ITAD Ruling No. 038-03

February 21, 2003 ITAD RULING NO. 038-03 Article 15, RP-Japan BIR Ruling DA ITAD # 163-02 BIR Ruling DA ITAD # 169-02 ROHM Apollo Semiconductor Phils., Inc. (RASPI) People's Technology Complex-Special Economic Zone Maduya, Carmona, Cavite Attention: Ms. Merlita M. Macaspac Accounting Supervisor Gentlemen : This refers to your application for relief from double taxation dated January 14, 2003 requesting for a ruling regarding the tax rate to be used on your royalty payments under your Consulting Agreement with ROHM Apollo Co., Ltd. (APOLLO) pursuant to the RP-Japan tax treaty. It is represented that APOLLO is a non-resident foreign corporation duly organized and existing under and by virtue of the laws of Japan with principal address at Hirokawa Industrial Estate, Hirokawa, Yame-gun, Fukuoka-ken, 834-0111, Japan; 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 December 13, 2002 issued by the Securities and Exchange Commission (SEC); that RASPI, on the other hand, is a domestic corporation duly organized and existing under the laws of the Philippines with principal office at People's Technology Complex, Carmona, Cavite; that it is registered with the Philippine Economic Zone Authority (PEZA) as an Ecozone Export Enterprise under Certificate of Registration No. 00-077 dated September 18, 2000; that on October 1, 2001, RASPI and APOLLO entered into a Consulting Agreement wherein APOLLO shall provide RASPI with the following consulting services for the management of RASPI upon its request: (1) consulting services for the management and/or administration of business; (2) consulting services for the management of personnel; (3) consulting services for the management of funds; (4) consulting services relating to safety and health; (5) consulting services in the manufacture of products; (6) consulting services in the maintenance of production machinery; (7) consulting services in the transfer of technical know-how; and (8) other consulting services necessary or incidental to any of the foregoing items; that APOLLO shall send members of its staff to RASPI upon request from time to time in order to provide these services; that in consideration thereof, RASPI shall pay APOLLO a consulting fee in such amount equivalent to a certain percentage of the Net Sales of products provided, however, that: (i) the rate shall be reviewed and amended, if necessary, every year; (ii) said fee shall be 5.3% effective October 1March 31, 2002 and 4.4% effective April 1December 31, 2002 of Net Sales; and (iii) any amendment of the rate shall be subject to prior approval of the Technology Transfer Registry of the Philippine Bureau of Patents, Trademarks and Technology Transfer; that the Agreement shall be valid and remain in force for a period of two (2) years commencing on its effectivity date and shall be renewed for successive periods of one (1) year each, unless either party gives to the other a written notice specifically stating the party's intent not to extend the Agreement at least one (1) month before the expiration of the initial one (1) year period, or any subsequent extended one (1) year period; that the Consulting Agreement complied with the provisions of Sections 87 and 88 of Chapter IX, Part II of the Intellectual Property Code on Voluntary Licensing per Certificate of Compliance No. 5-2002-000165 issued by the Intellectual Property Office dated November 21, 2002. In reply, please be informed that Article 12(4) of the RP-Japan tax treaty provides that: "Article 12 Royalties xxx xxx xxx 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" 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 ORGANIZATION 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; of technique." In the know-how contract, one of the parties 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. HAEIac In the instant case, it is evidently clear that the consulting fee under the Consulting Agreement is not in consideration of royalties as understood under Article 12 of the RP-Japan tax treaty. It is our view that the Consulting Agreement does not involve payments in consideration for information that alludes to the concept of "know-how" that would otherwise permit APOLLO to transfer technology into the Philippines and impart to RASPI its special knowledge and experience which remain unrevealed to the public. Neither the agreement provides for the use of, or the right to use industrial, commercial or scientific equipment, or for information concerning scientific, industrial or commercial experience. Moreover, the Court of Tax Appeals had the occasion to distinguish between the payment of service fee from royalty when it declared that, whenever the payee has proprietary interest in the property giving rise to the income, then the payment is royalty. ( Phil. Refining Co. (PRC) vs. CIR, CTA Case No. 2872 dated January 15, 1986 ) Thus, the consulting fees paid to APOLLO are not considered royalties but constitute compensation for dependent personal services under Article 15 of the same tax treaty. Premises considered, the consultancy fees shall be governed by Article 15 of the RP-Japan tax treaty which provides that: "Article 15 Dependent Personal Services (1) Subject to the provisions of Articles 16, 18, 19, 20 and 21, salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that Contracting State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other Contracting State. (2) Notwithstanding the provisions of paragraph (1), remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned Contracting State if: a) the recipient is present in that other Contracting State for a period or periods not exceeding in the aggregate 183 days in the calendar year concerned, and b) the remuneration is paid by, or on behalf of, an employer who is not a resident of that other Contracting State, and c) the remuneration is not borne by a permanent establishment or a fixed base which the employer has in that other Contracting State. xxx xxx xxx" According to the aforequoted provisions, a resident of Japan is not taxable in the Philippines if his presence in the latter is merely for 183 days or less in a year and the remuneration of such resident " is paid by, or on behalf of, a person who is a resident of Japan and the remuneration or income is not borne directly by a permanent establishment which that person has in the Philippines ." As certified by RASPI, the presence of the APOLLO personnel in the Philippines, except for Mr. Kondo, did not exceed 183 days. As such, their remuneration shall not be subject to Philippine income tax pursuant to Article 15 of the RP-Japan tax treaty. In the case of Mr. Kondo, documents submitted will show that he stayed in the Philippines for a period of 340 days. Accordingly, inasmuch as his stay in the Philippines in the calendar year 2001 did not exceed 180 days, he is considered a nonresident alien not doing business in Philippines and his remuneration is subject to twenty-five (25%) percent final income tax pursuant to Section 25(B) of the Tax Code. For calendar year 2002, Mr. Kondo shall be considered a nonresident alien doing business pursuant to Section 25(A)(1) of the Tax Code of 1997 having stayed in the Philippines for more than 180 days. As such, his remuneration shall be subject to the graduated tax rate of 5% to 32%, in the same manner as an individual Filipino citizen, pursuant to Section 24(A)(1)(c) of the Tax Code of 1997. Accordingly, Mr. Kondo's income from sources within the Philippines is subject to creditable withholding tax on compensation income pursuant to Section 57 of the Tax Code of 1997 as implemented by Revenue Regulations No. 2-98 specifically Section 2.78 thereof. As such, Mr. Kondo should file an income tax return for his income in the year 2002 pursuant to Section 51(A)(1)(d) of the Tax Code of 1997 and pay the tax due thereon. Finally, as regards the profits derived by APOLLO under the Consulting Agreement, please be informed that paragraph 1, Article 7 of the same tax treaty provides: "Article 7 Business Profits 1. The profits of an enterprise of a Contracting State shall be taxable only in that Contracting State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in that other Contracting State but only so much of them as is attributable to that permanent establishment. xxx xxx xxx" In relation to the aforequoted Article 7(1) of the RP-Japan tax treaty, its Article 5(6) further provides: "Article 5 Permanent Establishment xxx xxx xxx 6. An enterprise of a Contracting State shall be deemed to have a permanent establishment in the other Contracting State if it furnishes in that other Contracting State consultancy services, or supervisory services in connection with a contract for a building, construction or installation project through employees or other personnel other than an agent of an independent status to whom paragraph (7) applies , provided that such activities continue (for the same project or two or more connected projects) for a period or periods aggregating more than six months within any taxable year. However, if the furnishing of such services is effected under an agreement between the Governments of the two Contracting States regarding economic or technical cooperation, that enterprise shall, notwithstanding any provisions of this Article, not be deemed to have a permanent establishment in that other Contracting State. xxx xxx xxx" Based on the abovequoted Articles 5 and 7 of the RP-Japan tax treaty, the furnishing of services, particularly consultancy services, performed within the Philippines by APOLLO through its personnel may give rise to a permanent establishment if the activities concerned are carried out for a period of more than 6 months within a taxable year. Inasmuch as the activities defined in the Consulting Agreement will be carried out for two (2) years as specified therein, APOLLO is considered to have a permanent establishment in the Philippines, thus, the profits derived by APOLLO under the Consulting Agreement are subject to Philippine income tax. ( BIR Ruling No. ITAD 169-02 dated September 26, 2002 ). Such profits are treated as income of a nonresident foreign corporation subject to 32% final income tax as provided under Section 28(B)(1) of the Tax Code. TESDcA Moreover, the said consultancy fees are subject to the 10% value-added tax (VAT) pursuant to Section 108 of the Tax Code of 1997. Accordingly, RASPI, being the resident withholding agent and payor in control of the payment shall be responsible for the withholding of the 10% final VAT on such royalty fees before making any payment to APOLLO. In remitting the VAT withheld, RASPI shall use BIR Form No. 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 RASPI upon filing its own VAT Return, if it is a VAT-registered taxpayer. In case RASPI is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased which may be treated as "expense" or "asset" whichever is applicable. In addition, RASPI is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of APOLLO, the first three copies thereof to be given to APOLLO and the fourth copy to be retained by RASPI 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 ] Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service