Payments Received by MKI-Phil. from Conduct of Trade or Business Deemed Ordinary Business Income

November 7, 2000 BIR RULING NO. 057-00 27 (D) (1) 000-00 SGV & Co. 6760 Ayala Avenue Makati City Attention: Mr . J . A . Osana Gentlemen : This refers to your letter dated September 13, 1999 requesting confirmation that the income derived by your client, Midas-Kapiti International Inc. (Philippines) ["MKI-Phils"], from its bank-clients in the distribution of computer systems software and rendition of maintenance services is in the nature of ordinary business income subject to the 33% (for 1999) regular corporate income tax and not the 20% final tax on gross royalty payments under Section 27(D)(1) of the Tax Code of 1997. It is represented that MKI-Phils is a BOI-registered (non-pioneer) domestic company primarily engaged in the licensing, implementation and maintenance of computer software in the domestic and foreign markets; that it is licensed by Midas Kapiti International in the United Kingdom ("MKI-UK") to distribute, support and use in the Philippines Licensed Systems, owned by MKI-UK, comprising of computer software for banks, including basic and related materials and services incidental thereto; that MKI-Phils does not and will not acquire any proprietary rights of whatever kind in or over the Licensed Systems except to distribute, support and use the same within the Philippines; that MKI-Phils pays royalties to MKI-UK net of the 15% final withholding tax prescribed by Article 11(2)(a)(i) of the RP-UK Tax Treaty, that as its principal and main activity, MKI-Phils distributes the Licensed Systems by entering with Philippine bank-clients into Licensing Agreements (LA) as well as Consultancy, Supplementary License and Services Agreement; that the LA grants the bank-client the non-exclusive right to use the Licensed System or a modified form of the System for its own internal business purposes only and not to serve, directly or indirectly, as a data processing unit for third persons; that the Services Agreement, on the other hand, provide for the technical services to be performed by MKI-Phils personnel to the bank-client in support of the Licensed System; that MKI-Phils receives fees in consideration for the rights granted and the support services provided. In reply, please be informed that Section 27(D)(1) of the Tax Code of 1997 provides as follows: "(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%) 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. cASEDC 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 will be considered null and void. Very truly yours, (SGD.) DAKILA B. FONACIER Commissioner of Internal Revenue