BIR Ruling [DA-355-99]

June 17, 1999 BIR RULING [DA-355-99] Quisumbing Torres & Evangelista 11th Floor, Pacific Star Building, Makati Avenue cor. Sen. Gil J. Puyat Avenue Makati City Attention: Attys . Edgardo M . de Vera and Shennan A . Sy Gentlemen : This refers to your letter dated June 16, 1997, requesting on behalf of your client, Ace Hardware Corporation (ACE), a non-resident corporation organized and existing under the laws of the State of Delaware, USA, for relief from double taxation under Article 8(1) of the RP-US Tax Treaty on the business profits received by it from Hardware Work Shop, Inc. (Work Shop), a corporation organized and existing under Philippine laws; and that the royalty payments under its Distribution Agreement (DA) are subject to the reduced tax rate of 15% under Article 13(2)(b)(iii) of the RP-US Tax Treaty in relation to Article 12(2)(b) of the RP-Netherlands Tax Treaty. It is represented that ACE is the owner of the trade names and service marks "ACE", "ACE Hardware" and "ACE Home Center", and associated logos, commercial symbols and such other trademarks and service marks (ACE Marks) in several countries around the world including the Philippines; that it has licensed Work Shop the right to use ACE Marks in connection with the sale of home improvement products, tools, hardwares, plaints and related merchandise (Merchandise) and the establishment and operation of hardware retail stores (ACE Stores) in the Philippines; that ACE owns certain confidential information relating to unique business and commercial operational plans and strategies, human resource development, cash flows management and techniques and other know-how and proprietary systems related to the sale of Merchandise and management of ACE stores, that ACE has established a superior reputation, demand and goodwill for the Merchandise and services sold under the ACE Marks; that ACE has expended time, effort and money to develop a unique and successful system for selling the Merchandise (System) through the establishment and operation of retail establishments under the ACE Marks; that on May 20, 1996 a Distribution Agreement (DA) was entered into by and between ACE and Work Shop whereby the latter is granted the license to establish and operate hardware retail stores in the Philippines under the ACE Marks, the right to purchase Merchandise from ACE for resale at ACE Stores in the Philippines and to obtain from ACE technical know-how and information and assistance relating to the establishment and operation of ACE Stores and the marketing and sale of the Merchandise; that in consideration thereof, Work Shop will pay ACE a Distributor Fee of US$500,000.00 over a period of 5 years and Additional Fee of US$5,000.00 for each additional store number requested and for the technical know-how and information relating to the establishment and operation of ACE Stores and the marketing and sale of the Merchandise; that Work Shop will pay ACE a Continuing Distributorship Fee (CDF) in an amount equivalent to 3% of the cost of Merchandise purchased by Work Shop from or through ACE or Ace's vendors in the United States; that the CDF shall not exceed US$500,000.00 per calendar year during the term of the DA; that on May 20, 1996, ACE and Work Shop entered into a License Agreement (LA) granting Work Shop the exclusive right to use the ACE Mark's in the Philippines, and/or grant sub-licenses to others to establish and operate ACE Stores in the Philippines in accordance with operational procedures and standards prescribed by ACE from time to time; that Work Shop is also granted the exclusive right to have access to ACE's proprietary systems, operations manuals, standard forms and formats, and operational knowledge within the Philippines; that on October 11, 1996, Work Shop assigned all of its rights and obligations under the DA and the LA to ACE Hardware Philippines, Inc. (ACE-Philippines); and that in compliance with the pre-registration conditions set by the Bureau of Patents, Trademarks and Technology Transfer for the registration of the LA, on June 4, 1997, ACE executed an Amendatory Agreement with ACE-Philippines amending clauses 7.01(b) and 10.02 of the LA. Based on the foregoing representations, you now request confirmation of your opinion that the Distributor Fee, Additional Store Fee and the Continuing Distributorship Fee under the DA are considered as royalty payments subject to the reduced tax rate of 15% pursuant to Article 13(2)(b)(iii) in relation to Article 12(2)(b) of the RP-Netherlands Tax Treaty. In reply, please be informed that your opinion is hereby confirmed. Under Article 13(2)(b)(iii) of the RP-US Tax Treaty, pertinent portion of which is quoted as follows: "ARTICLE 13 "Royalties "(1) . . . "(2) However, the tax imposed by that other Contracting State shall not exceed (a) In the case of the United States, 15 percent of the gross amount of the royalties, and (b) In the case of the Philippines, the least of: (i) 25 percent of the gross amount of the royalties, (ii) 15 percent of the gross amount of the royalties, where the royalties are paid by a corporation registered with the Philippine Board of Investments and engaged in preferred areas of activities, and (iii) The lowest rate of Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State. In the instant case, ACE is a non-resident foreign corporation not engaged in trade or business in the Philippines as envisioned under Section 25(b)(i) of the Tax Code, as amended [now Section 28(B)(1) of the Tax Code of 1997] and as such, the Distributor Fee, Additional Store Fee and Continuing Distributorship Fees are in the nature of royalties subject to tax at a rate of 15% applying the provision of Article 13(2)(b)(iii) of the RP-US Tax Treaty in relation to Article 12(2)(b) of the RP-Netherlands Tax Treaty. (BIR Ruling No. 26-94 dated January 21, 1994) However, the royalty payments made by Work Shop to ACE or Ace's vendors in the United States are subject to value-added tax (VAT) pursuant to Section 102(a) of the Tax Code, as amended [now Section 108(A)(1) of the Tax Code of 1997]. Furthermore, the VAT on rental and/or royalties to non-resident foreign corporations or owners for the sale of services and use or lease of properties in the Philippines shall be based on the contract price agreed upon by the licensor and licensee. The licensee shall be responsible for the payment of VAT on such rentals and/or royalties in behalf of the non-resident foreign corporation or owner by filing a separate VAT declaration/return for this purpose. The duly validated VAT declaration/return is sufficient evidence in claiming input tax credit by the licensee. (Sec. 4.102-1(b) of Revenue Regulations No. 7-95) In view thereof, Work Shop shall, before making payment of royalties to ACE, withhold and remit to this Bureau the 10% VAT due thereon, by filing a separate VAT return for and in behalf of ACE. LexLib 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, Commissioner of Internal Revenue By: (SGD.) SIXTO S. ESQUIVIAS IV Deputy Commissioner (Legal & Enforcement Group)