Royalty payments

FCP is a corporation organized and existing under Philippine law and a wholly-owned subsidiary of Japan-based FCJ. It seeks a ruling on whether the royalty payments it makes to its mother company are exempt from the value-added tax, both during the six-year income tax holiday (ITH) period extended by the Philippine Economic Zone Authority and after the lapse of the ITH, should it choose to pay a 5% final tax on its gross income earned in lieu of all national and local taxes in accordance with Section 24 of RA 7916.

FCP is registered with PEZA under Republic Act 7916 as a pioneer status manufacturer and exporter of vacuum fluorescent display and component parts. As a registered PEZA entity, FCP’s entire business activity is limited within the special economic zone and its output is entirely sold abroad.

On May 1, 1996, FCP entered into a 10-year technical assistance and licensing agreement with FCJ, where the Japan-based company agreed to furnish technical information and granted a license to FCP to use its patents to manufacture and sell vacuum fluorescent display under the trademark, FUTABA.

For the licensing and technical information, FCP agreed to pay royalties to FCPJ equivalent to 5% of net sales.

The Philippine VAT system adopts the destination principle, wherein imports are taxed and exports are given total immunity. This system of taxation, applied to goods crossing national borders, is designed to make our local products competitive in foreign markets.

In line with this principle, the royalties paid by FCP to FCJ is exempt from the VAT, both during the income tax holiday period and after the ITH period when it is subject to the 5% commutation tax. To further ensure that the export price of the commodities exporter has no VAT component, the local sales of VAT suppliers to PEZA-registered enterprises such as FCP have been declared zero-rated (RMC No. 74-99). Otherwise, FCP will be required to shoulder the VAT on its inputs, which will add up to the export cost of its products.

Since FCP’s foreign licensor is exempt from VAT, FCP’s royalty payments are accordingly exempt from VAT. FCP is also exempt from the 10% VAT on its payments and remittances of the royalties, which otherwise should be paid under the provisions of Section 110 of the National Internal Revenue Code, as amended by RA No. 7718, No. 7-95, otherwise known as the consolidated Value-Added Tax Regulations.

(VAT ruling No. 039-2001 dated June 28, 2001. This ruling is issued on the basis of represented facts. However, if upon investigations, it will be disclosed that the facts are different, then this ruling shall be considered null and void).