entities exempt from VAT by reason of PD 66 and RA 7916 are effectively zero-rated. However, instead of zero-rating which is not available to nonresident suppliers, the provision for exempt transactions under Section 109 (q) [now Section 109 (K)] of the Tax Code of 1997 which provides VAT exemption for transactions that are exempt under special laws, e.g. , Republic Act No. 7916 or PEZA Law, is particularly applicable to the instant case. cADEIa Such being the case, the royalties paid by Rohm-Philippines , being a PEZA registered enterprise, to Rohm-Japan under the Agreement should be, as it is hereby confirmed to be, exempt from VAT. This ruling is issued on the basis of the foregoing 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. Please note that this cited provision has been retained by Republic Act (RA) No. 9337, although with the modification as to the applicable rate when the circumstances so warrant. 2. Effective February 1, 2006, the rate shall be 12%. 3. Referring to the old Section 109 (q) of the Tax Code of 1997 [now Section 109 (K), as amended by RA No. 9337].