ITAD Ruling No. 045-05

May 19, 2005 ITAD RULING NO. 045-05 Article 13, Philippines-United States tax treaty Article 12, Philippines-China tax treaty Tax Code of 1997, Section 108 RMC No. 46-2002 dated September 2, 2002 BIR Ruling No. DA-ITAD-101-03 Joaquin Cunanan & Co. 29th Floor Philamlife Tower 8767 Paseo de Roxas 1226 Makati City Attention: Tammy H. Lipana Managing Partner, Tax Services Gentlemen : This refers to your letter dated February 10, 2005, on behalf of your client, Lear Corporation Automotive Services (Netherlands) B.V.- Philippine Branch (LASN Branch), requesting confirmation on the following opinion: 1. that the royalties to be paid by LASN Branch to Lear Corporation are subject to the preferential tax rate of 10% under the Philippines-United States of America (Philippines-United States) tax treaty in relation to the Philippines-China tax treaty; 2. that the royalties to be paid shall not be subject to 10% value-added tax (VAT) and; 3. that the said royalties are deductible from LASN Branch's gross sales for purposes of computing its taxable income subject to 5% tax under Republic Act No. 7916 (PEZA Law). It is represented that Lear Corporation (Lear Corporation) is a nonresident foreign corporation existing and organized under the laws of the State of Delaware, United States of America; 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 (SEC) dated February 2, 2005; that Lear Corporation is the owner of Lear intangible property required for the manufacturing and marketing of automotive wire harness products; that LASN Branch is a domestic company with license to do business in the Philippines under SEC Registration No. A2002100134 dated November 22, 2002; that it is an export enterprise registered with the Philippine Economic Zone Authority (PEZA) under PEZA Registration No. 02-075 dated December 27, 2002; that on November 22, 2004 LASN Branch entered into an Intangibles Licensing Agreement (Agreement) with Lear Corporation whereby the latter grants LASN Branch the non-exclusive right and license to use intangible property which includes product design intangibles, process intangibles, the Lear Corporation trademark and such other intangibles required in connection with the manufacturing, assembling, processing and designing the automotive wiring harness products of LASN Branch; that the Agreement was entered into force on January 1, 2004; that in consideration for the use of the Intangible Property, LASN Branch will pay Lear Corporation an arm's length royalty charge according to the schedule set out under the Agreement; and that the Agreement complies 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. 5-2005-00013 dated January 23, 2005, issued by the Intellectual Property Office. In reply, please be informed that Article 13 of the Philippines-United States tax treaty provides, viz : "Article 13 Royalties "1. Royalties derived by a resident of one of the Contracting States from sources within the other Contracting State may be taxed by both Contracting States. "2. However, the tax imposed by that other Contracting State shall not exceed a) In the case of the United States, 15 percent of the gross amount of the royalties, and b) In the case of the Philippines, the least of: (i) 25 percent of the gross amount of the royalties, (ii) 15 percent of the gross amount of the royalties, where the royalties are paid by a corporation registered with the Philippine Board of Investments and engaged in preferred areas of activities, and (iii) the lowest rate of Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State . (Underscoring supplied) "3. 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 cinematographic films or films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or other like right or property, or for information concerning industrial, commercial or scientific experience. The term "royalties" also includes gains derived from the sale, exchange or other disposition of any such right or property which are contingent on the productivity, use, or disposition thereof. "xxx xxx xxx" and, in relation thereto, Article 12 of the Philippines-China tax treaty provides, viz : "Article 12 ROYALTIES "1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. "2. However, such royalties may also be taxed in the Contracting State in which they arise and according to the laws of that 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 royalties arising from the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films or tapes for television or broadcasting, or b) 10 per cent of the gross amount of royalties arising from the use of or the right to use, any patent, trade mark, design or model, plan, secret formula or process, or from the use of or the right to use, industrial, commercial, or scientific equipment, or for information concerning industrial, commercial or scientific experience. (Underscoring supplied) For as long as the transfer of technology, under Philippine law, is subject to approval, the limitation of the tax rate mentioned under (b) shall, in the case of royalties arising in the Republic of the Philippines, only apply if the contract giving rise to such royalties has been approved by the Philippine competent authorities. "3. 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 cinematography films, or 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" Pursuant to the aforequoted "most-favored-nation" clause under Article 13(2)(b)(iii) of the Philippines-United States tax treaty, the tax imposed on royalties derived by a resident of the United States from sources within the Philippines shall be the lowest rate of Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State. Relative thereto, pursuant to Article 12(2)(b) of the Philippines-China tax treaty, the tax charged shall not exceed 10% of the gross amount of royalties arising from the use of, or the right to use, any patent, trademark, design or model, plan, secret formula or process, or from the use of, or the right to use, industrial, commercial, or scientific equipment, or for information concerning industrial, commercial or scientific experience. It is noteworthy that in the case of Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc. and Court of Appeals , G.R. No. 127105, promulgated on June 25, 1999, the Supreme Court interpreted the "most-favored-nation" clause, particularly the phrase "paid under similar circumstances", as referring to the manner of payment of taxes and not to the subject matter of the tax which is royalties. ( BIR Ruling No. DA-ITAD 101-03 dated July 24, 2003 ) A plain reading of the Philippines-China tax treaty and the Philippines-United States tax treaty provisions on the avoidance of the double taxation shows a similarity on the manner of payment of taxes, that is, the allowable foreign tax credit on both treaties is the amount actually paid in the Philippines. Such being the case, this Office is of the opinion and so holds that the royalty fees paid by LASN Branch to Lear Corporation are subject to the preferential tax rate of 10% based on the gross amount thereof pursuant to Article 13(2)(b)(iii) of the Philippines-United States tax treaty in relation to Article 12(2)(b) of the Philippines-China tax treaty. (DA-ITAD-101-03 dated July 24, 2003; RMC No. 46-2002 dated September 2, 2002) Moreover, under Section 108 of the National Internal Revenue Code (Tax Code) of 1997, 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 VAT. Under the current regulations, the sale of services to ECOZONE Enterprise 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 Republic Act (RA) No. 7916 or the PEZA Law granting indirect tax exemption 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 the nonresident supplier cannot avail of, the provision for exempt transaction under Section 109 of the Tax Code which provides VAT exemptions for transactions which are exempt under special laws, e.g. R.A. No. 7916 or the PEZA Law, is particularly applicable to the instant case. In the case of payment for lease or royalties paid to a nonresident 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 nonresident lessor, such as Lear Corporation should be, as it is hereby confirmed to be exempt from VAT. (VAT Ruling No. 095-99 dated September 14, 1999) THDIaC As regards to your query on whether the above royalty payments are deductible from LASN Branch's gross sales for purposes of computing its taxable income subject to 5% tax under R.A. No. 7916 or the PEZA Law, please be informed that the matter is outside the jurisdiction of this office, hence, we decline to rule on the said issue. 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.) JAMES H. ROLDAN Assistant Commissioner Legal Service