ITAD BIR Ruling No. 040-10

September 21, 2010 ITAD BIR RULING NO. 040-10 Article 12, Philippines-Netherlands tax treaty; Section 28 (B) (1) in relation to Section 32 (B) (5) of the Tax Code of 1997, as amended; BIR Ruling No. ITAD-012-02; BIR Ruling No. DA-ITAD-041-02; BIR Ruling No. DA-ITAD-003-03; BIR Ruling No. DA-ITAD-100-03; BIR Ruling No. DA-ITAD-059-08 SyCip Gorres Velayo & Co. 6760 Ayala Avenue, 1226 Makati City, Philippines Attention: J.A. Osana Tax Division Gentlemen : This refers to your application for tax treaty relief dated October 2, 2008, on behalf of your client, Nike European Operations Netherlands B.V. (Nike-Netherlands) , requesting confirmation that royalty payments made by Nike Philippines, Inc. (Nike-Philippines) to Nike-Netherlands under their Intellectual License and Exclusive Distribution Agreement constitute royalties subject to the preferential tax rate of fifteen percent (15%) pursuant to Article 12 of the Philippines-Netherlands tax treaty. It is represented that Nike-Netherlands is a foreign corporation with office address at Colosseum 1, 1213 NL Hilversum, The Netherlands, tax number 8028.20.323, and is a resident of The Netherlands in the sense of the convention for the avoidance of double taxation between the Republic of the Philippines and the Kingdom of the Netherlands, per the Declaration of Residence, issued by J.C. Ghijsen, inspector of company tax at Belastingdienst/Utrecht-Gooi kantoor Utrecht; that Nike-Netherlands is not registered either as a corporation or as a partnership in the Philippines based on the Certification issued by the Securities and Exchange Commission dated September 25, 2008; that Nike-Netherlands is engaged in the trade and distribution of sportwears, sportsgoods, attributes and accessories; while Nike-Philippines is a corporation organized and existing under the laws of the Philippines with business address at 39th Floor Rufino Tower, 6784 Ayala Avenue, Makati City, Philippines; that Nike-Philippines is also engaged in the trade and distribution of sportswears, sportsgoods, attributes and accessories. It is further represented that Nike-Philippines and Nike-Netherlands entered into an Intellectual Property License and Exclusive Distribution Agreement (Agreement) effective as of June 1, 2008, whereby Nike-Netherlands grants to Nike-Philippines license and distribution rights; that the grant of the said license covers: a) A non-transferable, non-exclusive and worldwide license to manufacture or sub-contract for the manufacture of accessories, apparel, equipment and footwear (the "Licensed Goods") using the Trademarks and other Proprietary Rights owned, assigned or licensed to Nike-Netherlands ; and DCcHAa b) A non-transferable and exclusive license to sell in the Philippines the Licensed Goods and to use the Trademarks and other Proprietary Rights in the Philippines in connection with the advertising, marketing and sale of the Licensed Goods. That Articles 10 & 3 of the said Agreement provide that in consideration of the above grants, Nike-Philippines agreed to pay royalty as follows: "10. ROYALTIES. 10.1 Within thirty (30) days prior to the beginning of each Agreement Year (except in the case of the first Agreement Year, in which case, within thirty (30) days following the commencement of the first Agreement Year), and subject to approval by Licensor, Licensee shall elect one of the following royalty payment options, all payments to be made in such currency as instructed by Licensor and permitted by applicable law: (a) Royalty Option A: On June 1 of the relevant Agreement Year, Licensee agrees to pay Licensor the Discount Royalty. For purposes of this Agreement, 'Discount Royalty' means a royalty amount equal to the product of (x) six percent (6%) of the Forecasted Net Sales Revenues for such Agreement Year multiplied by (y) the Libor Discount Percentage (the 'Discount Rate'). For purposes of this Agreement, 'Libor Discount Percentage' means, with respect to any Agreement Year, the difference between one hundred percent (100%) and the six-month London Interbank Offered Rate for peso borrowings as of June 1 of such Agreement Year. Within thirty (30) days after the conclusion of such Agreement Year, Licensee shall provide Licensor with the Annual Revenue Report evidencing the Actual Net Sales Revenues for such Agreement Year. In the event that Actual Net Sales Revenues exceed the Forecasted Net Sales Revenues for such Agreement Year, resulting in an underpayment of royalties by Licensee, then Licensee shall pay the product of (x) the Discount Rate multiplied by (y) the difference between Actual Net Sales Revenues and Forecasted Net Sales Revenues to Licensor within thirty (30) days after the conclusion of the Agreement Year in question. In the event that Actual Net Sales Revenues are lower than the Forecasted Net Sales Revenues for the Agreement Year in question, resulting in an overpayment of royalties by Licensee, Licensor shall either, at its discretion, (i) refund such overpayment within thirty (30) days of receiving the Annual Revenue Report from Licensee in addition to any payment that may be due pursuant to Section 4.2 or (ii) net the overpayment against future payments of Licensee under this Agreement. All payments shall be made in accordance with Licensor's standard intercompany practices. (b) Royalty Option B: Licensee agrees to pay Licensor a royalty of six percent (6%) of the Actual Net Sales Revenues of all Licensed Goods Sold in the Licensed Territory. Upon receipt by Licensee of an invoice with respect to any royalty payment in any calendar month, Licensee shall pay to Licensor the amount specified in such invoice, in full, by no later than the last business day of such calendar month. All payments shall be made in accordance with Licensor's standard inter-company payment practices. xxx xxx xxx" That unless sooner terminated by either party in accordance with the provisions of this Agreement, the Agreement Term shall be the period commencing on June 1, 2008 and ending on May 31, 2009; that the Agreement will then be renewed for an additional one-year term unless one party gives the other party written notice of termination not later than March 1 of the then-current Agreement Term of its determination not to renew the Agreement; and that the issue/s or transaction subject of the above request for ruling is not under investigation neither is it subject of an on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings nor a judicial appeal. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended, applies in general. It provides: "Section 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 . . ., dividends, . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, Section 32 (B) (5) of the Tax Code of 1997, as amended provides: "Section 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: CIDcHA 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. xxx xxx xxx" In this particular case, the treaty involved is the Philippines-Netherlands tax treaty which, in its Article 12, provides as follows, viz.: "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. xxx xxx xxx 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. xxx xxx xxx" Based on the above-mentioned provisions, royalty payments will be taxed at a preferential rate of ten percent (10%) if the payor is an enterprise registered and engaged in preferred areas of activities in the Philippines, or 15% of the gross amount of the royalties in all other cases. Considering that Nike-Philippines is not a Board of Investments (BOI) registered enterprise engaged in preferred areas of activities in the Philippines, this Office is of the opinion and so holds that the royalty payments made by Nike-Philippines to Nike-Netherlands under the Intellectual Property License and Exclusive Distribution Agreement are subject to the preferential tax rate of 15% of the gross amount of royalties pursuant to Article 12 (2) (b) of the Philippines-Netherlands tax treaty. (BIR Ruling No. ITAD-012-02 dated January 29, 2002; BIR Ruling No. DA-ITAD-041-02 dated April 5, 2002; BIR Ruling No. DA-ITAD-003-03 dated January 15, 2003; BIR Ruling No. DA-ITAD-100-03 dated July 16, 2003; BIR Ruling No. DA-ITAD-059-08 dated August 11, 2008) Moreover, the said royalty payments by Nike-Philippines to Nike-Netherlands shall be subject to the 12% value-added tax (VAT) under Section 108 of the Tax Code, as amended, which 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 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: cEITCA xxx xxx xxx The phrase 'sale or exchange of services' means the performance of all kinds or services in the Philippines for others for a fee, remuneration or consideration, including . . . . 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; xxx xxx xxx" 1 Accordingly, Nike-Philippines , being the resident withholding agent and payor in control of the payment, shall be responsible for the withholding of the 12% final VAT on such royalty before making any payment to Nike-Netherlands. In remitting the VAT withheld, Nike-Philippines shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and proof of payment thereof shall serve as documentary substantiation for the claim of input tax by Nike-Philippines upon filing its own VAT return, if it is a VAT-registered taxpayer. In case Nike-Philippines is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of goods or properties purchased which may be treated as an "expense" or as an "asset", whichever is applicable. In addition, Nike-Philippines is required to issue the Certificate of Final Income Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies thereof to be given to Nike-Netherlands upon its request and the fourth copy to be retained by Nike-Philippines as its file copy. [ Section 4.110.3 (b), Revenue Regulations No. (RR) 7-95, as amended by RR 08-02 (now Section 4.114-2, RR 16-05, as amended by RR 04-07); Section 4.114 (d), as amended by RR 28-03 ] 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. Section 108 was amended by Republic Act No. 9337, which was signed into law on May 24, 2005, which became effective on 1 November 2005. The VAT rate was increased to 12% on 1 February 2006 in accordance with the Memorandum of the Executive Secretary to the Secretary of Finance dated 31 January 2006, as circularized by Revenue Memorandum Circular No. 07-2006 dated 31 January 2006.