DA ITAD BIR Ruling No. 049-10

May 17, 2010 DA ITAD BIR RULING NO. 049-10 Article 12, Philippines-Netherlands tax treaty; BIR Ruling No. ITAD-012-02; BIR Ruling No. DA-ITAD-041-02; BIR Ruling No. DA-ITAD-003-03; BIR Ruling No. DA-ITAD-100-03; BIR Ruling No. DA-ITAD-059-08 Eufemio Law Offices Third Floor, The Esquire Centre Gomezville cor. Guerrero Streets Addition Hills, Mandaluyong City Attention: Atty. Edson T. Eufemio Gentlemen : This refers to your letter dated October 10, 2008 requesting confirmation of the following: 1. That the license fee paid by RTG STUDIO, INC. (RTG) to NINIVE HOLDING B.V. ( Ninive ) under their Master License Agreement dated December 7, 2007 is subject to 15% income tax pursuant to Article 12 of the Philippines-Netherlands tax treaty. 2. That the license fee paid by RTG to Ninive, the former being a Cagayan Economic Zone Authority registered enterprise, is not subject to the value-added tax (VAT). It is represented that Ninive is a nonresident foreign corporation organized and existing under the laws of The Netherlands as evidenced by its Articles of Association; that Ninive has principal office address at De Cleyen 3, 1391 RL Abcoude, The Netherlands; that it is not registered either as a corporation or as a partnership in the Philippines as evidenced by the Certification of Non-Registration of Corporation/Partnership dated April 8, 2008 issued by the Securities and Exchange Commission (SEC); that, on the other hand, RTG is a domestic corporation with principal office address located at Cagayan Economic Complex, Sta. Ana, Cagayan; that it is registered with the Cagayan Special Economic Zone Authority (CSEZA) under CSEZFP Enterprise No. CF-050 dated October 6, 2006; and that RTG is engaged in the business of a Software Provider for Interactive Gaming. AHEDaI It is further represented that on December 7, 2007, RTG and Ninive entered into a RTG Studio-Ninive Master License (Agreement) whereby Ninive grants to RTG, during the Term 1 and within the Territory, 2 the non-transferable right and license to the RNG Software, including all Updates 3 and Documentation 4 (whether alone or as part of a collective work); that the Agreement shall include the right by RTG to sublicense the RNG Software to Operators 5 for use by Players 6 in Legal Jurisdiction; 7 that RTG Master License shall during the Term be an exclusive grant to RTG, but shall in any case be converted into a non-exclusive license if, upon Ninive giving prior written notice to RTG the License Fee paid or payable by both RTG (under this Agreement) and RTG Asia (under its master license agreement [the "RTG Asia-Hastings MLA"] with Hastings International B.V.), in respect of the RNG Software in any consecutive twelve (12) month period, starting January 1, 2008, is less than One Million Dollars (US$1,000,000); that subject to the minimum amounts set forth on Exhibit A, RTG shall, during the Term, pay to Ninive, in the United States Dollars or such other currencies as the Parties may mutually agree an aggregate license fee equal to fifty percent (50%) of the gross proceeds and amounts collected each calendar month by RTG from each Operator (or affiliate) on account of the use and exploitation of the RNG Software by such Operator (and affiliates), including all license fees, advances, retainers, initial fees, and otherwise, excluding only software customization fees that are unique to such Operator; and that the issue or transaction subject of the above application is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or a judicial appeal. In reply, please be informed that concerning software payments, the Bureau of Internal Revenue issued Revenue Memorandum Circular No. 44-2005 8 dated September 8, 2005 which covers payments made as of September 8, 2005 and treats software payments either as business income, royalties, rental income, or capital gains, depending on the nature of the transaction out of which such payments are made, to wit: Section 5 of RMC No. 44-2005 provides: "Section 5. Characterization of Transactions. The character of payments received in a transaction involving the transfer of computer software depends on the nature of the rights that the transferee acquires under the particular arrangement regarding the use and exploitation of the program. a. Transfer of copyright rights. A transfer of software is classified as a transfer of a copyright right if, as a result of the transaction, a person acquires any one or more of the rights described below: i. The right to make copies of the software for purposes of distribution to the public by sale or other transfer of ownership, or by rental, lease or lending; ii. The right to prepare derivative computer programs based upon the copyrighted software; SEIcAD iii. The right to make a public performance of the software; iv. The right to publicly display the computer program; or v. any other rights of the copyright owner, the exercise of which by another without his authority shall constitute infringement of said copyright. The determination of whether a transfer of a copyright right in a software is a sale or exchange of property is made on the basis of whether, taking into account all facts and circumstances, there has been a transfer of all substantial rights in the copyright. A transaction that does not constitute a sale or exchange because not all substantial rights have been transferred will be classified as a license generating royalty income. When only copyright rights are transferred, payments made in consideration therefor are royalties. On the other hand, when copyright ownership is transferred, payments made in consideration therefor are business income. xxx xxx xxx" In as much as it is represented that Ninive grants to RTG, a non-transferable right and license to the RNG Software including, among others, the right to sublicense the RNG Software to Operators for use by Players in Legal Jurisdiction, 9 have been transferred to RTG, such transfer of software is classified as a license generating royalty income under Section 5 (a) of RMC No. 44-2005. Accordingly, the license fees paid or payable to Ninive for RTG's use of the RNG Software from the effective date of the Agreement on December 7, 2007 and shall continue until the 10th anniversary thereof, are treated as royalties under RMC No. 44-2005. Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended, applies in general. It provides: "Section 28. Rates of Income Tax on Foreign Corporations. xxx xxx xxx (B) Tax on Nonresident Foreign Corporation. (1) In General. Except as otherwise provided in this Code, a foreign corporation not engaged in trade or business in the Philippines shall pay a tax equal to thirty-five percent (35%) of the gross income received during each taxable year from all sources within the Philippines, such as interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and capital gains, except capital gains subject to tax under subparagraph 5(c): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, Section 32 (B) (5) of the Tax Code of 1997, as amended provides: "Section 32. Gross Income. xxx xxx xxx (B) Exclusions from Gross Income. The following items shall not be included in gross income and shall be exempt from taxation under this Title: xxx xxx xxx (5) Income Exempt under Treaty. Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines. xxx xxx xxx" Thus, the provisions of the Philippines-Netherlands tax treaty may apply in this case. Article 12 of the Philippines-Netherlands tax treaty provides as follows: "Article 12 Royalties 1. Royalties arising in one of the States and paid to a resident of the other State may be taxed in that other State. DaScCH 2. However, such royalties may also be taxed in the State in which they arise, and according to the laws of that State, but if the recipient is the beneficial owner of the royalties the tax so charged shall not exceed: a) 10 per cent of the gross amount of the royalties where the royalties are paid by an enterprise registered, and engaged in preferred areas of activities in that State; and b) 15 per cent of the gross amount of the royalties in all other cases. 3. The competent authorities of the States shall by mutual agreement settle the mode of application of paragraph 2. 4. 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 cinematograph films or tapes for radio or television broadcasting, any patent, trademark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience. xxx xxx xxx" Under paragraph 4 above, 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 cinematograph films or tapes for radio or television broadcasting, any patent, trademark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience are considered as royalties. Thus, payments made by RTG to Ninive for the right to use the RNG Software are, for tax treaty purposes, royalties. And since RTG is not registered and engaged in preferred areas of activities in the Philippines, such royalty payments to Ninive are subject to 15% income tax based on the gross amount thereof, pursuant to paragraph (2) (b) of Article 12 of the Philippines-Netherlands tax treaty. (BIR Ruling No. ITAD-012-02 dated January 29, 2002; BIR Ruling No. DA-ITAD-041-2002 dated April 5, 2002; BIR Ruling No. DA-ITAD-003-03 dated January 15, 2003; BIR Ruling No. DA-ITAD-100-03 dated July 16, 2003; BIR Ruling DA-ITAD-059-08 dated August 11, 2008) As regards the imposition of the VAT on the license fees to Ninive , please be informed further that Section 108 of the Tax Code of 1997, as amended by Republic Act No. 9337, provides as follows: "SEC. 108. Value-added Tax on Sale of Services and Use or Lease of Properties. (A) Rate and Base of Tax. There shall be levied, assessed and collected, a value-added tax equivalent to ten percent (10%) of gross receipts derived from the sale or exchange of services, including the use or lease of properties: Provided, That the President, upon recommendation of the Secretary of Finance, shall, effective January 1, 2006, raise the rate of value-added tax to twelve percent (12%), after any of the following conditions has been satisfied: '(i) Value-added tax collection as percentage of Gross Domestic Product (GDP) of the previous year exceeds two and four-fifth percent (2 4/5%); or '(ii) National government deficit as percentage of GDP of the previous year exceeds one and one-half percent (1 1/2%). xxx xxx xxx '(1) The lease or the use of or the right or privilege to use any copyright, patent, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or right; xxx xxx xxx" Thus, in general, the VAT is imposed on the royalty payments made to Ninive in the Philippines. On every payment of license fees, RTG is required to withhold such VAT and treat the same as a "passed on" VAT, pursuant to Section 4.110-3 (b) of Revenue Regulations No. 7-95 as amended [now Section 4.114-2 (b) of Revenue Regulations No. 16-05] . DHIcET However, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866, February 11, 2005), the Supreme Court held, viz.: "Applying the special laws we have earlier discussed, respondent as an entity is exempt from internal revenue laws and regulations. This exemption covers both direct and indirect taxes, stemming from the very nature of the VAT as a tax on consumption, for which the direct liability is imposed on one person but the indirect burden is passed on to another. Respondent, as an exempt entity, can neither be directly charged for the VAT on its sales nor indirectly made to bear, as added cost to such sales, the equivalent VAT on its purchases. Ubi lex non distinguit, nec nos distinguere debemus. Where the law does not distinguish, we ought not to distinguish. Moreover, the exemption is both express and pervasive for the following reasons: . . ., RA 7916 states that 'no taxes, local and national, shall be imposed on business establishments operating within the ecozone.' Since this law does not exclude the VAT from the prohibition, it is deemed included. Exceptio firmat regulam in casibus non exceptis. An exception confirms the rule in cases not excepted; that is, a thing not being excepted must be regarded as coming within the purview of the general rule. Moreover, even though the VAT is not imposed on the entity but on the transaction, it may still be passed on and, therefore, indirectly imposed on the same entity a patent circumvention of the law. That no VAT shall be imposed directly upon business establishments operating within the ecozone under RA 7916 also means that no VAT may be passed on and imposed indirectly. Quando aliquid prohibetur ex directo prohibetur et per obliquum. When anything is prohibited directly, it is also prohibited indirectly. xxx xxx xxx" Such being the case, the payment of license fees by RTG, being a CSEZA-registered enterprise, to Ninive under the above Agreement should be, as it is hereby confirmed to be, exempt from VAT. This ruling is issued on the basis of the facts as represented. However, if upon investigation it shall be disclosed that the actual facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. aSIAHC Very truly yours, Commissioner of Internal Revenue By: (SGD.) GREGORIO V. CABANTAC Deputy Commissioner Legal and Inspection Group Footnotes 1. The term of the RTG Master License granted herein shall commence on the date hereof and shall continue until the 10th anniversary thereof, unless sooner terminated as provided herein. 2. "Territory" shall mean all of the Philippines and its islands. 3. "Updates" shall mean, with respect to the RNG Software, all changes, amendments, modifications, corrections, enhancements, replacements, new releases or new versions of such software developed and generally made available by NINIVE. 4. "Documentation" means, with respect to the RNG Software, all operating manuals, user instructions and other related materials relating to such software and generally made available by NINIVE (whether physically or by electronic means) under the terms of this Agreement, including (without limitation), any part or copy thereof, proof of concept, and functionality documentation. 5. "Operator" shall mean each operator located within the Legal Jurisdiction who has entered into a license agreement with RTG, for the license and exploitation within the Territory of the RNG Software. 6. "Player" shall mean those authorized users that access and utilize the RNG Software via the web site in which the RNG Software is offered for play by the Operator. 7. "Legal Jurisdiction" shall mean any country or jurisdiction within the Territory in which online/Internet gaming and/or sportsbook operations are expressly permitted and legal. Without limiting the foregoing, Singapore is not a Legal Jurisdiction. 8. Taxation of Payments for Software. 9. Refer to Footnotes 3 and 7.