ITAD Ruling No. 036-03

February 19, 2003 ITAD RULING NO. 036-03 Article 12, RP-Japan BIR Ruling No. DA-ITAD # 217-02 Joaquin Cunanan & Co. 29th Floor, Philamlife Tower 8767 Paseo de Roxas 1226 Makati City, Manila Attention: Mr. George J. Lavadia Principal, Tax Services Department Gentlemen : This refers to your application for relief from double taxation dated December 23, 2002 on behalf of your client Daikoku Electronics Phils. Inc. (DEPI) requesting confirmation that the royalty payments of DEPI to Daikoku Electric Wire Co., Ltd. (Daikoku Japan) under their Technical Assistance Agreement is Subject to the preferential tax rate of 25% pursuant to Article 12 of the RP-Japan tax treaty. It is represented that Daikoku Japan is a foreign corporation duly organized and existing under and by virtue of the laws of Japan with principal address at 767-90 Hachisu Kurobani-cho, Nasu-Gun, Tochigi-Pref, Japan; that it is engaged in the business of manufacturing and selling of coil for electric and electronics parts; that it is not registered either as a corporation or as a partnership and has not been licensed to engage in business in the Philippines per certification dated October 16, 2002 issued by the Securities and Exchange Commission (SEC); that DEPI, on the other hand, is a domestic corporation registered with the Philippine Economic Zone Authority (PEZA) as an Ecozone Export Enterprise under Certificate of Registration No. 98-071 dated December 22, 1998; that it is primarily engaged in the business of manufacturing, processing, distributing and marketing of electronic products and the parts, components and accessories therefor, including specifically electronic coils, semiconductor devices and transistors; that on January 15, 2001, a Technical Assistance Agreement was entered into by and between Daikoku Japan and DEPI whereby Daikoku Japan granted DEPI a non-exclusive and non-assignable license to use its know-how in the manufacture and sale of coils for electric and electronics part as evidenced by Certificate of Compliance No. 5-2002-00138 dated January 15, 2001 issued by the Intellectual Property Office; that in consideration for the rights and licenses provided by Daikoku Japan, DEPI agrees to pay royalty at the rate provided hereunder to be computed on the net selling price of the products manufactured and sold by the Licensee during the term of this agreement: Product Royalty Rate Magnetic coils, 5% (EP2, EN2, EQ1, ET2 & etc.) Other coils 5% (Stepping motor and etc.) that the agreement shall be effective until December 31, 2001, unless earlier terminated, and shall be automatically extended for one (1) year unless either of the parties hereto notifies the other in writing of its desire to terminate this agreement. 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 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. (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. cTECHI (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 aforecited tax treaty provisions, royalty payments will be taxed at the preferential tax rate of ten per cent (10%) if the payor is a Board of Investments (BOI)-registered enterprise; fifteen per cent (15%) if the payments are in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting; and in all other cases, twenty-five per cent (25%) of the gross amount of the royalties. Such being the case, since DEPI is not a BOI-registered enterprise, and the payments it makes to Daikoku 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 the herein royalty payments are subject to the preferential tax rate of twenty five per cent (25%) of the gross amount of royalties pursuant to Article 12(2)(b) of the RP-Japan tax treaty. ( BIR Ruling No. DA-ITAD-217-02 dated December 27, 2002 ) Relative to the issue on VAT, 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 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. 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 provides VAT exemption for transactions which are exempt under special laws, e.g., Republic Act No. 7916 or PEZA Law. 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 DEPI is a PEZA-registered export enterprise, it may not be passed on with nor claim input VAT, then its payment of royalties to Daikoku Japan should be, as it is hereby confirmed to be, exempt from VAT. 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