ITAD BIR Ruling No. 016-11

January 20, 2011 ITAD BIR RULING NO. 016-11 Article 13, Philippines-United States tax treaty; Article 12, Philippines-China tax treaty Heinz UFC Philippines, Inc. 12/F Centerpoint Condominium Garnet Road cor. Julia Vargas Avenue Ortigas Center, Pasig City Attention: Mr. Salvador B. Viray Tax Manager Gentlemen : This refers to your letter dated November 14, 2005, requesting confirmation of your opinion that the royalty fees paid by HEINZ UFC PHILIPPINES, INC. (HUFC) to H.J. HEINZ COMPANY (HJHC) are subject to the preferential tax rate of 10 percent (10%) pursuant to the "most-favored-nation" clause of the Philippines-United States of America (RP-US) tax treaty in relation to the Philippines-China tax treaty. TIHCcA Facts It is represented that HJHC is a nonresident foreign corporation duly organized and existing under the laws of the Commonwealth of Pennsylvania, United States of America (USA), with principal office at 600 Grant Street, 60th Floor, Pittsburgh, Pennsylvania 15219, USA; 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 September 15, 2005; that HUFC is a corporation duly organized and existing under the laws of the Philippines with office address at 12/F Centerpoint Condominium, Garnet Road cor Julia Vargas Avenue, Ortigas Center, Pasig; that it is primarily engaged in the manufacture, marketing and distribution of sauces and other consumer food products in the Philippines; that on March 1, 2000, HJHC entered into a "Trademark License Agreement" with HUFC whereby HJHC granted to HUFC a non-exclusive license to use (i) the "HEINZ" trade name as part of HUFC's corporate name, Heinz-UFC Philippines, Inc., (ii) the HEINZ trademarks on advertising, sales and marketing materials or items, company stationery and documentation in the Philippines; and (iii) HEINZ keystone logo as a corporate identifier on food products manufactured or sold by HUFC; that HUFC shall, in consideration for the grant of license, pay a royalty of P10,000,000.00 per year or such other amounts as may be agreed from time to time between the parties; and that the Trademark License Agreement and its Supplemental Agreement between H.J. Heinz Company and Heinz UFC Phils., Inc. comply with Sections 87 and 88 of the Intellectual Property Code. Ruling In reply, please be informed that Section 28 (B) of the National Internal Revenue Code (Tax Code) of 1997 as amended, applies in general. It provides: "Section 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): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, Section 32 (B) (5) of the Tax Code of 1997, as amended provides: "Section 32. Gross Income. xxx xxx xxx (B) Exclusions from Gross Income. The following items shall not be included in gross 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" In this particular case, the treaty involved is the RP-US tax treaty, Article 13 of which provides, viz. : "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; TcCSIa (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" Under the "most-favored-nation" clause found in Article 13 (2) (b) (iii) of the RP-US 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 this light, Article 12 of the Philippines-Netherlands tax treaty provides, viz. : "Article 12 ROYALTIES 1. Royalties arising in one of the States and paid to a resident of the other State may be taxed in that other State. 2. However, such royalties may also be taxed in the 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) 10 per cent of the gross amount of the royalties where the royalties are paid by an enterprise registered, and engaged in preferred areas of activities in that State; and (b) 15 per cent of the gross amount of the royalties in all other cases. (Emphasis supplied) 3. The competent authorities of the States shall by mutual agreement settle the mode of application of paragraph 2. 4. 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 radio or television 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" Moreover, Article 12 (Royalties) of the Philippines-China tax treaty, which became effective on January 1, 2002, 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. 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: TcEaAS 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. 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. 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." 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", 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-52-03, April 8, 2003) A perusal of the RP-US, Philippines-Netherlands and the Philippines-China tax treaty provision on the avoidance of double taxation shows a similarity on the manner of payment of taxes, that is, the allowable foreign tax credit on the three treaties is the amount actually paid in the Philippines. Such being the case, and since HUFC is not registered and engaged in preferred areas of activities in the Philippines, royalties arising in the Philippines and payable to HJHC for the year 2001 are subject to tax at the rate of 15 percent pursuant to Article 13 (2) (b) (iii) of the RP-US tax treaty in relation to Article 12 (2) (b) of the Philippines-Netherlands tax treaty. On the other hand, royalty payments beginning January 1, 2002 shall be subject to 10 percent pursuant to Article 13 (2) (b) (iii) of the RP-US tax treaty in relation to Article 12 (2) (b) of the Philippines-China tax treaty. (BIR Ruling DA-ITAD 102-02 dated May 28, 2002; RMC 46-02 dated September 2, 2002) . HJHC shall deduct and withhold the tax at the time the royalty income payment is paid or payable, or the income payment is accrued or recorded as an expense or asset, whichever is applicable, and whichever comes first. The term "payable" refers to the date the obligation becomes due, demandable, or legally enforceable. (Section 4-Time of Withholding, Revenue Regulations No. 12-2001) In view thereof, this Office is of the opinion and so holds that the royalty payments of HUFC to HJHC under their Trademark Licensing Agreement, before January 1, 2002, are subject to Philippine tax at the rate of 15 percent, pursuant to Article 13 (2) (b) (iii) of the RP-US tax treaty in relation to Article 12 (2) (b) of the Philippines-Netherlands tax treaty, while the royalty payments from January 1, 2002 onwards shall be subject to tax at the rate of ten percent (10%), pursuant to the RP-US tax treaty in relation to Article 12 (2) (b) of the Philippines-China tax treaty which took effect on January 1, 2002. (BIR Ruling No. 126-01 dated October 30, 2001, Revenue Memorandum Circular (RMC) No. 46-2002 dated September 2, 2002) (BIR Ruling Nos. 101-03; 102-03 and 103-03) Moreover, the said royalty payments to be paid by HUFC to HJHC in the Philippines are subject to the 10% 1 [now 12%] value-added tax (VAT) pursuant to Sec. 108 of the Tax Code of 1997. 2 Accordingly, HUFC, being the resident withholding agent and payor in control of the payment shall be responsible for the withholding of the 10% [now 12%] final VAT on such royalty before making any payment to HJHC. In remitting the VAT withheld, HUFC shall use 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 documentary substantiation for the claim of input tax by HUFC upon filing its own VAT return, if it is a VAT-registered taxpayer. In case HUFC is a non-VAT registered taxpayer, the passed on VAT withheld shall form part of the cost of the service purchased which may be treated as "expense" or "asset" whichever is applicable. In addition, HUFC, is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of HJHC's, the first three copies thereof to be given to HJHC's and the fourth copy to be retained by HUFC as its file copy. [Sections 4 & 6, Revenue Regulations (RR) No. 4-2000; Section 3 of RR 8-2002; Section 7 of RR 14-2002] aCIHAD This ruling is issued based on 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. The rate shall be 12% effective February 1, 2006 based on the Republic Act No. 9337 which was signed into law on May 24, 2005. 2. 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, amended Section 106 (A) to read as: "SEC. 106. Value-added Tax on Sale of Goods or Properties. (A) Rate and Base of Tax. There shall be levied, assessed and collected on every sale, barter or exchange of goods or properties, a value-added tax equivalent to ten percent (10%) of the gross 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 two and four fifth percent (2 2 * /5%); or (ii) National government deficit as a percentage of GDP of the previous year exceeds one and one-half percent (1 1/2%). 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.