ITAD Ruling No. 012-02

January 29, 2002 ITAD RULING NO. 012-02 Philips Semiconductor (Phils.) Inc. Real Street, Pamplona Las Pias, Metro Manila Attention: Mr. Ayasamy Ramajillu Director, Finance and Accounting Gentlemen : This refers to your letter dated January 16, 2001 requesting for the renewal of the authority previously granted by this Office and in effect applying for tax treaty relief relative to the application of the preferential tax treaty rate of 10% on your royalty payments to Koninklijke Philips Electronics N.V., (Philips) pursuant to the provisions of Article 12, paragraphs 2 and 4 of the RP-Netherlands tax treaty. DcTAIH It is represented that Philips is a non-resident foreign corporation duly organized and existing under the laws of the Netherlands with principal office in Eindhoven, The Netherlands; that it is not registered either as a corporation or as partnership licensed to do business in the Philippines per Certification issued by Securities Exchange Commission dated March 26, 1998; that Philips Semiconductors (Phils.) Inc. (PSPI) is a corporation organized and existing under the laws of the Philippines and registered as an export enterprise with the Philippine Economic Zone Authority (PEZA) (formerly Export Processing Zone Authority) under Certificate of Registration No. EP-94-77 dated September 28, 1994; that PSPI cancelled its BOI registration as a pre-condition for the approval of its application for registration under PEZA; that on October 16, 2000, Philips and PSPI entered into an Industrial Cooperation Agreement whereby the latter is granted the right and license to manufacture and sell semiconductor devices, accessories and components while Philips shall furnish the necessary technical information, materials, services and licenses; that the said Agreement shall become operative from January 1, 2001 and shall continue for a period of five (5) years and extendible for successive periods of five years each; and that PSPI shall pay Philips a service charge of three percent (3%) on the "Company's relevant turn-over of the Products assembled and/or manufactured, used, sold or otherwise disposed of by the Company". In reply, please be informed that Article 12 of the RP-Netherlands tax treaty provides as follows: "ARTICLE 12 ROYALTIES "1. Royalties arising in one of the States and paid to a resident of the other State may be taxed in that other State. "2. However, such royalties may also be taxed in the 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: (a) 10 per cent of the gross amount of the royalties where the royalties are paid by an enterprise registered and engaged in preferred areas of activities in that State ;and (b) 15 per cent of the gross amount of the royalties in all other cases. "3. ... "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 or tapes for radio or television broadcasting, 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." xxx xxx xxx." Based on the foregoing, the royalty payments will be taxed at the preferential tax rate of ten percent (10%) if the payor is an enterprise registered and engaged in preferred areas of activities and in all other cases, fifteen percent (15%) of the gross amount of the royalties. However, no definition of the phrase "engaged in preferred areas of activities" is provided for under the RP-Netherlands Tax Treaty. In this regard, Article 3, paragraph (2) of the said tax treaty provides for the following guidelines: "2. As regards the application of the Convention by either of the States, any term not otherwise defined shall, unless the context otherwise requires, have the meaning which it has under the laws of that State relating to the taxes which are the subject of this Convention." In the absence of a definition of the term "engaged in preferred areas of activities" in the said tax treaty, it is therefore necessary to refer to Article 16 of Executive Order No. (E.O.) 226, as amended, otherwise known as the Omnibus Investments Code of 1987, which defines the term "preferred areas of investments" as economic activities that the Board of Investments shall have declared as such in accordance with Article 28 of the said Code which shall either be pioneer or non-pioneer. Moreover, it appears that the phrase "enterprise registered and engaged in preferred areas of activities" does not refer to PEZA-registered enterprises but to BOI-registered enterprises, because the RP-Netherlands Tax Treaty was signed on March 9, 1989, or prior to the effectivity of Republic Act No. 7916, otherwise known as the Special Economic Zone of 1995. Thus, in applying Article 12 of the RP-Netherlands Tax Treaty, this Office already had the occasion to issue rulings where the phrase "enterprise registered and engaged in preferred areas of activities" consistently referred to BOI-registered enterprise engaged in preferred areas of investments. (BIR Ruling No. 129-98 and ITAD Ruling No. 54-00) Inasmuch as PSPI's registration with the BOI was cancelled as a precondition for the approval of its application for PEZA registration, PSPI consequently lost its status as an enterprise registered and engaged in preferred areas of activities as contemplated under paragraph 2(b) of Article 12 herein aforecited. In view of all the foregoing, this Office is of the opinion and so holds that PSPI is no longer qualified to avail of the preferential tax rate of ten per cent (10%) on its royalty payments to Philips for lack of legal basis. Corollarily, the instant request for renewal of the authority previously granted by this Office relative to the application of the preferential tax rate of ten per cent (10%) on your royalty payments to Philips is hereby denied. Such being the case, PSPI's royalty payments to Philips shall now be subject to the preferential tax rate of fifteen percent (15%) and not to the ten per cent (10%) as previously allowed under a different situation. The said tax should be deducted and withheld in accordance with Sec. 2.57.4 of Revenue Regulations No. 2-98, as amended by Revenue Regulations No. 12-2001, viz: "Sec. 2.57.4. Time of withholding . The obligation of the payor to deduct and withhold the tax under Section 2.57 of these Regulations arises at the time an income payment is paid or payable, or the income payment is accrued or recorded as an expense or asset, whichever is applicable, in the payor's books, whichever comes first. The term "payable" refers to the date the obligation becomes due, demandable or legally enforceable. Provided, however, that where income is not yet paid or payable but the same has been recorded as an expense or asset, whichever is applicable, in the payor's books, the obligation to withhold shall arise in the last month of the return period in which the same is claimed as an expense or amortized for tax purposes. xxx xxx xxx" If prior to the receipt of this ruling, PSPI erroneously withheld the 10% preferential tax rate instead of the 15% tax rate on royalties remitted to Philips, any increments accruing from any deficiency tax (representing the 5% tax difference) are hereby abated pursuant to Section 204(B) of the NIRC of 1997 as implemented by Revenue Regulations No. (RR) 13-2001 because of the difficulty in interpretation of the said tax treaty, provided that any deficiency tax is paid within thirty (30) days from receipt of this ruling. For this purpose, PSPI is hereby enjoined to comply with the procedural requirements of RR 13-2001. Finally, as a PEZA registered enterprise, PSPI is subject to "5% special tax regime, in lieu of all taxes", hence, PSPI is exempt from VAT pursuant to Revenue Memorandum Circular No. 74-99. This ruling is issued on the basis of the foregoing facts as represented. However, if upon investigation it shall be disclosed that the facts are different, then, this ruling shall be considered null and void. TASCDI Very truly yours, (SGD.) REN G. BAEZ Commissioner of Internal Revenue