ITAD Ruling No. 217-02

December 27, 2002 ITAD RULING NO. 217-02 RP-Japan tax treaty, Article 12 NIRC, Sec. 108 BIR Ruling No. DA-ITAD-103-02 VAT Ruling No. 009-99 Joaquin Cunanan & Co. 14th Floor Multinational Bancorporation Centre 6805 Ayala Avenue, Makati City Attention: Atty. Alexander B. Cabrera Partner, Tax Services Department Gentlemen : This refers to your letter dated August 7, 2002 on behalf of your client, F-Tech Philippines Manufacturing (FTPMI), requesting confirmation that: a) The fees to be paid by FTPMI under the technical assistance agreement it entered into with F-Tech Inc. (FTI) are royalties subject to the preferential tax rate of 25% pursuant to Article 12(2)(b) of the Philippines-Japan tax treaty; and b) Such fees are not subject to the 10% value-added tax (VAT). It is represented that FTI is a non-resident foreign corporation duly organized and existing under the laws of Japan with principal office address at No. 19 Showanuma, Shobumachi, Minami-Saitamagun, Saitama Pref., Japan, engaged, among others, in the business of manufacturing and selling automobile parts, motorcycle and power products; that it is not registered either as a corporation or as a partnership and has not been licensed to engage in business in the Philippines per certification dated August 1, 2002 issued by the Securities and Exchange Commission (SEC); that in relation to its business, FTI has acquired certain industrial property rights, manufacturing know-how, quality standards and marketing methods; that FTPMI, on the other hand, is a Philippine Economic Zone Authority (PEZA)-registered domestic corporation with principal office address at 118 North Science Avenue, Laguna Technopark, Bian, Laguna primarily engaged in the manufacture, sale and export otherwise dealing in auto part, machine components and the like; that on January 1, 2001, a Technical Assistance Agreement was entered into by and between FTI and FTPMI whereby FTI granted FTPMI a non-exclusive right and license to use its industrial proprietary rights and know-how; that in consideration for the rights and licenses provided by FTI, FTPMI agrees to pay royalty not to exceed 3% of its net sales; and that the said Agreement complies with the provisions of the Intellectual Property Code on Voluntary Licensing per Intellectual Property Office Certificate of Compliance No. 5-2002-00076 dated July 10, 2002. In reply, please be informed that Article 12 of the RP-Japan tax treaty provides as follows: "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" Based on the aforecited tax treaty provisions, royalty payments will be taxed at the preferential tax rate of ten per cent (10%) if the payor is a Board of Investments (BOI)-registered enterprise; fifteen per cent (15%) if the payments are in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting; and in all other cases, twenty-five per cent (25%) of the gross amount of the royalties. DacASC Such being the case, since FTPMI is not a BOI-registered enterprise, and the payments it makes to FTI are not in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting, this Office is of the opinion and so holds that 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-103-02 ) Relative to the issue on VAT, Section 108 of the Tax Code of 1997 states that the lease or use of property or property rights is embraced within the definition of "sale or exchange of services" and is subject to VAT. Under the current regulations, the sale of services to Ecozone Enterprises may be considered effectively zero-rated for VAT purposes but subject to the limitation that the sale of service is made to persons or entities who enjoy indirect tax exemption [Section 4.102-2(c), Revenue Regulations No. 7-95]. Since there is no express provision under the PEZA law granting exemption from indirect taxes to Ecozone Enterprises, the recognition of zero-rated sale of services is made to rest on the Cross Border Doctrine or Destination Principle of the VAT system, viz: "the country taxes all value-added, at home and abroad, for goods that have as their destination the consumers of that country. Exports are exempt, imports are taxable . . ." (VAT Ruling No. 009-99 dated January 21, 1999 ) The same principle is applicable to the case at hand. It should be noted that the transfer of technology is in connection with the manufacture of products for export. However, instead of the zero-rating which is not available to non-resident suppliers, the provision for exempt transactions under Section 109 of the Tax Code of 1997 which provides VAT exemption for transactions which are exempt under special laws, e.g., Republic Act 7916 or PEZA law, is particularly applicable to the instant case. In the case of payment for lease or royalties to a non-resident owner, the responsibility for withholding the VAT and paying the same rest on the payor. However, since PEZA-registered export enterprise may not be passed on with nor claim input VAT, then its payment of royalties to a non-resident lessor, such as FTI should be, as it is hereby confirmed to be, exempt from VAT. 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