ITAD Ruling No. 015-04

February 20, 2004 ITAD RULING NO. 015-04 Article 12; RP-Japan Tax treaty BIR Ruling No. DA-ITAD-58-02 Joaquin Cunanan & Co. Unit 306, Keppel Center Samar Loop corner Cardinal Rosales Avenue Cebu Business Park 6000 Cebu City Attention: Virgilio L. Manguilimotan Partner-VISMIN Operations Assurance Services Gentlemen : This refers to your application for tax treaty relief dated December 15, 2003 on behalf of your client, NEC Corporation (NEC Japan), requesting confirmation that the royalty payments of NEC Telecom Software Philippines, Inc. (NEC Phil.) to NEC Japan are subject to twenty five per cent (25%) withholding tax pursuant to Article 12(2)(b) of the RP-Japan tax treaty. It is represented that NEC Japan is a non resident foreign corporation duly organized and existing under the laws of Japan with principal office address at 7-1, Shiba 5-Chome Minato-Ku, Tokyo 108-8001, Japan; that it is no longer registered either as a corporation or as a partnership licensed to do business in the Philippines since the cancellation of its license on July 29, 1998 per certification dated December 16, 2003 issued by the Securities and Exchange Commission (SEC); that NEC Phil. is a domestic corporation duly organized and existing under the laws of the Philippines with office address at Asiatown I.T. Park, Apas, Cebu City; that NEC Phil. is a Philippine Economic Zone Authority (PEZA)-registered enterprise under Certificate of Registration No. 01-018-IT dated December 21, 2001; that NEC Phil. is licensed to engage in, operate, conduct, and maintain the business of researching, studying, designing, developing, processing, modifying, repairing, debugging, subcontracting, importing and exporting of software for telecommunication equipment and systems; that on August 1, 2003, NEC Japan and NEC Phil. entered into a License Agreement whereby the former grants and agrees to grant to the latter the following: a) the authority to use NEC Letters in a part of its trade name, b) a non-transferable and non-exclusive right to use NEC Mark in the Territory on the Products and Services and in catalogues, pamphlets, promotional materials, and other advertisement media to be utilized by the latter for the marketing, distribution, and/or provision of Products and Services, and c) the authority to use NEC Mark as its corporate mark in its advertising, outdoor signs, vehicles, business cards for employees, displays, office stationery goods, and the like; that in consideration for the authorization and grant of license, NEC Phil. agrees to pay to NEC Japan the royalty in the amount calculated according to the following: (i) 0.12% of NEC Phil.'s gross sales amount to customers other than NEC and/or NEC SEC Consolidated Subsidiaries, plus (ii) 0.12% of NEC Phil.'s total gross sales amount; and that the License Agreement is covered by Certificate of Compliance No. 5-2003-00036 issued by the Intellectual Property Office (IPO) on November 28, 2003. In reply, please be informed that Article 12 of the RP-Japan tax treaty provides 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 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. 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 shall be subject to 15% if the royalties are paid in respect of the use of or the right to use cinematograph films and films or tapes for or television broadcasting, 10% if the Philippine Company is a Board of Investments (BOI)-registered enterprise, and 25% of the gross amount of royalties in all other cases. Such being the case, the royalty payments of NEC Phil. to NEC Japan are subject to preferential tax rate of 25% pursuant to Article 12(2)(b) of the RP-Japan tax treaty. (BIR Ruling No. DA-ITAD 58-02 dated April 24, 2004) Moreover, Section 108 of the Tax Code of 1997 states that, the lease or use of property or property rights is embraced within the definition of "sale or exchange of services" and is subject to value-added tax (VAT). Under the current regulations, the sale of services to Ecozone Enterprises may be considered effectively zero-rated for VAT purposes but subject to the limitation that the sale of service is made to persons or entities who enjoy indirect tax exemption [Section 4.102-2 (c), Revenue Regulations No. 7-95]. Since there is no express provision under the PEZA law granting exemption from indirect taxes to Ecozone Enterprises, the recognition of zero-rated sale of services is made to rest on the Cross Border Doctrine or Destination Principle of the VAT system, viz : " the country taxes all value-added, at home and abroad, for goods that have as their destination the consumers of that country. Exports are exempt, imports are taxable. . . .(VAT Ruling No. 009-99 dated January 21, 1999) The same principle is applicable to the case at hand. It should be noted that the transfer of technology is in connection with the manufacture of products for export. However, instead of zero-rating which is not available to non-resident suppliers, the provision for exempt transactions under Section 109 of the Tax Code of 1997 which provides VAT exemption for transactions which are exempt under special laws, e.g., Republic Act 7916 or PEZA law, is particularly applicable to the instant case. In the case of payment for lease or royalties to a non-resident owner, the responsibility for withholding the VAT and paying the same rest on the payor. However, since PEZA-registered export enterprise may not be passed on with nor claim input VAT, then its payment of royalties to a non-resident owner, such as NEC Japan should be, as it is hereby confirmed to be, exempt from VAT. (VAT Ruling No. 095-99 dated September 14, 1999) TacESD Thus ruling is issued on the basis of the facts 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