BIR Ruling [DA-369-06]

June 15, 2006 BIR RULING [DA-369-06] 27 (A) (1); 057-00, DA518-03 Rodriguez and Zurbito HMR Group PTY Compound Philacor Drive, DR. A. Santos Avenue Barangay San Antonio, Sucat Road Paraaque City Attention: Atty. Manuel O. Zurbito, Jr . Gentlemen : This refers to your letter dated May 24, 2006 stating that your client, VEROLD CORPORATION, is a 100% Filipino owned and controlled corporation primarily engaged in wholesale/retail trade; that to properly merchant its products and that of its affiliates, comprising of wide range of home appliances and office equipments, it embarked into the franchising business; that for this purpose it caused the registration of the trade name Save on Surplus Enterprises with the Department of Trade and Industry on January 16, 2000; that thereafter, it entered into Franchising Agreements, allowing person and/firm meeting its standards to open and operate Save on Surplus outlets in Manila and in the Provinces as well; that the products of VEROLD Corporation and its affiliates, in particular HMR Auction Services, Inc. were distributed through these SOS franchise outlets; that in 2005, pursuant to its business expansion program, Save on Surplus, Inc. was incorporated; that thereafter, VEROLD Corporation assigned its Save on Surplus business to its subsidiary Save on Surplus, Inc. which from that moment on carried on the franchising business of VEROLD Corporation; and that the royalty and franchise fees mentioned at the onset were paid by the franchisees perforce of the Franchising Agreements. In connection therewith, you now request for an opinion that the income generated by VEROLD Corporation and Save on Surplus, Inc. in the form of royalty and franchise fees in the ordinary course of their business are subject to the regular corporate income tax and not to the 20% final tax on royalty. In reply thereto, please be informed that this Office had already occasion to rule on the matter when it said 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." DTEcSa In applying the above-cited rulings, it is clear that the royalties and other fees received by VEROLD Corporation and Save on Surplus, Inc. 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 VEROLD Corporation and Save on Surplus, Inc. which is to engage in the wholesale and retail of office equipments as provided in its Articles of Incorporation. SUCH BEING THE CASE, the royalty and franchise fees derived by VEROLD Corporation and Save on Surplus, Inc. in the conduct of their business shall form part their ordinary income subject to the regular corporate income tax imposed under Section 27(A)(1) of the Tax Code of 1997, as amended by Republic Act No. 9337. 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