ITAD Ruling No. 056-03

April 15, 2003 ITAD RULING NO. 056-03 Article 12, RP-Japan Sec. 108, NIRC Revenue Regulations 7-95 BIR Ruling No. DA-ITAD No. 115-02 VAT Ruling No. 009-99 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 March 6, 2003 on behalf of your client, TDK Philippines Corporation (TDK-Phil), requesting confirmation of your opinion that the royalty payments of TDK-Phil to TDK Corporation (TDK-Japan) pursuant to a Technical License Agreement are subject to the preferential tax rate of 25% pursuant to Article 12 of the RP-Japan tax treaty, but are exempt from the 10% value-added tax (VAT). It is represented that TDK-Japan is a non-resident foreign corporation duly organized and existing under and by virtue of the laws of Japan with principal address at 13-1 Nihonbashi 1-Chome, Chuo-ku Tokyo, 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 issued by the Securities and Exchange Commission (SEC) dated March 24, 2003; that TDK-Phil, on the other hand, is a domestic corporation registered with the Philippine Economic Zone Authority (PEZA) as an Ecozone Export Enterprise with principal address at 119 East Science Avenue SEPZ Laguna Technopark, Bian, Laguna; that on March 20, 1998, a Technical License Agreement was entered into by and between TDK-Japan and TDK-Phil whereby TDK-Japan granted TDK-Phil a non-exclusive, non-transferable and non-sublicenseable license to use the technology to manufacture, sell, export and/or otherwise dispose of the licensed products under the Agreement in the Philippines; that the Technical License Agreement is registered with the Intellectual Property Office (IPO) with Certificate of Compliance No. 52000-00016; and that in consideration for the license provided by TDK-Japan, TDK-Phil shall pay TDK-Japan a nonrefundable royalty in the amount of two percent (2%) based on the net sales amount of the licensed products manufactured and sold by TDK-Phil. 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. DCHIAS (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 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 TDK-Phil is not a BOI-registered enterprise, and that the payments made to TDK-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-115-02 dated June 4, 2002 ) As regards the VAT issue, please be informed that the lease or use of property or property rights is embraced within the definition of "sale or exchange of services" under Section 108 of the Tax Code of 1997 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 instant case. However, instead of zero-rating which is not available to non-resident suppliers, the provision for exempt transactions under Section 109(q) of the Tax Code of 1997 on VAT exemption for transactions which are exempt under special laws, e.g., Republic Act No. 7916 or PEZA Law, applies. In the case of payment of lease or royalties to a non-resident owner, the withholding and payment of the VAT is the responsibility of the payor. However, since TDK-Phil is a PEZA-registered export enterprise, it may not pass on nor claim input VAT. Hence, the royalty payments by TDK-Phil to TDK-Japan shall 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