DA ITAD BIR Ruling No. 106-07

November 16, 2007 DA ITAD BIR RULING NO. 106-07 Article 133 (b) (iii) of the Philippines-United States tax treaty Article 12 (2) (b) of the Philippines China tax treaty RMC 46-2002 BIR Ruling No. DA-ITAD-101-03 Isla Lipana & Co. 29th Floor Philam Tower 8767 Paseo de Roxas 1226 Makati City Attention: Ms. Mary Assumption S. Bautista-Villareal Principal, Tax Services Gentlemen : This refers to your letter dated October 16, 2006, on behalf of your client, Krispy Kreme Doughnut Corporation (KKDC), requesting confirmation of your opinion that the royalties received by KKDC under the Franchise Agreement it entered into with The Real American Doughnut Company (RADC), are subject to a 10% preferential tax rate, pursuant to the most favored nation clause of the Philippines-United States of America (Philippines-United States) tax treaty in relation to the Philippines-China tax treaty. It is represented that KKDC, with office address at 370 Knollwood Street Suite 500, Winston-Salem, NC, USA 27103 is a US corporation and a resident of the United States of America for purposes of U.S. taxation with TIN Number 56-1318322, as certified on September 11, 2006 by the Field Director, Philadelphia Accounts Management Center, Department of Treasury, Internal Revenue Service, Philadelphia, PA.; that, it is not registered either as a corporation or as a partnership in the Philippines per certification issued by the Securities and Exchange Commission dated October 16, 2006; that RADC is a corporation duly organized and existing under the laws of the Philippines with principal address at 4/F Salustiana D. Ty Bldg., Paseo de Roxas St., Makati City 1226. It is further represented that on April 26, 2006, KKDC and RADC entered into an International Franchise Agreement (Agreement) wherein KKDC grants RADC the right to use KKDC's system for a term of fifteen (15) years solely in connection with the conduct and operation of the STORE; 1 that as a consideration of the right granted, RADC shall pay KKDC, an initial franchise fee plus royalties based on the gross sales of the Krispy Kreme Store; and that the issue and transaction subject of the request for ruling filed on behalf of KKDC is not subject of any tax investigation or audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal per certification issued by RADC dated December 19, 2006. In reply please be informed that Article 13 of the Philippines-United States tax treaty provides as follows: "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. EAICTS 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 (ii) 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 . (emphasis supplied) (c) in all other cases, 25 percent 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 cinematograph 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. 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 hereof. "xxx xxx xxx" In relation thereto, Article 12 of the Philippines-China tax treaty provides, viz: "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 recipients is the beneficial owner of the royalties, the tax so charged shall not exceed: HSaCcE (a) 15 percent 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 including cinematograph films or tapes for television or broadcasting, or (b) 10 percent of the gross amount of royalties arising from the use of, or the right to use, any patent, trademark, 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 (Emphasis supplied) Based on the above-mentioned provisions, the tax imposed on royalties derived by a resident of the United States from sources within the Philippines shall be the lowest rate of Philippine tax that may be imposed on royalties of the same kind and paid under similar circumstances to a resident of a third State. Relative thereto, it is noteworthy that under Article 12 (2) (b) of the Philippines-China tax treaty, the tax charged shall not exceed 10% of the gross amount of royalties arising from the use of, or the right to use, any patent, trademark, 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. In the case of Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc. and Court of Appeals, G.R. No. 127105, promulgated on June 25, 1999, the Supreme Court interpreted the "most-favored-nation" clause, particularly the phrase "paid under similar circumstances" under the Philippines-United States tax treaty, as referring to the manner of payment of taxes and not to the subject matter of the tax which is royalties. (BIR Ruling No. DA-ITAD-142-03 dated September 23, 2003) In connection with the manner of payment of taxes, Article 23 of the Philippines-United States tax treaty reads: "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 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. . . . ." On the other hand, Article 23 of the Philippines-China tax treaty provides, viz: Article 23 METHODS FOR THE ELIMINATION OF DOUBLE TAXATION 1. In China, double taxation shall be eliminated as follows: CHcESa Where a resident of China derives income from the Philippines the amount of tax on that income payable in the Philippines in accordance with the provisions of this Agreement, may be credited against the Chinese tax imposed on that resident. The amount of the credit, however, shall not exceed the amount of Chinese tax on that income computed in accordance with the taxation laws and regulations of China. xxx xxx xxx Article 23 of the Philippines-United States tax treaty and Article 23 of the Philippines-China tax treaty, though differently worded, plainly reveal a similarity in the provisions on relief from or avoidance of double taxation to their respective residents. Thus, the tax on royalty payments to residents of US and China are paid under similar circumstances, i.e. , the amount of royalty income tax paid or accrued to the Philippine under the respective tax treaties is available as tax credit against the income tax payable in their respective countries. US residents may, therefore, invoke the preferential tax rate of 10% on royalties, accruing beginning January 1, 2002, 2 arising in be Philippines "from the use of, or the right to use, any patent, trade mark, design or model, plan, secret formula or process, . . ., or for information concerning industrial, commercial or scientific experience" under the Philippines-China tax treaty, pursuant to the "most-favored-nation" clause of the Philippines-United States tax treaty. Such being the case, this Office is of the opinion and so holds that the royalty payments of KKDC to RADC under the subject Agreement are subject to a final withholding tax at the rate of 10% pursuant to the Philippines-China tax treaty. [Revenue Memorandum Circular (RMC) No. 46-2002 dated September 2, 2002; BIR Ruling No. DA-ITAD-101-03 dated July 24, 2003] Furthermore, the royalty fees paid by KKDC are subject to the 12% 3 value-added tax (VAT) pursuant to Section 108 of the Tax Code of 1997, as amended by Republic Act No. 9337. Accordingly, KKDC, being the payor in control of the payment shall be responsible for the withholding of VAT on such fees on behalf of RADC by filing a separate VAT return for and on behalf of the RADC using BIR Form No. 1600 (Monthly Remittance return of Value-Added tax and Other Percentage Taxes Withheld). The duly filed BIR Form 1600 and proof of payment thereof shall serve as sufficient basis for the claim of input tax to be applied against the output tax that may be due from KKDC, if it is a VAT-registered taxpayer. In case KKDC is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost, of the service purchased or treated as an "expense" or an "asset", whichever is applicable. In addition, KKDC 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 RADC upon its request, and the fourth copy to be retained by KKDC as its file copy. [Section 4.110-3 (b), Revenue Regulations (RR) No. 7-95, as amended by RR Nos. 4-02, 8-02, and 14-02 (now Section 4, 114-2 (b), RR No. 16-05); Section 4.1144 (D), RR No. 2-98, as last amended by RR No. 28-03] 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. IcHSCT Very truly yours, Commissioner of Internal Revenue By: (SGD.) GREGORIO V. CABANTAC Deputy Commissioner Footnotes 1. STORE means the Krispy Kreme Store owned and operated by RADC pursuant to the subject Agreement. 2. September 2, 2002. 3. Effective February 1, 2006 rate is 12%.