DA ITAD BIR Ruling No. 059-08

August 11, 2008 DA ITAD BIR RULING NO. 059-08 Article 12, Philippines-Netherlands tax treaty; BIR Ruling No. DA-ITAD 127-05 Nisce Mamuric Guinto Rivera & Alcantara Law Offices 8th Floor, 139 Corporate Center 139 Valero Street, Salcedo Village Makati City Attention: Atty. Jose Roberto L. Mamuric Atty. Perly Anne A. Pe Gentlemen : This refers to your letter dated April 16, 2007, requesting a confirmatory ruling that royalty payments made by International Specialty Concepts, Inc., (ISCI-Philippines) to ITX Merken B.V. (ITX-Netherlands) under a Contract for Franchise Distribution are subject to the preferential tax rate of fifteen percent (15%) pursuant to Article 12 of the Philippines-Netherlands tax treaty. cDTHIE It is represented that ITX-Netherlands is a nonresident foreign corporation organized and existing under the laws of the Netherlands with principal office address located at Nieuwezijds Voorburgwal 307 1012 RM, Amsterdam, The Netherlands; that ITX-Netherlands is not registered either as a corporation or as a partnership in the Philippines as evidenced by a Certificate of Non-Registration dated January 3, 2007 issued by the Securities and Exchange Commission; that ISCI-Philippines is a domestic corporation with office address at 5/F Midland Buendia Bldg., 403 Sen. Gil Puyat Avenue, Makati City. It is further represented that on July 1, 2005, ITX-Netherlands and ISCI-Philippines entered into a Contract for Franchise Distribution which is entered into on account of the following: "FIRST. That ITX-Netherlands is a Dutch company, belonging to the 'INDITEX Group', that owns the rights of the exploitation of the know-how of the 'ZARA' chain, and of the trademarks and other signs of industrial property used in this chain of stores. SECOND. That ITX-Netherlands has developed specific distribution methods, sales-point design and shop management that have meant that the brand 'ZARA' is recognized in the market as a distinctive sign of a chain of stores engaged in the sale of clothes, shoes and accessories, having achieved great commercial prestige. This fame is fundamentally based on trademark 'ZARA' in the classes of the International Classification of Goods and Services connected with the textile activity, which is legally used and managed by ITX-Netherlands. THIRD. That ISCI-Philippines is interested in setting up and running in the Philippines, shops under the name of "ZARA" using the particular 'know-how' of this chain of stores, using its trademarks and other rights of industrial property and in brief selling exclusively the products belonging to this trademark under an exclusive commercial distribution system. FOURTH. That ISCI-Philippines recognizes and accepts the importance for ITX-Netherlands for the different companies which make up the same business group and for other possible future distributors, of maintaining the special characteristics of the above described business so that the image of 'ZARA' stores does not deteriorate with respect to the public. ISCI-Philippines equally recognizes the special singular relationship that must bind it to ITX-Netherlands and the mutual benefits to be derived from respect towards the criteria and commercial policies made, as well as the necessity to establish continuous communication channels and collaboration between both parties even though they retain the position of individual employers. xxx xxx xxx" That under the Contract, ITX-Netherlands (Franchisor) grants to ISCI-Philippines (Franchisee) a right to run a "ZARA" franchise under the following terms and conditions embodied therein, and which consist of: a) The authorization to open in the Philippines, under the "ZARA" shop-sign, the stores that have been expressly approved by the Franchisor, for the sale of clothing, footwear and accessories. b) The Franchisee's use of the specific methods of sales-point design, shop management and product display developed and carried out by the Franchisor in the "ZARA" stores. aIHCSA c) The Franchisee's use of the distinctive signs of industrial property (trademarks and shop-sign) for clothes, footwear and accessories used in the "ZARA" chain of stores, in classes 18th and 25th of the International Classification of Good and Services provided in the Nice Convention of 15 June 1957. d) The Franchisor shall give the Franchisee commercial assistance for the duration of the franchise under the conditions which are detailed in the other parts of the Contract. That in consideration thereof, ISCI-Philippines will pay ITX-Netherlands 5.89% of its turnover during the previous six-month term; 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 the pertinent paragraphs of Article 12 of the Philippines-Netherlands tax treaty provide 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. 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 percent 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 percent 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. IaHDcT 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, "royalties" 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. Thus, payments made by ISCI-Philippines to ITX-Netherlands for the right to run "ZARA" franchise are, for tax treaty purposes, royalties. And since ISCI-Philippines is not registered and engaged in preferred areas of activities in the Philippines, such royalty payments to be paid by it to ITX-Netherlands are subject to 15 percent 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. DA-ITAD 127-05 dated November 9, 2005) Finally, as regards value-added tax (VAT), the royalties paid by ISCI-Philippines to ITX-Netherlands are subject to 10% VAT under the old Section 108 (A) (1) of the National Internal Revenue Code of 1997 (Tax Code) and Section 108 (A) (1) of the Tax Code as amended 1 for payments made from July 1, 2005 to January 31, 2006. However, royalty payments made from February 1, 2006 shall be subject to 12% VAT. 2 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 ISCI-Philippines shall be responsible for the withholding of the VAT on the royalties before remitting them to ITX-Netherlands. In remitting to the Bureau of Internal Revenue the VAT withheld on the royalties, ISCI-Philippines shall use BIR Form No. 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld). If a VAT-registered taxpayer, ISCI-Philippines 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, ISCI-Philippines may include as part of the cost of the software products licensed to it by ITX-Netherlands 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, ISCI-Philippines is required to issue in quadruplicate the Certificate of Final Tax Withheld at Source (BIR Form No. 2306), the first three copies for ITX-Netherlands and the fourth copy for ITX-Philippines as its file copy. HCEISc 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. Very truly yours, Commissioner of Internal Revenue By: (SGD.) GREGORIO V. CABANTAC Deputy Commissioner Footnotes 1. 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. . . . The phrase 'sale or exchange of services' shall likewise include: (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" 2. Republic Act No. 9337 (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), which was signed into law on May 24, 2005 and became effective on November 1, 2005, amended Section 108 (A) to read as: "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 two and four-fifth percent (2 4/5%); 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' shall likewise include: (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" 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. ACHEaI