ITAD BIR Ruling No. 002-12

January 10, 2012 ITAD BIR RULING NO. 002-12 Article 12, Philippines-Finland tax treaty KPI Elevators, Inc. 2nd Floor King's Court 2 Building 2129 Chino Roces Avenue 1231 Makati City Attention: Ms. Melissa Navarro Accounting Manager Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on May 27, 2011, requesting confirmation that royalties to be paid by KPI Elevators, Inc. ( "KPI Elevators") to Kone Corporation ( "Kone") are subject to 25 percent preferential tax rate pursuant to the Convention Between the Republic of the Philippines and the Republic of Finland for the Avoidance of Double Taxation and Prevention of Fiscal Evasion with Respect to Taxes on Income ( "Philippines-Finland tax treaty" ). It is represented that Kone is a corporation organized and existing under the laws of Finland and is a resident thereof based on the Certificate of Fiscal Residence issued by the Large Tax Office of Finland; that it is not registered either as a corporation or as a partnership based on the certification issued by the Securities and Exchange Commission dated May 25, 2011; and that KPI Elevators, on the other hand, is a corporation duly organized and existing under the laws of the Philippines, with principal office at 2nd Floor, King's Court 2 Building, 2129 Chino Roces Avenue, Makati City, Philippines. It is further represented that on January 1, 2009, Kone and KPI Elevators entered into a Franchise Fee Agreement ( "Agreement") whereby the former granted to the latter a non-exclusive license (sub-license as the case may be) to use the following: 1. Kone Technology: 2. Know-How means the body of knowledge, technical experience, skills, methods, processes, tools, technical and confidential information; 3. Show-How means practical advice and support to be provided by Kone to enable sale, installation, maintenance, modernization and repairing of elevators, escalators, autowalks and automated doors in its territory; 4. Trade Marks means the trade marks, service marks, logos, trade or business names and any application for any of the foregoing; and 5. IT systems means a) any software, hardware or systems and related documentation in relation to which Kone owns the Intellectual Property rights provided or made available to KPI Elevators; b) any developments or modifications made to such software, hardware or systems by any company within the Kone Group or otherwise and in relation to which Kone owns the Intellectual Property Rights; c) any associated processes. DHACES for the conduct of the latter's business; that Kone likewise granted a non-exclusive access to use the Third Party Systems 1 for the conduct of its business; that in consideration of the license and other grants by Kone to KPI Elevators, the latter agreed to pay the former a franchise fee, which will be calculated under the Arm's Length Principle as a percentage of KPI Elevator's net sales, benchmarked by reference to analogous third party arrangements, and the parties agree to the benchmarked rate; that this Agreement shall remain in effect through December 31, 2009; and that the Agreement shall be renewed automatically for successive one-year periods thereafter unless either party shall, at least 30 days before the end of the initial term or any subsequent one-year period thereafter, give written notice to the other of its desire to terminate the Agreement. It is finally represented that the royalties subject of the application are not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Certification issued by the Accounting Manager of KPI Elevators on May 18, 2011. In reply, please be informed that Sections 14 and 13 of Revenue Memorandum Order ("RMO") No. 72-2010 2 which was published in the Manila Bulletin on October 20, 2010, and effective November 4, 2010, provide that: "Section 14. When and Where to File the TTRA. All tax treaty relief applications (updated BIR Forms No. 0901-D, 0901-I, 0901-R, 0901-P, 0901-S, 0901-T, 0901-O and 0901-C) relative to the implementation and interpretation of the provisions of Philippine tax treaties shall only be submitted to and received by the International Tax Affairs Division (ITAD). If the forms of any necessary documents are submitted to any other BIR office, the application shall be considered as improperly filed. Filing should always be made BEFORE the transaction. Transaction for purposes of filing the TTRA shall mean before the occurrence of the first taxable event. Failure to properly file the TTRA with ITAD within the period prescribed herein shall have the effect of disqualifying the TTRA under this RMO." (Emphasis Supplied) Relative thereto, please be informed that under Section III (2) of RMO No. 1-00 (Procedures for Processing Tax Treaty Relief Application) ("RMO 1-2000") , any availment of tax treaty relief (exemption from income tax or reduction of tax) shall be preceded by an application filed at the International Tax Affairs Division ("ITAD") of this Bureau at least 15 days before the intended transaction or payment of income, thus: "III. Policies: In order to achieve the above-mentioned objectives, the following policies shall be observed: xxx xxx xxx 2. Any availment of the tax treaty relief shall be preceded by an application by filing BIR Form No. 0901 (Application for Relief from Double Taxation) with ITAD at least 15 days before the transaction i.e., payment of dividends, royalties, etc., accompanied by supporting documents justifying the relief . . ." (Emphasis ours) This condition was emphasized by the Court of Tax Appeals in Mirant (Philippines) Operations Corporation vs. Commissioner of Internal Revenue (C.T.A. Case No. 6382 dated June 7, 2005) where it ruled: " However, it must be remembered that a foreign corporation wishing to avail of the benefits of the tax treaty should invoke the provisions of the tax treaty and prove that indeed the provisions of the tax treaty applies to it, before the benefits may be extended to such corporation. In other words, a resident or non-resident foreign corporation shall be taxed according to the provisions of the National Internal Revenue Code, unless it is shown that the treaty provisions apply to the said corporation, and that, in cases the same are applicable, the option to avail of the tax benefits under the tax treaty has been successfully invoked. aTcIEH Under Revenue Memorandum Order 01-2000 of the Bureau of Internal Revenue, it is provided that the availment of a tax treaty provision must be preceded by an application for a tax treaty relief with its International Tax Affairs Division (ITAD). This is to prevent any erroneous interpretation and/or application of the treaty provisions with which the Philippines is a signatory to. The implementation of the said Revenue Memorandum Order is in harmony with the objectives of the contracting state to ensure that the granting of the benefits under the tax treaties are enjoyed by the persons or corporations duly entitled to the same. The Court notes that nowhere in the records of the case was it shown that petitioner indeed took the liberty of properly observing the provisions of the said order. Petitioner quotes various BIR, as well as ITAD, Rulings issued to several foreign corporations seeking for a tax relief from the office of the respondent. However, not any one of these rulings pertains to the petitioner. It must be stressed that BIR rulings are issued based on the facts and circumstances surrounding particular issue/issues in question and are resolved on a case-to-case basis. It would be thus erroneous to invoke the ruling of the respondent in specific cases, which have no bearing to the case of petitioner." (Emphasis ours) This decision was also upheld by the Supreme Court in a Resolution (G.R. No. 168531) dated February 18, 2008. Furthermore, the necessary requirement laid down in RMO 1-2000 is reiterated in subsequent rulings of the Court of Tax Appeals: Deutsche Bank AG Manila Branch vs. Commissioner of Internal Revenue (C.T.A. Case No. EB 456 dated May 29, 2009), CBK Power Company Ltd. vs. Commissioner of Internal Revenue (C.T.A. Case Nos. 6699, 6844 and 7166 dated March 29, 2010) and Manila North Tollways Corporation vs. Commissioner of Internal Revenue (C.T.A. Case No. 7864 dated April 12, 2011) . cHCaIE In view of the foregoing, with respect to those royalties paid by KPI Elevators to Kone prior to the filing of the TTRA, specifically from January 2009 up to May 27, 2011 , this Office hereby DENIES the use of preferential rate since the TTRA was filed beyond the 15-day period prescribed by the RMO. Accordingly, the said royalties shall be subject to income tax at the rate of 30 percent as provided under Section 28 (B) (1) of the 1997 National Internal Revenue Code, as amended. However, the royalties paid by KPI Elevators to Kone from May 28, 2011 may qualify for preferential tax rate under Article 12 of the Philippines-Finland tax treaty . It 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, if such resident is the beneficial owner of the royalties. 2. Such royalties may also be taxed in the Contracting State in which they arise, and according to the law of that State. However, the tax so charged shall not exceed: a) 15 percent of the gross amount of the royalties, where the royalties are paid by an enterprise registered with and engaged in preferred areas of activities, and also royalties in respect of cinematographic films or tapes for television or broadcasting, and royalties for the use of, or the right to use, any copyright of literary, artistic or scientific work; and b) in all other cases, 25 percent of the gross amount of the royalties. xxx xxx xxx" Under paragraph 1, Article 12 of the Philippines-Finland tax treaty, royalties paid by KPI Elevators to Kone may be taxed in Finland, the country where Kone , the beneficial owner of the royalties, is a resident. Paragraph 2 of the same Article provides that the subject royalties may likewise be taxed in the Philippines, where they arise, but the tax so charged shall not exceed: (a) 15 percent of the gross amount of the royalties if they are paid (i) by an enterprise registered with and engaged in preferred areas of activities, (ii) in respect of cinematographic films or tapes for television or broadcasting, or (iii) for the use or the right to use of a copyright of literary, artistic or scientific work; and (b) 25 percent of the gross amount of the royalties in all other cases. Accordingly, the royalties to be paid by KPI Elevators to Kone from May 28, 2011 under the Franchise Fee Agreement, being essentially royalties for the use or the right to use of trademark, patent, design, and utility model rights, are subject to preferential rate of 25 percent of the gross amount thereof. Moreover, the above royalty payments shall be subject to value-added tax ("VAT") as provided for in Section 108 of the Tax Code, as amended, viz. : "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%) 3 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' means the performance of all kinds of services in the Philippines for others for a fee, . . . . 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; . . ." With regard to the procedures for the withholding and the payment of the VAT, KPI Elevators, being the resident withholding agent and payor in control of payment, shall be responsible for the withholding of the final VAT on such fees before making any payment to Kone . In remitting the VAT withheld, KPI Elevators shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and the proof of payment thereof shall serve as documentary substantiation for the claim of input tax to be applied against the output tax that may be due from KPI Elevators if it is a VAT-registered taxpayer. In case KPI Elevators is not VAT-registered, the passed-on VAT withheld shall form part of the cost of the service purchased and may treat such VAT as an "expense" or as an "asset", whichever is applicable. In addition, KPI Elevators is required to issue in quadruplicate a Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies for Kone and the fourth copy for KPI Elevators as its file copy. (Sections 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 of RR 8-2002; Section 7 of RR 14-2002) caHCSD 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, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Third Party Systems mean a software, hardware or systems and related documentation in relation to which a third party owns the Intellectual Property Rights provided or made available to KPI Elevators by Kone in accordance with this Agreement and in relation to which Kone has the right to sub-license the right to use that system to KPI Elevators. 2. Guidelines on the Processing of Tax Treaty Relief Applications pursuant to existing Philippine Tax Treaties dated August 25, 2010. 3. 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.