BIR Ruling [DA-568-06]

September 20, 2006 BIR RULING [DA-568-06] Lina Lavarez Didulo & Leviste-Avellana Unit 2202 Asia Tower Building, Paseo de Roxas cor. Benavidez St., Legaspi Village, Makati City Attention: Atty. Jose Leonilo V. Didulo Partner Gentlemen : This refers to your letter dated September 05, 2006 stating that your client, EMI Philippines, Inc . ("EMI Philippines") is a Philippine domestic corporation duly issued by the Securities and Exchange Commission (SEC) a Certificate of Registration with No. AS095-001465 dated September 18, 2001, and holding office at the 3rd Floor, Universal Tower Building, 1487 Quezon Avenue, West Triangle, Quezon City; that as stated in the Primary Purpose of its Articles of Incorporation, EMI Philippines is licensed by the SEC to engage in the business of acquisition of rights; origination; marketing; licensing; manufacturing; importation; warehousing; distribution and sale on a wholesale basis of musical repertoire on cassette, compact disks and other audio and audio-visual carriers; and the acquisition, origination and exploitation of musical copyrights and other related incidental activities; that EMI Music Publishing Asia ("EMI-HK"), a division of EMI Group Hong Kong Limited with offices at Suite 5703, 57 Floor, Central Plaza, 18 Harbour Road, Wanchaj, Hong Kong, is a non-resident foreign corporation not licensed to engage in trade or business in the Philippines as certified to by the SEC; that in a Licensing Agreement dated July 1, 2004, EMI-HK granted EMI Philippines the: (a) exclusive license covering all copyright, and all other rights of a like nature conferred by the laws of the Licensed Territory (Philippines), whether vested or contingent, and such other rights as may be conferred or created by law or international arrangement or convention whether by way of new or additional rights or by way of extension or renewal of existing rights, of and in the words and music of the Compositions; (b) the exclusive right to grant non exclusive licenses worldwide for the synchronization, recording and use in and in connection with motion pictures and television films (including television and cinema advertisements) produced in the Licensed Territory (Philippines); (c) with Royaltor's prior written consent (where necessary and as advised in advance by the Publisher to the Administrator, the non-exclusive right to make new adaptations and arrangements of the Compositions, to translate the lyrics or provide new lyrics for purposes of exploitation in the Licensed Territory (Philippines), all new matter including but not limited to adaptations, arrangements, translations and new titles shall be the property of the Publisher (EMI Hong Kong) or the relevant Royaltor or copyright owner of that Composition; and (d) the non-exclusive right to use the names, images and likenesses of the composers and lyricists of the Compositions in connection with the exploitation of the Compositions in the Licensed Territory (Philippines); that in another Agreement dated January 1, 2006 EMI Hong Kong granted EMI Philippines the exclusive rights: (a) to print, publish and sell sheet and other print music of any Work (defined as each separate musical work with any accompanying lyrics comprising the Catalogue including all adaptations, arrangements, alterations and transcriptions of such works ), and to include any Work in any printed album, folio, book, newspaper or other publication or on the cover or insert of any audio or audio-visual devise; (b) to license mechanical, electrical, magnetic, optical digital, electronic and other reproductions of any Work; (c) with the prior written consent of the Publisher, to license the use of any Work for synchronization for any commercial advertisement of any product by any media and for synchronization with motion picture films, TV films, CD-ROMs, karaoke, videocassettes, video discs, digital video devices and other audio-visual devices; (d) to broadcast, re-broadcast, distribute to subscribers to cable program services, transmit and publicly perform any Work; (e) to license the grand rights of any Work; (f) to license the use of any of the Work for making available copies to the public via the service commonly known as the "internet" (g) with the prior written consent of the Publisher, to make adaptations, translations, arrangements, additions, alterations of and to any Work provided such resulting versions are the property of the Publisher; aSADIC (h) to collect all income from the exploitation of such rights; (i) to collect the so-called publisher's share of all income generated by the exercise of such rights; and (j) to license and permit others to do any one or more of these things. that in the implementation of the Agreements, EMI Philippines entered into License Agreements with Philippine domestic corporations whereby in consideration for the grant, exploitation and exercise such rights, EMI Philippines receives income in the form of "royalties". In this connection, you now request confirmation of your opinion on the following: 1. Royalty payments received by EMI Philippines from its Philippine domestic corporation-licensees shall be classified as active income subject to the regular corporate income tax rate of 32% (now 35%) pursuant to Section 27(A) of the Tax Code of 1997 and not to the 20% final withholding tax; and 2. These royalty payments are not subject to the 2% creditable withholding tax unless the payor belongs to the top 10,000 corporations designated by the BIR. In support of the request, you have submitted copies of the following: 1. EMI Philippines SEC Certificate of Registration and Articles of Incorporation; 2. EMI Philippines and EMI-HK agreements dated July 1, 2004 and January 1, 2006; and 3. Certification of Non-registration of Corporation/Partnership issued by the SEC on September 5, 2006 that EMI Hong Kong is classified as a non-resident foreign corporation not engaged in trade or business in the Philippines. In reply, 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. DA 518-03 dated December 17, 2003, BIR Ruling DA-115-06 dated March 16, 2006 and BIR Ruling DA-116-06 dated March 16, 2006, the BIR citing Section 27 (D)(1) of the Tax Code of 1997, 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. DEAaIS "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." In applying the above-cited rulings, it is clear that the royalties received by EMI Philippines are in the nature of ordinary business income considering that, the income was derived or generated from activities that are in accordance with the primary purpose of EMI Philippines which is licensing and sub-licensing of musical compositions and performance of support services as provided in its Articles of Incorporation. Consequently, the royalty income derived by EMI Philippines in the conduct of its business shall form part of its ordinary income subject to the now 35% 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 under Section 57 of the Tax Code of 1997, as amended, and the royalty payments are not subject to creditable withholding tax since the said income is not among those enumerated under the withholding tax regulations as subject to withholding tax. However, if EMI Philippines' 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 EMI Philippines. 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.) JAMES H. ROLDAN Assistant Commissioner Legal Service