First PGMC Enterprises, Inc.

July 14, 2022 ITAD BIR RULING NO. 013-22 Article 11 (2), PH-Hungary Tax Treaty; Sections 28 (B) (1) and (4), 105 and 108, Tax Code, as amended Sycip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Gentlemen : This refers to your tax treaty relief application that was filed on November 8, 2016 requesting confirmation that the royalty payments made by First PGMC Enterprises, Inc. (" FPGMC ") to Aviemore Holdings Limited Liability Company (" Aviemore ") are subject to the preferential income tax rate of 10% pursuant to the "most-favored-nation" (MFN) clause under Article 11 (2) (b) of the Convention between the Republic of the Philippines and the Republic of Hungary for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (PH-Hungary Tax Treaty), in relation to the Agreement between the Government of the Republic of the Philippines and the Government of the United Arab Emirates for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital (PH-UAE Tax Treaty). FACTS Aviemore is a corporation duly organized and existing under the laws of Hungary based on its Deed of Foundation, and a resident thereof based on the Certificate of Residency duly issued by the tax authority of Hungary. It is not registered as a corporation in the Philippines nor licensed to do business in the Philippines per the Certification of Non-Registration of Company duly issued by the Securities and Exchange Commission. Pursuant to its Deed of Foundation, Aviemore is engaged in the leasing of intellectual property and similar products. On the other hand, FPGMC is a domestic corporation engaged in the business of manufacturing, importing, exporting, buying, selling, marketing, distributing at wholesale or otherwise dealing with food and other merchandise item. On September 26, 2016, FPGMC and Aviemore entered into a Trademark License Agreement (the Agreement) whereby the latter granted the former an exclusive, non-transferable license to use its various trademarks in the Philippines and worldwide but in connection with FPGMC's business of producing, distributing and marketing food products. In consideration, FPGMC shall pay Aviemore an annual royalty fee at a rate equal to two and a half percent (2.5%) of FPGMC's net sales of the Products. The Agreement commenced on September 8, 2014 and shall continue unless terminated by Aviemore for reasons stated in the Agreement. RULING In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997 (Tax Code),as amended, income derived by a nonresident foreign corporation is subject to income tax at the rate of 30%: SEC. 28. Rates of Income Tax on Foreign Corporations . xxx xxx xxx (B) 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) and (d) above: 1 However, under Section 32 (B) (5) of the Tax Code, such income is exempt to the extent required by any treaty obligation binding upon the Philippine government: SEC. 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: 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 Being a resident of Hungary, Aviemore invoked the MFN clause under Article 11 (2) (b) of the PH-Hungary Tax Treaty, in relation to Article 12 (2) of the PH-UAE Tax Treaty. The MFN clause is not applicable Under Article 11 (2) (b) of the PH-Hungary Tax Treaty, royalties arising in the Philippines and paid to a resident of Hungary are subject to tax at 15% or at the lowest rate of Philippine tax that may, under similar circumstances, be imposed on royalties derived by a resident of a third State, thus: Article 11 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. Such royalties may also be taxed in the Contracting State in which they arise and according to the laws of that State. However, if the recipient is the beneficial owner of the royalties, the tax so charged shall not exceed the lesser of: a. 15 percent of the gross amount of the royalties, b. the lowest rate of Philippine tax that may, under similar circumstances, be imposed on royalties derived by 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, any patent, trademark ,design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience and includes payments of any kind in respect of motion picture films and works on films or videotapes or video cassettes for use in connection with television or tapes for the use of radio broadcasting. (Emphasis supplied) xxx xxx xxx The MFN clause speaks of 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 this case, Aviemore invoked Article 12 (2) of the PH-UAE Tax Treaty, which provides that royalties arising in the Philippines and paid to a resident of the United Arab Emirates (UAE) may be subjected to a preferential income tax rate of (10%), 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, the 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 10 per cent of the gross amount of the royalties. x x x 3. The term "royalties" as used in this Article 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 cinematographic films and films or tapes for television or radio 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. xxx xxx xxx (Emphasis supplied) It is worth emphasizing that the applicability of the MFN clause is not automatic but is subject to certain conditions. Utmost, Aviemore must be able to prove that the tax on royalties under both treaties is paid under similar circumstances. In Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc. , 2 the Supreme Court construed the phrase "paid under similar circumstances" under the most favored nation clause as referring to circumstances that are tax-related .In other words, the similarity in the circumstances of payment of taxes on the royalties derived from the Philippines is a condition for the enjoyment of the most favored nation treatment . In the recent case of Cargill Philippines, Inc. vs. Commissioner of Internal Revenue , 3 the Court laid down the two conditions that must be met for the most favored nation clause to apply: (1) similarity in subject matter, i.e. ,royalties derived from the Philippines by a resident of Hungary and of the third state must be of the same kind or class; and (2) similarity in circumstances in the payment of tax, i.e. ,the tax consequences of royalty payments under the two treaties must be under similar circumstances. This requires a showing that the method employed for eliminating or mitigating the effects of double taxation under the treaty with Hungary and the third State are the same. It is undisputed that the first condition was satisfied in this case. Both Article 11 (3) of the PH-Hungary Tax Treaty and Article 12 (3) of the PH-UAE Tax Treaty cover royalties for the use of, or the right to use, any copyright of literary, artistic or scientific work, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience. Certainly, the royalty payments made by FPGMC to Aviemore for the use of the latter's trademarks in producing, distributing and marketing its food products in the Philippines and other territories are within the definition of royalties under the said treaty provisions. The Bureau does not agree, however, that the methods employed for eliminating or mitigating the effects of double taxation under the tax treaty with Hungary and UAE are the same. The pertinent provisions of the said tax treaties are as follows: PH-Hungary Tax Treaty PH-UAE Tax Treaty Article 22 ELIMINATION OF DOUBLE TAXATION xxx xxx xxx 2. In the case of Hungary, double taxation shall be eliminated as follows: a) Where a resident of Hungary derives income which in accordance with the provisions of this Convention, may be taxed in the Philippines, Hungary shall, subject to the provisions of sub-paragraphs (b) and (c) exempt such income from tax. b) Where a resident of Hungary derives income which, in accordance with the provisions of Article 9, 10 and 11 may be taxed in the Philippines, Hungary shall allow as a deduction from tax on income of that resident an amount equal to the tax paid in the Philippines. Such deduction shall not, however, exceed that part of the tax, as computed before the deduction is given which is attributable to such items of income derived from the Philippines . xxx xxx xxx (Emphasis supplied) Article 23 ELIMINATION OF DOUBLE TAXATION xxx xxx xxx 2. In the case of the United Arab Emirates, double taxation shall be eliminated as follows: Where a resident of the United Arab Emirates derives income which in accordance with the provisions of this Agreement, may be taxed in the Philippines, the United Arab Emirates shall allow as a deduction from tax on income of that person an amount equal to the tax on income paid in the Philippines .(Emphasis supplied) Based on the foregoing treaty provisions, both countries adopt the credit method for eliminating double taxation. The difference lies, however, in the amount that may be credited against the tax to which a nonresident taxpayer may be liable in Hungary and UAE. While UAE uses the full credit method , i.e. ,the deduction of the total amount of tax paid in the Philippines on income which may be taxed therein, Hungary employs the ordinary credit method , i.e. ,the deduction allowed for the tax paid in the Philippines is restricted to that part of its own tax which is appropriate to the income which may be taxed in the Philippines. In other words, the tax credit allowed in UAE for the tax paid in the Philippines is not subject to any limitation while the tax credit allowed in Hungary is only limited to that part of its own tax which is appropriate or proportionate to the Philippine-sourced income. Therefore, it cannot be said that the tax on royalties under the PH-Hungary Tax Treaty is paid under circumstances similar to the tax on royalties under the PH-UAE tax treaty. In view of the foregoing, the Bureau hereby rules that the MFN clause under the PH-Hungary Tax Treaty cannot apply. Accordingly, the royalty income derived by Aviemore from the Philippines are subject to 15% pursuant to Article 11 (2) (a) of the PH-Hungary Tax Treaty. Value-Added Tax (VAT) Finally, the gross receipts derived by Aviemore from the sale of services to FPGMC are also subject to VAT at the rate of 12% under Section 108 (A),in relation to Section 105, of the Tax Code, to wit: SEC. 105. Persons Liable . Any person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, renders services, and any person who imports goods shall be subject to the value-added tax (VAT) imposed in Sections 106 to 108 of this Code. The value-added tax is an indirect tax and the amount of tax may be shifted or passed on to the buyer, transferee or lessee of the goods, properties or services. This rule shall likewise apply to existing contracts of sale or lease of goods, properties or services at the time of the effectivity of Republic Act No. 7716. The phrase 'in the course of trade or business' means the regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto, by any person regardless of whether or not the person engaged therein is a non-stock, nonprofit private organization (irrespective of the disposition of its net income and whether or not it sells exclusively to members or their guests),or government entity. The rule of regularity, to the contrary notwithstanding, services as defined in this Code rendered in the Philippines by nonresident foreign persons shall be considered as being rendered in the course of trade or business. 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: 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%) x x x. The phrase " sale or exchange of services " means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration x x x. 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; (2) The lease or the use of, or the right to use of any industrial, commercial or scientific equipment; xxx xxx xxx Lease of properties shall be subject to the tax herein imposed irrespective of the place where the contract of lease or licensing agreement was executed if the property is leased or used in the Philippines. The term " gross receipts " means the total amount of money or its equivalent representing the contract price, compensation, service fee, rental or royalty, including the amount charged for materials supplied with the services and deposits and advanced payments actually or constructively received during the taxable quarter for the services performed or to be performed for another person, excluding value-added tax. x x x (Underscoring supplied) Pursuant to Section 105 of the Tax Code, as amended, any person who, in the course of trade or business, renders services, among others, shall be subject to the VAT imposed in Section 108 thereof. Included in the coverage of taxable persons are non-resident persons who perform services in the Philippines and who are deemed to be making sales in the course of trade or business, even if the performance of services is not regular. 4 Section 108 of the Tax Code, on the other hand, states that the gross receipts derived from the sale or exchange of services, including the use or lease of properties, not otherwise falling under the transactions subject to zero percent (0%) rate, are subject to 12% VAT. Under the said provision, the phrase "sale of services" includes not only the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration but also 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 in the Philippines, among others. Thus, the lease or the use of or the right to use Aviemore's trademarks in the Philippines is subject to 12% VAT based on the gross amount of royalties. In accordance with Section 4.114-2 of Revenue Regulations (RR) No. 16-2005, 8 FPGMC shall, before making payment to Aviemore, withhold the 12% VAT using BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld) 9 and shall remit the same within ten (10) days following the end of the month the withholding was made. This ruling is issued on the basis of the facts as represented. However, if it will be disclosed upon investigation that the facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. Very truly yours, (SGD.) LILIA CATRIS GUILLERMO Commissioner of Internal Revenue Footnotes 1. The income tax rate for nonresident foreign corporations was reduced to 25% under Republic Act (RA) No. 11534, otherwise known as an "Act Reforming the Corporate Income Tax and Incentives System, amending for the Purpose Sections 20, 22, 25, 27, 28, 29, 34, 40, 57, 109, 116, 204 and 290 of the National Internal Revenue Code of 1997, as Amended, and Creating Therein New Title XIII, and for Other Purposes" or the CREATE Law. 2. G.R. No. 127105, June 25, 1999, 309 SCRA 87. 3. G.R. No. 203346, September 9, 2020. 4. Sec. 4.105-3, RR No. 16-2005, otherwise known as Consolidated Value-Added Tax Regulations of 2005. 5. Note from the Publisher: Copied verbatim from the official document. Missing footnote reference and footnote text. 6. Note from the Publisher: Copied verbatim from the official document. Missing footnote reference and footnote text. 7. Note from the Publisher: Copied verbatim from the official document. Missing footnote reference and footnote text. 8. Consolidated Value-Added Tax Regulations of 2005, as amended by RR No. 4-2007 (Amending Certain Provisions of Revenue Regulations No. 16-2005, as Amended, Otherwise Known as the Consolidated Value-Added Tax Regulations of 2005). 9. Now BIR Form No. 1600-VT (Monthly Remittance Return of Value-Added Tax Withheld).