BIR Ruling [DA-641-04]

December 17, 2004 BIR RULING [DA-641-04] RP-US Tax Treaty; Sec. 105; 106; 27 (A) BIR Ruling Nos. 020-99; 046-02; 510-03; 211-88; 004-04 Siguion Reyna Montecillo & Ongsiangko Law Offices 4th & 6th Floors Citibank Center Paseo de Roxas, Makati City Attention: Attys. Jose Lis C. Leagogo, Celso L. Cruz, Monina V. Vierneza-Dejon and Ajee A. Tiu-Co Gentlemen : This refers to your letter dated October 7, 2004 requesting on behalf of your client, Glaxo Smith Kline Philippines, Inc. (hereafter "GSK" ), for a confirmation that: 1. Sale of trade marks and know-how by Eli Lilly and Company (hereafter "Lilly US") to GSK: (a) the proceeds from the sale of trademarks and know-how by Lilly US to GSK and Duncan Pharmaceuticals Philippines, Inc. (hereafter "Duncan") are not royalties; (b) income derived by Lilly US from the sale of trademarks and know-how is considered business profit not subject to income tax under the RP-US Tax Treaty and consequently not subject to withholding tax; (c) the proceeds from the sale of trademarks by Lilly US to GSK and Duncan are not subject to the 10% VAT, the sale being an isolated transaction and not made in the regular course of trade or business of Lilly US; and (d) the price paid by GSK and Duncan to Lilly US for the trademarks and related know-how are deductible from taxable income in the form of amortization expense over a period of 15 years. 2. Sale of Health Registration Data, Manufacturing and Marketing Know-How by Lilly Philippines to GSK and Duncan (a) the proceeds from the sale of Health Registration Data, Manufacturing and Marketing Know-How by Lilly Philippines to GSK and Duncan are not considered royalties but gains from the sale of intangible assets subject to the 32% regular corporate income tax; (b) the sale of Health Registration Data, Manufacturing and Marketing Know-How by Lilly Philippines to GSK and Duncan is not subject to the 10% VAT, the sale being an isolated transaction and not made in the regular course of trade or business of Lilly Philippines; and (c) the price paid by GSK and Duncan to Lilly Philippines for the Health Registration Data, Manufacturing and Marketing Know-How is deductible from their respective taxable income in the form of amortization over the same period that the trademarks are amortizable. 3. Sale of Inventory by Lilly Philippines to GSK and Duncan (a) the sale of inventory and bulk materials by Lilly Philippines to GSK and Duncan is subject to the 32% regular corporate income tax; (b) the sale of inventory and bulk materials is subject to the 10% VAT under Section 106(A) of the Tax Code of 1997. 4. Sale of inventory by Lilly Philippines to distributors, i.e. Zuellig Pharma Corporation, for and on behalf of GSK and Duncan pending issuance of a CPR: (a) income derived by GSK and Duncan from the sale of inventory by Lilly Philippines for and on its behalf is subject to the 32% regular corporate income tax; (b) the sale of inventory by Lilly Philippines for and on behalf of GSK and Duncan is subject to the 10% VAT; and (c) the subsequent assignment of the receivables from Zuellig by Lilly Philippines to GSK and Duncan, respectively, is not subject to income tax. The facts as you represented, are as follows GSK is a corporation organized and existing under Philippine laws with a principal place of business at 2266 Chino Roces Avenue, Makati City, Philippines. It is primarily engaged in the business of manufacturing, importing, exporting, dealing in, and distributing, at wholesale, packets of infant, dietetic and invalid foods and liquid of all kinds; pharmaceutical, medicinal and veterinary compounds, preparations and drugs of all kinds; sterile products and antibiotics; medicinal, cosmetic and veterinary products, vaccines; nutritionals, dietary and foods supplements; healthcare products of every kind and medical devices. It is one of the top 5,000 corporations for purposes of the creditable withholding tax under Revenue Regulations No. 2-98, as amended. Duncan is a corporation organized and existing under the Philippine laws to import, export, buy, manufacture, sell and generally deal in chemical, medicinal, pharmaceutical, biological, drug and cosmetic products of all kinds, milk, chocolate and related products, and appliances and apparatus used or useful in connection therewith, both as principal and as agent, broker or dealer. Duncan is a wholly-owned subsidiary of GSK with a principal place of business at 2266 Chino Roces Avenue, Makati City, Philippines. It is registered with the Bureau of Internal Revenue as a VAT taxpayer. Lilly US is a non-resident corporation organized and existing under the laws of the United States with a principal place of business at the Lilly Corporate Center, Indianapolis, Indiana 46285, United States of America. It is a global research-based pharmaceutical company dedicated to creating and delivering innovative pharmaceutical-based healthcare solutions that enable people to have longer, healthier and more active lives. Lilly Philippines is a corporation organized and existing under Philippine laws with a principal place of business at the 18th Floor, Galleria Corporate Center, Robinson's Galleria, EDSA corner Ortigas Avenue, Quezon City 1110, Metro Manila, Philippines. Lilly Philippines is primarily engaged in the delivery of innovative pharmaceutical-based healthcare and animal health care products to the Philippine market. Lilly US, Lilly Philippines, GSK and Duncan proposes to enter into a Memorandum of Understanding (hereafter the "MOU") covering the sale of the portfolio of six (6) branded drugs: Axid (Nizatidine), Ceclor (Cefaclor), Dobutrex (Dobutamine HCL), Ilosone (Erythromycin Estolate), Keflex (Cephalexen Monohydrate) and Vancocin (Vancomycin), with Duncan acquiring the Keflex brand. The MOU will include the following transactions (1) Sale of trademarks and know-how by Lilly US to GSK and Duncan; (2) Sale of respective Health Registration. Data, Manufacturing Know-How and Marketing Know-How by Lilly Philippines to GSK and Duncan; (3) Sale of existing inventory of products and bulk materials by Lilly Philippines to GSK and Duncan; and (4) Sale of medicines by Lilly Philippines to distributors for and on behalf of GSK and Duncan pending issuance of CPR's for each brand/product. In consideration of the sale of trademarks and know-how owned by Lilly US, GSK and Duncan shall pay Lilly US a lump-sum amount in two (2) installments. In addition thereto, GSK and Duncan shall pay Lilly US as additional amount depending on the brands' actual performance for the next two years, equal to Php0.32 and Php0.33 for every peso of sales in excess of Php515 million and Php567 for calendar years 2005 and 2006 respectively, up to a maximum of Php 1023 million. On the other hand, GSK and Duncan shall pay Lilly Philippines a lump-sum amount for the sale and transfer of Health Registration Data and Know-How, Manufacturing Know-How and Marketing Know-how owned, developed and used by Lilly Philippines in registering, manufacturing, selling and distributing the branded drugs in the Philippines. To ensure the continuous supply of the branded drugs in the market pending issuance of a CPR to GSK and Duncan for the respective brands purchased from Lilly US, GSK and Duncan shall also purchase finished products and bulk materials from Lilly Philippines pursuant to a Supply Strategy to be executed by the parties. In the event that such inventory of finished products and bulk materials are not sufficient to cover the demand pending the issuance of the CPR., Lilly Philippines, on the one hand, GSK or Duncan, on the other, shall, as needed, enter into a Receivable Assignment Agreement whereby Lilly Philippines shall sell additional inventory to Zuellig Pharma Corporation (hereafter "Zuellig"), the primary distributor of Lilly Philippines, at current prices, and thereafter assign the receivable from Zuellig to GSK and/or Duncan at cost. In view of GSK's and Duncan's lack of authority to sell, Lilly Philippines shall sell the branded drugs to Zuellig for and on behalf of GSK and/or Duncan until such time that their respective CPR's are issued. This shall be covered by a Receivables Assignment between Lilly Philippines and GSK and/or Duncan. After compliance with the conditions set forth in the MOU, the parties shall enter into respective final agreements covering each transaction, i.e. Agreement for the Acquisition of Certain Assets (Trademarks), Agreement for Inventory Purchase, Health Registration Data Package and Marketing Know-How Agreement, Agreement for Transfer of Manufacturing Know-How, Marketing and Promotion Agreement, and Receivables Assignment Agreement for the above transaction. In reply, please be informed of the following: 1. On the sale of Trademark by Lilly US to GSK : (a) The transaction price for the sale of trademark by Lilly US to GSK and Duncan is not considered royalty pursuant to Article 13(3) of the RP-US Tax treaty, viz: "(3) The term "royalties" as used in this Article means payments of any kind received as a consideration, for the use of, or the right to use , any copyright of literary, artistic or scientific work, including cinematographic films or films or tapes used for radio or television broadcasting, any patent, trademark, design or model, plan, secret formula or process, or other like right of property, or for information concerning industrial, commercial or scientific experience. The term "royalties" also includes gains derived from the sale, exchange or other disposition of any such right or property which are contingent on the productivity, use, or disposition thereof. " (Emphasis supplied) The sale of trademarks contemplated in the Memorandum of Understanding (MOU) involves not only the transfer of the use or the right to use the trademark, but of the title or ownership of the trademark in the Philippines. Hence, the fixed transaction price on the sale of trademark by Lilly US to GSK cannot be considered royalties under the RP-US Tax Treaty. (BIR Ruling No. 020-99 dated February 24, 1999 and ITAD Ruling No. 046-02 dated April 10, 2002.) With regard to the additional payments that may be required from GSK and/or Duncan, depending on the sales for the years 2005-2006, this Office hereby confirm your opinion that said additional payments likewise, do not constitute royalties. (b) The income derived by Lilly US from the sale of trademark GSK and Duncan is considered business profits under Article 8(l)(6) of the RP-US Tax Treaty, viz: "(1) Business profits of a resident of one Contracting State shall be taxable only in that State unless the resident has a permanent establishment in the other Contracting State. If the resident has a permanent establishment in that other Contracting State, tax may be imposed by that other Contracting State on the business profits of the resident but only or so much of them as are attributable to the permanent establishment. xxx xxx xxx (6) The term "business profits" means income derived from any trade or business whether carried on by an individual, corporation or any other person, or group of persons, including the rental of tangible personal (movable) property." Considering that Lilly US has no permanent establishment in the Philippines, this Office likewise confirm your opinion that the gain derived from the sale of trademarks and related intellectual properties is not subject to Philippine income tax. Accordingly, no withholding tax is due from payments made by GSK and Duncan for the purchase of the trademarks. Hence, additional payments that may be made by GSK and Duncan to Lilly US are likewise business profits derived by Lilly US which are not subject to Philippine income tax and consequently to withholding tax. (c) The sale of trademarks and related know-how by Lilly US to GSK and Duncan are not subject to the 10% VAT pursuant to Section 105 of the Tax Code of 1997 for the reason that such sale is not related to the regular commercial activity of Lilly US, nor is it incidental to the creation and delivery by Lilly US of innovative pharmaceutical-based healthcare solutions. (BIR Ruling No. DA-510-03 dated December 17, 2003) (d) 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. (BIR Ruling Nos. 211-88 dated May 20, 1988 and 046-02, supra ) 2. Sale of Health Registration Data and Know-How, Manufacturing Know-How and Marketing Know-How (a) The treatment of the proceeds of the sale of trademarks by Lilly US and payments received by Lilly Philippines for the sale not merely the use of or the right to use, the health registration data, manufacturing and marketing know-how are not royalties but gains from the sale of assets subject to the 32% regular corporate income tax pursuant to Section 27(A) of the Tax Code of 1997. (BIR Ruling No. 020-99 dated February 24, 1999 and ITAD Ruling No. 046-02 dated April 10, 2002) As intangible assets, the sale of know-how by Lilly Philippines to GSK, a top 10,000 corporation is not subject to the expanded withholding tax (EWT) which applies only to income payments to local supplier of goods pursuant to Section 2.57.2(M) of Revenue Regulations (Rev. Regs.) No. 2-98, as amended by Rev. Regs. No. 17-2003. (b) The sale of health registration data, manufacturing know-how by Lilly Philippines is not subject to the 10% VAT pursuant to Section 105 of the Tax Code of 1997 since such sale is not made in the ordinary course of trade or business of Lilly Philippines. Similarly, the sale of marketing know-how is an isolated transaction not subject to the 10% VAT. (BIR Ruling No. DA-510-03 dated December 17, 2003) (c) The Health Registration Data, Manufacturing and Marketing Know-how acquired by GSK and Duncan from Lilly Philippines are expected to be of use to GSK and Duncan for the same period within which the respective trademarks that are related to are expected to generate profits for GSK and Duncan. Hence, the price paid for their acquisition may be claimed as deductions from gross income as ordinary and necessary expenses directly connected with the sale of medicines in the form of amortization for a period of fifteen years pursuant to Section 34(F) of the Tax Code. 3. Sale of Existing Inventory of Products and Bulk Materials (a) The sale of existing inventory and bulk materials by Lilly Philippines to GSK and Duncan is subject to the 32% regular corporate income tax or 2% minimum corporate income tax, if applicable, pursuant to Section 27(A)(D)(E) of the Tax Code of 1997, and considering that GSK being one of the top 10,000 corporation, is required to withhold and remit to the Bureau of Internal Revenue (BIR) 1% of income payments to local supplier of goods pursuant to Section 2.57.2(M) of Revenue Regulations No. 2-98, as amended by Rev. Regs. No. 17-2003. (BIR Ruling No. 004-04 dated February 11, 2004) (b) The sale of existing inventory is subject to the 10% VAT on sale of goods pursuant to Section 106(A) of the Tax Code of 1997. ECAaTS 4. Sale of Inventory by Lilly Philippines to Zuellig for and on behalf of GSK and/or Duncan (a) Income from sales made by Lilly Philippines to Zuellig or other distributors for and on behalf of GSK or Duncan during the pendency of the application for a CPR with BFAD, shall constitute the taxable income of GSK and Duncan subject to the 32% regular corporate income tax, and considering that GSK being one of the top 10,000 corporation, is required to withhold and remit to the Bureau of Internal Revenue (BIR) 1% of income payments to local supplier of goods pursuant to Section 2.57.2(M) of Revenue Regulations No. 2-98, as amended by Rev. Regs. No. 17-2003. (BIR Ruling No. 004-04 dated February 11, 2004) (b) Since there is lack of authority on the part of GSK and Duncan to sell pending issuance of their respective CPR's, Lilly Philippines, as the licensed manufacturer, shall issue its own invoices and receipts to evidence the sales. Such being the case, Lilly Philippines shall be liable for the 10% VAT due on the sales. Consequently, Lilly Philippines shall likewise be entitled to credit the input VAT paid on the importation, purchase or manufacture of the inventory sold. (BIR Ruling No. 004-04 dated February 11, 2004) (c) Since the sale is made by Lilly Philippines for and on behalf of GSK and Duncan and the assignment is made at cost without Lilly Philippines making a profit, the assignment of receivables does not result to any income on the part of Lilly Philippines, there being no flow of wealth from one party to the other. 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 Deputy Commissioner Legal & Inspection Group