ITAD BIR Ruling No. 022-11

January 21, 2011 ITAD BIR RULING NO. 022-11 Article 12, Philippines-Germany tax treaty; Section 28, NIRC of 1997; BIR Ruling No. 75-88; BIR Ruling No. DA-ITAD-109-02 Sycip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: Emmanuel C. Alcantara Head, Tax Service Gentlemen : This refers to your letter dated December 16, 2009 requesting confirmation that the royalty payments to be paid by Adidas Philippines, Inc. (hereinafter referred to as "API") to adidas AG (hereinafter referred to as "AAG") are subject a preferential tax rate of 10 percent of the gross amount of royalties, pursuant to Article 12 (2) (b) of the Convention between the Government of the Republic of the Philippines and the Government of the Federal Republic of Germany for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (hereinafter referred to as the "Philippines-Germany tax treaty" ). EaISDC It is represented that AAG is a nonresident foreign corporation duly organized and existing under the laws of Germany, with principal place of business at Adi-Dassler-Platz 1-2, 91074 Herzogenaurach, Germany and is registered for tax purposes under the tax number: 216/115/20295 as evidenced by a Certificate of Fiscal Residence issued by the German tax authority dated March 19, 2009; that AAG is not registered either as a corporation or as a partnership in the Philippines as shown in the Certification of Non-Registration issued by the Securities and Exchange Commission on June 2, 2009; and that API, on the other hand, is a corporation duly organized and existing under the laws of the Philippines, with business address at 38th Floor, Robinsons Equitable Bank Tower, ADB Ave. corner Poveda St., Ortigas Center, Pasig City. It is further represented that on January 1, 2009, API and AGG entered into a License Agreement (hereinafter referred to as the "Agreement" ) which shall be effective from January 1, 2009 and shall continue for an initial period ending on December 31, 2011; that it and shall be automatically renewed for additional and successive one (1) year periods subject to either party's right to terminate; that pursuant to the Agreement, AGG grants to API: (a) the non-exclusive right and license to use the KNOW HOW 1 to manufacture LICENSED PRODUCT 2 in the TERRITORY 3 and (b) the exclusive licence to promote, distribute, market and sell Licensed Products so made throughout the Territory under or by reference to the MARKS; 4 that having been due compliance with the requirement of law and with the regulations prescribed by the Director of Patents under Republic Act No. 166, as amended, the following Marks are duly registered in the Philippine Patent Office (now Intellectual Property Office or "IPO"): Trademark Certificate of Registration No. Date of Registration Three Stripes Device 28685 (Renewal) December 29, 1980 ADIDAS 26597 January 23, 1979 ADIDAS 52649 May 18, 1992 3 Stripes Logo 52938 July 15, 1992 ADIDAS & LOGO 52839 July 2, 1992 That in consideration of the foregoing, API shall pay AAG a standard royalty of 6% to all Contract Years 5 for which the Budgeted Berry Ratio 6 between 1.2 and 1.34; and that the transaction subject of the herein request for ruling 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 of the taxpayers involved. In reply, please be informed that royalty payments to a nonresident foreign corporation are, in general, covered by Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended. 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 . . ., royalties . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). TIDHCc 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 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" In accordance with the foregoing, Article 12 of the Philippines-Germany tax treaty may apply to the subject request for ruling, thus: "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 law of that State, but 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 TAacHE 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 cinematograph films or tapes for television or 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. xxx xxx xxx" Based on the foregoing, royalty payments to a resident of Germany arising in the Philippines may be taxed at the preferential tax rate of 15 percent of the gross amount of the royalties if the royalties are paid in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting; and 10 percent if the royalties are paid for the use or the right to use, patent, trademark, design or model, plan, secret formula or process for the industrial, commercial or scientific equipment or for information concerning industrial, commercial or scientific experience, but shall, however, apply only if the contract giving rise to such royalties has been approved by the Philippine competent authorities. Considering that the subject royalty payments of API to AGG under the Agreement fall under paragraph 2 (b) of the aforementioned tax treaty being derived from the grant of a right to use the know how to manufacture licensed products and exclusive license to promote, distribute, market and sell licensed products, and that the trademarks have been approved by a Philippine competent authority i.e. , the IPO, this Office is of the opinion and so holds that the said royalties are subject to Philippine tax at the rate of 10 percent of the gross amount of royalties, pursuant to Article 12 (2) (b) of the Philippines-Germany tax treaty. (BIR Ruling No. 075-88 dated March 4, 1988; BIR Ruling No. DA-ITAD-109-02 dated May 30, 2002) EACIaT Moreover, as provided in Section 108 of the Tax Code of 1997, the said royalty payments are subject to value-added tax (VAT): "SEC. 108. 7 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%) 8 of gross receipts derived from the sale or exchange of services, including the use or lease of properties. xxx xxx xxx (3) The supply of scientific, technical, industrial or commercial knowledge or information; xxx xxx xxx" With regard to the procedures for the withholding and the payment of the VAT pursuant to Sections 4 and 6 of Revenue Regulations No. 4-2002, Section 3 of Revenue Regulations No. 8-2002, and Section 7 of Revenue Regulations No. 14-2002, API shall be responsible for the withholding of VAT on the royalties fee before remitting it to AGG. In remitting to the Bureau of Internal Revenue the VAT withheld, API shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld). If it is a VAT-registered taxpayer, API may use as documentary substantiation for its claim of input VAT the duly filed BIR Form No. 1600 and the proof of payment accompanying such form. On the other hand, if it is a non VAT-registered taxpayer, API may include as part of the cost of the royalty fees to it by AGG the VAT consequently shifted or passed on to it. In addition, API is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies for AGG and the fourth copy for API 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. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. "Know-how" means any inventions, technical knowledge, methods, manufacturing secrets, designs, specifications, drawings, marketing plans, business plans, manuals, and the like, owned by or proprietary to or acquired during the term of this Agreement by Licensor or other member of the adidas group and which licensor considers reasonable necessary to the manufacture and distribution of products and licensed products and which shall include, without limitation the patents. 2. "Licensed Product" means those Products which Licensor grants Licensee the right to manufacture under the provision therein. 3. "Territory" means Philippines. 4. "Marks" means those trade mark, trade names, logos and devices owned by Licensor or other member of the adidas Group in the Territory as listed in Exhibit "A" attached hereto, as may be amended from time to time, and such other trade marks, trade names, logos and devices as the parties may agree, in writing, shall be added to such Exhibit. 5. "Contract Year" means the period commencing on the Effective Date and ending December 31, 2009, for the first Contract Year, and each successive twelve (12) month period commencing with January 1, 2010. 6. "Berry Ratio" means Gross Profit divided by Operating Expenses. 7. Section 108 was amended by 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, 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 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 (1 * 4/5%); or (ii) National government deficit as a percentage of GDP of the previous year exceeds two and four-fifth percent (2 4/5%). xxx xxx xxx 8. 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.