ITAD BIR Ruling No. 027-16

March 17, 2016 ITAD BIR RULING NO. 027-16 Article 12 (Royalties), Philippines-Netherlands tax treaty Law Offices of Siguion Reyna Montecillo & Ongsiako 4th & 6th Floors, Citibank Center 8741 Paseo de Roxas, Makati City Attention: Ms. Veronica Jude E. Abarquez Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on December 12, 2013 requesting confirmation that royalties paid by Swedish Match Philippines, Inc. ("SMPI") to Swedish Match Lighters B.V. ("Swedish Match") are subject to income tax at the rate of 10 percent pursuant to the Convention between the Kingdom of the Netherlands 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-Netherlands tax treaty") . Facts Swedish Match is a foreign corporation and a resident of the Netherlands based on its amended Articles of Association and its Declaration of Residence issued by the Tax Administration of Arnhem in the Netherlands on November 6, 2013. It is not registered as a corporation or partnership in the Philippines based on the Certificate of Non-Registration issued by the Securities and Exchange Commission on January 13, 2014. On the other hand, SMPI is a domestic corporation organized and existing under Philippine laws which is registered as an Ecozone Export Enterprise under Philippine Economic Zone Authority. SMPI and Swedish Match entered into a Trademark License Agreement where Swedish Match grants SMPI the non-exclusive right to use the "CRICKET" Technology 1 and Trademarks 2 to the manufacture and sale of Cricket Patented Products 3 in the Philippines. In consideration, SMPI will compensate Swedish Match as follows: a. for the use of Cricket Technology, a royalty equal to the SMPI's share in the worldwide production of Cricket lighters times Euro 500.000 per calendar year, and b. for the use of Cricket Trademarks, SMPI's share in the worldwide production of Cricket lighters times Euro 841.240 per calendar year. The royalties for each year shall be paid by SMPI within 60 days after year-end, except for royalties for the fiscal year 2013, which shall be payable not later than December 31, 2013. The Agreement retroactively took effect on January 1, 2013 and will be in effect unless terminated by either of the Party. 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 Finance Manager of SMPI on December 11, 2013. 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: "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 FROM REFERENCE CODE: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." CAIHTE 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-Netherlands tax treaty. Article 12 thereof provides: "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. 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." Under Article 12, royalties arising in the Philippines and paid to a resident of the Netherlands may be taxed in the Philippines at a rate not to exceed (a) 10 percent if the royalties are paid by a registered enterprise and engaged in preferred areas of activities in the Philippines, and (b) 15 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 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 ("know-how") . Accordingly, since SMPI is granted a right to use the Cricket Technology and Cricket Trademarks to the manufacture and sale of Cricket Patented Products in the Philippines, the royalties paid by SMPI to Swedish Match are essentially payments for the use of secret formula or process, patent, know-how and trademark and as such are considered royalties . Moreover, since SMPU is a registered enterprise and engaged in preferred areas of activities in the Philippines, such royalties paid by SMPI to Swedish Match shall be subject to income tax at the rate of 10 percent , pursuant to paragraph 2 (a), Article 12 of the Philippines-Netherlands tax treaty. With regard to the imposition of VAT on service fees paid to Swedish Match , Section 108 of the Tax Code of 1997 provides as follows: "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, 4 raise the rate of value-added tax to twelve percent (12%). . ." However, since SMPI is registered with PEZA and entitled to fiscal incentives under Republic Act No. 7916 , 5 the Supreme Court, in Commissioner of Internal Revenue vs. Seagate Technology (Philippines) (G.R. No. 153866 dated February 11, 2005) , ruled that: "Applying the special laws we have earlier discussed, respondent as an entity is exempt from internal revenue laws and regulations. This exemption covers both direct and indirect taxes, stemming from the very nature of the VAT as a tax on consumption, for which the direct liability is imposed on one person but the indirect burden is passed on to another. Respondent, as an exempt entity, can neither be directly charged for the VAT on its sales nor indirectly made to bear, as added cost to such sales, the equivalent VAT on its purchases. Ubi lex non distinguit, nec nos distinguere debemus . Where the law does not distinguish, we ought not to distinguish. DETACa Moreover, the exemption is both express and pervasive for the following reasons: First, RA 7916 states that 'no taxes, local and national, shall be imposed on business establishments operating within the ecozone.' Since this law does not exclude the VAT from the prohibition, it is deemed included. Exceptio firmat regulam in casibus non exceptis . An exception confirms the rule in cases not excepted; that is, a thing not being excepted must be regarded as coming within the purview of the general rule. Moreover, even though the VAT is not imposed on the entity but on the transaction, it may still be passed on and, therefore, indirectly imposed on the same entity a patent circumvention of the law. That no VAT shall be imposed directly upon business establishments operating within the ecozone under RA 7916 also means that no VAT may be passed on and imposed indirectly. Quando aliquid prohibetur ex directo prohibetur et per obliquum . When anything is prohibited directly, it is also prohibited indirectly." Accordingly, since Swedish Match , the nonresident lessor of know-how, is not a VAT registered taxpayer, such royalties paid to it by SMPI shall, for purposes of VAT, be exempt from VAT and not subject to zero-percent VAT; in either case, no output VAT is shifted or passed-on to SMPI. 6 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. "Cricket Technology" shall mean technology that Swedish Match has patented (as described under A sub (i) of the preamble) and other, patented/patentable knowledge directly those n patents, including technical information related to the manufacturing processes and know-how. 2. "Cricket Trademarks" shall mean the trademarks which Swedish Match has registered (as described under A sub (iii) of the preamble), but will also be understood to include all copyright protected material (including product designs and logos) used in the process of adapting to, imprinting on, or otherwise used to create the finished version of the Cricket Patented Products. 3. "Cricket Patented Technology" shall mean all lighters, components and other products which are (to be) manufactured by SMPI under the Agreement. 4. 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. 5. Entitled An Act Providing for the Legal Framework and Mechanism for the Creation, Operation, Administration, and Coordination of Special Economic Zones in the Philippines, Creating for this Purpose, the Philippine Economic Zone Authority (PEZA), and for Other Purposes . 6. Revenue Regulations No. 16-2005 (Consolidated Value-Added Tax Regulations of 2005) , as amended, provides: "SEC. 4.106-5. Zero-Rated Sales of Goods or Properties. A zero-rated sale of goods or properties (by a VAT-registered person) is a taxable transaction for VAT purposes, but shall not result in any output tax. However, the input tax on purchases of goods, properties or services related to such zero-rated sale, shall be available as tax credit or refund in accordance with these Regulations." "SEC. 4.109-1. VAT-Exempt Transactions. (A) In general. 'VAT-exempt transactions' refer to the sale of goods or properties and/or services and the use or lease of properties that is not subject to VAT (output tax) and the seller is not allowed any tax credit of VAT (input tax) on purchases. The person making the exempt sale of goods, properties or services shall not bill any output tax to his customers because the said transaction is not subject to VAT." n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision. n Note from the Publisher: Copied verbatim from the official document. The words "directly those" should read as "directly related to the".