ITAD Ruling No. 220-02

December 27, 2002 ITAD RULING NO. 220-02 RP-Japan, Sections 5 and 12 Tax Code of 1997 Sec. 108 BIR Ruling No. 094-96 BIR Ruling No. DA-ITAD-103-02 SGV & Co. 6th Floor Ayala Life FGU Center Mindanao Avenue cor. Biliran Road Cebu Business Park Cebu City Attention: Lauris dela Pea Tax and Business Advisory Gentlemen : This refers to your letter dated May 14, 2002 requesting confirmation of your opinion that the royalty payments by Taiyo Yuden (Philippines), Inc. (Taiyo-Philippines) to Taiyo Yuden Co. Ltd. (Taiyo-Japan) are subject to the preferential tax rate of twenty-five percent (25%) pursuant to the RP-Japan tax treaty. It is represented that Taiyo-Japan is a non-resident foreign corporation duly organized and existing under the laws of Japan with principal office address at Matsumura Bldg. 16-20 Ueno 6-Chome Taito-ku, Tokyo, Japan; that it is registered with the Securities and Exchange Commission (SEC) as a representative office in the Philippines authorized to carry out the following functions: 1) Act as a liaison office and deal directly with clients; 2) Undertake information dissemination and promotion of the company's products; 3) Study and investigate export feasibility; 4) Cope with customer's complaints and coordinate after sales service; 5) Coordinate warranty claims; 6) Conduct market research for its production and market expansion; and 7) Act as a communications link between clients and the company's head office; that the representative office shall not derive any income from sources within the Philippines and will not participate in any manner in the management of any subsidiary or branch that it might have in the Philippines; that Taiyo-Philippines is a domestic corporation duly organized and existing under the laws of the Philippines with principal office at Mactan Economic Zone, Lapu-lapu City; that on April 1, 2002, an Intellectual Property License and Technical Assistance Agreement was executed by and between Taiyo-Japan and Taiyo-Philippines whereby the former granted the latter a license of its intellectual property rights and thereafter shall provide Taiyo-Philippines proprietary/technical information for its manufacture and sale of the licensed products; that in consideration for such grant, Taiyo-Philippines shall pay Taiyo-Japan a royalty of three percent (3%) of the net sales of the licensed products and a technical assistance fee for Taiyo-Japan's technical assistance for Taiyo-Philippines' implementation of manufacture, sale, modification and/or improvement of the Products; and that above Agreement has been duly registered with the Intellectual Property Office on April 1, 2002 under Certificate of Compliance No. 5-2002-00064. 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 . (emphasis supplied) "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 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. CHDAaS "5. The provisions of paragraphs (1), (2) and (3) shall not apply if the beneficial owner of the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties arise, through a permanent establishment situated therein, or performs in that other Contracting State independent personal services from a fixed base situated therein, and the right or property in respect of which the royalties are paid is effectively connected with such permanent establishment or fixed base. In such case the provisions of Article 7 or Article 14, as the case may be, shall apply. "xxx xxx xxx" Based on the aforequoted provisions, the royalty payments will be taxed at a preferential tax rate not exceeding 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. The preceding paragraph, however, does not apply if the recipient of the royalty, being a resident of Japan, carries on business in the Philippines through a permanent establishment (PE) to which the royalty income is attributable. In this light, Article 5 of the RP-Japan tax treaty provides: "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. "2. The term 'permanent establishment' includes especially: a) a store or other sales outlet; b) a branch; c) an office; d) a factory; e) a workshop; f) a warehouse; g) a mine, an oil or gas well, a quarry or other place of extraction of natural resources. "3. A building site or construction or installation project constitutes a permanent establishment only if it lasts more than six months. "4. Notwithstanding the preceding provisions of this Article, the term 'permanent establishment' shall be deemed not to include: a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise; e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character ; (emphasis supplied) f) the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs (a) to (e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character." In the instant case, since the function of the representative office in the Philippines is limited only to liaise with its head office, then Taiyo Japan is not deemed to have a PE in the Philippines. Therefore, and since Taiyo Philippines is not a BOI-registered enterprise, and the payments made by Taiyo-Philippines to Taiyo Japan 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 tax at the rate of twenty-five percent (25%) of the gross amount of royalties pursuant to Article 12(2)(b) of the RP-Japan tax treaty. ( BIR Ruling No. 094-96 dated August 30, 1996 and BIR Ruling No. DA-ITAD 103-02 dated May 28, 2002 ) 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