ITAD Ruling No. 196-02

November 7, 2002 ITAD RULING NO. 196-02 RP-Japan, Article 12 BIR Ruling No. ITAD-46-00 Isuzu Autoparts Manufacturing Corporation 114 North Main Avenue, Phase III Special Economic Zone, Laguna Technopark Bian, Laguna Attention: Mr. Masayasu Hideshima Finance and Accounting Manager Gentlemen : This refers to your supplemental request dated April 26, 2001, in relation to BIR Ruling No. ITAD 41-01 dated April 10, 2001, to include other royalty payments of Isuzu Autoparts Manufacturing (IAMC) to Isuzu Motors Limited (IML) and subject the same to a preferential tax rate of twenty five percent (25%) pursuant to Article 12 of the RP-Japan tax treaty. Further to the representations made in connection with the above-mentioned ruling, it is represented that the Technical Assistance Agreement entered into by and between IAMC and IML provides that during the Technical Cooperation Period, 1 IAMC may request IML in writing to furnish Technical Information 2 concerning the Licensed Transmission 3 and the Licensed Components 4 which IAMC has decided to manufacture and assemble; that to compensate IML for making document copies relative to the Technical Information to be furnished to IAMC, the latter shall pay IML for each copy (total page area of all pages in book type information) the following fees, in addition to actual cost of delivery in Japanese Yen without deductions of any kind in thirty (30) days from the date of invoice of IML: Type of Copies Fees (Japanese Yen) Reproductible Ozaphan 18,000 per square meter Reproductible Sepia 8,100 per square meter Blue Print 4,600 per square meter Offset Copy 8,100 per square meter Microfilm Card (Master) 2,500 per yard Microfilm Card (Duplicate) 1,800 per yard Microfilm Card (Index) 1,000 per yard Technical Standard 160 per sheet Engineering Parts List 160 per sheet CESS List 160 per sheet E.C.S. 160 per sheet C.N.D. 160 per sheet Others Actual Cost that should IAMC request IML to translate the Technical Information into the English language, a translation fee of Four Thousand Five Hundred Twenty Yen (4,520) shall be paid in respect of the first translation of each document (or each page in case of book type information); that IML shall, upon agreement with IAMC, send to the latter's facilities in the Philippines such number of IML's employees to advice and train IAMC's employees on matters concerning the manufacture and assembly of Licensed Transmission and Licensed Components; that when IML sends its employees to IAMC's facilities in the Philippines for the advisory and training services, IAMC shall pay IML an advisory service fee at the rate of Eighty Thousand Yen (80,000) per man day for such service fee performed during the period of stay in the Philippines which shall not exceed 183 days; that when IML trains IAMC's employees at IML facilities, IAMC shall pay IML a training fee at the rate of Ten Thousand Yen (10,000) per IML man hour. In reply, please be informed that Article 12 of the RP-Japan tax treaty provides as follows: "Article 12 "Royalties "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) . . . "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." The tax treaty defines "royalties" to include "payments of any kind received as a consideration for information concerning industrial, commercial or scientific experience ." According to the Commentaries of the ORGANIZATION FOR ECONOMIC CO-OPERATION 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 the 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 and which remain unrevealed to the public. This type of contract thus differs from contracts for the provision of services, in which one of the parties undertakes to use the customary skills of his calling to execute work himself for the other party. Thus, payments obtained as consideration for after-sales service, for services rendered by a seller to the purchaser under guarantee, for pure technical assistance, or for an opinion given by an engineer, an advocate or an accountant, do not constitute royalties within the meaning of paragraph 4. ( BIR Ruling No. ITAD 67-00 ) aDTSHc Accordingly, the earlier stated fees for making documents copies relative to the provisions of Technical Information to be paid by IAMC to IML pursuant to their Technical Assistance Agreement fall within the definition of "royalties" under the above-quoted provision of the RP-Japan tax treaty, since it is being paid for the dispatch of the technical personnel without which the transfer of know-how would not be possible. ( BIR Ruling ITAD No. 46-00 ) Such being the case, the fees to be paid by IAMC to IML relative to the provision of technical information, and for the advisory and training services rendered by the latter under the said Technical Assistance Agreement are subject to the preferential tax rate of 25%, pursuant to Article 12(2)(b) of the RP-Japan tax treaty. This ruling is issued based on 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 parties herein are concerned. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service Footnotes 1. Technical Cooperation Period means the period commencing on the Effective Date (November 1, 1996) of the Agreement and terminology upon the expiration of five (5) years thereafter. 2. Technical Information means the following documentary technical information: (i) the technical documents that IML owns, possesses or has the right to grant licenses and utilizes, at the time of IML's delivery of such documents to IAMC for the manufacture and assembly, by IML or other party or parties under IML's license of the Model Transmission and of the Model Component; and (ii) such revision changes improvements, modification and updated version to the technical documents described in the preceding paragraph (i) as we subsequently made or organized by IML from time to time during the Technical Cooperation Period. 3. Licensed Transmission means any transmission that IAMC manufactures or assembles in accordance with IML's design of and specifications for the Model Transmission corresponding to such transmission, utilizing all or any portion of the Technical Information furnished to IAMC by IML. 4. Licensed Component means any transmission part or assembly manufactured or assembled by IAMC in the Republic of the Philippines for repair and services for Licensed Transmissions, utilizing all or any portion of the Technical Information furnish to IAMC by IML.