BIR Ruling [DA-187-02]

October 16, 2002 BIR RULING [DA-187-02] Joaquin Cunanan & Co. 29th Floor Philamlife Tower 8767 Paseo de Roxas Makati City Attention: Atty. George J. Lavadia Principal Gentlemen : This refers to your letter dated July 2, 2002 requesting for clarificatory ruling that the local (Philippine) customers of Fun Characters, Inc. (FCI) should no longer withhold the 20% final tax on royalty payments, made to FCI for the services rendered, considering that in BIR Ruling No. DA249-2001 dated December 3, 2001, this Office ruled that STDEcA "Considering the foregoing, 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 FCI from the active conduct of trade or business is considered ordinary business income subject to the ordinary corporate income tax of 33% for the year 1999 and 32% for year 2000 onwards." It is represented that FCI is a domestic company primarily engaged in sublicensing to third parties the use of copyrights relating to the Disney Characters and Disney materials in various promotion and merchandising activities; that it renders advertising, promotions, and other services for the sub-licensees to enhance the value of the licensed materials to the sub-licensees; that it is licensed by Disney Enterprises, Inc. of Delaware, U.S.A, (DEI) to sublicense, support, promote and protect Walt Disney trademarks/characters owned by DEI in the Philippines; that FCI does not and will not acquire any proprietary rights of whatever kind in or over the Walt Disney trademarks/characters except to distribute, support and use the same in the Philippines; that FCI pays royalties to DEI, which are subjected to the final withholding tax of 15% pursuant to the Philippines-US Tax Treaty; that as its principal activity, FCI sublicenses to third parties the right to use the Walt Disney trademarks/characters by entering into License Agreement (LA); that the LA grants the clients the non-exclusive right to use the Walt Disney trademarks/characters in a number of merchandising activities and endeavors; that in addition, FCI also provides assistance in consumer awareness of the Walt Disney trademarks/characters through various marketing activities such as the following: 1. Art and Product Approval: All licensees' products including silhouette, design, character artwork are submitted to FCI for review and approval at all four levels, namely, concept, final art, pre-production and actual sample. 2. Design Support If required by the licensee, FCI Artists develop designs/artworks for the licensees' products. 3. Advertising FCI regularly advertises the various Disney events, brands and products to support licensees. These include Print Ads, TV Commercials, Radio Contests, Billboards and Press Releases. 4. Consumer Promotions To support licensees' sales at retail stores, FCI develops and implements consumer promotions. Generally, mechanics of these consumers' promotion are free gifts for a certain amount of purchase of Disney products or raffle coupons for a certain amount of purchase for a chance to win a bigger prize. 5. Special Events FCI organizes special events to promote the Disney characters and sales of licensees. These are generally 3 to 4 day treats to Filipino families complete with interactive theme-park experience including games, shows, character meetings and greetings, and retailing. 6. Mall Tie-in Promotions FCI organizes and implements promotional tie-ins with major malls such as SM Malls, the Ayala Centers and Robinsons Malls to promote Disney products. These mall promotions include mall theme decors, shows, attractions, character appearances and special retailing of Disney products in the high traffic areas of the malls. FCI then receives fees from its Philippine clients in consideration for the non-exclusive right to use the Walt Disney trademarks/characters and the support services provided to promote said characters. In reply thereto, please be informed that Section 27(D)(1) of the 1997 Tax Code states: "(D) Rates of tax on certain passive income (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 benefits 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%) of such interest income. . . . (Emphasis ours.) 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, the royalties and other fees received by FCI are in the nature of active income arising from the active pursuit of its business expense because these activities are in accordance with its primary purpose, which is the sublicensing of licensed materials to its Philippine clients and the performance of support services as provided under the Second Article of FCI's Articles incorporation, which pertinently reads: "To engage in, conduct, and carry on the business of distributing, marketing, and promoting licensed materials including but not limited to artwork, trademarks, characters, and motion pictures or television properties; to sub-license the use of such licensed materials; to protect such licensed materials, and all rights, title, and interest therein, against unauthorized use or infringements; and to engage in consumer or trade advertising, promotion, marketing, and public relations, market research, and other activities to enhance the value of the licensed materials to the sub-licensees." Accordingly, as confirmed in BIR Ruling No. DA-249-2001, the fees received by FCI are in the nature of active income arising from the active pursuit of its business subject to the normal 32% corporate income tax. Consequently, since said payments are not considered passive income then these are not subject to the 20% final withholding tax. Moreover, there is no duty to withhold on such payment as required under Section 57 of the Tax Code of 1997. Finally, the payments are, likewise, not subject to creditable withholding tax (CWT) at source under Section 57(B) of the said Code, as implemented under the Revenue Regulations No. 2-98, as amended by Revenue Regulations No. 6-2001, as further amended by Revenue Regulations No. 12-2001 since the payment of FCI is not among those listed therein that are subject to CWT. ( BIR Ruling Nos. 057-00 dated November 7, 2000; DA249-2001 dated December 3, 2001 ) IN VIEW OF THE FOREGOING, the local (Philippine) clients of FCI should neither withhold 20% from their payments to FCI as these are already subject to 32% corporate income tax on the part of FCI, nor subject their payments to creditable withholding tax. 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. EHASaD Very truly yours, (SGD.) EDMUNDO P. GUEVARA Deputy Commissioner Legal & Inspection Group