ITAD Ruling No. 098-05

September 7, 2005 ITAD RULING NO. 098-05 Articles 12, Philippines-Japan Tax Treaty BIR Ruling No. ITAD 30-05; 144-04; 217-02 Joaquin Cunanan & Co . 29th Floor Philamlife Tower 8767 Paseo de Roxas Makati City 1226 Attention: Mary Assumption S . Bautista-Villareal Principal, Tax Services Gentlemen : This refers to your application for tax treaty relief dated February 7, 2005, on behalf of your client, KISHO SAKATA ELECTRONICS (P) INC. (KSEPI), requesting confirmation that: (1) royalty fees paid by KSEPI to Kisho Electronics Company Ltd. (KECL) under the Royalties Agreement are subject to the preferential final withholding tax rate of twenty-five percent (25%) pursuant to Article 12(2)(b) of the Philippines-Japan tax treaty; and ScCDET (2) service fees paid by KSEPI to KECL under the Marketing Agreement are not subject to Philippine income/withholding tax on the ground that KECL does not have a permanent establishment in the Philippines, pursuant to Article 7 in relation to Article 5 of the Philippines-Japan tax treaty and that said fees are not considered Philippine source income pursuant to Sections 23(F) and 42(A)(3) of the Tax Code of 1997. It is represented that KECL is a nonresident foreign corporation duly organized and existing under the laws of Japan with main office address at Cuore Tokan, 5-11-15, Arakawa, Arakawa-ku, Tokyo and is the parent company of KSEPI; that it is not registered either as a corporation or as a partnership licensed to do business in the Philippines per certification dated January 31, 2005 issued by the Securities and Exchange Commission; that KSEPI, on the other hand, is a domestic corporation organized and existing under the laws of the Philippines with principal address at 108 Technology Avenue, Special Export Processing Zone, Laguna Technopark, Bian, Laguna; that it is registered with the Philippine Economic Zone Authority (PEZA) as an Ecozone Export Enterprise under Certificate of Registration No. 95-127 dated November 27, 1995; that it started its commercial operations in January 1997 and it is now subject to the regime of 5% tax in lieu of all other taxes under Republic Act (RA) No. 7916 after its income tax holiday incentive expired on December 31, 2002; that on April 1, 2000, KSEPI and KECL executed two (2) Agreements, namely: Royalties Agreement and Marketing Agreement; that under the Royalties Agreement, KECL shall render technical support/assistance and management consultancy services to KSEPI for the manufacture, assembly, and/or improvement/development of audio level meters, computer coils, coil motors, and other computer parts and accessories (the Products); that the technical assistance shall include the provision of drawings and specifications, list of component parts, process specifications, performance specifications, test data, lay-out of manufacturing facilities, list of machinery and equipment, and other information necessary to manufacture, assemble, and/or improve/develop the Products; that KSEPI agrees to pay a monthly royalty calculated at the rate of one percent (1%) of the Net Selling Price of all Products sold by KSEPI' during the term of the Agreement; that the Agreement shall come into force on the commencement date, April 1, 2000, and shall remain in force for a period of two (2) years, which shall be automatically extended from year to year for one (1) year periods, unless either party gives a written notice of termination. It is further represented that under the Marketing Agreement, KECL shall promote, market, advertise, and disseminate information on, and liaise with parties interested in, the Products of KSEPI to the head offices/parent companies of PEZA-registered companies in Japan, supplying sufficient, necessary, requisite, or suitable materials, as may be agreed upon in the Agreement and with KSEPI; that the above services are to be performed exclusively in Japan; that it shall become effective on the commencement date, April 1, 2000, and remain in effect until terminated by one of the parties; that in consideration thereof, KSEPI or its agent(s) or representative(s) shall pay a service fee in the following amount not exceeding P1,000,000.00 per month to be determined on the following bases: (i) salaries of marketing team assigned by KECL to market and promote KSEPI in Japan; (ii) reasonable representation expenses incurred in the course of the engagement; (iii) reasonable mark-up on the costs incurred for rendering the service. In reply, please be informed as follows: 1. On the Royalties Agreement Article 12 of the Philippines-Japan tax treaty provides: "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; aCTHDA 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 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, royalty payments will be taxed at the preferential tax rate of ten percent (10%), if the payor is a Board of Investments (BOI)-registered enterprise; fifteen percent (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 KSEPI is not a BOI-registered enterprise, and its payments to KECL under the Royalties Agreement 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 said 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 Philippines-Japan tax treaty. (BIR Ruling No. DA-ITAD-217-02 dated December 27, 2002) 2. On the Marketing Agreement Inasmuch as it is represented that the services to be rendered by KECL in favor KSEPI shall be performed entirely, in Japan, the Philippines-Japan tax treaty finds no application in the instance case as the performance of the subject services does not result in a case of double taxation for which a tax treaty relief may be sought. ( DA-ITAD No . 152-02 dated August 29, 2002 ). As such, the fees to be paid by KSEPI to KECL are governed by Section 23(F), in relation to Section 42(A)(3), both of the Tax Code of 1997, as amended, to wit: "SEC 23. General Principles of Income Taxation in the Philippines. Except when otherwise provided in this Code: "xxx xxx xxx "(F) A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines. "xxx xxx xxx "SEC. 42. Income from Sources Within the Philippines. "(A) Gross Income From Sources Within the Philippines. The following items of gross income shall be treated as gross income from sources within the Philippines: "xxx xxx xxx "(3) Services Compensation for labor or personal services performed in the Philippines; "xxx xxx xxx" In view thereof, the fees to be remitted by KSEPI to KECL are considered income derived from sources outside the Philippines and are, therefore, not subject to Philippine income tax and consequently to the withholding tax. (DA-ITAD-026-03 dated January 30, 2003) 3. On Value-Added Tax (VAT) 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. However; pursuant to VAT Ruling No. 100-99, dated September 16, 1999; the dispositive portion of which provides: " In the case of payment for royalties to a nonresident owner, the responsibility for withholding the VAT and paying the same rests on the payor : However, since PEZA-registered export enterprise may not be passed on with nor claim input VAT, then payment of royalties to a nonresident lessor , . . . . , should be as it is hereby confirmed to be, exempt from VAT. " Accordingly, payment of royalties by KSEPI, a PEZA-registered corporation, to KECL, a nonresident owner is hereby confirmed to be exempt from VAT. HIETAc 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