ITAD Ruling No. 160-04

December 29, 2004 ITAD RULING NO. 160-04 Articles 5, 7 & 12, Philippines-Japan tax treaty NIRC, Sec. 108 BIR Ruling No. DA-ITAD-142-02 Sycip Gorres Velayo & Co 6760 Ayala Avenue 1226 Makati City Attention: R. C. Vinzon Tax Division Gentlemen : This refers to your letter dated December 1, 2004, on behalf of your client, Daikyo International Philippine, Inc., (Daikyo Phil), requesting confirmation of your opinion that the fees to be paid by Daikyo Phil to Daikyo Gikein Kogyo Co., Ltd. (Daikyo Japan) for services to be rendered are not subject to Philippine income tax under the Philippines-Japan tax treaty. It is represented that Daikyo Japan is a nonresident, foreign corporation duly organized and existing under the laws of Japan with executive office located at DK Bldg. 1-22-4 Sonan, Sagamihara-City, Kanagawa Pref. 228-0812, Japan; that it is engaged in the business of manufacturing adhesive tape and die cutting; 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 October 28, 2004; that Daikyo Phil is a corporation duly organized and existing under the laws of the Republic of the Philippines with principal office address at Carmelray Industrial Park-1 Canlubang, Calamba, Laguna; that on October 26, 2004, Daikyo Phil and Daikyo Japan entered into a Service Agreement whereby Daikyo Japan shall send employees to the Philippines to conduct the inspection and quality control of the machinery of Daikyo Phil and to provide assistance through consultation when necessary; that in consideration for said services, Daikyo Phil shall pay Daikyo Japan the amount of One Million Fifty Thousand Yen (Y1,050,000) on a quarterly basis; and that the aggregate stay of the employees of Daikyo Japan to carry out the aforesaid services in the Philippines shall not exceed one (1) month in a given taxable year. In reply, please be informed that Article 12(4) of the Philippines-Japan tax treaty defines the term "royalties", as follows: "Article 12 (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." The tax treaty defines " royalties " to include "payment of any kind received as a consideration for information concerning industrial, commercial or scientific experience." According to the commentaries of the ORGANISATION FOR ECONOMIC COOPERATION AND DEVELOPMENT (OECD) Committee on Fiscal Affairs on the Model Tax Convention [par. 11, Commentary on Article 12 (royalties), 1998, p. 151), such information alludes to the concept of "know-how". The definition of know-how, which has been adopted by the said Committee, is "all the undivulged technical information, whether capable of being patented or not, that is necessary for the industrial reproduction of a product or process, directly and under the same conditions; inasmuch as it is derived from experience, know-how represents what a manufacturer cannot know from mere examination of the product and mere knowledge of the progress of technique." In a know-how contract, one of the parties agrees to impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public. (BIR Ruling No. DA-ITAD No. 49-02 dated April 15, 2002) Further, in the case of Philippine Refining Company vs. CIR , CTA Case No. 2872 dated January 15, 1986, the Court of Tax Appeals had an occasion to rule on the distinction of service fees from royalties, to wit: "To distinguish between compensation for service and royalty payments, one must inquire on whether the payee has proprietary interest in the property giving rise to the income. If the payee has none, then the payment is a compensation, for personal services, If the payee has proprietary interest then the payment is royalty." Applying the above discussions to the instant case, there is nothing in the subject Agreement that would require transfer into the Philippines of technology, equipment or other property where Daikyo Japan has proprietary interest or would otherwise permit Daikyo Japan to impart to Daikyo Phil their special knowledge and experience which remain unrevealed to the public. Likewise, inasmuch as Daikyo Japan shall render these services using their customary skills, then the compensation to be received therefor shall not constitute as consideration for the use of, or the right to use, any copyright, patent, trademark, design or model, plan, secret formula or process, or for the transfer of technology. In this regard, Article 7 of the Philippines-Japan tax treaty provides as follows: "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." xxx xxx xxx" In relation, Article 5 of the same tax treaty provides, viz : "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 or partly carried on. 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" (emphasis supplied) Based on the aforequoted provisions, it is clear that if a corporation which is a resident of the Japan carries on business in the Philippines through a permanent establishment situated therein, the profits of the same shall be subject to Philippine income tax, but only so much of them as is attributable to that permanent establishment. For this purpose, a Japanese corporation may be deemed to have a permanent establishment in the Philippines if, among others, the furnishing of consultancy or supervisory services by such corporation, through its employees or other personnel, in the same or connected project, continue within the Philippines for a period or periods aggregating more than six months within any taxable year. Considering that the employees of Daikyo Japan shall perform the subject services in the Philippines for less than six months in a given taxable year, more particularly for period not exceeding one month, Daikyo Japan is not deemed to have a permanent establishment in the Philippines to which its business profits may be attributed to. Accordingly, this Office is of the opinion and so holds that the fees to be paid Daikyo Phil to Daikyo Japan under the Service Agreement are not subject to Philippine tax pursuant to Article 7(1) in relation to Article 5(6) of the Philippines-Japan tax treaty. (BIR Ruling No. DA-ITAD-142-02 dated August 20, 2002) However, the service fees for the portion of services rendered in the Philippines are subject to 10% value-added tax (VAT) pursuant to Section 108 of the Tax Code of 1997. Accordingly, Daikyo Phil being the resident withholding agent and payor in control of the payment, shall be responsible for the withholding of the 10% final VAT before making any payment to Daikyo Japan. In remitting the VAT withheld, Daikyo Phil shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and proof of payment thereof shall serve as documentary substantiation for the claim of input tax by Daikyo Phil upon filing its own VAT return, if it is a VAT-registered taxpayer. In case Daikyo Phil is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased or treated as "expense" or "asset," whichever is applicable. In addition, Daikyo Phil is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate upon request of Daikyo Japan, the first three copies thereof to be given to Daikyo Japan and the fourth copy to be retained by Daikyo Phil as its file copy. [Section 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 of RR No. 8-2002; Section 7 of RR No. 14-2002] ACDTcE 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