DA ITAD BIR Ruling No. 056-06

May 22, 2006 DA ITAD BIR RULING NO. 056-06 Philippines-Singapore tax treaty Article 12 Bernaldo Mirador & Directo Law Offices Unit 1807 Cityland Condominium 10-Tower 1 6815 Ayala Avenue corner H.V. Dela Costa St. Makati City Attention: Atty. Rosario S. Bernaldo Managing Partner Gentlemen : This refers to your letter dated June 9, 2005, on behalf of your client, Cityneon Philippines, Inc. (CPI), requesting confirmation that the service fees paid by CPI to Cityneon International Pte. Ltd. (CIPL) in consideration for services performed by CIPL outside the Philippines are considered as income from sources outside the Philippines and are not subject to Philippine income tax, expanded withholding tax and value-added tax and that CPI shall be allowed to claim such service fees as deduction for income tax purposes. It is represented that CIPL is a nonresident foreign corporation duly organized and existing under laws of Singapore, with principal address at 84 Genting Lane, No. 05-01 Singapore 349584; that CIPL is not registered either as a corporation or as a partnership in the Philippines per certification issued by Securities and Exchange Commission dated May 24, 2005; that CIPL is engaged in the business of providing services for the conceptualization, designing and management of exhibitions and promotional as well as social events; that CIPL possesses substantial valuable knowledge of a specialized nature relating to the management and operation of CPI's business; that CIPL is willing to transfer certain "know-how", technical information, and technical services and assistance related in the management and operation of the business of CPI; that CPI is a corporation duly organized and existing under the laws of the Philippines under SEC Registration No. A1997-5352 with principal office at RMT no. 7 Main Avenue, ACSIE Compound, Severina Industrial Subdivision, Km. 16 West Service Road, South Super Highway, Paraaque City, Metro Manila. It is further represented that on May 12, 2005, CPI and CIPL entered into a Management Service Agreement, whereby, considering the nature of the business of CIPL and its valuable knowledge of specialized nature relating to the management and operation of such business and considering the financial resources and technical exclusivity of the information directly related to the performance of the said services which is being possessed by CIPL, CIPL undertook to transfer certain "know-how", technical information, and technical services and assistance related to the management and operation of the businesses of CPI; that under the Agreement, CIPL shall render services to CPI consisting of the following: a) The scope of the services is either fixed or based on actual consumption or use, but in either case shall cover technical and administrative support for priority tasks, including but not limited to the fields of project development, advertising, financing, controlling and IT as applicable for the purposes of centralized coordination and consultations. b) To determine operating policy, standards of service, the maintenance of assets and any other matters affecting the business operation of CPI. c) To recommend, prepare, supervise and direct all phases of marketing, advertising, sales and business promotion of CPI. d) To carry out all programs contemplated by the annual operating budget and to determine credit policies. e) To hire, supervise and discharge all personnel of CPI including the Executive Staff and to determine employment policies including compensation and entering into any agreements with labor unions, if any. f) To purchase or lease all operating supplies and operating equipment, and additions to, and replacements of, operating equipment and operating supplies. cSIADa g) To hire such persons or organizations as CIPL may deem necessary to provide services, supplies and advice with respect to the operation of CPI provided that such services are previewed in the approved budget. h) To enter into such contracts for the provision of supplies utilities maintenance repairs and services to the operations of CPI as CIPL shall consider necessary or appropriate for its proper operation and maintenance. i) To introduce latest technical know-how on international administrative systems. j) To provide such other related services. that the term of the agreement shall be for a period of five (5) years commencing from January 1, 2005 up to December 31, 2009, renewable upon agreement by both parties; that for the duration of this agreement, Mr. Lim Poh Hock will be assigned to handle this account and that he shall visit the office of CPI not to exceed an accumulative period of twenty (20) days per year or for a maximum of one hundred twenty five (125) days; and that in consideration for the services rendered by the CIPL to CPI, CIPL shall charge CPI annual management and service fees in the amount equivalent to 2% of the total sales plus reimbursable out of pocket expenses, exclusive of 10% value-added tax. In reply, please be informed that the subject payments by CPI to CIPL under their Management Service Agreement are royalties and not business profits pursuant to Article 12 of the Philippines-Singapore tax treaty which provides, as follows: "Article 12 Royalties 1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. 2. However, such royalties may also be taxed in the Contracting State in which they arise, and according to the law of that State, but if the recipient is the beneficial owner of the royalties, the tax so charged shall not exceed: (a) in the case of the Philippines, 15 per cent of the gross amount of the royalties, where the royalties are paid by an enterprise registered with the Philippine Board of Investments and engaged in preferred areas of activities and also royalties in respect of cinematographic films or tapes for television or broadcasting; (b) in the case of Singapore, where the royalties are approved under the Economic Expansion Incentives (Relief from Income Tax) Act of Singapore, the royalties shall be exempt; (c) in all other cases, 25 per cent of the gross amount of the royalties. 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 tapes for television or broadcasting, any patent, trade mark, 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" The treaty defines "royalties" to include " payment of any kind received as a consideration for information concerning industrial, commercial or scientific experience ." According to the commentaries of the ORGANISATION FOR ECONOMIC COOPERATION AND DEVELOPMENT (OECD) Committee on Fiscal Affairs on the Model Tax Convention [par. 11 and 12, Commentary on Article 12 (Royalties), 2003, p. 175], such information alludes to the concept of "know-how" . The definition adopted by the said Committee is, "all the undivulged technical information, whether capable of being patented or not, that is necessary for the industrial reproduction of a product or process, directly and under the same conditions; inasmuch as it is derived from experience, know-how represents what a manufacturer cannot know from mere examination of the product and mere knowledge of the progress of technique." In a know-how contract, one of the parties agrees to impart to the other, so that he can use them for his own account, his special knowledge and experience which can remain unrevealed to the public. (BIR Ruling DA-ITAD No. 57-05 dated June 17, 2005) Further, in the case of Philippine Refining Company vs. CIR CTA Case No. 2872 dated January 15, 1986, the Court of Tax Appeals had an occasion to rule on the distinction of service fees from royalties, to wit: "To distinguish between compensation for service and royalty payments, one must inquire on whether the payee has proprietary interest in the property giving rise to the income. If the payee has none, then the payment is a compensation for personal services, if the payee has proprietary interest then the payment is royalty." Applying the above discussions to the instant case, the herein services of CIPL to CPI under the subject Management Service Agreement, includes the transfer into the Philippines of certain "know-how"/ technical information where CIPL has proprietary interest or which would permit CIPL to impart to CPI its substantial valuable knowledge of a specialized nature which remain unrevealed to the public. Hence, the herein payments constitute as consideration for the transfer of information concerning industrial, commercial or scientific experience. Accordingly, the payments by CPI to CIPL are within the purview of the definition of "royalties" under Article 12 of the Philippines-Singapore tax treaty, quoted as follows: "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 tapes for television or broadcasting, any patent, trade mark, 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." Considering that CPI is not a BOI-registered enterprise, and that the payments are not in respect of cinematographic films or tapes for radio or television or broadcasting, payments made by CPI to CIPL under the Management Service Agreement are subject to tax at the rate of 25 percent of the gross amount thereof. (BIR Ruling No. DA-ITAD 163-00 dated October 30, 2000) Finally, the fees paid by CPI for the services to be rendered by CIPL in the Philippines are subject to the value-added tax (VAT) pursuant to Section 108 of the Tax Code of 1997. 1 With regard to the procedures for withholding and paying the VAT, Sections 4 and 6 of Revenue Regulations No. 4-2000, Section 3 of Revenue Regulations No. 8-2002, and Section 7 of Revenue Regulations No. 14-2002, provide that CPI shall be responsible for the withholding of the VAT on the service fees before remitting them to CIPL. In remitting to the Bureau of Internal Revenue the VAT withheld on the service fees, CPI shall use BIR Form No. 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld). If a VAT-registered taxpayer, CPI may use as documentary substantiation for its claim of input VAT the duly filed BIR Form No. 1600 and the proof of payment accompanying it. If a non-VAT-registered taxpayer, CPI may include as part of the cost of the services furnished to it by CIPL the VAT consequently shifted or passed on to it and may treat such VAT either as an expense or as an asset , whichever is applicable. In addition, CPI is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies thereof to be given to CIPL upon its request, and the fourth copy to be retained by CPI as its file copy. As regards your opinion that the service fees to be paid by CPI to CIPL qualify as deductible business expense under Section 34(a)(1) of the Tax Code of 1997, as amended, please be informed that we decline to rule on the matter considering the factual nature of the issue raised. This ruling is issued based on the facts as represented. However, if upon investigation it shall be disclosed that the facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. HTCDcS Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. Republic Act No. 9337 (An Act Amending Section 27, 28, (An Act Amending Sections 27, 28, 34, 106, 107, 108, 109, 110, 111, 112, 113, 114, 116, 117, 119, 121, 148, 151, 151, 236, 237 And 288 Of The National Internal Revenue Code Of 1997, As Amended, And For Other Purposes), signed into law on May 24, 2005 and became effective on November 1, 2005, amended Section 108(A), which now reads: "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 selling price or gross value in money of the goods or properties sold, bartered or exchanged, such tax to be paid by the seller or transferor: Provided, that the President, upon the 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 a percentage of Gross Domestic Product (GDP) of the previous year exceeds one and one-half percent (1 1/2%); or (ii) National government deficit as a percentage of GDP of the previous year exceeds one and one-half percent (1 1/2%). The phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration . . ." The VAT rate was increased to 12% on February 1, 2006, in accordance with the Memorandum of the Executive Secretary to the Secretary of Finance dated January 31, 2006, as circularized by Revenue Memorandum Circular No. 7-2006 (Publishing the Full Text of the Memorandum from Executive Secretary Eduardo R. Ermita dated January 31, 2006 Approving the Recommendation of the Secretary of Finance to Increase the Value Added Tax Rate from Ten Percent to Twelve Percent) dated January 31, 2006.