ITAD BIR Ruling No. 017-10

August 11, 2010 ITAD BIR RULING NO. 017-10 Art. 12 (Royalties), Philippines-Switzerland Tax Treaty; BIR Ruling No. 40-07 Ong Meneses Gonzales & Gupit Law Offices Suite 1515 Cityland 10 Tower 1 Ayala Avenue, Makati City Attention: Atty. Francisco B. Gonzales Tax Counsel Gentlemen : This refers to your letter dated October 30, 2008, 1 requesting for applicable income taxes due on the royalty fees paid by INSTONE PHILIPPINES INC. (Instone-Philippines) to INSTONE INTERNATIONAL HOLDINGS AG (Instone International) pursuant to the Philippines-Switzerland tax treaty. DaEATc It is represented that Instone International is a nonresident foreign corporation organized and existing under the laws of Switzerland as evidenced by its Articles of Association; that its principal office is at Churerstrasse 135 8808 Pfaffikon/SZ Switzerland; that Instone International is not registered either as a corporation or as a partnership in the Philippines as confirmed by the Certification of Non-Registration dated July 28, 2008 issued by the Securities and Exchange Commission; that, on the other hand, Instone-Philippines is a domestic corporation with principal office at 8th Floor 1st E-Bank Building, 8737 Paseo de Roxas St., Makati City; and that Instone-Philippines is engaged in the business of cruise, marine and offshore travel agency. It is further represented that Instone International and Instone-Philippines entered into a License Agreement (Agreement) whereby Instone International grants to Instone-Philippines an exclusive right to use as of the 1st of January 2007 only in relation to the Business 2 for the duration of the Agreement the following: i) Mark 3 in the Territory 4 (only for the services which are covered by the registration); And a non-exclusive right to use as of the 1st of January 2007 only in relation to the Business for the duration of the Agreement the: i) Trade Name 5 in the Territory; and ii) InstoneSYS 6 in the Territory. Instone-Philippines does not have the right to use and/or register the Mark and/or the Trade Name, or any similar designation, as a domain name. That Instone-Philippines does not have the right to sub-license; that all rights in and to the application and registration and to all the reputation and goodwill associated with the Mark throughout the Territory and all rights, reputation and goodwill associated with the Trade Name and the InstoneSYS throughout the Territory, including any reputation and goodwill as may accrue as a result of Instone-Philippines' use of the Mark and/or the Trade Name and/or InstoneSYS are reserved to and shall belong absolutely to Instone International; that Instone-Philippines agrees to execute such documents and do such other things as Instone International may reasonably request from time to time, including after termination of the Agreement, to confirm any such rights to Instone International; that Instone-Philippines has no right to modify, alter or otherwise make any add-ons and/or changes to the InstoneSYS; that Instone-Philippines' use of the Mark, the Trade Name and the InstoneSYS shall at all times be in full accordance with Instone International's existing network-wide instructions and specifications, which might be modified from time to time by Instone International, as well as in accordance with any other instructions Instone International might provide from time to time to Instone-Philippines; that, in addition, Instone International has also the right to control, at any time, the use that Instone-Philippines makes of the Mark, the Trade Name and the InstoneSYS and Instone-Philippines shall provide Instone International with any information and documents it might request to this effect; that in consideration of Instone International granting the right to use the Mark, the Trade Name and the InstoneSYS according to the Agreement, Instone-Philippines shall pay the royalties as set out in Schedule 1 7 of the Agreement; that the Agreement shall commence on the date of the signature of the Parties or on January 1, 2007, and shall continue, except as mentioned in the last paragraph of Article 5 of the Agreement, for the period of 10 years unless terminated earlier pursuant to the instances stated in the Agreement; 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. ISAaTH In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended, applies in general to royalty payments received by nonresident foreign corporations. 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" (Emphasis ours) 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 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" (Emphasis ours) In relation thereto, the provisions of the Philippines-Switzerland tax treaty which you invoked may apply to your instant request for relief particularly its Article 12, which 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, the royalties may also be taxed in the Contracting State in which they arise and according to the laws of that State, but the tax so charged shall not exceed 15 per cent of the gross amount of the royalties. 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 and films and tapes for television or radio broadcasting, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience. xxx xxx xxx" Based on the aforementioned paragraph 3, payments received as a consideration for the use of, or the right to use, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience are considered royalties. Paragraph 2 of the same Article also provides that royalties arising from sources within the Philippines and derived by a resident of Switzerland may be taxed but the tax so charged shall not exceed 15 per cent of the gross amount of the royalties. Such being the case, the royalty fees paid by Instone-Philippines to Instone International for the former's use of the Mark, Trade Name and InstoneSYS of the latter shall be subject to a preferential tax rate not exceeding 15 per cent of the gross amount of the royalties. (BIR Ruling No. ITAD 40-07 dated March 19, 2007) ETHIDa Finally, as regards value-added tax (VAT), the royalties for the use or the right to use of the Mark, Trade Mark and InstoneSYS to be paid by Instone-Philippines to Instone International are subject to VAT pursuant to Section 108 (A) of the Tax Code of 1997, 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" 8 With regard to the procedures for the withholding and payment of 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 Instone-Philippines shall be responsible for the withholding of the VAT on the royalties before remitting them to Instone International. In remitting to the Bureau of Internal Revenue the VAT withheld on the royalties, Instone-Philippines shall use BIR Form No. 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld). In addition, Instone-Philippines is required to issue in quadruplicate the Certificate of Final Tax Withheld at Source (BIR Form No. 2306), the first three copies for Instone International and the fourth copy for Instone-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. TADaES Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Received by this Office on December 17, 2008. 2. "Business" means the cruise, marine and offshore travel agency business. 3. "Mark" means the trademarks mentioned in Schedule 2 of the Agreement. 4. "Territory" means Philippines. 5. "Trade Name" means the designation "Instone International". 6. "InstoneSYS" means the proprietary ISO-based quality business manual which describes the operational workflows and quality controls used by the Instone Group Companies and the Authorised Persons and which is the template for the operations of an Instone Group Company and the Authorised Persons (as it exists at the time of the execution of this Agreement and any further editions of it that might be provided by Instone International to Instone-Philippines during the duration of this Agreement). 7. Once the Net Assets Threshold (CHF 500'000) and the Net Sales Income Threshold (CHF 750'000) have been achieved in accordance with Article 3 paragraph 2 of the Agreement, the Royalty shall be 5% of the Licensee's net sales income (being commissions, fees, rebates, incentives, etc.) of the products sold by the Licensee, calculated in accordance with generally accepted accounting principles and practices in Switzerland. The royalty shall accrue daily and shall be reviewed annually in line with prevailing market conditions as Instone International shall determine in its reasonable opinion. 8. 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 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: 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 4/5%); 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.