ITAD BIR Ruling No. 015-16

March 11, 2016 ITAD BIR RULING NO. 015-16 Articles 13 & 23, Philippines-United States tax treaty; Articles 12 & 22, Philippines-Czech tax treaty Petron Corporation San Miguel Head Office Complex No. 40, San Miguel Avenue Mandaluyong City Attention: Joel Angelo C. Cruz AVP-General Counsel and Corporate Secretary Gentlemen : This refers to your application for tax treaty relief filed on December 7, 2011 requesting confirmation that the license fees to be paid by Petron Corporation ("Petron") to Belco Technologies Corporation ("Belco USA") are subject to the preferential rate of 10 percent pursuant to the Convention between the Government of the Republic of the Philippines and the Government of the United States of America with Respect to Taxes on Income ("Philippines-US tax treaty") in relation to the Agreement between the Government of the Republic of the Philippines and the Government of the People's Republic of China for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income . ("Philippines-China Republic tax treaty") . Basic Representations It is represented that Belco USA is a taxpayer of the United States of America (USA) for the year 2011, as evidenced by a Certificate dated June 20, 2011 issued by the Department of Treasury, Internal Revenue Service of USA; that Belco USA is organized under the General Corporation Law of the State of Delaware with registered office at the Corporation Trust Center, 1209 Orange Street, City of Wilmington, County of New Castle, Delaware based on its Certificate of Incorporation; that Belco USA is not registered either as a corporation or as a partnership in the Philippines per Certification issued by the Securities and Exchange Commission dated December 9, 2011; and that, on the other hand, Petron is a domestic corporation with principal address at San Miguel Head Office Complex No. 40, San Miguel Avenue, Mandaluyong City. It is further represented that on November 17, 2011, Belco USA and Petron entered into an Agreement for EDV Wet Scrubbing System License for the RMP-2 Fluidized Catalytic Cracking Unit ("Agreement") whereby Belco USA shall provide Petron the License Package for the FCC Flue Gas Scrubber Unit of the Petron Bataan Refinery Master Plan 2; that in consideration of the license, Petron shall pay Belco USA $490,000.00 according to the following schedule : Percentage Due 10% upon signing of the Agreement 40% upon submission of P&IDs 50% upon submission of PDP books that Citibank, N.A. effected the following outward remittances for Petron in favor of Belco USA based on the Certification issued by Citibank, N.A. dated September 19, 2012: Date Amount (USD) 3-Jan-12 49,000.00 8-Mar-12 400,000.00 12-Apr-12 245,000.00 It is represented finally, that the issue/s or transaction subject of the above request for ruling is not under investigation, neither is it subject of an on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings nor a judicial appeal based on the Sworn Statement issued by the AVP-General Counsel and Corporate Secretary of Petron dated December 6, 2011. DETACa In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997 (NIRC of 1997), as amended. It provides: "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 . . . royalties . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, income derived by Belco USA in the Philippines, may be exempt from income tax or may be subjected to a preferential tax rate, if such income, in this case royalties, are excluded from gross income pursuant to Section 32 (B) (5) of the same Code provides: "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" With respect to a treaty that you invoked the Philippines-United States tax treaty, Article 13 of which provides: "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." HEITAD In accordance with the foregoing, the Philippines-US tax treaty , particularly its Article 13, may apply to the subject royalty fees received by Belco USA under the subject Agreement. Article 13 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 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. xxx xxx xxx" According to paragraph 2 (b) above, royalties arising in the Philippines and derived by a resident of the United States are subject to (a) 25 percent of the gross amount of the royalties for royalties in general, (b) 15 percent of the gross amount of the royalties if they are paid by a corporation registered with the Philippine Board of Investments and engaged in preferred areas of activities, and (c) 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. Concerning (c) or commonly known as the "most-favored-nation" tax treatment of royalties, the Supreme Court, in the case of the Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc. and the Court of Appeals (the S.C. Johnson case), 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 derived by the resident of the other country must be of the same kind as those derived by a resident of the third country, which are subject of a most-favored-nation tax treatment under the existing tax treaty between the Philippines and that third country. Second, in mitigating the effects of double taxation of income derived by its residents from foreign sources, the mechanism employed by the other country for this purpose must be the same with that employed by the third country also, which can be determined by taking into account and comparing the respective articles on Elimination of Double Taxation of the tax treaties with the Philippines of the other country and of the third country. Pursuant to the "most-favored-nation" clause in Article 13 (2) (b) (iii) of the Philippines-United States tax treaty, 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 paid under similar circumstances to a resident of a third State. In relation to the most-favored-nation treatment, 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) ("S.C. Johnson case") , required two conditions for this treatment to apply. First , royalties arising in the Philippines and paid to a resident of the United States must be of the same class as those derived in the Philippines by a resident of a third State to which the tax treaty between the Philippines and the third State subjects such royalties to a most-favored-nation treatment. Second , in eliminating or mitigating the effects of double taxation on royalties, the United States must allow to its resident the same amount of tax credit or deduction as that allowed by the third State to the latter's resident against the income tax due of that resident in the third State with respect to the royalties. Pertinent portion of this ruling reads: "The purpose of a most favored nation clause is to grant to the contracting party treatment not less favorable than that which has been or may be granted to the 'most favored' among other countries. The most favored nation clause is intended to establish the principle of equality of international treatment by providing that the citizens or subjects of the contracting nations may enjoy the privileges accorded by either party to those of the most favored nation. The essence of the principle is to allow the taxpayer in one state to avail of more liberal provisions granted in another tax treaty to which the country of residence of such taxpayer is also a party provided that the subject matter of taxation, in this case royalty income, is the same as that in the tax treaty under which the taxpayer is liable. Both Article 13 of the RP-US Tax Treaty and Article 12 (2) (b) of the RP-West Germany Tax Treaty, above-quoted, speaks of tax on royalties for the use of trademark, patent, and technology. The entitlement of the 10% rate by U.S. firms despite the absence of a matching credit (20% for royalties) would derogate from the design behind the most favored nation clause to grant equality of international treatment since the tax burden laid upon the income of the investor is not the same in the two countries. The similarity in the circumstances of payment of taxes is a condition for the enjoyment of most favored nation treatment precisely to underscore the need for equality of treatment . We accordingly agree with petitioner that since the RP-US Tax Treaty does not give a matching tax credit 20 percent for the taxes paid to the Philippines on royalties as allowed under the RP-West Germany Tax Treaty, private respondent cannot be deemed entitled to the 10 percent rate granted under the latter treaty for the reason that there is no payment of taxes on royalties under similar circumstances. " (Emphasis ours) For this purpose, you cite the Philippines-China tax treaty. Under paragraph 2 (b), Article 12 thereof, royalties (except royalties 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) arising in the Philippines and paid to a resident of China are subject to income tax at the rate of 10 percent, provided the contract giving rise to the royalties has been approved by the Philippine competent authorities, 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, 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 recipient is the beneficial owner of the royalties, the tax so charged shall not exceed: a) 15 per cent of the gross amount of 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 per cent of the gross amount of royalties arising from the use of, or the right to use, 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. ATICcS For as long as the transfer of technology, under Philippine law, is subject to approval, the limitation of the tax rate mentioned under (b) shall, in the case of royalties arising in the Republic of the Philippines, only apply if the contract giving rise to such royalties has been approved by the Philippine competent authorities ." Concerning the first requirement , royalties for the use of the Payless ShoeSource System and the Marks, being essentially royalties for the use of trade mark, design, model or plan , are within the definition of royalties under the Royalties article of the Philippines-United States and the Philippines-China tax treaties, to wit: United States: 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." China: "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 cinematography films, or films or tapes for radio or television 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." Concerning the second requirement , under the Relief from Double Taxation article of these treaties, income tax paid or withheld in the Philippines on royalties arising therein and paid to a resident of the United States and a resident of China is allowed as a tax credit or deduction against the income tax of these residents in their respective countries, 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. . ." China : "Article 23 Methods for the Elimination of Double Taxation 1. In China, double taxation shall be eliminated as follows: 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 the Chinese tax on that income computed in accordance with the taxation laws and regulations of China." Based on the foregoing, this Office is of the opinion and so holds that the license fees to be paid by Petron to Belco USA under the Agreement are subject to 10 percent income tax rate based on the gross amount thereof, under Article 13 (2) (b) (iii) of the Philippines-United States tax treaty, in relation to Article 12 (2) (a) of the Philippines-China tax treaty. Moreover, the said royalty payments by Petron to Belco USA being payments for the lease or the use of or the right or privilege to use a copyright in the software in the Philippines, shall be subject to the 12% value-added tax (VAT) under Section 108 of the Tax Code of 1997, as amended. Accordingly, Petron , being the resident withholding agent and payor in control of the payment, shall be responsible for the withholding of the 12% final VAT on such royalty before making any payment to Belco USA . In remitting the VAT withheld, Petron shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and proof of payment thereof shall serve as documentary substantiation for the claim of input tax by Petron upon filing its own VAT return, if it is a VAT-registered taxpayer. In case Petron is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of goods or properties purchased which may be treated as an "expense" or as an "asset", whichever is applicable. In addition, Petron 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 Belco USA upon its request and the fourth copy to be retained by Petron as its file copy. [ Section 4.110.3 (b), Revenue Regulations No. (RR) 7-95, as amended by RR 08-02 (now Section 4.114-2, RR 16-05); Section 4.114 (d), as last amended by RR 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. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue