DA ITAD BIR Ruling No. 068-07

May 23, 2007 DA ITAD BIR RULING NO. 068-07 Articles 5 (Permanent Establishment), 8 (Business Profits), 13 (Royalties) and 23 (Relief from Double Taxation); Philippines-United States of America tax treaty; BIR Ruling Nos. DA-ITAD 42-06 and 76-06 Rodrigo Berenguer & Guno 4th Floor, Philippine First Building 6764 Ayala Avenue Makati City Attention: Atty. Tomas M. Guno Atty. Cliburn Anthony A. Orbe Gentlemen : This refers to your letter dated December 14, 2004 requesting confirmation that license fees to be paid by The Insular Life Assurance Co., Ltd. (Insular Life) to L.I.D.P. Consulting Services, Inc. (L.I.D.P.) under a Renewal of License Agreement are subject to 10% income tax rate pursuant to the Convention between the Government of the Republic of the Philippines and the Government of the United States of America with Respect to Taxes on Income (Philippines-United States tax treaty). Basic facts It is represented that L.I.D.P. is a corporation organized and existing under the laws of the United States of America, with address at 3590 Hobson Road, Woodridge, Illinois 60517, United States of America; that L.I.D.P. is engaged primarily in the provision of data processing services and in acting as consultants for data processing clients, as stated in its Articles of Incorporation filed at the Office of the Secretary of the State of Illinois on April 23, 1981; that L.I.D.P. is not registered as a corporation or as a partnership in the Philippines, as confirmed by the Certification of Non-Registration of Corporation/Partnership dated December 22, 2004 issued by the Securities and Exchange Commission; and that, on the other hand, Insular Life is a corporation organized and existing under the laws of the Philippines, with address at 18th Floor, Insular Life Corporate Center, Filinvest Corporate City, Alabang 1770, Muntinlupa City, Philippines. It is also represented that on July 11, 1995, L.I.D.P. and Insular Life entered into a License Agreement, whereby L.I.D.P. granted Insular Life a non-assignable, non-transferable and non-exclusive license to use the proprietary software systems therein referred to as the Program Product ; that the License Agreement has a term of five (5) years from July 11, 1995 to July 10, 2000; that on December 20, 2001, L.I.D.P. and Insular Life entered into a Renewal of License Agreement, whereby L.I.D.P. renewed the license it previously granted to Insular Life to use the Program Product (including programs, source code, 1 options, documentation, data and information of said software system) for another six (6) years, retroactive from July 11, 2000 until June 30, 2006; that the Program Product means the proprietary and confidential software system owned by L.I.D.P. (LIDP Life Insurance Software) whether in print, magnetic, electronic or video format and includes both source and object codes, 2 including programs, options, programming techniques, flowcharts, all product lines 3 and data and information and any modifications, 4 enhancements, additions, corrections, improvements, releases, 5 L.I.D.P. enhancements, 6 and any other changes to the software system, and includes also the initial copy of the Program Product (that was delivered to Insular Life in 1995) and any and all full or partial copies of Program Product; that under the Renewal of License Agreement, Insular Life was and continues to be permitted to use the Program Product and Documentation 7 as a Single Site/Single Company License, which permits Insular Life and its employees to use the Program Product and Documentation to administer and process at its premises the product lines solely for its own internal use and benefit; and that in consideration for the license granted, Insular Life will pay L.I.D.P. license fees in accordance with the following schedule: a) The license fee for the period July 11, 2000 to June 30, 2001, amounting to US$148,298.04, has been fully paid by Insular Life and L.I.D.P acknowledged receipt of the fee. HSCcTD b) The license fee for the period July 1, 2001 to June 30, 2002, amounting to US$157,195.80, is to be paid in equal monthly installments of US$13,099.66, on or before the first day of each month. Insular Life will also pay license fees for the periods July 1, 2002 to June 30, 2003, July 1, 2003 to June 30, 2004, July 1, 2004 to June 30, 2005, and July 1, 2005 to June 30, 2006, in equal monthly installments on or before the first day of each month. c) Any increase in the license fee after the first year (July 1, 2001 to June 30, 2002) will not be more than 6% of the immediately preceding license fee, and L.I.D.P. will notify Insular Life of any such increase not later than the first day of June of the applicable year in which the increase will be effective. d) In the event that the Renewal of License Agreement is terminated before June 30, 2006 due to nonpayment of license fees, Insular Life will not be liable for the monthly installments of the license fees remaining after the date of such termination. Upon such termination, the license for the Program Product will cease immediately and Insular Life will at its expense return the Program Product and Documentation to L.I.D.P. It is finally represented that the Renewal of License Agreement has complied with the provisions of Sections 87 and 88, Chapter IX, Part II of the Intellectual Property Code (Republic Act No. 8293) on Voluntary Licensing, as confirmed by Certificate of Compliance No. 5-2002-00071 dated February 20, 2004 issued by the Intellectual Property Office. Ruling A. On income tax In reply, please be informed that the Bureau of Internal Revenue has issued two Revenue Memorandum Circulars (RMCs) that govern the taxation of software payments: RMC 77-2003 (Classification of Payments for Software for Income Tax Purposes) dated November 18, 2003 and RMC 44-2005 (Taxation of Payments for Software) dated September 8, 2005. Under RMC 77-2003, which provides characterization of software payments made or to be made before September 8, 2005, software payments are generally treated as royalties, thus: " Definition of Royalties Includes Payments for the Use of Software : The term "royalties" as generally used means payment 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 films or tapes used for radio or television 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. The term "use" as contained herein shall include the reselling or distribution of software. Software is generally assimilated as a literary, artistic or scientific work protected by the copyright laws of various countries including the Philippines; thus payments in consideration for the use of, or the right to use, a copy or a copyrighted article relating to software are generally royalties." On the other hand, under RMC 44-2005, which provides characterization of software payments made or to be made on or after September 8, 2005, software payments are treated either as business income, royalties, rental income, or capital gains, depending on the nature of the transaction out of which such payments are made. Under this RMC, software payments are treated as royalties only if the transaction does not constitute a sale or exchange and not all substantial rights in the software have been transferred but merely the copyright rights in the software. However, if a person acquires a copy of a software but does not acquire any of the copyright rights in the software (or only acquires a de minimis grant of such rights), and the transaction does not involve the provision of services or of know-how, the acquisition is treated as a transfer of a copyrighted article only and payments for it constitute as business income and not as royalties , thus: "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. ATcEDS 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; 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. b. Transfer of copyrighted articles. A copyrighted article incorporating a software includes a copy of the software from which the work can be perceived, reproduced, or otherwise communicated, either directly or with the aid of a machine or device. The copy of the software may be fixed in the magnetic medium of a floppy disk or a CD-ROM, or in the main memory or hard drive of a computer, or in any other medium. If a person acquires a copy of a software but does not acquire any of the rights described above (or only acquires a de minimis grant of such rights), and the transaction does not involve the provision of services or of know-how, the transfer of the copy of the software is classified solely as a transfer of a copyrighted article and payments for which constitute business income." Taking into account the different tax treatment of software payments under the two RMCs and the mode of payment of the license fees on a monthly basis, pursuant to the old RMC 77-2003, the license fees to be paid by Insular Life to L.I.D.P. for the LIDP Life Insurance Software for the periods July 11, 2000 to June 30, 2001, July 1, 2001 to June 30, 2002, July 1, 2002 to June 30, 2003, July 1, 2003 to June 30, 2004, July 1, 2004 to June 30, 2005, and July 1 to August 31, 2005, are treated as royalties and subject to the reduced income tax under Article 13 of the Philippines-United States tax treaty. On the other hand, pursuant to the new RMC 44-2005, the license fees to be paid by Insular Life to L.I.D.P. for the period September 1, 2005 to June 30, 2006 are treated as business income or business profits and subject to income tax if attributable to a permanent establishment which L.I.D.P. has in the Philippines, under Articles 5 and 8 of the Philippines-United States tax treaty. (i) On license fees treated as royalties Under paragraph 2(b)(iii), Article 13 of the Philippines-United States tax treaty, the license fees to be paid for the periods July 11, 2000 to June 30, 2001, July 1, 2001 to June 30, 2002, July 1, 2002 to June 30, 2003, July 1, 2003 to June 30, 2004, July 1, 2004 to June 30, 2005, and July 1 to August 31, 2005, are subject to the lowest rate of Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State (commonly known as the most-favored-nation tax treatment of royalties): "Article 13 ROYALTIES 1. Royalties derived by a resident of one of the Contracting States from sources within the other Contracting State may be taxed by both Contracting States. 2. However, the tax imposed by that other Contracting State shall not exceed a) In the case of the United States, 15 percent of the gross amount of the royalties, and b) In the case of the Philippines, the least of: (i) 25 percent of the gross amount of the royalties, (ii) 15 percent of the gross amount of the royalties, where the royalties are paid by a corporation registered with the Philippine Board of Investments and engaged in preferred areas of activities, and (iii) the lowest rate of Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State." In relation to the most-favored-nation tax treatment, the Supreme Court, in Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc. and Court of Appeals (G.R. No. 127105 dated June 25, 1999), has cited two conditions for royalties arising in the Philippines and derived by a resident of another country (in this case, the United States) to be subject to a most-favored-nation tax treatment. First , the royalties in question derived by a resident of the other country (the United States) must be of the same kind as those derived by a resident of the third country which are subject to a most-favored-nation tax treatment under the existing tax treaty between the Philippines and the third country. Secondly , the mechanism employed by the other country (the United States) in mitigating the effects of double taxation of foreign-sourced income derived by its residents must be the same with that employed by the third country, which can be determined by taking into account and comparing the articles on Elimination of Double Taxation of the other country (the United States) and the third country under their respective tax treaties with the Philippines. In looking for a third country that grants a most-favored-nation tax treatment, you have cited Germany and, accordingly, the Agreement between the Republic of the Philippines and the Federal Republic of Germany for the Avoidance of Double Taxation with Respect to Taxes on Income and Capital (Philippines-Germany tax treaty), which was signed on July 22, 1983, and whose provisions on taxes apply on income derived or which accrued on or after January 1, 1985. Paragraph 2, Article 12 of the Philippines-Germany tax treaty provides: "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 the tax so charged shall not exceed: a) 15 per cent of the gross amount of royalties arising from the use of, or the right to use, any copyright of literacy, artistic or scientific work including cinematograph films or tapes for television or broadcasting, or b) 10 per cent of the gross amount of royalties arising from the use of, or the right to use, any patent, trade mark, design or model, plan, secret formula or process, or from the use of, or the right to use, industrial, commercial, or scientific equipment, or for information concerning industrial, commercial or scientific experience. TaSEHD For as long as the transfer of technology, under Philippine law, is subject to approval, the limitation of the tax rate mentioned under (b) shall, in the case of royalties arising in the Republic of the Philippines, only apply if the contract giving rise to such royalties has been approved by the Philippine competent authorities." Under paragraph 2, royalties arising in the Philippines and derived by a resident of Germany are subject to (a) 15% income tax for royalties from the use or the right to use of any copyright of literary, artistic or scientific work including cinematograph films or tapes for television or broadcasting, and (b) 10% income tax for royalties from the use or the right to use of any patent, trade mark, design or model, plan, secret formula or process, or from the use of, or the right to use, industrial, commercial, or scientific equipment, or for information concerning industrial, commercial or scientific experience. Because software payments are generally treated as royalties for the use or the right to use of a copyright of literary, artistic or scientific work under RMC 77-2003, the license fees to be paid by Insular Life to L.I.D.P. for the periods in question are subject to 15% income tax based on the gross amount thereof, and not to 10% income tax as requested. As to the second requirement for the most-favored-nation tax treatment that the United States and Germany should employ the same mechanism in mitigating the effects of double taxation of foreign-sourced income derived by their residents, a comparison of the articles on Elimination of Double Taxation in their respective tax treaties with the Philippines reveal that they do not employ such a same mechanism, to wit: Philippines-United States tax treaty : "Article 23 RELIEF FROM DOUBLE TAXATION Double taxation of income shall be avoided in the following manner: 1. In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof, the United States shall allow to a citizen or resident of the United States as a credit against the United States tax the appropriate amount of taxes paid or accrued to the Philippines and, in the case of a United States corporation owning at least 10 percent of the voting stock of a Philippine corporation from which it receives dividends in any taxable year, shall allow credit for the appropriate amount of taxes paid or accrued to the Philippines by the Philippine corporation paying such dividends with respect to the profits out of which such dividends are paid. Such appropriate amount shall be based upon the amount of tax paid or accrued to the Philippines, but the credit shall not exceed the limitations (for the purpose of limiting the credit to the United States tax on income from sources within the Philippines or on income from sources outside the United States) provided by United States law for the taxable year. For the purpose of applying the United States credit in relation to taxes paid or accrued to the Philippines, the rules set forth in Article 4 (Source of Income) shall be applied to determine the source of income. For purposes of applying the United States credit in relation to taxes paid or accrued to the Philippines, the taxes referred to in paragraphs 1(b) and 2 of Article 1 (Taxes Covered) shall be considered to be income taxes." Philippines-Germany tax treaty : "Article 24 RELIEF FROM DOUBLE TAXATION 1. Tax shall be determined in the case of a resident of the Federal Republic of Germany as follows: a) Unless the provisions of subparagraph (b) apply, there shall be excluded from the basis upon which German tax is imposed, any item of income arising in the Republic of the Philippines and any item of capital situated within the Republic of the Philippines which, according to this Agreement, may be taxed in the Republic of the Philippines. The Federal Republic of Germany, however, retains the right to take into account in the determination of its rate of tax the items of income and capital so excluded. In the case of income from dividends the foregoing provisions shall apply only to such dividends as are paid to a company (not including partnerships) being a resident of the Federal Republic of Germany by a company being a resident of the Republic of the Philippines at least 25 per cent of the capital of which is owned directly by the German company. For the purposes of taxes on capital there shall also be excluded from the basis upon which German tax is imposed any shareholding, the dividends which are excluded or, if paid, would be excluded according to the immediately foregoing sentence from the basis upon which German tax is imposed. b) Subject to the provisions of German tax law regarding credit for foreign tax, there shall be allowed as a credit against German income and corporation tax payable in respect of the following items of income arising in the Republic of the Philippines, the tax paid under the laws of the Philippines and in accordance with this Agreement on: (aa) income to which Article 8 applies; (bb) dividends, not dealt with in subparagraph (a); (cc) interest, as defined in paragraph 5 of Article 11; (dd) royalties, as defined in paragraph 3 of Article 12; (ee) gains to which paragraph 3 of Article 13 applies; (ff) remuneration to which Article 16 applies; (gg) income to which Article 17 applies; (hh) income to which the second sentence of paragraph 1 of Article 19 applies; (ii) income to which Article 22 applies. c) For the purpose of credit referred to in subparagraph (b) the Philippine tax shall be deemed to be (aa) in the case of dividends referred to in (bb) of subparagraph (b), 20 per cent of the gross amount of the dividends; (bb) in the case of interest referred to in (cc) of subparagraph (b), 15 per cent of the gross amount of the interest; (cc) in the case of royalties for which the tax is reduced to 10 or 15 per cent according to paragraph 2 of Article 12, 20 per cent of the gross amount of such royalties." For the United States, it uses the ordinary credit method whereby the United States (as country of residence) would limit a taxpayer's allowable tax credit to that portion of the taxpayer's tax liability in the United States that is attributable to income that was taxed in the Philippines (the country of source or situs). As a result of this limitation, if the Philippines has an effective tax rate that exceeds the effective tax rate of the United States on a particular income, the taxpayer would not receive full credit for foreign taxes paid. For Germany, it uses the exemption-with-progression method 8 for one group of income (subparagraph (a), Article 24) and the ordinary credit method for another group of income including royalties (subparagraph (b), Ibid .). However, for dividends, interest and royalties to which the ordinary tax credit applies, Germany provides an additional tax credit or a tax sparing credit of 10% and 5% to these types of income which are either subject to 10% or 15% income tax in the Philippines (subparagraph (c), Ibid .). This tax sparing credit is not available to residents of the United States under the Philippines-United States tax treaty as the United States would limit a taxpayer's allowable tax credit only to that portion of the taxpayer's tax liability in the United States that is attributable to income that was actually taxed in the Philippines. This being the case, the Philippines-Germany tax treaty cannot be used as a basis for the grant of the most-favored-nation tax treatment. Nonetheless, we are pleased to inform you that aside from the Philippines-Germany tax treaty, there are other Philippine tax treaties that provide for a 15% income tax on royalties: for example, the Convention between the Kingdom of the Netherlands and the Republic of the Philippines for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (Philippines-Netherlands tax treaty), which was signed on March 9, 1989, and whose provisions on taxes apply on income derived or which accrued on or after January 1, 1992. The articles on Royalties and Elimination of Double Taxation of the Philippines-Netherlands tax treaty provide: "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 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 literacy, 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." "Article 22 ELIMINATION OF DOUBLE TAXATION xxx xxx xxx 1. The Netherlands, when imposing tax on its residents, may include in the basis upon which such taxes are imposed the items of income which, according to the provisions of this Convention, may be taxed in the Philippines. 2. Without prejudice to the application of the provisions concerning the compensation of losses in the unilateral regulations for the avoidance of double taxation, where a resident of the Netherlands derives items of income which according to Article 6, Article 7, paragraph 6 of Article 10, paragraph 6 of Article 11, paragraph 5 of Article 12, paragraphs 1 and 2 of Article 13, Article 14, paragraph 1 of Article 15, paragraphs 1 and 3 of Article 16, paragraph 2 of Article 18 and Article 19 of this Convention may be taxed in the Philippines and are included in the basis referred to in paragraph 1, the Netherlands shall exempt such items of income by allowing a proportionate reduction of its tax. This reduction shall not, however, exceed that part of the Netherlands tax as computed before the reduction is given, which is otherwise due on the said items of income. 3. Further, the Netherlands shall allow a deduction from the Netherland tax so computed for the items of income which according to paragraph 2 of Article 8, paragraph 2 of Article 10, paragraph 2 of Article 11, paragraph 2 of Article 12 and Article 17 of this Convention may be taxed in the Philippines to the extent that these items are included in the basis referred to in paragraph 1. The amount of this deduction shall be equal to the tax paid in the Philippines on these items of income, but shall not exceed that part of the Netherlands tax which is otherwise due on the said items of income. 4. For the purposes of paragraph 3, where the Philippine tax actually paid on interest and royalties arising in the Philippines is lower than 15 per cent, then, the tax paid in the Philippines on these items of income shall be deemed to be 15 per cent." As to the first condition for the most-favored-nation tax treatment, under paragraph 2 (b), Article 12 of the Philippines-Netherlands tax treaty, royalties for the use or the right to use of any copyright of literary, artistic or scientific work (to which the license fees to be paid by Insular Life to L.I.D.P. for the LIDP Life Insurance Software are assimilated), among others, which are not paid by an enterprise registered and engaged in preferred areas of activities in the Philippines, are subject to 15% income tax based on the gross amount thereof. As to the second condition for the most-favored-nation tax treatment, under paragraph 3, Article 22 of the tax treaty, the Netherlands applies the ordinary credit method to profits from the operation of ships and aircraft in international traffic, and dividends, interest and royalties to the extent they are not effectively connected to a permanent establishment or a fixed base, and income of artistes and athletes. In addition, under paragraph 4 of Article 22, the Netherlands allows a 5% tax sparing credit for interest and royalties subject to 10% income tax in the Philippines; for royalties, under paragraph 2 (a) of Article 12, the 5% tax sparing credit is granted only to Netherlands residents who receive royalties from companies in the Philippines who are registered and engaged in preferred areas of activities in the Philippines. In the case of Insular Life, which is not a registered enterprise engaged in preferred areas of activities in the Philippines (for example, with the Board of Investments), the 5% tax sparing credit could not apply because the royalties to be paid by Insular Life is subject to 15% income tax and not to 10% income tax. Finally, under paragraph 2 of Article 22, the Netherlands applies the exemption-with-progression method to all other types of income. acCDSH In fine, because the two conditions for the most-favored-nation tax treatment of royalties are both present in the Philippines-Netherlands tax treaty, the 15% income tax under paragraph 2 (b), Article 12 of this tax treaty can be availed of. Hence, this Office is of the opinion and so holds that the license fees to be paid by Insular Life to L.I.D.P. for the LIDP Life Insurance Software for the periods July 11, 2000 to June 30, 2001, July 1, 2001 to June 30, 2002, July 1, 2002 to June 30, 2003, July 1, 2003 to June 30, 2004, July 1, 2004 to June 30, 2005, and July 1 to August 31, 2005 are subject to 15% income tax based on the gross amount thereof, pursuant to paragraph 2 (b) (iii), Article 13 of the Philippines-United States tax treaty in relation to Articles 12 and 22 of the Philippines-Netherlands tax treaty. (BIR Ruling Nos. DA-ITAD 76-06 dated June 23, 2006 and DA-ITAD 42-06 dated April 11, 2006) (ii) On license fees treated as business income or business profits On the other hand, with respect to the license fees to be paid by Insular Life to L.I.D.P. for the period September 1, 2005 to June 30, 2006, as stated previously, pursuant to the new RMC 44-2005, such license fees are treated as business income or business profits and subject to income tax if attributable to a permanent establishment which L.I.D.P. has in the Philippines, under Articles 5 and 8 of the Philippines-United States tax treaty. Under RMC 44-2005, when only a copy of a software is acquired but not the copyright rights in the software (or acquired only a de minimis grant of such rights), and the transaction does not involve the provision of services or of know-how, the transfer of the copy of the software is classified solely as a transfer of a copyrighted article and payments for which constitute business income or business profits. Under the Renewal of License Agreement, Insular Life and its employees were merely granted by L.I.D.P. the right to use the LIDP Life Insurance Software as a Single Site/Single Company License, which permits them to use the software to administer and process the product lines solely for its own internal use and benefit at its premises. Under the Agreement, Insular Life and its employees were not granted by L.I.D.P. the following copyright rights in the software mentioned in RMC 44-2005 as: 1. 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; 2. The right to prepare derivative computer programs based upon the software; 3. The right to make a public performance of the software; 4. The right to publicly display the computer program; or 5. Any other rights of L.I.D.P., the exercise of which by Insular Life without the former's authority constitutes infringement of the copyright in the software. This being the case, under Articles 5 and 8 of the Philippines-United States tax treaty, the license fees in question are subject to Philippine income tax only if they are attributable to a permanent establishment which L.I.D.P. has in the Philippines, to wit: "Article 8 BUSINESS PROFITS 1. Business profits of a resident of one of the Contracting States shall be taxable only in that State unless the resident has a permanent establishment in the other Contracting State. If the resident has a permanent establishment in that other Contracting State, tax may be imposed by that other Contracting State on the business profits of the resident but only on so much of them as are attributable to the permanent establishment." TcDaSI "Article 5 PERMANENT ESTABLISHMENT 1. For the purposes of this Convention, the term "permanent establishment" means a fixed place of business through which a resident of one of the Contracting States engages in a trade or business. 2. The term "fixed place of business" includes but is not limited to: a) A seat of management; b) A branch; c) An office; d) A store or other sales outlet; e) A factory; f) A workshop; g) A warehouse; h) A mine, quarry, or other place of extraction of natural resources; i) A building site or construction or assembly project or supervisory activities in connection therewith, provided such site, project or activity continues for a period of more than 183 days; and j) The furnishing of services, including consultancy services, by a resident of one of the Contracting States through employees or other personnel, provided activities of that nature continue (for the same or a connected project) within the other Contracting State for a period or periods aggregating more than 183 days." As defined, a permanent establishment is a fixed place of business through which L.I.D.P. engages in a trade or business, and includes, for example, a branch or an office. Relative thereto, taking into account the Certification of Non-Registration of Corporation/Partnership dated December 22, 2004 issued by the Securities and Exchange Commission which confirmed that L.I.D.P. is not registered either as a corporation or as a partnership licensed to engage in business in the Philippines, this Office is of the opinion and so holds that L.I.D.P. does not have a permanent establishment or a fixed place of business in the Philippines. In such absence, the license fees to be paid by Insular Life to L.I.D.P. for the period, September 2005 to June 2006, are therefore not subject to Philippine income tax. (BIR Ruling No. DA-ITAD 42-06 dated April 11, 2006) cCESTA B. On value-added tax (VAT) Finally, under Section 106 (A) of the National Internal Revenue Code of 1997 (Tax Code), the license fees to be paid by Insular Life to L.I.D.P. for the LIDP Life Insurance Software for all the periods, July 11, 2000 to June 30, 2001, July 1, 2001 to June 30, 2002, July 1, 2002 to June 30, 2003, July 1, 2003 to June 30, 2004, July 1, 2004 to June 30, 2005, and July 1, 2005 to June 30, 2006, are subject to VAT: "SEC. 106. Value-added Tax on Sale of Goods or Properties. (A) Rate and Base of Tax. There shall be levied, assessed and collected on every sale, barter or exchange of goods or properties, a value-added tax equivalent to ten percent (10%) of the gross 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. xxx xxx xxx" 9 With the increase of the VAT rate to 12% on February 1, 2006, consequently, the license fees to be paid in February, March, April, May and June 2006, are subject to the 12% VAT rate. 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 Insular Life shall be responsible for the withholding of the VAT on the license fees before remitting them to L.I.D.P. In remitting to the Bureau of Internal Revenue the VAT withheld on the fees, Insular Life shall use BIR Form No. 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld). If a VAT-registered taxpayer, Insular Life 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, Insular Life may include as part of the cost of the LIDP Life Insurance Software licensed to it by L.I.D.P. the VAT consequently shifted or passed on to it and may treat the VAT either as an expense or an asset, whichever is applicable. In addition, Insular Life is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies for L.I.D.P. and the fourth copy for Insular Life as its file copy. This ruling is issued on the basis of 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. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. Source Code means the set of instructions used to direct computer functions written in computer programming language. 2. Object Code means computer programs in machine-readable form. 3. Product Lines means the different insurance Products Lines that Program Product is designed to administer, consisting of: (1) life insurance products universal life, variable universal life, interest sensitive whole life, ordinary life, term life, first and second to die, (2) annuity products variable annuities, fixed annuities, single premium, flexible premium, guaranteed investment, and (3) health insurance products disability income, long term care, Medicare supplement insurance, hospital expense, major medical. 4. Modifications means any modification, enhancement, addition, correction, improvement, Release or other change to Program Product. 5. Release means a release of the Program Product licensed under the Renewal of License Agreement which is released subsequent to the delivery of the Initial Copy of Program Product to Insular Life and which may include error corrections, improvements and/or enhancements made to the Program Product, but does not necessarily include any modifications specific to Insular Life and does not include new subsystems or capabilities which may be developed by L.I.D.P. 6. L.I.D.P. Enhancements means any and all Modifications, whether in print, magnetic, electronic, video or visual format, to the Program Product and Documentation, including the ideas, processes, formulas, and methods relating thereto. 7. Documentation means the proprietary and confidential user/functional documentation, installation procedures, training materials, and any other materials owned by L.I.D.P. which relate to the use, programming, functioning, and maintenance of Program Product that is supplied by L.I.D.P. to Insular Life whether in print, magnetic, electronic, or video format. 8. Under the principle of exemption, Germany does not tax the income, which according to the tax treaty, may be taxed in the Philippines. The principle of exemption may be applied by two main methods: a) the income which may be taxed in the Philippines is not taken into account at all by Germany for purposes of its tax; Germany is not entitled to take the income so exempted into consideration when determining the tax to be imposed on the rest of the income (full exemption method); b) the income which may be taxed in the Philippines is not taxed by Germany, but Germany retains the right to take that income into consideration when determining the tax to be imposed on the rest of the income (exemption-with-progression method). To illustrate the two methods, suppose a German taxpayer has an income of 150,000, 100,000 of which is derived in Germany and 50,000 in the Philippines. The effective tax rate in Germany is 10% for an income of 100,000 and below, and 20% for an income of more than 100,000. Where Germany applies the full exemption method, the taxpayer is taxed only on income derived in Germany and not on that derived in the Philippines. Germany does not take into consideration the exempted income when determining the tax to be imposed on the rest of the income (100,000) so that the tax to be imposed on such income is 10% only, the applicable rate to an income of 100,000. Where Germany applies the exemption with progression method, the taxpayer is taxed only on income derived in Germany and not on that derived in the Philippines. However, Germany takes into consideration the exempted income when determining the tax to be imposed on the rest of the income (100,000) so that the tax to be imposed on such income is 20%, the rate applicable to an income of 150,000. 9. 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 106 (A) to read as: "SEC. 106. Value-added Tax on Sale of Goods or Properties. (A) Rate and Base of Tax. There shall be levied, assessed and collected on every sale, barter or exchange of goods or properties, a value-added tax equivalent to ten percent (10%) of the gross 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%). 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.