ITAD Ruling No. 151-02

August 27, 2002 ITAD RULING NO. 151-02 RP-Japan, Articles 11 & 12 BIR Ruling No. DA-ITAD-94-01 BIR Ruling No. DA-ITAD-103-01 BIR Ruling No. DA-ITAD-97-02 KSS Philippines, Inc. New Cebu Township One Special Ecozone Barangay Cantao-an, Naga, Cebu Attention: Ms. Connie S. Planco Accounting Manager Gentlemen : This refers to your letter dated May 08, 2002, requesting confirmation that your interest and royalty payments to your mother company, Kinseki Ltd. (Kinseki), are both subject to the preferential withholding tax rate of ten per cent (10%), pursuant to the RP-Japan tax treaty. It is represented that Kinseki is a foreign corporation duly organized and existing under the laws of Japan with office address at 1-8-1, Izumihoncho, Komae-Shi, Tokyo, Japan; that it is not registered either as a corporation or as a partnership and has not been licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated May 17, 2002; that KSS Philippines, Inc. (KSS) is a Japanese-owned company duly registered with the Philippine Economic Zone Authority (PEZA) per Certificate of Registration No. 97-016 dated February 20, 1997; that KSS is engaged in the manufacture of SMD quartz crystal for export to Japan and other countries; that on June 14, 2001, the PEZA Board has approved and granted KSS pioneer status for its production of SMD Quartz Crystal; that the following Loan Agreements were entered into by and between Kinseki and KSS, to wit: LOAN 1 Entered into on June 03, 1998, for the amount of One Billion Two Hundred Million Japanese Yen (1,200,000,000.00), payable within a period of three (3) years, from June 08, 1998 to June 08, 2001; LOAN 2 Entered into on August 26, 1999, for an amount of Seven Hundred Million Japanese Yen (700,000,000.00) payable within a period of 3 years, from August 30, 1999 to August 30, 2002; LOAN 3 Entered into on September 25, 2000, for an amount of Eight Hundred Million Japanese Yen (800,000,000.00) payable within a period of 3 years, from September 25, 2000 to September 25, 2003; LOAN 4 Entered into on May 23, 2001, for an amount of One Million US Dollars ($1,000,000.00) payable within a period of one (1) year, from May 25, 2001 to May 24, 2002. It is also represented that on April 10, 2001, a Support Undertaking was entered into by and between Kinseki and KSS whereby it was stipulated that when the transfer of production of Kinseki and related companies of Kinseki to KSS is completed, the support regarding quality assurance, quality control, design, production engineering and others will follow; that in consideration for the said support, KSS will pay royalty fees equivalent to 1% of the price of production quantity at Kinseki's products covered by the undertaking. In reply, please be informed that Article 11 of the RP-Japan tax treaty provides, viz : "Article 11 "(1) Interest 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 interest may also be taxed in the Contracting State in which it arises, and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the interest the tax so charged shall not exceed: ScaEIT "(a) 10 per cent of the gross amount of the interest if the interest is paid in respect of Government securities, or bonds or debentures; "(b) 15 per cent of the gross amount of the interest in all other cases. "(3) Notwithstanding the provisions of paragraph (2), the amount of tax imposed by the Philippines on the interest 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 interest, shall not exceed 10 per cent of the gross amount of the interest. "xxx xxx xxx "(5) The term "interest" as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and in particular, income from Government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. "xxx xxx xxx Based on the aforecited provisions, interest paid to a resident of Japan will be taxed at a preferential rate of 10% if the interest is paid in respect of government securities, bonds or debentures, or if it is paid by a company, being a resident of the Philippines registered with the Board of Investments (BOI) and engaged in preferred pioneer areas of investment; and in all other cases, fifteen per cent (15%) of the gross amount of interest. As regards the definition of the phrase "engaged in preferred pioneer areas of investment," Article 3(2) of the same tax treaty provides, viz : "2. As regards the application of this Convention by a Contracting State, any term not defined in this Convention shall, unless the context otherwise requires, have the meaning which it has under the laws of that Contracting State concerning the taxes to which this Convention applied." Relative thereto, Article 16 of Executive Order No. (EO) 226, as amended, otherwise known as the Omnibus Investments Code of 1987, defines the term 'preferred areas of investments' as economic activities that the BOI shall have declared as such in accordance with Article 28 of the said Code which shall either be pioneer or non-pioneer . ( Revenue Memorandum Circular No. 15-2002 dated April 24, 2002 ) In view of all the above, it is clear that the provisions of Article 11(3) of the RP-Japan tax treaty granting a 10% preferential tax rate applies only to BOI-registered enterprises engaged in preferred areas of investment more so that the RP-Japan tax treaty was signed on May 17, 1980, or prior to the effectivity of Republic Act No. 7916, otherwise known as the Special Economic Zone Act of 1995. Also, this Office already had the occasion to issue rulings where the phrase 'enterprise engaged in preferred pioneer areas of investment' consistently referred to BOI-registered enterprise engaged in preferred areas of investments. ( BIR Ruling No. DA-ITAD-94-01; BIR Ruling No. DA-ITAD-97-02 ) Such being the case, since KSS is not a BOI-registered enterprise, and the interest payments are not in respect of government securities, or bonds or debentures, therefore, contrary to your opinion, the herein interest payments are subject to the preferential tax rate of 15% based on the gross amount of the interests, pursuant to Article 11(2)(b) of the RP-Japan tax treaty. ( BIR Ruling No. DA-ITAD-97-02 ) As regards the royalty payments, Article 12 of the RP-Japan tax treaty provides, viz : "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. "(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, trademark, 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" As discussed earlier and for reasons stated therein, since KSS is not a BOI-registered enterprise, and the payments it makes to Kinseki are not in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, therefore, contrary to your opinion, 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-103-01 ) Finally, the Loan Agreements entered into by and between KSS and Kinseki are subject to the documentary stamp tax imposed under Section 180 of the National Internal Revenue Code of 1997. TSacAE This ruling is issued on the basis of the foregoing 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