DA ITAD BIR Ruling No. 144-06

November 21, 2006 DA ITAD BIR RULING NO. 144-06 Art. 13, Philippines-United States of America Tax Treaty; BIR Ruling No. DA-ITAD 108-02 Sycip Gorres Velayo & Co . 6760 Ayala Avenue 1226 Makati City Attention: M.F.A. Balili Tax Services Gentlemen : This refers to your letter dated July 28, 2006, filed with this Office on August 21, 2006, requesting confirmation of your opinion that the royalties paid by Warner Bros. (F.E.) Inc. Philippine Branch (Warner Philippines) to Twentieth Century Fox International Corporation (Fox-US) for the use in the Philippines of motion picture films owned by Fox-US are subject to (1) the preferential rate of 15% final withholding tax pursuant to the provisions of Article 13(2)(b)(iii) of the Philippines-United States of America (Philippines-US) tax treaty, and (2) the 12% value-added tax. It is represented that Fox-US is a nonresident foreign corporation and a resident of the United States of America for purposes of U.S. taxation as shown in the Certification dated July 13, 2006 issued by Andrew E. Zuckerman, Field Director, Philadelphia Accounts Management Center, Department of the Treasury, Internal Revenue Service, Philadelphia, PA 19255; that its principal office is located at 10201 West Pico Boulevard, Los Angeles, California; that Fox-US is not registered either as a corporation or as a partnership in the Philippines as confirmed by the Certification of Non-Registration dated August 1, 2006 issued by the Securities and Exchange Commission; that Warner Philippines is a company duly organized under the laws of the State of New York, with its principal offices at 10201 West Pico Boulevard, Los Angeles, California 90035, U.S.A. and the Philippines branch of Warner Bros. (F.E.), Inc., a company duly organized under the laws of the State of Delaware, with its principal branch offices at 4th Floor, Ramon Magsaysay Award Foundation Center, 1680 Roxas Boulevard, Manila. It is further represented that on August 15, 2001, Fox-US and Warner Philippines entered into a Philippines Motion Picture License Agreement whereby the former grants to the latter the exclusive Theatrical Rights in the Language 1 for the Picture(s) in the Territory; 2 that in consideration of the rights granted to Warner Philippines, the former shall pay Fox-US a royalty equal to 92% of Gross Billings accrued in each fiscal year less 100% of the Allowable Distribution Expenses; 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. EACIaT In reply, please be informed that as regards income tax, the royalties for the theatrical rights to be paid by Warner Philippines to Fox-US are subject to the preferential tax rate under Article 13 of the Philippines-US tax treaty, to wit: "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. 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). In relation thereto, 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 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. EacHSA In looking for a third country which grants a most-favored-nation tax treatment on royalties, among the countries you cited you placed emphasis on Russia, particularly, the Convention between the Government of the Republic of the Philippines and the Government of the Russian Federation for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (Philippines-Russia tax treaty), whose provisions on taxes apply on income derived or which accrued January 1, 1998. As to the first condition for the most-favored-nation tax treatment, it is noteworthy that payments for copyright of literary, artistic or scientific work (to which royalties for the theatrical rights to be paid by Warner Philippines to Fox-US are assimilated), which are considered royalties under paragraph 3, Article 13 of the Philippines-United States tax treaty, are likewise considered as such under paragraph 2, Article 12 of the Philippines-Russia tax treaty, to wit: "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, the royalties may also be taxed in the Contracting State in which they arise and according to the laws of the State, but the tax so charged shall not exceed 15 per cent of the gross amount of royalties. xxx xxx xxx" As to the second condition for the most-favored-nation tax treatment, it is also noteworthy that the United States and Russia employ the same mechanism in mitigating the effects of double taxation of foreign-sourced income derived by their residents, that is, the ordinary credit method , as provided under their respective articles on Elimination of Double Taxation of their tax treaties with the Philippines, to wit: United States : "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. DHITCc xxx xxx xxx" Russia : "Article 23 RELIEF FROM DOUBLE TAXATION In the case of the Philippines, double taxation shall be avoided in the following manner: Subject to the provisions of the laws of the Philippines relating to the allowances as credit against Philippine tax of tax payable in any country other than the Philippines, income taxes paid or have accrued under the laws of the Russian Federation and in accordance with this Convention, whether directly or by deduction, in respect of income from sources within the Russian Federation shall be allowed as a credit against Philippines tax payable in respect of that income. In the case of a Philippine corporation owning more than 50 per cent of the voting stock of a Russian company from which it receives dividends in any taxable year, the Philippines shall also allow credit for the appropriate amount of taxes paid or accrued in the Russian Federation to a Russian company paying such dividends with respect to the profits out of which such dividends are paid. The deduction shall not, however, exceed that part of the Philippine income tax, as computed before the deduction is given, which is appropriate to the income which may be taxed in the Russian Federation. In the case of the Russian Federation, double taxation shall be avoided in the following manner: Where a resident of the Russian Federation derives income from the Philippines, the amount of tax of that income payable in the Philippines in accordance with the provisions of this Convention, may be credited against the tax levied in the Russian Federation imposed on that resident. The amount of credit, however, shall not exceed the amount of the Russian tax on that income computed in accordance with taxation laws and regulations of the Russian Federation. Under the ordinary credit method, the United States and Russia (as countries of residence of the income recipient) would limit a taxpayer's allowable tax credit to that portion of the taxpayer's tax liability in their countries that is attributable to the income 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 United States and of Russia on a particular income, the taxpayer would not receive full credit for the income tax imposed by the Philippines on such income. Therefore, because the two conditions for the most-favored-nation tax treatment on royalties are both satisfied, this Office is of the opinion and so holds that the royalties for the theatrical copyrights to be paid by Warner Philippines to Fox-US are subject to the preferential income tax rate of 15% based on the gross amount thereof, under paragraph 2(b)(iii), Article 13 of the Philippines-United States tax treaty in relation to paragraph 2(b)(iii), Article 13 of the Philippines-United States tax treaty in relation to paragraph 2, Article 12 of the Philippines-Russia tax treaty. (BIR Ruling No. DA-ITAD 108-02 dated May 30, 2002) ISCHET Finally, as regards value-added tax (VAT), the royalties for the theatrical rights to be paid by Warner Philippines to Fox-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" 3 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 Warner Philippines shall be responsible for the withholding of the VAT on the royalties before remitting them to Fox-US. In remitting to the Bureau of Internal Revenue the VAT withheld on the royalties, Warner Philippines shall use BIR Form No. 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld). If a VAT-registered taxpayer, Warner 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, Warner Philippines may include as part of the cost of the musical copyrights licensed to it by Fox-US the VAT consequently shifted or passed on to it and may treat such VAT either as expense or asset , whichever is applicable. In addition, Warner Philippines is required to issue in quadruplicate the Certificate of Final Tax Withheld at Source (BIR Form No. 2306), the first three copies for Fox-US and the fourth copy for Warner Philippines 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 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.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. The "Language" shall be Tagalog and English. A Picture shall be deemed to be in the Language if its original soundtrack is in the language, or if its is sub-titled or dubbed in the Language if and as approved by Fox in Advance in writing. The soundtrack on any sub-titled version shall be in the English language. 2. The "Territory" shall be in the Philippines and its respective territories and possessions, as their political borders exist on the Commencement Date. 3. 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, 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, as 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 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.