ITAD BIR Ruling No. 024-13

February 11, 2013 ITAD BIR RULING NO. 024-13 Articles 13 and 23, Philippines-US tax treaty Romulo Mabanta Buenaventura Sayoc & De Los Angeles 30th Floor, Citibank Tower 8741 Paseo de Roxas, Makati City Attention: Priscilla B. Valer Partner Gentlemen : This refers to your application for tax treaty relief filed on June 23, 2011 requesting confirmation that royalties to be paid by Avon Cosmetics, Inc. ("Avon Cosmetics") to Avon Products, Inc. ("Avon Products") are subject to Philippine income tax at the reduced 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 Convention between the Czech Republic and the Republic of the Philippines for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Czech tax treaty") . TAIaHE It is represented that Avon Products is a foreign corporation organized and existing under the laws of the United States of America and is a resident thereof for purposes of United States taxation, based on its Certificate of Incorporation, as amended, and on the Certification issued by the Internal Revenue Service of the United States on February 14, 2011; that Avon Products is situated at 1345 Avenue of the Americas, New York, New York, United States; that it is not registered as a corporation or partnership in the Philippines based on the Certification issued by the Securities and Exchange Commission on June 9, 2011; that, on the other hand, Avon Cosmetics is a corporation organized and existing under laws of the Philippines situated at Gercon Plaza, 7901 Makati Avenue, Makati City, Philippines. It is further represented that on June 6, 2011, Avon Products and Avon Cosmetics entered into a License Agreement ("Agreement") to replace the Original Agreement dated January 1, 2001; that under the new Agreement, Avon Products grants Avon Cosmetics an exclusive license to use the Property Rights in the Philippines, strictly in connection with the manufacture, sale and distribution of the Products; that Products means all products sold by Avon Cosmetics in the Philippines; that Property Rights means all rights of Avon Products with respect to the Technical Information, Patent Rights, and Trade Rights; that Technical Information means all commercial and technical assistance, information and know-how now or thereafter in the possession of Avon Products which is relevant to any aspects of the manufacture, distribution and sale of the Products and which Avon Products is permitted under applicable laws, regulations and agreements to disclose to Avon Cosmetics , including, without limitation, information and know-how relating to (1) production and manufacturing techniques, including any formulae, secret or otherwise, used in connection therewith, (2) engineering matters, (3) equipment design and maintenance, (4) research results, techniques and procedures, including information on pending patent applications, (5) marketing, (6) sales promotions and procedures, (7) packaging and labeling, and (8) human resources, legal, purchasing, finance, sourcing, computers and software support; that Patent Rights means all patents and patent applications in the Philippines, now or thereafter owned or controlled by or otherwise licensable from Avon Products , including all divisions, reissues, re-examinations, continuations, continuations-in-part, and extensions of the foregoing; that Trade Rights means all trademarks, service marks, logos, designs, trade names, trade dress and copyrights in the Philippines, which are now or thereafter owned or controlled by or otherwise licensable from Avon Products ; that in consideration, Avon Cosmetics shall pay royalties to Avon Products equivalent to 7 percent of the Net Sales of Products sold by Avon Cosmetics ; that royalties shall be in United States Dollars and shall be paid within 30 days following the last day of each calendar month or a part thereof; and that the Agreement shall take effect on January 6, 2011, and shall continue to have effect indefinitely, unless terminated. It is finally represented that the royalties subject of this ruling are 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 Certification issued by the Treasurer of Avon Cosmetics on May 26, 2011. In reply, please be informed that royalties paid to Avon , a foreign corporation not engaged in trade or business in the Philippines, are subject to income tax in the Philippines at the rate of 30 percent of the gross amount thereof. Section 28 (B) (1) (a) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, 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 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: * Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)" However, such royalties may be exempt from income tax or subject to a reduced rate to the extent required by any treaty obligation on the Philippines. Section 32 (B) (5) of the Tax Code provides: EDACSa "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." For this purpose, you invoke the Article 13 of the Philippines-US tax treaty. Its paragraphs 1, 2 and 3 provide: "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, (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." Under paragraph 2 (b) (iii) above, royalties arising in the Philippines and paid to a resident of the United States may be taxed in the Philippines at the lowest rate of income tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State (also known as the " most-favored-nation treatment "). Relative thereto, 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") , requires two conditions for a most-favored-nation treatment on royalties to apply. First, royalties arising in the Philippines and paid to a resident of the other State, in this case, the United States, must be of the same kind as those arising in the Philippines and paid to a resident of a third State to which the latter's tax treaty with the Philippines subjects the latter royalties to a most-favored-nation treatment. Second, the method of elimination of double taxation applied by the other State, in this case, the United States, on royalties paid to a resident thereof must be the same as that applied by the third State on royalties paid to its resident. Pertinent portions of the SC Johnson case read: "We are unable to sustain the position of the Court of Tax Appeals, which was upheld by the Court of Appeals, that the phrase 'paid under similar circumstances' in Article 13(2)(b), (iii) of the RP-US Tax Treaty should be interpreted to refer to payment of royalty, and not to the payment of the tax, for the reason that the phrase 'paid under similar circumstances' is followed by the phrase 'to a resident of a third state.' The respondent court held that 'Words are to be understood in the context in which they are used,' and since what is paid to a resident of a third state is not a tax but a royalty 'logic instructs' that the treaty provision in question should refer to royalties of the same kind paid under similar circumstances. dctai The above construction is based principally on syntax or sentence structure but fails to take into account the purpose animating the treaty provisions in point. To begin with, we are not aware of any law or rule pertinent to the payment of royalties, and none has been brought to our attention, which provides for the payment of royalties under dissimilar circumstances. The tax rates on royalties and the circumstances of payment thereof are the same for all the recipients of such royalties and there is no disparity based on nationality in the circumstances of such payment. On the other hand, a cursory reading of the various tax treaties will show that there is no similarity in the provisions on relief from or avoidance of double taxation as this is a matter of negotiation between the contracting parties . As will be shown later, this dissimilarity is true particularly in the treaties between the Philippines and the United States and between the Philippines and West Germany. xxx xxx xxx As stated earlier, the ultimate reason for avoiding double taxation is to encourage foreign investors to invest in the Philippines a crucial economic goal for developing countries. The goal of double taxation conventions would be thwarted if such treaties did not provide for effective measures to minimize, if not completely eliminate, the tax burden laid upon the income or capital of the investor. Thus, if the rates of tax are lowered by the state of source, in this case, by the Philippines, there should be a concomitant commitment on the part of the state of residence to grant some form of tax relief, whether this be in the form of a tax credit or exemption. Otherwise, the tax which could have been collected by the Philippine government will simply be collected by another state, defeating the object of the tax treaty since the tax burden imposed upon the investor would remain unrelieved. If the state of residence does not grant some form of tax relief to the investor, no benefit would redound to the Philippines, i.e., increased investment resulting from a favorable tax regime, should it impose a lower tax rate on the royalty earnings of the investor, and it would be better to impose the regular rate rather than lose much-needed revenues to another country. At the same time, the intention behind the adoption of the provision on 'relief from double taxation' in the two tax treaties in question should be considered in light of the purpose behind the most favored nation clause. 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 of 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 invoke the Philippines-Czech tax treaty. Concerning the first condition, paragraphs 1 and 2, 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. ESCTIA 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 beneficial owner of the royalties is a resident of the other Contracting State, the tax so charged shall not exceed: a) 10 per cent of the gross amount of the royalties arising from the use of, or the right to use, any copyright of literary, artistic or scientific work, other than that mentioned in sub-paragraph (b), 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; b) 15 per cent of the gross amount of the royalties arising from the use of, or the right to use, any copyright of cinematograph films, and films or tapes for television or radio broadcasting. The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of these limitations." With respect to the first condition , under paragraph 3, Article 12 of the Philippines-United States tax treaty, 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 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. Royalties also include 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. Relative thereto, under paragraph 2, Article 12 of the Philippines-Czech tax treaty, royalties arising in the Philippines and paid to a resident of Czech and paid for the use of, or the right to use, any copyright of literary, artistic or scientific work (except cinematograph films, and films or tapes for television or radio broadcasting), 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, are subject to income tax at the rate of 10 percent. Concerning the second condition , paragraph 1, Article 23 of the Philippines-United States tax treaty, and paragraph 2, Article 22 of the Philippines-Czech tax treaty, provide: 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 lime 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 and, in the case of a United States corporation owning at least 10 percent of the voting stock of a Philippine corporation from which it receives dividends in any taxable year, shall allow credit for the appropriate amount of taxes paid or accrued to the Philippines by the Philippine corporation paying such dividends with respect to the profits out of which such dividends are paid. Such appropriate amount shall be based upon the amount of tax paid or accrued to the Philippines, but the credit shall not exceed limitations (for the purpose of limiting the credit to the United States tax on income from sources within the Philippines or on income from sources outside the United States) provided by United States law for the taxable year." Czech "Article 22 ELIMINATION OF DOUBLE TAXATION xxx xxx xxx 2. In the case of a resident of the Czech Republic, double taxation shall be eliminated as follows: AEIcTD a) The Czech Republic, when imposing taxes on its residents, may include in the tax base upon which such taxes are imposed the items of income which according to the provisions of this Convention may also be taxed in the Philippines, but shall allow as a deduction from the amount of tax computed on such a base an amount equal to the tax paid in the Philippines. Such deduction shall not, however, exceed that part of the Czech tax, as computed before the deduction is given, which is appropriate to the income which, in accordance with the provisions of this Convention, may be taxed in the Philippines. b) Where in accordance with any provision of the Convention income derived by a resident of the Czech Republic is exempt from tax in the Czech Republic, the Czech Republic may nevertheless, in calculating the amount of tax on the remaining income of such resident, take into account the exempted income." Under paragraph 1, Article 23 of the Philippines-United States tax treaty, in eliminating or mitigating the effects of double taxation of income (including royalties) paid to its resident and arising from sources in the Philippines, the United States shall allow as credit against the income tax due in the United States on such income, the income tax imposed on that income in the Philippines. In the same manner, under paragraph 2 (a), Article 22, in eliminating or mitigating the effects of double taxation of income (including royalties) paid to its resident and arising from sources in the Philippines, Czech shall allow as deduction against the income tax due on such income, the income tax imposed on that income in the Philippines. 1 Relative thereto, however, please be informed that Section 14 of Revenue Memorandum Order ("RMO") No. 72-2010 , published in the Manila Bulletin on October 20, 2010, and effective November 4, 2010 provides, as follows: " SEC. 14 . When and Where to File the TTRA . All tax treaty relief applications (updated BIR Forms No. 0901-D, 0901-I, 0901-R, 0901-P, 0901-S, 0901-T, 0901-O and 0901-C) relative to the implementation and interpretation of the provisions of Philippine tax treaties shall only be submitted to and received by the International Tax Affairs Division (ITAD). If the forms of any necessary documents are submitted to any other BIR office, the application shall be considered as improperly filed. IHaECA Filing should always be made BEFORE the transaction. Transaction for purposes of filing the TTRA shall mean before the occurrence of the first taxable event. Failure to properly file the TTRA with ITAD within the period prescribed herein shall have the effect disqualifying the TTRA under this RMO . (Emphasis Supplied) " In view thereof, since the TTRA was filed only on June 23, 2011, after the date of effectivity of the Agreement on June 6, 2011, this Office hereby DENIES relief on all royalties under the Agreement paid before June 24, 2011 in violation of the requirement that filing of the TTRA should be made BEFORE the transaction under RMO 72-2010, that is the payment of royalties. Accordingly, said payments shall be subject to tax at the rate provided for in Section 28 of the above-cited Tax Code, as amended. However, relief is hereby GRANTED to all payments made on June 24, 2011 and thereafter. Accordingly, such royalties to be paid by Avon Cosmetics to Avon Products pursuant to the Agreement, for the use of the Technical Information, the Patent Rights and Trade Rights in connection with the manufacture, sale and distribution of the Products in the Philippines, being essentially royalties for the use of patent, know-how, and trademark, are subject to income tax at the rate of 10 percent of the gross amount thereof, pursuant to Article 12 of the Philippines-Czech tax treaty, as amended. Furthermore, under Section 108 (A) of Tax Code, as amended, the royalties in question, being payments for the use of intangible properties (patent, know-how, and trademark) in the Philippines, are subject to value-added tax ("VAT") at the rate of 12 percent, thus: "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, 2 raise the rate of value-added tax to twelve percent (12%). . ." Relative thereto, Avon Cosmetics shall withhold VAT on the royalties at the rate of 12 percent before remitting them to Avon Products . Avon Cosmetics shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). If Avon Cosmetics is a VAT-registered taxpayer, the duly-filed BIR Form No. 1600 and its accompanying proof of payment shall serve as documentary substantiation for its claim of input tax on the royalties. Otherwise, Avon Cosmetics may instead treat such VAT as an asset or expense, whichever is applicable. VAT withheld shall be remitted within 10 days following the end of the month the withholding was made. 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. Under paragraph 1 of Article 23, in addition to Philippine income tax allowed as credit against United States income tax, Philippine income tax imposed on the profits of a Philippine corporation who paid dividends to a United States corporation, which owns at least 10 percent of the voting stock of the Philippine corporation, shall be allowed as credit against United States income tax due on such dividends and payable by the United States corporation. This additional relief does not cover royalties under Article 13 of the Philippine-United States tax treaty. Under paragraph 2 (b) of Article 22, instead of allowing deduction or credit, Czech will exempt from Czech income tax, income arising in the Philippines and derived by a resident of Czech and which is exempt in Czech under the relevant article of the tax treaty. However, Czech will apply the 'exemption-with-progression' method in computing the taxable income of the recipient by taking into account the exempted income and applying the corresponding rate of Czech income tax thereon. This method of elimination of double taxation does not cover royalties under Article 12 of the Philippines-Czech tax treaty which are not exempt from Philippine income tax in the first place. 2. The VAT rate was increased to 12 percent beginning 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.