ITAD Ruling No. 113-05

September 30, 2005 ITAD RULING NO. 113-05 Article 12, Philippines-Japan tax treaty BIR Ruling No. DA-ITAD-20-04; BIR Ruling No. DA-ITAD-92-05; VAT Ruling No. 100-99 SGV & Co . 6760 Ayala Avenue 1226 Makati City Attention: R.C. Vinzon Tax Services Gentlemen : This refers to your letter dated March 31, 2005, on behalf of your client, NEC Tokin Electronics (Philippines), Inc. (NTEPH), requesting confirmation of your opinion that the royalty fees paid by NTEPH to NEC Tokin Corporation (NTC) pursuant to a Technical License Agreement, is subject to Philippine income tax under Article 12(2)(b) of the Philippines-Japan tax treaty. It is represented that NTC is a corporation duly organized and existing under the laws of Japan with principal office address at 6-7-1 Koriyama, Taihaku-ku, Sendai City, Miyagi-pref, 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 April 5, 2005; that NTEPH is a corporation duly organized and existing under the laws of the Philippines with principal address at 1 Ring Road, Light Industry & Science Park II Barangay La Mesa, Calamba, Laguna and registered with the Philippine Economic Zone Authority (PEZA) under Certificate Number 2005-284 dated January 12, 2005; that on May 15, 1996, NEC Corp and NEC Components Philippines (NCOPI) entered into a Technical License Agreement (Agreement);that NEC Corp, pursuant to the "Agreement of Division and Transfer of Business" dated January 31, 2002, transferred its assets, liabilities and other rights and obligations relating to its electro-mechanical device business to Tokin Corporation (which later changed its name to NTC);that the Agreement was one of the licensed agreements transferred to NTC (then Tokin Corporation);that on August 31, 2002, NCOPI, NTEPH and NTC entered into an Assignment of Registered Technical License Agreement wherein NCOPI assigned all of its rights and obligations under the aforementioned Technical License Agreement; that by virtue of the foregoing assignment of rights, NTEPH and NTC are bound as licensee and licensor, respectively, under the Agreement wherein the latter grants a non-exclusive and non-transferable right and license under know-how 1 to manufacture licensed products in the Philippines; that the pertinent provisions of the Agreement provide: TacESD GRANT OF LICENSE : 1) To the extent LICENSOR has the right to do so and pursuant to the terms and conditions contained herein, LICENSOR hereby grants to LICENSEE a non-exclusive and non-transferable right and license under KNOW-HOW to manufacture LICENSED PRODUCTS in the Republic of the Philippines. 2) To the extent LICENSOR has the right to do so and pursuant to the terms and conditions herein, LICENSOR hereby grants to LICENSEE a non-exclusive and non-transferable right and license under KNOW-HOW to sell, use lease or otherwise dispose of LICENSED PRODUCTS in the following countries: (a) the Republic of the Philippines; and (b) any other countries to be mutually agreed in writing between the parties hereto. TRANSFER OF KNOW-HOW 1) During the term of the Agreement, LICENSOR shall provide LICENSEE with KNOW-HOW by means of supplying technical documentation, training LICENSEE personnel and dispatching LICENSOR specialists as set in Sections 4, 5 and 6 hereof, respectively. 2) Measurement system and standards to be employed in transfer of KNOW-HOW to LICENSEE hereunder shall be the same as used in LICENSOR's EMD DIVISION. The language to be used in transfer of KNOW-HOW shall be English unless otherwise agreed upon by the parties hereto; and that in consideration of the Grant of License and Transfer of Know-How, Section 7.1 of the Technical License Agreement provides that the licensee (now NTEPH) shall pay licensor (now NTC) the royalties computed at the rate of five percent (5%) of NET SELLING PRICE of the LICENSED PRODUCTS. In reply, please be informed that Article 12 of 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; (b) 25 per cent of the gross amount of the royalties in all other cases. STcAIa "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 aforementioned provisions, royalty payments made by a Philippine corporation to a resident of Japan may be taxed at a rate not exceeding 10 percent of the gross amount of royalties if the payor is a Board of Investments (BOI)-registered enterprise engaged in preferred pioneer areas of investment, 15 percent if they are 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 percent in all other cases. Such being the case, this Office is of the opinion and so holds that since NTC 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 or the right to use cinematograph films and films or tapes for radio or television broadcasting, the royalty payments by NTEPH to NTC under the Technical License Agreement shall be subject to tax at the rate of 25% of the gross amount of the royalties, pursuant to Article 12(2)(b) of the Philippines-Japan tax treaty. In addition, Section 108 of the Tax Code of 1997 (Tax Code) states that the lease or use of any trademark, trade brand or other like property or rights embraced within the definition of "sale or exchange of services" and is subject to value-added tax (VAT). However, the dispositive portion of VAT Ruling No. 100-99 dated September 16, 1999 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. " Accordingly, payment of royalties by NTEPH, a PEZA-registered corporation, to NTC, a nonresident owner is hereby confirmed to be exempt from VAT. (BIR Ruling No. 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. EAcHCI Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. KNOW-HOW means information on manufacture, test and evaluation of LICENSED PRODUCTS; information on quality control of LICENSED PRODUCTS; information on production control and production engineering of LICENSED PRODUCTS; information on procurement of parts and materials of LICENSED PRODUCTS; and information on procurement of production equipment, jigs and tools to be used in manufacturing and testing LICENSED PRODUCTS.