ITAD Ruling No. 112-05

September 30, 2005 ITAD RULING NO. 112-05 Articles 5, 7 and 15 Philippines-Japan tax treaty BIR Ruling Nos. DA-ITAD 83-05, 62-05 and 92-05 Sycip Gorres Velayo & Co . 6760 Ayala Avenue 1226 Makati City Attention: Atty. Rafael C. Vinzon Tax Services Gentlemen : This refers to your letter dated February 7, 2005 requesting confirmation of your opinion that the dispatching fees to be paid by NEC Tokin Electronics (Philippines), Inc . to NEC Tokin Iwate Company Ltd. are not subject to Philippine income tax under the relevant articles of the Convention between the Republic of the Philippines and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (Philippines-Japan tax treaty). It is represented that on May 15, 1996, NEC Components Philippines, Inc . (a domestic corporation, organized and existing under the laws of the Philippines) and NEC Corporation (a nonresident foreign corporation, organized and existing under the laws of Japan) entered into a Technical License Agreement whereby NEC Corporation granted NEC Components Philippines. Inc . a nonexclusive and nontransferable right and license under Know-how 1 to manufacture Licensed Products 2 in the Philippines; that NEC Corporation will, upon NEC Components Philippines, Inc.'s request, dispatch specialists of its electromechanical device division 3 to NEC Components Philippines, Inc . to provide it with technical advice within the scope of Know-how; that the Technical License Agreement is registered with the Technology Transfer Registry of the Bureau of Patents and Trademarks and Technology Transfer, with Certificate of Registration No. 1940 dated April 1, 1997; that pursuant to the Agreement of Division and Transfer of Business dated January 31, 2002, NEC Corporation transferred its assets, liabilities and other rights and obligations relating to its electromechanical device business to Tokin Corporation (a nonresident foreign corporation, organized and existing under the laws of Japan) whereby the rights and obligations transferred to Tokin Corporation include those of NEC Corporation 's rights under the Technical License Agreement; that Tokin Corporation subsequently changed its corporate name to NEC Tokin Corporation ; that in view of the transfer, NEC Components Philippines, Inc . likewise assigned its electromechanical device business to NEC Tokin Electronics (Philippines), Inc . including its rights and obligations under the Technical License Agreement, pursuant to an Assignment of Registered Technical Licensed Agreement dated August 31, 2002 among NEC Components Philippines, Inc ., NEC Tokin Electronics (Philippines), Inc . and NEC Tokin Corporation ; that NEC Tokin Electronics (Philippines), Inc . is registered with the Philippine Economic Zone Authority (PEZA) under Certificate of Registration No. 02-043 dated August 19, 2002; that NEC Tokin Corporation's obligations under the Technical License Agreement to dispatch the specialists to NEC Tokin Electronics Philippines, Inc . were carried out by specialists from NEC Tokin Iwate Company Ltd ., a nonresident foreign corporation, organized and existing under the laws of Japan, with head office at 1, Karakai, Ichinoseki City, Iwate Prefecture, Japan as confirmed by the company's registration document dated December 21, 2004 issued by the Morioka Regional Legal Affairs Bureau Ichinoseki Branch; that NEC Tokin Iwate Company Ltd. is not registered either as a corporation or as a partnership licensed to engage in business in the Philippines, as confirmed by the Certificate of Non-Registration of Corporation/Partnership dated January 27, 2005 issued by the Securities and Exchange Commission; and that in consideration for the dispatch of the specialists, NEC Tokin Electronics (Philippines), Inc . shall, under the Technical License Agreement, pay NEC Tokin Iwate Company Ltd . a dispatching fee of One Hundred and Fifty United States dollars (US$150) for each specialist per calendar day. In reply, please be informed that the dispatching fees to be paid by NEC Tokin Electronics (Philippines) to NEC Tokin Iwate Company Ltd. , being income from the furnishing of services and not from the use or the right to use of an intangible property, are business profits and taxable as such under paragraph 1, Article 7 of the Philippines-Japan tax treaty: "Article 7 "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. DaEcTC "xxx xxx xxx" In relation, a permanent establishment is defined in paragraphs 1, 2 and 6, Article 5 of the tax treaty: "Article 5 "1. For the purposes of this Convention, the term "permanent establishment" means a fixed place of business through which the business of an enterprise is wholly partly carried on. "2. The term "permanent establishment" includes especially; a) a store or other sales outlet; b) a branch; c) an office; d) a factory; e) a workshop; f) a warehouse; g) a mine, an oil or gas well, a quarry or other place of extraction of natural resources. "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 foregoing, a permanent establishment exists for the furnishing of services if (1) NEC Tokin Iwate Company Ltd. has an office, or branch or any other fixed place of business in the Philippines for this purpose or (2) the services are furnished for an aggregate of more than six months within any taxable year. In neither instances can NEC Tokin Iwate Company Ltd. be considered to have a permanent establishment in the Philippines because (1) it does not have an office or a branch in the Philippines for the purpose of rendering the services, as confirmed by the relevant certification of non-registration issued by the Securities and Exchange Commission, and (2) the subject services are not performed for more than six months within the taxable years in question, year 2002 and onwards, where they are performed for merely an average period of thirty days within these taxable years. (BIR Ruling No. DA-ITAD 83-05 dated August 22, 2005) It should be noted that aside from an office or a branch or duration of activity, premises provided by NEC Tokin Electronics (Philippines), Inc . to the personnel concerned of NEC Tokin Iwate Company Ltd. constitutes a permanent establishment if such premises, which are at the disposal of these personnel although not owned by them, are utilized for a sufficiently long period of time and on a regular or predictable basis which does not necessarily exceed six months in any given taxable year. Thus considering that NEC Tokin Iwate Company Ltd ., will perform the services for at least ten years (the minimum life of the Technical License Agreement), and may be extended thereafter, the number of times and the length of time such services are performed in the Philippines will be taken into account in determining if NEC Tokin Iwate Company, Ltd ., has or will have already a permanent establishment. DaScAI On the other hand, the part of the subject service fees representing the remuneration of the specialists who will personally provide the services to NEC Tokin Electronics (Philippines), Inc . are generally subject to Philippine income tax, unless to conditions set forth in paragraph 2, Article 15 of the Philippines-Japan tax treaty are all complied with, to wit: "Article 15 "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 exercise 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" Paragraph 2 states that the subject remuneration will be exempt from tax if: (a) the specialist (taken individually) are present in the Philippines for an aggregate period or periods not exceeding 183 days in the calendar year concerned, (b) the remuneration is paid by an employer who is not a resident of the Philippines, and (c) the remuneration is not borne by a permanent establishment which the employer has in the Philippines. Based on the representations made herein, all the three conditions required in paragraph 2 above are satisfied considering that (a) the length of stay in the Philippines of the specialists of NEC Tokin Iwate Company Ltd. did not exceed 183 days because the duration of the activity is only thirty days within any calendar year, (b) the remuneration is paid by an employer, NEC Tokin Iwate Company Ltd ., who is a resident of Japan and not of the Philippines, and (c) the remuneration is not borne by a permanent establishment which NEC Tokin Iwate Company Ltd . might have in the Philippines, because, as previously explained, NEC Tokin Iwate Company Ltd. is not licensed to engage in business in the Philippines and as such is not deemed to have a permanent establishment in the country. This being so, the subject remuneration of the specialists are exempt from Philippine income tax. (BIR Ruling No. DA-ITAD 83-05 dated August 22, 2005) On the other hand, as regards value-added tax (VAT), the provision of services by NEC Tokin Iwate Company Ltd. to NEC Tokin Electronics (Philippines), Inc . is generally subject to ten percent (10%) VAT, under Section 108 of National Internal Revenue Code of 1997 (Tax Code): "Section 108. Value-Added Tax on Sale of Services and Use or Lease of Properties . A) Rate and Base of Tax. There shall be levied, assessed and collected, a value-added tax equivalent to ten percent (10%) of gross receipts derived from the sale or exchange of services, including the use or lease of properties. cCHITA " The phrase sale or exchange of services' means the Performance of all kinds of services in the Philippines for a fee, remuneration or consideration . . . (emphasis added) However, Section 109(q) of the Tax Code exempts from VAT transactions which are exempt under international agreements or under special laws: "SEC. 109. Exempt Transactions. The following shall be exempt from the value-added tax: "xxx xxx xxx" "(q) Transactions which are exempt under international agreements to which the Philippines is a signatory or under special laws, except those under Presidential Decree Nos. 66, 529 and 1590; "xxx xxx xxx" Concerning special laws relevant to NEC Tokin Electronics (Philippines), Inc . and other PEZA-registered enterprises, Section 24 of Republic Act No. 7916 (An Act Providing for the Legal Framework and Mechanism for the Creation, Operation, Administration, and Coordination of Special Economic Zones in the Philippines, Creating for this Purpose, the Philippine Economic Zone Authority (PEZA), and for Other Purposes) and Section 1, Rule XIV (incentives to ECOZONE Developers/Operators) of the Rules and Regulations to Implement this Act are worth mentioning: "Section 24. Exemption from Taxes Under the National Internal Revenue Code . Any Provision of existing laws, rules and regulations to the contrary, notwithstanding, no taxes, local and national, shall be imposed on business establishments operating within the ECOZONE. In lieu of paying taxes, five percent of the gross income earned by all business and enterprises within the ECOZONE shall be remitted to the national government. . ." Section 1. ECOZONE Developers/Operators. ECOZONE Developers/Operators shall be entitled to the following incentives: A. Exemption from National and Local Taxes and Licenses. An ECOZONE Developer/Operator shall to the extent of its construction and operation, be exempt from payment of all national internal revenue taxes and local government impost, fees, licenses or taxes, including but not limited to the following: 1. Internal revenue taxes such as gross receipts tax, value-added tax, ad valorem and excise taxes; 2. Franchise, common carrier or value added taxes and other percentage taxes on public and service utilities and enterprises. "xxx xxx xxx" Accordingly, since VAT is an indirect tax and the amount of tax may be shifted or passed on to NEC Tokin Electronics (Philippines), Inc . (Section 105, Tax Code), NEC Tokin Electronics (Philippines), Inc ., on the other hand, by reason that it is exempt from national internal revenue taxes like VAT under Section 24 of Republic Act No. 7916, cannot be obliged by NEC Tokin Iwate Company Ltd. to shoulder the payment of VAT on the provision of the subject services. This is further supported by PEZA Certificate No. 2005-284 dated January 12, 2005 issued to NEC Tokin Electronics (Philippines), Inc . which states that suppliers of goods, properties and services to NEC Tokin Electronics (Philippines), Inc ., being a PEZA-registered enterprise, are entitled to zero percent (0%) VAT for sales made to NEC Tokin Electronics (Philippines), Inc ., and by VAT Ruling No. 100-99 dated September 16, 1999, the dispositive portion of which provides: " In the case of payment for royalties to a non-resident 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 non-resident lessor, . . . should be as it is hereby confirmed to be exempt from VAT. " (BIR Ruling Nos. DA-ITAD 62-05 dated June 27, 2005 and DA-ITAD 92-05 dated September 1, 2005) 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. EAcIST Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner, Legal Service Footnotes 1. 'Know-how' means: (1) information on manufacture; test and evaluation of Licensed Products; (2) information on quality control of Licensed Products; (3) information on production control and production engineering of Licensed Products; (4) information on procurement of parts and materials of Licensed Products; and (5) information on procurement of production equipment, jigs and tools to be used in manufacturing and testing Licensed Products. 2. 'Licensed Products' means the following relays and connectors which are or may be designed and developed by NEC Corporation's electromechanical device division during the term of the Agreement, namely, (1) EP2 power relay; and (2) any other relays and connectors to be mutually agreed upon between the parties hereto. 3. 'Electromechanical Device Division' means the organizational entity within NEC Corporation and engaged in engineering and manufacturing Licensed Products as of Effective Date of the Agreement, or any other succeeding organizational entities.