BIR Ruling [DA-116-06]

March 16, 2006 BIR RULING [DA-116-06] 27 (A) (1); 057-00; DA518-03 Punongbayan & Araullo 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue Makati City Attention: Atty. Benedicta Du-Baladad Tax Partner Gentlemen : This refers to your letter dated April 25, 2005 stating that your client, Warner/Chappel Music Philippines, Inc. (WCM) is a domestic corporation organized for the purpose of importing, manufacturing, selling at wholesale only, distributing, exploiting, reproducing, licensing, sublicensing, marketing, and promoting all kinds of products and services related to music and entertainment activities; that WCM is the only entity representing the worldwide copyrights owned and controlled by Warner/Chappel Music, Inc. and its affiliates and has been duly authorized to enter into agreements regarding said copyrights in the Philippines; that WCM derives income primarily from royalty payments made by its clients arising from various License Agreements; that it has concluded several Mechanical License and Ringtone License Agreements with its clients, which include, among others, members of the Philippine Association of the Recording Industry, Inc. (PARI), advertising agencies, TV and radio stations, Filipino Society of Composers, Authors, and Publishers (FILSCAP), and other ringtone providers; that under the License Agreements, WCM, as licensor, grants the Licensee/s a non-exclusive mechanical reproduction license to record and/or reproduce in the Philippines the musical works of the Licensors as musical tones for use in cellular phones; and that in consideration of the rights granted to the Licensee, WCM receives royalty fees. In connection therewith, you now request confirmation of your opinion that "1. the royalty payments made to WCM shall be considered as active income subject to 32% regular corporate income and not passive income subject to the 20% final tax; and 2. the payments are not subject to creditable withholding tax of 2% unless the payor belongs to the top 10,000 corporations designated by the BIR." In reply thereto, please be informed that your opinion is hereby confirmed as follows: (1) In BIR Ruling No. 057-00 dated November 7, 2000 , later reiterated in BIR Ruling No. DA518-03 dated December 17, 2003 , this Office citing Section 27(D)(1) of the Tax Code of 1997, thus ruled that "(D) Rates of tax on certain passive incomes. (1) Interest from deposits and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements, and royalties. A final tax at the rate of twenty percent (20%) is hereby imposed upon the amount of interest on currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements received by domestic corporations, and royalties, derived from sources within the Philippines: Provided, however, that interest income derived by a domestic or a resident foreign corporation from a depository bank under the expanded foreign currency deposit system shall be subject to a final tax at the rate of seven and one-half percent (7-1/2%) of such interest income. . . . ." As expressly denoted in the caption, to be subject to the 20% final withholding tax, the royalties must be in the nature of passive income. On the other hand, since the income derived by MKI-Phils from the distribution of the Licensed Computer Systems to Philippine banks and the performance of support services is income generated in the active pursuit and performance of its primary purpose, this Office confirms your opinion that the same is clearly NOT passive income subject to the 20% final tax. Such being the case, the payments received by MKI-Phils from the active conduct of trade or business is considered ordinary business income subject to the 33% (for 1999) regular corporate income tax." HEISca In applying the above-cited rulings, it is clear that the royalties and other fees received by WCM are in the nature of ordinary business income because the aforesaid income was derived or generated from activities that are in accordance with the primary purpose of WCM which is licensing and sub-licensing of musical compositions and performance of support services as provided in its Articles of Incorporation. SUCH BEING THE CASE, the royalty income derived by WCM in the conduct of its business shall form part of its ordinary income subject to the 32% regular corporate income tax. (2) Generally, if the royalty income is considered as an active income, there is no duty to withhold on such payments as required under Section 57 of the Tax Code of 1997, as the royalty payments are not subject to creditable withholding tax since said income is not among those enumerated under the withholding tax regulations as subject to withholding tax. However, if WCM's client/payor is one of the top ten thousand (10,000) corporations designated by the BIR, the royalty shall be subject to the withholding tax of 2% which shall be creditable against the tax due on the taxable income of WCM. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service