ITAD Ruling No. 009-04

February 10, 2004 ITAD RULING NO. 009-04 Art. 12, RP-Japan tax treaty Sec. 108 (A) (1) & (3), NIRC Bernaldo Mirador Law Offices Unit 1807 Cityland Condominium 10-Tower 1 6815 Ayala Avenue cor. H.V. Dela Costa St. 1220 Makati City Attention: Rosario S. Bernaldo Managing Partner Gentlemen : This refers to your application for relief from double taxation dated October 24, 2003, requesting confirmation of your opinion that the royalty payments of your client, Shinryo (Philippines) Company, Inc. (Shinryo-Phils), to Shinryo Corporation (Shinryo-Japan) are subject to the 25 percent preferential tax rate pursuant to Article 12 of the RP-Japan tax treaty. It is represented that Shinryo-Japan is a non-resident foreign corporation duly organized and existing under the laws of Japan with principal office address at #2-4 Yotsuya, 2 Chome Shinjuku-Ku, Tokyo 160-8510 Japan; that it is not registered either as a corporation or as a partnership and has not been licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated November 11, 2003; that Shinryo-Phils is a domestic corporation duly organized and existing under Philippine laws with office address located at One Corporate Plaza 845 A. Arnaiz Avenue, Makati City; that October 1, 1993, Shinryo-Japan and Shinryo-Phils entered into and executed a Royalty & Technical Assistance Agreement (Agreement), for a period of 10 years, whereby the former will transfer to the latter certain know-how, technical information and technical services and assistance regarding the development of equipment and systems for mechanical building services and latest equipment and systems for environmental controls for industrial production; that in consideration for the above services, Shinryo-Phils shall pay Shinryo-Japan royalty fees equivalent to 3.5 percent (3.5%) of the net sales, defined under the Agreement as the invoice value based on the contract price of projects being undertaken by Shinryo-Phils less (a) commission, if any, and (b) taxes, excise or other government charges; that on September 1, 2003, the same parties entered into a Renewal of Royalty & Technical Assistance Agreement (Renewal Agreement), whereby the Agreement was renewed for another 5 years, to end on September 30, 2008, with the same terms and conditions; and that the Renewal Agreement is registered with the Intellectual Property Office (IPO) with Certificate of Compliance No. 5-2003-00114, valid for a period of five (5) years from October 1, 2003 to September 30, 2008. In reply, please be informed that Article 12 of the RP-Japan tax treaty provides, viz : "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 . (emphasis supplied) "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. "xxx xxx xxx" Based on the foregoing, the royalty payments will be taxed at a preferential rate not exceeding ten percent (10%) if the payor is a Board of Investments (BOI-registered enterprise, fifteen percent (15%) if the payments are in respect of the use of or the right to use cinematograph films and films or tapes for radio of television broadcasting, and in all other cases, twenty-five percent (25%) of the gross amount of royalties. The tax treaty defines " royalties " to include " payments of any kind received as a consideration for information concerning industrial, commercial or scientific experience ." According to the commentaries of the ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT (OECD) Committee on Fiscal Affairs on the Model Tax Convention [par. 11, Commentary on Article 12 (Royalties), 1998, p. 151), such information alludes to the concept of " know-how ". The definition of know-how, which has been adopted by the said Committee, is "all the undivulged technical information, whether capable of being patented or not, that is necessary for the industrial reproduction of a product or process, directly and under the same conditions; inasmuch as it is derived from experience, know-how represents what a manufacturer cannot know from mere examination of the product and mere knowledge of the progress of technique." 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. As thus defined by the Technical and Assistance Agreement by and between Shinryo-Japan and Shinryo-Phils, the information to be imparted by Shinryo-Phils is not a BOI-registered enterprise and the payments made by Shinryo-Phils to Shinryo-Japan are not in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, this Office is of the opinion and so holds that herein payments are subject to tax at the rate of 25% of the gross amount of royalties pursuant to Article 12 of the RP-Japan tax treaty. ( BIR Ruling No. DA-ITAD-163-02 dated September 23, 2003 ) Moreover, the said royalty payments are subject to 10% value-added tax (VAT) pursuant to Section 108 of the Tax Code of 1997. Accordingly, Shinryo-Phils being the resident withholding agent and payor in control of the payment, shall be responsible for the withholding of the 10% final VAT before making any payment to Shinryo-Japan. In remitting the VAT withheld, Shinryo-Phils shall use BIR Form 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form 1600 and proof of payment thereof shall serve as documentary substantiation for the claim of input tax by Shinryo-Phils upon filing its own VAT, if it is a VAT-registered taxpayer. In case Shinryo-Phils is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased or treated as "expense" or "asset" whichever is applicable. In addition, Shinryo-Phils is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in a quadruplicate upon request of Shinryo-Japan, the first three copies thereof to be given to Shinryo-Japan and the fourth copy to be retained by Shinryo-Phils as its file copy. [ Sections 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 of RR 8-2002; Section 7 of RR 14-2002 ] AacDHE In fine, Shinryo-Phils shall be responsible for the withholding of income tax at the rate of 25% of the gross amount of royalties, and the value-added tax at the rate of 10% of the contract amount. This ruling is issued on the basis of the facts as represented. However, if upon investigation it shall be disclosed that the facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service