Application of Maple Leaf Foods, Inc. for Relief from Double Taxation Under RP-Canada Tax Treaty

February 4, 1999 BIR RULING NO. 016-99 000-00-016-99 Britanico Consunji & Sarmiento 2nd Floor, Dacon Building 2281 Pasong Tamo Extension Makati City Attention: Attys . Kennedy B . Sarmiento and Carlia A . Valencia Gentlemen : This refers to your letter dated April 29, 1998 on the application of your client, Maple Leaf Foods, Inc. (Maple), a non-resident corporation organized and existing under the laws of Canada, for relief from double taxation under Article VII(1) of the RP-Canada Tax Treaty on the business profits received by it from Megalicious Foods Corporation (Megalicious), a corporation organized under Philippine laws; and that the royalty payments under its Master Franchise Agreement are subject to the lowest tax rate of 10% under Article XII(2)(b)(ii) of the RP-Canada Tax Treaty in relation to Article 12(2)(b) of the RP-West Germany Tax Treaty. It is represented that Maple possesses the exclusive franchise rights to a proprietary system (System) relating to the establishment, development and operation of a Country Style coffee and donut shop, which specializes in the sale and service, at retail, of coffee, donuts and other related products and services, and which has been developed through significant expenditures of time, skill, effort and money; that Maple has the exclusive world-wide right and license to use and license others to use the System and the trade name, trademarks and service marks as are designated in the agreement; that on August 12, 1996, Maple and Megalicious entered into a Master Franchise Agreement (MFA) and its Amendments dated November 19, 1996; that the MFA provides for the licensing by Maple as franchisor, to Megalicious, as master franchisee, of exclusive franchise rights to a proprietary system relating to the establishment, development and operation of country style coffee and donut shops in the Philippines in order to (i) build and develop Master Units within the Designated Territory; (ii) recruit prospective Unit Franchisees in the Designated Territory; and (iii) provide training and other support and services to Unit Franchisees in the Designated Territory, in accordance with the system and under the Proprietary Marks; that each Unit Franchisee shall operate its Franchised Business according to the terms of an individual Franchise Agreement, which shall include terms to: (1) conform with the requirements and the customs of the Designated Territory; (2) effect the provisions of the MFA; (3) a Sub-License Agreement for purposes of use of the Franchisor's Proprietary Marks, by the Unit Franchisees; and (4) such terms as mutually agreed to by the Franchisor and the Master Franchisee; that the Master Franchisee shall pay to the Franchisor a non-refundable fee in the sum of One Hundred Fifty Thousand Dollars ($150,000.00) for the lost development opportunities in the Designated Territory and as a technical service fee for the services that the Franchisor is obligated to provide pursuant to Section IV of the Agreement; that in addition, the Master Franchisee shall pay to the Franchisor a non-refundable fee in the sum of One Hundred Thousand Dollars ($100,000.00) for the use of the trademarks and intellectual property rights including the system of the Franchisor in the Designated Territory; that the Master Franchisee's principal source of remuneration under this Agreement shall be derived from its share of the revenues generated by the sale and operation of Franchised Businesses within the Designated Territory; that the Master Franchisee shall be entitled to its share of the unit franchise fees and ongoing royalties due under each individual Franchise Agreement for the Designated Territory, provided that the Master Franchisee fully and diligently performs its obligations throughout the term of this Agreement; that for each Unit Franchise awarded in the Designated Territory, the Master Franchisee shall pay to Franchisor seven (7) days prior to opening of all operating stores, whether corporate or sub-franchised, the Unit Franchise Fees for each: For traditional free standing, in line or mall The greater of twenty-five per cent (25%) of For traditional free standing, in line or mall The greater of twenty-five per cent (25%) of location; the fee collected or $7,500 For kiosks; The greater of twenty-five per cent (25%) of the fee collected or $3,000 For carts The greater of twenty-five per cent (25%) of the fee collected or $2,000 that all Franchised Businesses within the Designated Territory shall remit royalty payments due under the individual Franchise Agreements directly to the Master Franchisee; and that the Master Franchisee shall remit to the Franchisor two percent (2%) of each Franchised Businesses' (including the Master Franchisee's own Franchised Businesses') monthly gross sales. cdll In connection therewith, you now request for ruling that the amount of US$150,000.00 for the lost business opportunities and as technical service fee and for the product commissions to be paid by Megalicious to Maple as well as the unit franchise fees, are business profits earned in the Philippines by Maple, an entity without any permanent establishment in the Philippines and that the same are not subject to Philippine income tax/withholding tax under Article VII(1) of the RP-Canada Tax Treaty; and that the amount of $100,000.00 for the use of the trademarks and intellectual property rights including the system of Maple in the Designated Territory and two percent (2%) royalties to be paid under Clause VIII B.2 of the MFA, are considered royalty payments subject to the lowest tax rate of 10% pursuant to Article XII(2)(b)(ii) of the RP-Canada Tax Treaty in relation to Article XII(2)(b) of the RP-West Germany Tax Treaty In reply, please be informed that pursuant to Article VII(1) of the RP-Canada Tax Treaty, pertinent portion of which is quoted as follows: "ARTICLE VII " Business Profits "1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. . . ." Moreover, Article V(1) and (2) of the said Treaty provides, viz: "ARTICLE V " Permanent Establishment 1. For the purposes of this Convention, the term "permanent establishment" means a fixed place of business in which the business of the enterprise is wholly or partially carried on. 2. The term "permanent establishment" shall include especially: (a) a place of management; (b) a branch; (c) an office; (d) a factory; (e) a workshop; (f) a mine, quarry or other place of extraction of natural resources; (g) a building or construction site or supervisory activities in connection therewith, where such activities continue for a period more than six months; (h) an assembly or installation project which exists for more than three months; (i) premises used as a sales outlet; (j) a warehouse, in relation to a person providing storage facilities for others." Under the aforequoted provisions of the RP-Canada Tax Treaty, since Maple does not have a permanent establishment in the Philippines, the amount of $150,000.00 to be derived by Maple from Megalicious for the lost development opportunities in the Designated Territory and as a technical service fee for the services that Maple is obligated to provide under the MFA, and the 25% of any and all product commissions that will be collected and remitted by Megalicious from the franchised businesses as well as the unit franchise fees are considered business profits not subject to Philippine income tax and consequently to the withholding tax under Section 28(B)(1) in relation to Section 57(A) both of the Tax Code of 1997. On the other hand, under Article XII(2)(b)(ii) of the RP-Canada Tax Treaty, pertinent portion of which is quoted as follows: "ARTICLE XII " Royalties "(1) . . . "(2) Such royalties may also be taxed in the Contracting State in which they arise, and according to the law of that State. However, the tax so charged shall, provided that the royalties are taxable in the other Contracting State, not exceed: "(a) . . . "(b) in the Philippines, the lesser of (i) 25 per cent of the gross amount of the royalties; and (ii) the lowest rate of Philippine tax that may be imposed on royalties of the same kind paid in similar circumstances to a resident of a third State. In the instant case, since Maple is a non-resident foreign corporation and is not engaged in trade or business in the Philippines as envisioned under Section 28(B)(1) of the Tax Code of 1997, royalty payments made by Megalicious in the amount of $100,000.00 for the use of its trademarks and intellectual property rights including the system of Country Style donuts in the Philippines and the 2% franchised businesses monthly gross sales are subject to the Philippine income tax at the rate of 10% pursuant to Article XII(2)(b)(ii) of the RP-Canada Tax Treaty in relation to Article 12(2)(b) of the RP-West Germany Tax Treaty. The said tax shall be withheld and paid in the same manner and subject to the same condition as provided in Section 57(B) of the Tax Code of 1997. Moreover, the remittance by Megalicious to Maple of the said royalties shall be subject to the 10% value-added tax pursuant to Section 108(A)(1) of the Tax Code of 1997. Furthermore, the VAT on rental and/or royalties payable 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 on 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), Revenue Regulations No. 7-95) In view thereof, Megalicious shall, before making payment of royalties to Maple, withhold and remit to this Bureau the 10% VAT due thereon, by filing a separate VAT declaration/return for and on behalf of Maple. (Sec. 4.110-3(b), Revenue Regulations No. 7-95) 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. llcd Very truly yours, (SGD.) BEETHOVEN L. RUALO Commissioner of Internal Revenue