Salvador Guevara & Associates

March 20, 2007 BIR RULING [DA-162-07] DA-641-04; Secs. 34 (F) (1), 105, 106 (A) (2) (b), NIRC; Sec. 107, R.R. 2; Sec. 4.106-2, R.R. 16-2005 Salvador Guevara & Associates 815-816 Tower One & Exchange Plaza Ayala Avenue Makati City Attention: Atty. Edmundo P. Guevara Atty. Maria Rosario L. Bernardo Atty. Rabiev Tobias M. Racho Atty. Philip Miguel I. Ranada Gentlemen : This refers to your letter dated March 6, 2007, where you requested, on behalf of your client, Socite ds Produits Nestl S.A. (SPN) , for a ruling with respect to the tax consequences on the sale of SPN's trademarks as well as the sale of the remaining inventory and marketing materials of its current licensee, pursuant to a Memorandum of Undertaking (MOU) SPN intends to enter into with Alaska Milk Corporation (AMC). It is represented that SPN is a non-resident foreign corporation duly organized and existing under the laws of Switzerland with principal place of business and tax residence in Switzerland. It has no branch office in the Philippines. It is the owner of the trademarks "ALPINE", "KREM-TOP", and "LIBERTY" (Trademarks), which are duly registered with the Philippine Intellectual Property Office. Presently, SPN has a licensing agreement with Nestl Philippines, Inc. ("NPI") for the use of or the right to use the Trademarks. The products are currently being manufactured for and distributed by NPI under the brand names ALPINE, KREM-TOP, and LIBERTY. It is further represented that AMC is a domestic corporation duly organized and existing by virtue of the laws of the Philippines. It is engaged in the manufacture and distribution of milk products along three principal lines of business, namely, Liquid Canned Milk, Powdered Filled Milk, and UHT/Ready-to-Drink Milk, all of which are marketed under the "ALASKA" brand. It has an established marketing and distribution network in the Philippines for the distribution of its milk products. SPN and AMC apparently intend to enter into a MOU wherein AMC shall purchase the abovementioned Trademarks from SPN. After the sale of the Trademarks, AMC will then manufacture and distribute its milk products as the new owner of such Trademarks. In consideration for the above purchase, AMC shall pay SPN a lump-sum amount, which is based, among other business criteria, upon the estimated future sales of the former's products, taking into consideration the average remaining lives of the Trademarks in the hands of SPN based on their current registration and the period required to successfully build similar brands in the market, which is estimated to have an average remaining lifetime of ten (10) years. For purposes of financial statements reporting, AMC will value the Trademarks at cost less impairment loss, if any, on an annual basis in accordance with Philippine Financial Reporting Standards PAS 38 and that the impairment loss, if any, will not be claimed as a deductible expense in AMC's annual income tax returns. NPI, on its part, will terminate its licensing agreement with SPN and will also discontinue the manufacturing and distribution of its products under the abovementioned Trademarks. In addition, NPI will sell to AMC, at cost, its remaining inventories of the products and marketing materials existing as of the closing date of the sale of the Trademarks. IEAHca In this regard, you now request this Office to confirm your opinion on the abovementioned agreement with respect to the following: (A) AMC may deduct the full amount of the purchase price paid for the Trademarks as defined hereunder from its taxable income as amortization expense over a period of ten (10) years; (B) SPN's sale of its Trademarks to AMC is not subject to 12% VAT; and (C) Although Nestl Philippines, Inc. is generally subject to a 35% corporate income tax or 2% Minimum Corporate Income Tax (MCIT), as the case may be, the sale to AMC of its remaining inventory and marketing materials existing as of the closing date of the MOU will not be subject to income tax, since NPI will not recognize any gain. However, such sale will be subject to the 12% VAT. We reply as follows: With respect to your first query, please be informed that Section 34 (F) (1) of the Tax Code of 1997, as amended, states that: "(F) Depreciation. (1) General Rule. There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including reasonable allowance, for obsolescence) of property used in the trade or business. In the case of property held by one person for life with remainder to another person, the deduction shall be computed as if the life tenant were the absolute owner of the property and shall be allowed to the life tenant. In the case of property held in trust, the allowable deduction shall be apportioned between the income beneficiaries and the trustees in accordance with the pertinent provisions of the instrument creating the trust, or in the absence of such provisions, on the basis of the trust income allowable to each. xxx xxx xxx The above provision must be read in connection with Section 107 of Revenue Regulations (RR) No. 2 which provides that: "SEC. 107. Depreciation of intangible property. Intangibles, the use of which in the trade or business is definitely limited in duration, may be the subject of a depreciation allowance. Examples are patents, copyrights, and franchises. Intangibles, the use of which in the business or trade is not so limited, will not usually be a proper subject of such an allowance. If however, an intangible asset acquired through capital outlay is known from experience to be of value in the business for only a limited period, the length of which can be estimated from experience with reasonable certainty, such intangible asset may be the subject of a depreciation allowance, provided the facts are fully shown in the return or prior thereto to the satisfaction of the Commissioner of Internal Revenue." It is clear from the foregoing that a taxpayer is allowed a depreciation allowance that is deductible from its taxable income in respect of property used in its trade or business. With regard to intangible assets such as trademarks, these may be considered as depreciable assets upon showing that their use in trade or business is definitely limited in duration in accordance with Section 107 of RR 2. Applied to the present case, since the Trademarks to be sold by SPN to AMC have a remaining lifespan of 10 years, they are regarded as intangible assets that are subject to depreciation. This finds support in an earlier ruling issued by this Office (BIR Ruling DA-641-04, dated December 17, 2004) wherein it was held: ". . . the price paid by GSK and Duncan to Lilly US for their purchase of trademarks may be claimed as a deduction from their taxable income as periodic charges to amortization pursuant to Section 34(F) of the Tax Code of 1997." Such being the case, AMC may amortize the cost of the Trademarks acquired from SPN over a period of ten (10) years from the date of sale. It is understood, however, that for purposes of financial statements reporting, AMC will value the Trademarks at cost less impairment loss, if any, on an annual basis in accordance with Philippine Financial Reporting Standards PAS 38. For purposes of Income Taxation, the impairment loss, if any, will not be claimed as a deductible expense under the "all-events test" in AMC's annual income tax returns. On the matter of your second query, Section 105 of the Tax Code of 1997, as amended by RA 9337, provides that any person who, in the course of trade or business, sells, barters or exchanges goods or properties shall be subject to a value-added tax equivalent to 12% of the gross selling price or gross value in money of the goods or properties sold, bartered or exchanged, such tax to be paid by the seller or transferor. The phrase "in the course of trade or business" means the regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto. In this regard, under the above rule of regularity, all services are considered to be rendered in the regular course of trade or business and thus, subject to VAT. However, the rule of regularity does not hold true for all sales of goods/properties, especially where such goods/properties are sold by a taxpayer outside his ordinary course of trade or business. IEAacS For VAT purposes, the sale or use of trademarks may either be treated as a sale of goods/properties or as a sale of services. Under Section 106 (A) (2) (b) of the Tax Code of 1997, as amended, and as implemented by Section 4.106-2 of RR 16-2005, a trademark as an intangible object is considered as "goods or properties" the sale of which, if made in the course of trade or business, is subject to VAT. On the other hand, under Section 108 (A) (1) of the same Tax Code, the licensing or grant of right or privilege to lease or use any intangible such as a trademark is considered as a sale or exchange of service in the course of trade or business and therefore, subject to VAT. It must be pointed out here that under the rule of regularity, SPN would be subject to VAT for the licensing of its Trademarks as such is its trade or business. However, SPN's sale of such Trademarks to AMC is considered a sale of properties by a non-resident foreign corporation that is not made in the course of SPN's regular trade or business, or, for that matter, necessary or incidental in carrying out such trade or business in the Philippines. Thus, applying the rule of regularity, said sale is not subject to VAT. (BIR Ruling DA-641-04 dated December 14, 2004). Finally, with respect to whether or not NPI is liable to corporate income tax or MCIT, Section 27 (A) of the Tax Code of 1997, as amended by RA 9337, provides that: "SEC. 27. Rates of Income Tax on Domestic Corporations . (A) In General . Except as otherwise provided in this Code, an income tax of thirty-five percent (35%) is hereby imposed upon the taxable income derived during each taxable year from all sources within and without the Philippines by every corporation, as defined in Section 22(B) of this Code and taxable under this Title as a corporation, organized in, or existing under the laws of the Philippines: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." The above provision must be read in accordance with Section 27 (E) (1) & (4) of the same Tax Code which state: "(E) Minimum Corporate Income Tax on Domestic Corporations. (1) Imposition of Tax. A minimum corporate income tax of two percent (2%) of gross income as of the end of the taxable year, as defined herein, is hereby imposed on a corporation taxable under this Title, beginning on the fourth taxable year immediately following the year in which such corporation commenced its business operations, when the minimum income tax is greater than the tax computed under Subsection (A) of this Section for the taxable year." (4) Gross Income Defined. For purposes of applying the minimum corporate income tax provided under Subsection (E) hereof, the term 'gross income' shall mean gross sales less sales returns, discounts and allowances and cost of goods sold. 'Cost of goods sold' shall include all business expenses directly incurred to produce the merchandise to bring them to their present location and use. "For a trading or merchandising concern, 'cost of goods sold' shall include the invoice cost of the goods sold, plus import duties, freight in transporting the goods to the place where the goods are actually sold including insurance while the goods are in transit. "For a manufacturing concern, 'cost of goods manufactured and sold' shall include all costs of production of finished goods, such as raw materials used, direct labor and manufacturing overhead, freight cost, insurance premiums and other costs incurred to bring the raw materials to the factory or warehouse." xxx xxx xxx The above provisions state the general rule that unless a corporation is exempt or enjoying a preferential tax regime under the law, it is subject to either the normal corporate income tax (35%) or MCIT (2%) of its gross income. Even assuming that there is no gain to speak of with respect to the income generated by a particular activity by a corporation, such a situation will only spare it from corporate income tax and not the MCIT. Moreover, any and all income not otherwise subject to final withholding tax shall be included in computing the gross income of that corporation subject to the MCIT. The MCIT can apply even if NPI sells its remaining inventory and marketing materials to AMC at cost, and the basis of its imposition is the gross income derived from such sale and not the presence or lack of gain on the part of the former. Accordingly, the actual sale by NPI to AMC of its remaining inventory and marketing materials existing as of the closing date of the MOU would be subject to MCIT, if applicable. In addition, such sale will be subject to 1% expanded withholding tax as well as to 12% VAT. TaCSAD 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.) JOSE MARIO C. BUAG Commissioner of Internal Revenue