DA ITAD BIR Ruling No. 105-08

December 12, 2008 DA ITAD BIR RULING NO. 105-08 Arts. 13, Philippines-United States of America Tax Treaty; BIR Ruling No. DA-ITAD 60-07 Sycip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: Mark Anthony P. Tamayo Partner, Tax & Customs Services Gentlemen : This refers to your letter dated February 20, 2008 requesting confirmation of your opinion that the royalties paid by Monsanto Philippines, Inc. (Monsanto-Philippines) to Monsanto Company (Monsanto-US) are subject to preferential tax rate of ten percent (10%) of the gross amount of royalty payments in accordance with the "most favored nation" clause of the Philippines-United States of America (Philippines-US) tax treaty in relation to the provisions of the Philippines-Czech Republic tax treaty. It is represented that, Monsanto-US is a corporation organized and existing under the laws of the United States of America as evidenced by its Amended and Restated Certificate of Incorporation; that its principal office is at 800 North Lindbergh Boulevard, St. Louis, Missouri, 63167, U.S.A.; that Monsanto-US is not registered either as a corporation or as a partnership in the Philippines as confirmed by the Certification of Non-Registration dated February 28, 2008 issued by the Securities and Exchange Commission; that Monsanto-Philippines is a domestic company with principal office at 7th Floor Ayala Life-FGU Center, Alabang-Zapote Road, Alabang, Muntinlupa City. It is further represented that on February 1, 2004, Monsanto-US and Monsanto-Philippines entered into a License Agreement whereby the former grants to the latter a non-exclusive, non-transferable license, with right of sublicense (the "License") to Licensed Patents, 1 Licensed Trademarks 2 and Technical Information, 3 to the extent Monsanto-US is legally authorized to do so, to use the same for and in connection with the manufacture, sale, marketing, advertising, promotion and distribution of Products 4 with the Territory, 5 upon the terms and subject to the conditions set forth therein; that without limitation of the foregoing, Monsanto-Philippines may use grade or type designations in connection with Licensed Trademarks, which grade or type designations are also used by Monsanto-US in connection with such Licensed Trademarks only if the Products on or in relation to which such grade or type designations used are made in accordance with specifications, standards and directions supplied or approved in writing by Monsanto-US; that in consideration of such License granted under the Agreement, Monsanto-Philippines shall pay Monsanto-US an amount equal to two percent (2%) of Monsanto-Philippines' total Net Sales for each of the Products which Monsanto-Philippines, or anyone authorized by Monsanto-Philippines, manufactures and sells; that this Agreement shall commence on Effective Date 6 and, subject to earlier termination in accordance with any provision of this Agreement, shall remain in effect for a period of five (5) years, and shall be automatically renewed for successive one (1)-year periods, unless and until terminated earlier by either party hereto by not less than ninety (90) days prior written notice to the other party hereto, subject, however, to the provisions set forth in this Agreement; and that the issue or transaction subject of 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. cITaCS In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997 as amended, applies in general to royalty payments received by non resident foreign corporations. It provides: "Section 28. Rates of Income Tax on Foreign Corporations . xxx xxx xxx (8) 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: STIcEA 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" In relation thereto, the provisions of the Philippines-US tax treaty may apply to your instant request for relief particularly its Article 13, which provides: "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 TSHcIa (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. 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 films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or other like right or property, or for information concerning industrial, commercial or scientific experience. The term 'royalties' also includes gains derived from the sale, exchange or other disposition of any such right or property which are contingent on the productivity, use, or disposition thereof. xxx xxx xxx" Paragraph 2 (b) (iii) above provides that royalties arising in the Philippines and derived by a resident of the United States shall be subject to the lowest rate of Philippine income 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), 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 qualified for 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 the most favored-nation tax treatment under the existing tax treaty between the Philippines and the third country. Second, 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 respective 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 which grants a most-favored-nation tax treatment on royalties, you cited the Czech Republic, particularly, the Convention between the Government of the Republic of the Philippines and the Government of the Czech Republic for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (Philippines-Czech tax treaty), which entered into force on September 23, 2003, and whose provisions on taxes apply on income derived or which accrued beginning January 1, 2004. Article 12 of this 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 laws of that State, but if the beneficial owner of the royalties is a resident of the other Contracting State, the tax so charged shall not exceed: ECaITc a) 10 per cent of the gross amount of the royalties arising from the use of, or the right to use, any copyright of literary, artistic or scientific work, other than that mentioned in sub-paragraph (b), 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; b) 15 per cent of the gross amount of the royalties arising from the use of, or the right to use, any copyright of cinematograph films, and films or tapes for television or radio broadcasting. The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of these limitations. xxx xxx xxx" According to paragraph 2, royalties arising in the Philippines and derived by a resident of Czech are subject to income tax at the rate of (a) 10% of the gross amount of the royalties arising from the use of, or the right to use, any copyright of literary, artistic or scientific work (except those for cinematograph films, and films or tapes for television or radio broadcasting), 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, or (b) 15% of the gross amount of the royalties for royalties arising from the use of, or the right to use, any copyright of cinematograph films, and films or tapes for television or radio broadcasting. Applying the Philippines-Czech tax treaty, the royalty fee to be paid by Monsanto-Philippines to Monsanto-US for the right to use of the Licensed Patents, Licensed Trademark and Technical Information, may be subject to 10% based on the gross amount thereof, provided the two conditions for the most-favored-nation tax treatment of royalties (as described above) are both satisfied. HIEAcC On whether the first condition is satisfied, we note that under paragraph 3, Article 13 of the Philippines-US tax treaty quoted below, payments received as a consideration for the use or the right to use of patents, information concerning industrial, commercial or scientific experience (know-how), and copyright of literary, artistic or scientific work (to which the royalty fee for the use or the right to use of the Licensed Patents, Licensed Trademark and Technical Information, are assimilated, (respectively) are all considered royalties, thus: "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 films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or other like right or property, or for information concerning industrial, commercial or scientific experience. The term 'royalties' also includes gains derived from the sale, exchange or other disposition of any such right or property which are contingent on the productivity, use, or disposition thereof." In the same manner, although lacking a separate paragraph for the definition of royalties in its article, paragraph 2 (a), Article 12 of the Philippines-Czech tax treaty, as quoted above, provides that royalties arising from the use or the right to use of patents, information concerning industrial, commercial or scientific experience (know-how), and copyright of literary, artistic or scientific work, among others, are subject to income tax rate of 10% of the gross amount thereof. This being the case, the first condition for the most-favored-nation tax treatment of royalties is satisfied, which requires the royalties derived by a resident of the US must be of the same kind as those derived by a resident of Czech. As to the second condition, under paragraph 1, Article 23 of the Philippines-US tax treaty below, the mechanism employed in mitigating the effects of double taxation of income from foreign source is the ordinary credit method. It provides: CHDTIS "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. xxx xxx xxx" Under the ordinary credit method the, US (as country of residence) would limit a taxpayer's allowable tax credit to that portion of the taxpayer's tax liability in the US that is attributable to the income that is taxed in the Philippines (the country of source or country of situs). As a result of this limitation, if the Philippines has an effective tax rate that exceeds the effective tax rate of the US on a particular income, the US would not grant the taxpayer a full credit for the income tax imposed by the Philippines on such income. In the same manner, under paragraph 2, Article 22 of the Philippines-Czech tax treaty below, it can be seen that ordinary credit method is also employed by Czech as a mechanism for mitigating the effects of double taxation of income derived by its residents from foreign sources, thus: "Article 22 Elimination of Double Taxation xxx xxx xxx 2. In the case of a resident of the Czech Republic, double taxation shall be eliminated as follows: ESCacI a) The Czech Republic, when imposing taxes on its residents, may include in the tax base upon which such taxes are imposed the items of income which according to the provisions of this Convention may also be taxed in the Philippines, but shall allow as a deduction from the amount of tax computed on such a base an amount equal to the tax paid in the Philippines. Such deduction shall not, however, exceed that part of the Czech tax, as computed before the deduction is given, which is appropriate to the income which, in accordance with the provisions of this Convention, may be taxed in the Philippines. b) Where in accordance with any provision of the Convention income derived by a resident of the Czech Republic is exempt from tax in the Czech Republic, the Czech Republic may nevertheless, in calculating the amount of the tax on the remaining income of such resident, take into account the exempted income. xxx xxx xxx" This being the case, the second condition for the most-favored nation tax treatment of royalties, which requires that the mechanism employed by the US in mitigating the effects of double taxation of income derived by its residents from foreign sources must be the same with that employed by Czech, is also satisfied. In fine, by reason that the conditions for the most-favored-nation tax treatment of royalties laid down by the Supreme Court in the S.C. Johnson case are both satisfied, royalty fees to be paid by Monsanto-Philippines to Monsanto US for the use or the right to use of the Licensed Patents, Licensed Trademark and Technical Information, beginning February 1, 2004, is subject to 10% income tax based on the gross amount thereof. (BIR Ruling No. DA-ITAD 60-07 dated May 11, 2007) SCIacA Finally, as regards value-added tax (VAT), the royalties for the use or the right to use of the Licensed Patents, Licensed Trademark and Technical Information to be paid by Monsanto-Philippines to Monsanto-US are subject to VAT under Section 108 (A) of the National Internal Revenue Code of 1997 (Tax Code), as amended, to wit: "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" 7 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 Monsanto-Philippines shall be responsible for the withholding of the VAT on the royalties before remitting them to Monsanto-US. In remitting to the Bureau of Internal Revenue the VAT withheld on the royalties, Monsanto-Philippines shall use BIR Form No. 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld). If a VAT-registered taxpayer, Monsanto-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. In addition, Monsanto-Philippines is required to issue in quadruplicate the Certificate of Final Tax Withheld at Source (BIR Form No. 2306), the first three copies for Monsanto-US and the fourth copy for Monsanto-Philippines as its file copy. cEAIHa 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. "Licensed Patents" shall mean all patents and patent applications in the Territory now owned or licensed, or hereafter acquired or licensed during the Term of this Agreement, by and on behalf of Monsanto-US relating to the manufacture, use, sale, marketing, advertising, promotion and/or distribution of the Products and any thereof, provided however, that Licensed Patents shall not, under any circumstances, include patents and patent applications relating to genes, recombinant DNA, genetic events, promoters, plants plant cells, or tests or kits for the detection of any of the foregoing. 2. "Licensed Trademarks" shall mean all trademarks, registered or not, and trademark applications in the Territory now owned or licensed, or hereafter acquired or licensed during the Term of this Agreement, by or on behalf of Monsanto-US, adopted or used in connection with the Products and any thereof, including without limitation, the trademark ROUNDUP. 3. "Technical Information" shall mean and include any and all technical information, know-how, trade secrets, inventions, data, technology and other information now owned or licensed by Monsanto-US, or hereafter acquired or licensed by Monsanto-US during the Term of this Agreement, in connection with the Products or any thereof, including, without limitation, (i) all manufacturing data and protocols, as well as engineering information, relating to the Products or useful for the development of the Products, (ii) processes and analytical methods used in the development, testing and analysis of the Products; (iii) new or improved operating procedures, research and pilot plant technology, design information on manufacturing plants and equipment, raw material specifications, Product applications and end uses for Products or any thereof; and (iv) packaging, manufacturing, advertising, marketing and/or distribution data. "Technical Information" shall not include any data or other information whatsoever relative to costs, prices, proof margins, customers or customer relationships, sales volumes, market areas or quantities of Products as actually produced. acCITS 4. "Products" shall mean certain agricultural and residential chemicals and animal agricultural products manufactured using any Licensed Patents, Licensed Trademarks and Technical Information, which products generally belong to the product groups listed on Exhibit A to this Agreement, including improvements, modifications and variations made by or on behalf of Monsanto-Philippines during the term of this Agreement (as such Exhibit A may be amended from time to time upon mutual agreement of the parties hereto). 5. "Territory" shall mean the Philippines, unless otherwise expressly specified in this Agreement. 6. February 1, 2004. 7. 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: IcADSE (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' 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.