ITAD Ruling No. 040-05

May 9, 2005 ITAD RULING NO. 040-05 Article 11 & 12, Philippines-Japan tax treaty BIR Ruling No. DA-ITAD-20-04 BIR Ruling No. DA-ITAD-122-03 VAT Ruling No. 100-99 ITO-Seisakusho Philippines Corporation Lot C2-1 B, Carmelray Industrial Park II KM. 54 National Highway, Barangay Tulo & Punta Calamba City, Laguna Attention: Ms. Rose Andrion Admin. and Accounting Manager Gentlemen : This refers to your letter dated January 29, 2004, requesting a ruling to the effect that the interest and royalty payments to be received by ITO SEISAKUSHO CO., LTD. (ITO-Japan) from ITO SEISAKUSHO PHILIPPINES CORPORATION (ITO-Phil), formerly ITO-FGI Corporation, are subject to 15% and 25% preferential tax rates, respectively, pursuant to the Philippines-Japan tax treaty. It is represented that ITO-Japan is a corporation organized and existing under the laws of Japan with principal address at 101, Hironaga-cho Yokkaichi City, Miet, Japan; that it is not registered either as a corporation or as a partnership licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated January 14, 2004; that ITO-Phil is a domestic corporation organized and existing under the laws of the Philippines, and a PEZA-registered enterprise per Certificate of Registration No. 02-017 dated January 9, 2003; that on November 31, 2003, ITO-Japan and ITO-Phil entered into a Technical and Assistance Agreement (Agreement) which was registered with the Intellectual Property Office (IPO), as evidenced by the Certificate of Registration issued by the IPO dated March 10, 2004; that under the provisions of the Agreement, ITO-Phil shall pay to ITO-Japan royalty fees in the amount of Three Hundred Thousand Pesos (PHP300,000.00) monthly during the term of the said Agreement; that the Agreement became effective on November 1, 2003 upon approval by pertinent Government Authorities of the Republic of the Philippines, after having been signed by both companies; that the Agreement shall continue to be in full force and effect for a period of ten (10) years, unless sooner terminated as provided for elsewhere in the same Agreement; and that if neither company gives twelve (12) months prior written notice before its expiration date, then said Agreement shall be automatically renewed and continued year to year. It is further represented that on June 6, 2003, ITO-Phil and ITO-Japan entered into a Loan Agreement under which the former received from the latter the total sum of Seventy Two Million Sixty Thousand Seven Hundred Fifteen Yen (72,060,715.00) to finance the construction of ITO-Phil's building and the acquisition of various machines to be used for its business operation; that in consideration for the loan granted by ITO-Japan, ITO-Phil shall pay an interest of two percent (2%) per annum based on the principal amount; and that ITO-Phil agrees to pay semi-annually every 30th of March and 30th of September, in 20 equal installments with the first installment made on March 30, 2004. EACIcH In reply, please be informed that royalty payments and interest income received by ITO-Japan are subject to Philippine tax as follows: 1. On Royalties Article 12 of the Philippines-Japan tax treaty provides: "Article 12 "Royalty "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. "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 and 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 aforequoted provisions, royalties paid by a resident of the Philippines to a resident of Japan may be taxed at a rate not exceeding 10% of the gross amount of the royalties if the payor is a Board of Investments (BOI)-registered enterprise engaged in preferred pioneer areas of investments, 15% 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 broadcasting, and 25% in all other cases. Such being the case, this Office is of the opinion and so holds that since ITO-Phil is not a BOI-registered enterprise engaged in preferred pioneer areas of investment, and that the subject royalty payments are not paid in respect of the use of the right to use cinematograph films and films or tapes for radio or television broadcasting, royalty payments by ITO-Phil to ITO-Japan under the above Agreement shall be subject to Philippine income tax at a rate of 25% of the gross amount of the royalties pursuant to Article 12(2)(b) of the Philippines-Japan tax treaty. (BIR Ruling No. DA-ITAD-20-04 dated March 8, 2004) 2. On Interest Article 11 of the Philippines-Japan tax treaty provides: "Article 11 "Interest "1. Interest 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 interest may also be taxed in the Contracting State in which it arises, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the interest the tax so charged shall not exceed: a) 10 per cent of the gross amount of the interest if the interest is paid in respect of Government securities, or bonds or debentures; b) 15 per cent of the gross amount of the interest in all other cases. "xxx xxx xxx "5. The term 'interest' as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profit, and in particular, income from Government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. cEASTa "xxx xxx xxx" Based on the above, the preferential tax rate to be withheld by ITO-Phil on its interest payments to ITO-Japan shall be fifteen percent (15%) of the gross amount of the interest since it is not paid in respect of Government securities or bonds and debentures, pursuant to Article 11(2)(b) of the Philippines-Japan tax treaty. Moreover, the loan agreement executed by and between them shall be subject to documentary stamp tax imposed under Section 179 of the Tax Code of 1997, as amended. (BIR Ruling No. ITAD-DA-122-03 dated August 11, 2003) 3. On Value-added tax (VAT) 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" which includes, viz : "(1) The lease or the use of or the right or privilege to use any copyright, patent, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or right; "(2) The lease or the use of, or the right to use of any industrial, commercial, or scientific equipment; "(3) The supply of scientific, technical, industrial or commercial knowledge or information "(4) The supply of any assistance that is ancillary and subsidiary to and is furnished as a means of enabling the application or enjoyment of any such property, or right as is mentioned in the subparagraph (2) or any such knowledge or information as is mentioned in subparagraph (3); "(5) The supply of services by a nonresident person or his employee in connection with the use of property or rights belonging to, or the installation or operation of any brand, machinery or other apparatus purchased from such nonresident person; "(6) The supply of technical advice, assistance or services rendered in connection with technical management or administration of any scientific, industrial or commercial undertaking, venture, project or scheme; "(7) The lease of motion picture films, films, tapes and discs; and "(8) The lease or the use of or the right to use radio, television, satellite transmission and cable television time. "xxx xxx xxx" and as such is subject 10% VAT. Under current Revenue 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 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 . . ." (BIR Ruling No. DA-ITAD-20-04 dated March 8, 2004) The same principle is applicable to the case at hand. However, instead of zero-rating which the non-resident lessor cannot avail of, the provision for exempt transactions under Section 109(q) of the Tax Code of 1997 which provides VAT exemptions for transactions that are exempt under special laws, e.g, Republic Act No. 7916 or PEZA law, is particularly applicable to the instant case. For the payment of royalties to a nonresident owner, the responsibility for withholding the VAT and paying the same rests on the payor. However, since ITO-Phils is a PEZA-registered enterprise and may not be passed on with nor claim input VAT, then its payment of royalties to a nonresident owner, such as ITO-Japan should be, and is confirmed to be exempt from VAT. (BIR Ruling No. DA-ITAD-20-04 dated March 8, 2004 and VAT Ruling No. 100-99 dated September 16, 1999) 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. ETDHaC Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service