ITAD BIR Ruling No. 035-17

November 7, 2017 ITAD BIR RULING NO. 035-17 Article 12 (Royalties) Philippines-Japan tax treaty ______________________________ ______________________________ ______________________________ Attention: ____________________ Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on April 8, 2013, requesting confirmation that royalties paid by Corporation 1 ("Corp1") to Corporation 2 ("Corp2") are subject to a preferential tax rate of 10% pursuant to the Convention between the Republic of the Philippines and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income as amended 1 ("Philippines-Japan tax treaty") . caITAC It is represented that Corp2 is a resident of Japan within the meaning of the Philippines-Japan tax treaty based on a Certificate of Residence issued by __________ Tax Office dated December 3, 2012; that it is engaged in the business of manufacturing and selling consumer products including toothpaste, toothbrush, mouthwash, dental floss, inter dental brush, shampoo, conditioner, hair styling products, liquid body soap, liquid hand soap, facial foam, skin care lotion and other products of similar nature ("Royalty Products") in Japan and various other parts of the world and has developed and possesses secret processes, formulae and technical information, know-how, patents and designs for the manufacture of the Royalty Products ; that it is not registered either as a corporation or as a partnership in the Philippines as shown in the Certification of Non-Registration of Company issued by the Securities and Exchange Commission; and that on the other hand, Corp1 is a corporation organized and existing under the laws of the Philippines. It is also represented that Corp2 and Corp1 entered into a Technical Know-How and Trademark License Agreement ("Agreement") on December 18, 2012, whereby Corp2 granted Corp1 (i) a non-transferrable, exclusive, sole license, without the right to sublicense, to use the Technical Know-How 2 to manufacture, and to use brand trademarks to distribute and sell the Royalty Products in the territory; and (ii) Corp2 also granted Corp1 a non-transferrable, sole license, without the right to sublicense, to use the housemark trademark 3 for the purpose of manufacturing, distributing and selling the Royalty Products in the territory. In addition, under the Agreement, Corp2 will provide technical assistance, 4 at all times, to Corp1 relating to necessary advice, guidance, consultation, assistance and training in connection with the marketing and promotion of the Royalty Products ; and that for this purpose Corp2 agreed to dispatch technical personnel to the plant of Corp1 or those otherwise specified by Corp1 subject to the terms and conditions separately agreed between the parties. It is further represented that in consideration, Corp1 shall pay Corp2 a royalty rate and consultation fee rate by multiplying the Net Selling Price 5 for each Royalty Products with appropriate percentages for the covered years. 6 It is finally represented, per sworn statement issued by the President of Corp1 on April 6, 2013, that the issue or transaction subject of this 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 judicial appeal. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, 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 interest, 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%). (Emphasis supplied) ICHDca xxx xxx xxx However, said income derived by a nonresident foreign corporation may be exempt or partially exempt from income tax pursuant to a treaty obligation to which the Philippine government is bound. Thus, Section 32 (B) (5) of the Tax Code of 1997, as amended provides: 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. . . In relation thereto, Article 12 of the Philippines-Japan tax treaty may apply to the herein case. The said treaty provides: Article 12 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 laws of that Contracting State, but if the recipient is the beneficial owner of the royalties the tax so charged shall not exceed: (a) 15 per cent 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; (b) 10 per cent of the gross amount of the royalties in all other cases. cDHAES 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 and films or tapes for radio or television 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 above-quoted provisions, the Philippines may tax the royalties paid by a resident thereof to a company which is a resident of Japan at a rate not exceeding 15 percent if the royalties are paid in respect of the use of or the right to use cinematograph films and films or tapes for radio and television broadcasting; and 10 percent of the gross amount of royalties in all other cases. Furthermore, the technical assistance extended by Corp2 to Corp1 under the grant of Technical know-how, is considered as royalty since the grant is merely ancillary to the principal purpose of marketing and promotion of Royalty Products under the Agreement . This is clarified in the following commentaries of the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (Condensed Version, July 22, 2010) : "11.6 In business practice, contracts are encountered which cover both know-how and the provision of technical assistance. One example, amongst others, of contracts of this kind is that of franchising, where the franchisor imparts his knowledge and experience to the franchisee and, in addition, provides him with varied technical assistance, which, in certain cases, is backed up with financial assistance and the supply of goods. The appropriate course to take with a mixed contract is, in principle, to break down, on the basis of the information contained in the contract or by means of a reasonable apportionment, the whole amount of the stipulated consideration according to the various parts of what is being provided under the contract, and then to apply to each part of it so determined the taxation treatment proper thereto. If, however, one part of what is being provided constitutes by far the principal purpose of the contract and the other parts stipulated therein are only of an ancillary and largely unimportant character, then the treatment applicable to the principal part should generally be applied to the whole amount of the consideration ." (Emphasis ours) Accordingly, since the intangible property subject of the Agreement is essentially for the use of, or the right to use trademark license and know-how , and not cinematograph films and films or tapes for radio or television broadcasting, royalties by Corp1 to Corp2 are subject to income tax at the rate of 10 percent , pursuant to paragraph 2 (b), Article 12 of the Philippines-Japan tax treaty, as amended. Moreover, as provided in Section 108 of the Tax Code of 1997, said royalties 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 the 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: xxx xxx xxx The phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for others for a fee, . . . 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; (2) The supply of scientific, technical or commercial knowledge information; . . . 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 Revenue Regulations No. 14-2002, Corp1 shall be responsible for the withholding of VAT on the royalties before remitting them to Corp2 . In remitting to the Bureau of Internal Revenue the VAT withheld, Corp1 shall use BIR Form No. 1600 (Monthly Remittance return of Value-Added Tax & Other Percentage Taxes Withheld). If it is a VAT-registered taxpayer, Corp1 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, Corp1 may include as part of the cost of the royalty fees to it by Corp2 the VAT consequently shifted or passed on to it. In addition, Corp1 is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies for Corp2 and the fourth copy for Corp1 as its file copy. This ruling is issued on the basis of the foregoing 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.) CAESAR R. DULAY Commissioner of Internal Revenue Footnotes 1. Protocol amending the Philippines-Japan tax treaty which took effect in January 1, 2009. 2. Technical Know-how means the raw material standard, technical standard, information about product, ingredient, manufacturing standard (including technical assistance), packaging standard, design, standard test method, quality control know-how and other technical information. 3. Housemark Trademark means the trademarks possessed and owned by Corp2 in territory. 4. See Article 3 of the Technical know-how and Trademark License Agreement. 5. Net Selling Price means the gross invoice price for the Royalty Products sold by Corp1 with the deduction of the sales return thereof. 6. See Schedule IV of the Agreement.