ITAD Ruling No. 020-04

March 8, 2004 ITAD RULING NO. 020-04 Article 12, RP-Japan tax treaty BIR Ruling No. DA-ITAD-35-03 SyCip Gorres Velayo & Co. 6F Ayala Life-FGU Center Mindanao Avenue cor. Biliran Road Cebu Business Park, Cebu City 6000 Cebu Attention: Lauris L. Dela Pea Tax Services Gentlemen : This refers to your application for relief from double taxation dated December 17, 2003 on behalf of NEC Technologies Philippines, Inc. (NEC Technologies) requesting confirmation that the royalty payments made by NEC Corporation are subject to the preferential tax rate of 25% withholding tax, pursuant to Article 12(2)(b) of the RP-Japan tax treaty. It is represented that NEC Corporation is a nonresident foreign corporation organized and existing under the laws of Japan with principal office at 7-1 Shiba 5-chome, Taito-ku, Japan; that NEC Corporation 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 April 1, 2003 issued by the Securities and Exchange Commission; that NEC Technologies is a corporation duly organized and existing under the laws of the Philippines with principal office at Mactan Economic Zone I, Lapu-lapu City, Cebu; that NEC Technologies is a Philippine Economic Zone Authority (PEZA)-registered enterprise under Certificate of Registration No. 89-031 dated August 18, 1989; that on August 1, 2003 NEC Technologies and NEC Corporation entered into a License Agreement (Agreement) whereby NEC Corporation shall grant NEC Technologies a license to use the trade name/trademark, service mark and corporate mark "NEC" as part of its trade name, corporate mark, trademark and service mark; and that in consideration thereof, NEC Technologies shall pay royalty in the amount calculate according to the following formula: (i) 0.12% of NEC Technologies' gross sales amount to customers other than NEC and/or NEC SEC Consolidated Subsidiaries, plus (ii) 0.12% of NEC Technologies ' total gross sales amount It is further represented that both corporations agree that the royalty shall be applicable and paid for all products and services of NEC Technologies even if some of those products and services are provided by NEC Technologies without using NEC mark; and that in the event that NEC Technologies has conducted advertising activities using the NEC mark through the mass-media, such as TV, newspapers and magazines and has reported to NEC Corporations actual cost for the advertising activities, the former may deduct 30% of the amount of the actual cost incurred for such advertising activities from the amount of royalty payable to the latter, subject only to certain limitations. In reply, please be informed that Article 12 of the RP-Japan tax treaty provides, viz : "Article 13 "Royalties "(1) Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting States. "(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 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 or films or tapes used 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 aforementioned provisions, royalty payments made by a Philippine corporation to a resident of Japan may be taxed at a rate not exceeding 10 per cent of the gross amount of royalties if the payor is a Board of Investments (BOI)-registered enterprise engaged in preferred pioneer areas of investment, 15 per cent if it is paid in respect of the use of or the right to use cinematograph films and films or tapes for radio or television and, 25 per cent in all other cases. Such being the case, this Office is of the opinion and so holds that since NEC Technologies is not a BOI-registered enterprise engaged in preferred pioneer areas of investment, and, the subject royalty payments are not paid in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, the said royalty payments by NEC Technologies to NEC Corporation under the above License Agreement shall be subject to tax at the rate not exceeding 25% of the gross amount of the royalties pursuant to Article 12(2)(b) of the RP-Japan tax treaty. Moreover, Section 108 of the Tax Code of 1997 states that the lease or use of any trademark, trade brand or other like property or right 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 grant of license to use trademark 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 ) aHTEIA This 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