ITAD BIR Ruling No. 023-16

March 15, 2016 ITAD BIR RULING NO. 023-16 Article 12 (Royalties), Philippines-Singapore tax treaty Sycip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: Atty. Fabian K. Delos Santos Partner, Tax Services Gentlemen : This refers to your tax treaty relief application filed on March 18, 2014 requesting confirmation that royalties paid by Garena Philippines, Inc. ("Garena Philippines") to Garena Online Private Limited ("Garena") are subject to income tax at the rate of 25 percent pursuant to the Convention between the Republic of the Philippines and the Republic of Singapore for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Singapore tax treaty") . Facts Garena is a foreign corporation and a resident of the Singapore based on its Memorandum and Articles of Association and the Certificate of Residence issued by the Inland Revenue Authority of Singapore on February 24, 2014. It is not registered as a corporation or partnership in the Philippines based on the Certificate of Non-Registration of Company issued by the Securities and Exchange Commission on February 25, 2014. On the other hand, Garena Philippines is a domestic corporation organized and existing under Philippine laws. Garena has developed Garena Plus , an online social game publishing platform ("Platform") , and intends to grant the right to the License to install and use the Platform in the Philippines to Garena Philippines . On March 1, 2013, Garena Philippines and Garena entered into a License Agreement ("Agreement") where Garena granted Garena Philippines a non-exclusive and non-transferable license to install and operate the Platform in the Philippines provided that Garena Philippines will not: a) make available or distribute all or any part of the Licensed Materials to any third party whether by assignment, sub-license or by any other means; b) copy, adapt, reverse engineer, decompile, disassemble, or modify, in whole or in part, any if the Licensed Materials, except as allowed by the Agreement and c) conceal or remove any title, trademark, copyright, proprietary or restricted rights notices contained in the Licensed Materials. In consideration, Garena Philippines will pay licensing fee to Garena equivalent to 30 percent of the net revenue generated from the games running on the Platform and other net revenues directly associated with and generated from the operation of the Platform, including but not limited to membership fees, and privilege fees. The license fees shall be payable by Garena Philippines in US Dollars within 30 days after invoicing date by applying the middle rate ruling at the payment date as promulgated by major local banks in the Philippines. The Agreement took effect on March 1, 2013 and will be in effect for three years. It is finally represented that the issue or transaction subject of the above application is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Sworn Statement issued by the General Manager of Garena Philippines on March 10, 2014. Ruling In reply, please be informed that under Section 28 (B) (1) of the Tax Code, royalties paid to a foreign corporation not engaged in trade or business in the Philippines are subject to income tax at the rate of 30 percent, to wit: CAIHTE "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: n Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." However, under Section 32 (B) (5) of the Tax Code, such royalties are exempt or partially exempt to the extent required by any treaty obligation on the Philippines, to wit: "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." With respect to a treaty, you invoke the Philippines-Singapore tax treaty. Paragraphs 1, 2 and 4, Article 12 thereof provide: "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, if the recipient is the beneficial owner of the royalties, the tax so charged shall not exceed: a) in the case of the Philippines, 15 per cent of the gross amount of the royalties, where the royalties are paid by an enterprise registered with the Philippine Board of Investments and engaged in preferred areas of activities and also royalties in respect of cinematographic films or tapes for television or broadcasting; b) in the case of Singapore, where the royalties are approved under the Economic Expansion Incentives (Relief from Income Tax) Act of Singapore, the royalties shall be exempt; c) in all other cases, 25 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 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." Under Article 12, royalties arising in the Philippines and paid to a resident of Singapore may be taxed in the Philippines at a rate not to exceed (a) 15 percent if the royalties are paid by an enterprise registered with the Board of Investments and engaged in preferred areas of activities, or if the royalties are paid in respect of cinematographic films or tapes for television or broadcasting; and (b) 25 percent in all other cases. The term royalties 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 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 ("know-how") . DETACa Accordingly, since Garena Philippines is granted a license to use the know-how on installation and operation of the Platform (Garena Plus) in the Philippines, the license fee paid by Garena Philippines to Garena falls within the definition of royalties under paragraph 3, Article 12 of the Philippines-Singapore tax treaty. The same characterization is envisaged in the following commentaries of the Organisation for Economic Co-operation and Development ("OECD") Model Tax Convention on Income and on Capital (Condensed Version, July 22, 2010) , to wit: "11.5 In the particular case of a contract involving the provision, by the supplier, of information concerning computer programming, as a general rule the payment will only be considered to be made in consideration for the provision of such information so as to constitute know-how where it is made to acquire information constituting ideas and principles underlying the program, such as logic, algorithms or programming languages or techniques, where this information is provided under the condition that the customer not disclose it without authorisation and where it is subject to any available trade secret protection." (Page 226) This being the case, since Garena is not registered with the Board of Investments and engaged in preferred areas of activities, and the license fees paid by Garena Philippines to Garena are not in respect of the use of cinematographic films or tapes for television or broadcasting, but for the use of trademark, copyright, patent, designs , and know-how , such royalties paid to Garena shall be subject to income tax at the rate of 25 percent, pursuant to paragraph 2 (c), Article 12 of the Philippines-Singapore tax treaty. Finally, under Section 108 (A) of the Tax Code, the said royalties for the use of intangible properties in the Philippines are subject to value-added tax ("VAT"), 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 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, 1 raise the rate of value-added tax to twelve percent (12%). . ." Relative thereto, Garena Philippines shall withhold VAT on the royalties at the rate of 12 percent before remitting them to Garena. Garena Philippines shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). If a VAT-registered taxpayer, Garena Philippines shall use the duly filed BIR Form No. 1600 and its accompanying proof of payment as documentary substantiation for Garena Philippines ' claim of input tax on the royalties; otherwise, it may treat the VAT as an asset or expense, whichever is applicable. VAT withheld shall be remitted within ten days following the end of the month the withholding was made. 2 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. The VAT rate is increased to twelve percent 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. 2. Pursuant to Section 4.112-2 of Revenue Regulations No. 16-2005 (Consolidated Value-Added Tax Regulations of 2005) , as amended by Revenue Regulations 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) , which provides: "SEC. 4.114-2. Withholding of VAT on Government Money Payments and Payments to Non-Residents . xxx xxx xxx (b) The government or any of its political subdivisions, instrumentalities or agencies including GOCCs, as well as private corporation, individuals, estates and trust, whether large or non-large taxpayers, shall withhold twelve percent (12%) VAT, starting February 1, 2006, with respect to the following payments: (1) Lease or use of properties or property rights owned by non-residents; and (2) Services rendered to local insurance companies with respect to reinsurance premiums payable to non-residents; and (3) Other services rendered in the Philippines by non-residents. In remitting VAT withheld, the withholding agent shall use BIR Form No. 1600 Remittance Return of VAT and Other Percentage Taxes Withheld. VAT withheld and paid for the non-resident recipient (remitted using BIR Form No. 1600), which VAT is passed on to the resident withholding agent by the non-resident recipient of the income, may be claimed as input tax by said VAT-registered withholding agent upon filing his own VAT Return, subject to the rule on allocation of input tax among taxable sales, zero-rated sales and exempt sales. The duly filed BIR Form No. 1600 is the proof or documentary substantiation for the claimed input tax or input VAT. Nonetheless, if the resident withholding agent is a non-VAT taxpayer, said passed-on VAT by the non-resident recipient of the income, evidenced by the duly filed BIR Form No. 1600, shall form part of the cost of purchased services, which may be treated either as an 'asset' or 'expense', whichever is applicable, of the resident withholding agent. VAT withheld under this Section shall be remitted within ten (10) days following the end of the month the withholding was made." n Note from the Publisher: Copied verbatim from the official document. The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.