ITAD BIR Ruling No. 039-13

February 28, 2013 ITAD BIR RULING NO. 039-13 Articles 13 (Royalties) and 23 (Relief from Double Taxation); Philippines-United States of America tax treaty Sycip Gorres Velayo and Co. 6760 Ayala Avenue Makati City Attention: Atty. Romulo S. Danao, Jr. Partner, Tax Services Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on June 29, 2011 requesting confirmation that royalties paid by Towers Watson Philippines, Inc. ("Towers Watson Philippines") to Towers Perrin Capital Corporation ("Towers Perrin") are subject to income tax at the 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-United States tax treaty") . Facts Towers Perrin is a foreign corporation and a resident of the United States based on its Certificate of Incorporation filed at the State of Delaware in the United States on December 4, 2000, and on its Certificate of Residence issued by the Internal Revenue Service of the United States on October 4, 2011. Towers Perrin is located at 1011 Centre Road, Suite 325, Wilmington, Delaware, United States. It is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission on May 17, 2011. On the other hand, Towers Watson Philippines is a domestic corporation located at 15th Floor, The Marajo Tower, 312 26th Street corner 4th Avenue, Fort Bonifacio, Global City, Taguig City, Philippines. On January 1, 2011, Towers Watson Philippines and Towers Perrin entered into a Global Intellectual Property License Agreement where Towers Perrin granted Towers Watson Philippines a non-exclusive license to use in the Philippines, among others, the trademarks 'Towers Watson' and 'TW' and their derivatives as part of the corporate name of Towers Watson Philippines and its subsidiaries. The trademarks will be used in connection with Towers Watson Philippines' business of providing services, computer software, and publications in the fields of compensation, employee benefits, human resources, insurance, business management, risk management, information technology, actuarial services, reinsurance brokerage services, and the provision of related products and services. In consideration, Towers Watson Philippines will pay royalties to Towers Perrin equivalent to 2 percent of its gross revenues in each calendar quarter. Invoices will be issued on a quarterly basis based on previous three months' actual gross revenues. The royalties will be paid within thirty days after the receipt of the relevant invoice from Towers Perrin. The Agreement took effect on January 1, 2011 for an initial period of five years or until December 31, 2015; thereafter, the Agreement may be extended by mutual agreement of the parties. CTaSEI Ruling In reply, please be informed that under Section 14 of Revenue Memorandum Order No. 72-2010 (Guidelines on the Processing of Tax Treaty Relief Applications (TTRA) Pursuant to Existing Philippine Tax Treaties) ("RMO 72-2010") , which covers income derived or which accrued on November 4, 2010 and thereafter, any availment of tax treaty relief (exemption from income tax or reduction of tax) shall be preceded by an application filed at the International Tax Affairs Division ("ITAD") of this Bureau before the intended transaction or payment of income, to wit: "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 or any necessary documents are submitted to any other BIR Office, the application shall be considered as improperly filed. 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 of disqualifying the TTRA under this RMO ." (Emphasis ours) This condition is emphasized by the Court of Tax Appeals in Mirant (Philippines) Operations Corporation vs. Commissioner of Internal Revenue (C.T.A. Case No. 6382 dated June 7, 2005) where it ruled: "However, it must be remembered that a foreign corporation wishing to avail of the benefits of the tax treaty should invoke the provisions of the tax treaty and prove that indeed the provisions of the tax treaty applies to it, before the benefits may be extended to such corporation . In other words, a resident or non-resident foreign corporation shall be taxed according to the provisions of the National Internal Revenue Code, unless it is shown that the treaty provisions apply to the said corporation, and that, in cases the same are applicable, the option to avail of the tax benefits under the tax treaty has been successfully invoked. TSADaI Under Revenue Memorandum Order 01-2000 of the Bureau of Internal Revenue, it is provided that the availment of a tax treaty provision must be preceded by an application for a tax treaty relief with its International Tax Affairs Division (ITAD). This is to prevent any erroneous interpretation and/or application of the treaty provisions with which the Philippines is a signatory to. The implementation of the said Revenue Memorandum Order is in harmony with the objectives of the contracting state to ensure that the granting of the benefits under the tax treaties are enjoyed by the persons or corporations duly entitled to the same . The Court notes that nowhere in the records of the case was it shown that petitioner indeed took the liberty of properly observing the provisions of the said order. Petitioner quotes various BIR, as well as ITAD, Rulings issued to several foreign corporations seeking for a tax relief from the office of the respondent. However, not any one of these rulings pertains to the petitioner. It must be stressed that BIR rulings are issued based on the facts and circumstances surrounding particular issue/issues in question and are resolved on a case-to-case basis. It would be thus erroneous to invoke the ruling of the respondent in specific cases, which have no bearing to the case of petitioner." (Emphasis ours) This decision is upheld by the Supreme Court in Resolution G.R. No. 168531 on February 18, 2008. Furthermore, the necessary requirement laid down in RMO 1-2000 is reiterated in subsequent rulings of the Court of Tax Appeals: Deutsche Bank AG Manila Branch vs. Commissioner of Internal Revenue (C.T.A. Case No. 456 dated May 29, 2009), CBK Power Company Ltd. vs. Commissioner of Internal Revenue (C.T.A. Case Nos. 6699, 6844 and 7166 dated March 29, 2010) and Manila North Tollways Corporation vs. Commissioner of Internal Revenue (C.T.A. Case No. 7864 dated April 12, 2011) . In view of the foregoing, since the Global Intellectual Property License Agreement that gives rise to the royalties has been in effect on January 1, 2011, but the relevant TTRA was filed only on June 29, 2011, this Office hereby DENIES relief on all royalties paid by Towers Watson Philippines to Towers Perrin on and before June 29, 2011, pursuant to Section 14 of RMO 72-2010. Accordingly, said royalties shall be subject to income tax at the rate of 30 percent under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, to wit: DTIACH "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%)." On the other hand, the royalties paid to Towers Perrin on June 30, 2011 and thereafter are subject to a most-favored-nation treatment (that is, the lowest rate of income as that imposed on royalties of the same kind arising in the Philippines and paid to a resident of a third State under similar circumstances), under paragraph 2 (b) (iii), Article 13 of the Philippines-United States tax treaty, to wit: "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. DHITCc 2. However, the tax imposed by that other Contracting State shall not exceed xxx xxx xxx b) In the case of the Philippines, the least of: xxx xxx xxx (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." With respect to the most-favored-nation treatment, 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) ("SC Johnson case") , had required two conditions for such treatment to apply. First, the royalties arising in the Philippines and paid to a resident of the United States must be of the same kind (that is, same type of intangible property, copyright, patent, know-how, etc.) as those derived in the Philippines by a resident of a third State and to which the tax treaty between the Philippines and the third State subjects such royalties to a most-favored-nation treatment. Second, the royalties paid to the United States resident must be paid under similar circumstances vis--vis those royalties paid to the third State resident, that is, the United States must allow the same amount of foreign tax credit to its resident as that allowed by the third State to its resident with respect to such royalties arising in the Philippines and subjected to tax therein. As pointed out in the SC Johnson case, royalties arising in the Philippines and paid to a United States resident are not paid under similar circumstances vis--vis royalties arising in the Philippines and paid to a German resident by reason that Germany provides an additional foreign tax credit of 10 percent (tax sparing credit) on the royalties or a total credit of 20 percent as against a foreign tax credit of 10 percent allowed by the United States. The pertinent portion of this ruling reads: SaTAED "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 the purpose of the most-favored-nation treatment, there is The Agreement between the Government of the Republic of the Philippines and the Government of the United Arab Emirates for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital ("Philippines-United Arab Emirates tax treaty") which took effect on January 1, 2009. Under paragraphs 1, 2 and 3, Article 12 of the Philippines-United Arab Emirates tax treaty, royalties arising in the Philippines and paid to a resident of the United Arab Emirates are subject to income tax in the Philippines at a rate not to exceed 10 percent. The term royalties means payment 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 and films or tapes for television or radio 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") . Article 12 reads: AECacS "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, the 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 10 per cent of the gross amount of the royalties. The competent authorities of the Contracting States shall, by mutual agreement, settle the mode of application of this limitation. 3. The term 'royalties' as used in this Article means payment 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 and films or tapes for television or radio 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." Moreover, under paragraph 2, Article 23 of the Philippines-United Arab Emirates tax treaty, the amount of foreign tax credit that the United Arab Emirates will allow its resident on such royalties arising in the Philippines and subjected to tax therein will be the actual amount of tax levied in the Philippines, which is 10 percent under Article 12 of the treaty, to wit: "Article 23 Elimination of Double Taxation xxx xxx xxx 2. In the case of the United Arab Emirates, double taxation shall be eliminated as follows: Where a resident of the United Arab Emirates derives income which in accordance with the provisions of this Agreement, may be taxed in the Philippines, the United Arab Emirates shall allow as a deduction from tax on income of that person an amount equal to the tax on income paid in the Philippines ." cDHAES In the same manner, under paragraph 1, Article 23 of the Philippines-United States tax treaty, the amount of foreign tax credit that the United States will allow its resident on such royalties arising in the Philippines and subjected to tax therein will be the actual amount of tax levied in the Philippines, to wit: "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 time 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 . . . Such appropriate amount shall be based upon the amount of tax paid or accrued to the Philippines, but the credit shall not exceed the 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 . . ." (Emphasis ours) In view of the foregoing, since royalties in general are subject to income tax at the rate of 10 percent under the Philippines-United Arab Emirates tax treaty, and since both the Philippines-United States and the Philippines-United Arab Emirates tax treaties allow only as foreign tax credit the actual amount of income tax levied on such royalties in the Philippines, the royalties paid by Towers Watson Philippines to Towers Perrin on June 30, 2011 and thereafter under the Agreement for the use of the trademarks 'Towers Watson' and 'TW' and their derivatives in connection with the conduct of Towers Watson Philippines' business in the Philippines shall be subject to income tax at the rate of 10 percent, pursuant to paragraph 2 (b) (iii), Article 13 of the Philippines-United States tax treaty, in relation to paragraph 2, Article 12 of the Philippines-United Arab Emirates tax treaty. Finally, under Section 108 (A) of Tax Code, the said royalties for the use of trademark in the Philippines are subject to value-added tax ("VAT"), to wit: HTScEI "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, 1 raise the rate of value-added tax to twelve percent (12%) . . ." Relative thereto, Towers Watson Philippines shall withhold VAT on the royalties at the rate of 12 percent before remitting them to Towers Perrin. Towers Watson Philippines shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). If it is a VAT-registered taxpayer, the duly filed BIR Form No. 1600 and accompanying proof of payment shall serve as documentary substantiation for Towers Watson Philippines' claim of input tax on the royalties; otherwise, it may treat such 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 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. 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."