Bernaldo Directo & Po Law Offices

September 29, 2021 ITAD BIR RULING NO. 044-21 Articles 8 (1), 5 (1) and (2), and 13 (2) (b) (i) of the Philippines-United States of America Tax Treaty, and Sections 28 (B) (1) and (4), 105 and 108 of the Tax Code Bernaldo Directo & Po Law Offices Unit 1807 Cityland Condominium 10-Tower 1 6815 Ayala Avenue cor. H.V. dela Costa St. 1200 Makati City Gentlemen : This refers to your tax treaty relief application that was filed on December 4, 2013 requesting confirmation that the royalty payments made by Diebold Philippines, Inc. (Diebold PH) to Diebold, Incorporated (Diebold US) are subject to the preferential income tax rate of 10% pursuant to the most favored nation (MFN) clause under Article 13 (2) (b) (iii) of 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 (PH-US Tax Treaty), in relation to the Article 12 (2) (a) of 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 (PH-UAE Tax Treaty). FACTS Diebold US is a foreign corporation duly organized and existing under the laws of the United States of America (US) based on its Amended and Restated Articles of Incorporation, and a resident thereof based on the Certificate of Residence duly issued by the Internal Revenue Service of the US. It is engaged in the manufacture, sale, erection, disposal of and dealing in and with all kinds of safes, locks, vaults, office equipment and systems, burglar-resisting, fire-resisting and protective materials, equipment and devices, structural materials, metal houses and all manner of steel and other metal products, among others. It is not registered as a corporation in the Philippines nor licensed to do business in the Philippines per the Certification of Non-Registration of Company duly issued by the Securities and Exchange Commission. On the other hand, Diebold PH is a domestic corporation engaged in the selling and carrying on the business of rendering services in maintenance and repair, counselling and giving advice on operation problems of Automatic Teller Machines (ATMs), cash deposit machines, passbook updating machines and all kinds of financial service machines including tools, accessories and spare parts thereof as well as related systems and computer software programs. acEHCD On July 2, 2013, Diebold PH and Diebold US entered into an International Depot Repair Agreement (the Agreement) whereby the latter agreed to grant the former a personal, non-exclusive right to use the licensed information and training for the sole and exclusive purpose of operating the Depot Repair Package and to use, install and operate the firmware only to the extent necessary to use the Depot Repair Package. The licensed information refers to the software (including firmware) and depot repair documentation provided to Diebold PH as well as additional repair folders associated with any module as Diebold US may allow Diebold PH to service from time to time under the Agreement. In addition, Diebold US shall provide Diebold PH the test equipment and tools, and a limited license to possess and use the same solely in accordance with the terms of the Agreement. Finally, Diebold US shall provide training for up to two (2) technicians at its location or the location of Diebold PH within one hundred (100) working days from the latter's acceptance of the test equipment, and an on-site support during the start-up of Diebold PH's depot repair operation. In turn, Diebold PH shall pay Diebold US an annual license fee of USD__________ and limited license fees for additional Depot Repair Packages to be determined upon implementation of such devices in the Philippines. Service fees for on-site assistance shall be USD__________ per day. The said fees shall be paid within thirty (30) days from the date of invoice. The Agreement shall be effective for a period of three (3) years and shall thereafter be renewed annually. RULING In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997 (Tax Code), as amended, income derived by a nonresident foreign corporation is subject to income tax at the rate of 30%: 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: 1 However, under Section 32 (B) (5) of the Tax Code, such income is exempt to the extent required by any treaty obligation binding upon the Philippine government: 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. SDHTEC xxx xxx xxx Being a resident of the US, Diebold US invoked the most favored nation clause under Article 13 (2) (b) (iii) of the PH-US Tax Treaty, in relation to Article 12 (2) of the PH-UAE Tax Treaty. Royalty Payments for Licensed Information, Firmware or Software Under Article 13 (2) (b) of the PH-US Tax Treaty, royalties arising in the Philippines and paid to a US resident, except those paid by a corporation registered with the Philippine Board of Investments and engaged in preferred areas of activities, are subject to tax at 25% or at the lowest tax 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, thus: 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. (Emphasis supplied) 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. xxx xxx xxx The "most favored nation" clause speaks of 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." In this case, Diebold US invoked Article 12 (2) of the PH-UAE Tax Treaty, which provides that royalties arising in the Philippines and paid to a resident of the United Arab Emirates (UAE) may be subjected to a preferential income tax rate of (10%), viz. : AScHCD 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. x x x 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. xxx xxx xxx (Emphasis supplied) Therefore, the tax treatment of royalties paid to Diebold US may be taken in relation to the PH-UAE Tax Treaty that provides a lower tax rate on the same type of income. In Commissioner of Internal Revenue vs. S.C Johnson and Son, Inc. , 2 the Supreme Court construed the phrase "paid under similar circumstances" under the most favored nation clause as referring to circumstances that are tax-related . In other words, the similarity in the circumstances of payment of taxes on the royalties derived from the Philippines is a condition for the enjoyment of the most favored nation treatment . In the recent case of Cargill Philippines, Inc. vs. Commissioner of Internal Revenue , 3 the Court laid down the two conditions that must be met for the most favored nation clause to apply: (1) similarity in subject matter, i.e. , royalties derived from the Philippines by a resident of the United States and of the third state must be of the same kind or class; and (2) similarity in circumstances in the payment of tax, i.e. , the tax consequences of royalty payments under the two treaties must be under similar circumstances. This requires a showing that the method employed for eliminating or mitigating the effects of double taxation under the treaty with the United States and the third state are the same. In this case, it is undisputed that the first condition was satisfied. Both Article 13 (3) of the PH-US Tax Treaty and Article 12 (3) of the PH-UAE Tax Treaty cover royalties for information concerning industrial, commercial or scientific experience and for the use of, or the right to use, any copyright of literary, artistic or scientific work. The Philippines recognizes that software is generally assimilated as a literary, artistic or scientific work protected by the copyright laws of various countries. Thus, payments in consideration for the use of, or right to use, a copyright relating to software are regarded as royalties in the Philippines. 4 Certainly, the royalty payments made by Diebold PH to Diebold US for the use of the licensed information and for the use, installation and operation of the firmware or software for the sole and exclusive purpose of operating the Depot Repair Package are within the definition of royalties under the said treaty provisions. The Bureau does not agree, however, that the methods employed for eliminating or mitigating the effects of double taxation under the tax treaty with the US and UAE are the same. The pertinent provisions of the said tax treaties are as follows: AcICHD PH-US Tax Treaty PH-UAE Tax Treaty 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 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 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. x x x (Emphasis supplied) 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. (Emphasis supplied) It is clear from the foregoing provisions that both countries adopt the credit method for eliminating double taxation, i.e. , the taxes paid in the Philippines on royalty income are allowed to be credited against the tax to which the nonresident taxpayer may be liable in the US or UAE. A careful reading of the treaty provisions shows, however, that the tax credit allowed under the PH-UAE Tax Treaty is equivalent to the amount of tax paid in the Philippines on the royalty income while the tax credit allowed under the PH-US Tax Treaty is the amount of tax paid or accrued to the Philippines but shall not exceed the limitations provided by the US law for the taxable year. Simply put, the tax credit allowed in the UAE for taxes paid in the Philippines is not subject to any limitation while that allowed in the US is subject to the limitations provided under its internal tax law. Hence, the tax on royalties under the PH-US Tax Treaty was not paid under circumstances similar to the tax on royalties under the PH-UAE Tax Treaty. In view of the foregoing, the Bureau hereby rules that the most favored nation clause under the PH-US Tax Treaty cannot apply. Accordingly, the royalty income derived by Diebold US from the Philippines are subject to 25% pursuant to Article 13 (2) (b) (i) of the PH-US Tax Treaty. Income Payments for the Use of Test Equipment Under Section 28 (B) (4) of the Tax Code, rentals for the use of machineries and other equipment shall be subject to a tax of seven and one-half percent (7 1/2%) of gross rentals or fees, to wit: SEC. 28. Rates of Income Tax on Foreign Corporations . (B) Tax on Nonresident Foreign Corporation . (4) Nonresident Owner or Lessor of Aircraft, Machineries and Other Equipment. Rentals, charters and other fees derived by a nonresident lessor of aircraft, machineries and other equipment shall be subject to a tax of seven and one-half percent (7 1/2%) of gross rentals or fees. xxx xxx xxx Therefore, any income received by Diebold US from the lease of its test equipment and other tools to Diebold PH are subject to tax at 7.5%. Business Profits Article 8 (1) and Article 5 (1) and (2) of the PH-US Tax Treaty provide as follows: TAIaHE Article 8 BUSINESS PROFITS 1. Business profits of a resident of one of the Contracting States shall be taxable only in that State unless the resident has a permanent establishment in the other Contracting State. If the resident has a permanent establishment in that other Contracting State, tax may be imposed by that other Contracting State on the business profits of the resident but only on so much of them as are attributable to the permanent establishment. xxx xxx xxx Article 5 PERMANENT ESTABLISHMENT 1. For the purposes of this Convention, the term "permanent establishment" means a fixed place of business through which a resident of one of the Contracting States engages in a trade or business. 2. The term "fixed place of business" includes but is not limited to: a) A seat of management; b) A branch; c) An office; d) A store or other sales outlet; e) A factory; f) A workshop; g) A warehouse; h) A mine, quarry, or other place of extraction of natural resources; i) A building site or construction or assembly project or supervisory activities in connection therewith, provided such site, project or activity continues for a period of more than 183 days; and j) The furnishing of services, including consultancy services, by a resident of one of the Contracting States through employees or other personnel, provided activities of that nature continue (for the same or a connected project) within the other Contracting State for a period or periods aggregating more than 183 days. xxx xxx xxx Pursuant to Article 8 of the PH-US Tax Treaty, the business profits of Diebold US shall be taxable only in the US unless it has a permanent establishment in the Philippines. A permanent establishment is defined as a fixed place through which a resident of one of the Contracting States engages in a trade or business and includes, but is not limited to, a seat of management, a branch, an office, a store or other sales outlet, a factory, a workshop, and a warehouse. It also includes the furnishing of services, including consultancy services, by a resident of one of the Contracting States through employees or other personnel, provided activities of that nature continue (for the same or a connected project) within the other Contracting State for a period or periods aggregating more than 183 days. Provided that it does not establish a fixed place of business in the Philippines or does not furnish services in the Philippines through its employees or other personnel for a period or periods aggregating more than 183 days, the business profits derived by Diebold US from the Philippines shall be exempt from income tax. cDHAES Value-Added Tax (VAT) Finally, the gross receipts derived by Diebold US from the sale of services to Diebold PH are also subject to value-added tax (VAT) at the rate of 12% under Section 108 (A), in relation to Section 105, of the Tax Code, to wit: SEC. 105. Persons Liable . Any person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, renders services, and any person who imports goods shall be subject to the value-added tax (VAT) imposed in Sections 106 to 108 of this Code. The value-added tax is an indirect tax and the amount of tax may be shifted or passed on to the buyer, transferee or lessee of the goods, properties or services. This rule shall likewise apply to existing contracts of sale or lease of goods, properties or services at the time of the effectivity of Republic Act No. 7716. The phrase 'in the course of trade or business' means the regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto, by any person regardless of whether or not the person engaged therein is a non-stock, nonprofit private organization (irrespective of the disposition of its net income and whether or not it sells exclusively to members or their guests), or government entity. The rule of regularity, to the contrary notwithstanding, services as defined in this Code rendered in the Philippines by nonresident foreign persons shall be considered as being rendered in the course of trade or business. 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, raise the rate of value-added tax to twelve percent (12%) x x x" x x x 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; TCAScE (2) The lease or the use of, or the right to use of any industrial, commercial or scientific equipment; xxx xxx xxx Lease of properties shall be subject to the tax herein imposed irrespective of the place where the contract of lease or licensing agreement was executed if the property is leased or used in the Philippines. The term "gross receipts" means the total amount of money or its equivalent representing the contract price, compensation, service fee, rental or royalty, including the amount charged for materials supplied with the services and deposits and advanced payments actually or constructively received during the taxable quarter for the services performed or to be performed for another person, excluding value-added tax. xxx xxx xxx Pursuant to Section 105 of the Tax Code, as amended, any person who, in the course of trade or business, renders services shall be subject to the VAT imposed in Section 108 thereof. Included in the coverage of taxable persons are non-resident persons who perform services in the Philippines and who are deemed to be making sales in the course of trade or business, even if the performance of services is not regular. 5 Sale of services also includes the lease or the use of intellectual property rights or of any industrial, commercial or scientific equipment in the Philippines. For the sale of services, the 12% VAT is generally imposed on all kinds of services performed in the Philippines 6 except those falling under the zero-rated sale of services 7 or exempt transactions. 8 In this case, the services rendered by Diebold US in the Philippines are subject to 12% VAT, while those rendered in the US, or outside the Philippines, are exempt from VAT. In addition, the gross receipts derived by Diebold from the lease of its test equipment and other tools, and from the lease or use of the licensed information and copyright in the Philippines are likewise subject to 12% VAT. Based on Section 4.114-2 of Revenue Regulations No. 16-2005, 9 Diebold PH shall, before making payment to Diebold US, withhold the 12% VAT using BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld) 10 and shall remit the same within ten (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 it will be disclosed upon investigation that the 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. The income tax rate for nonresident foreign corporations was reduced to 25% under Republic Act (RA) No. 11534, otherwise known as An Act Reforming the Corporate Income Tax and Incentives System, Amending tor the Purpose Sections 20, 22, 25, 27, 25, 29, 34, 40, 57, 109, 116, 204 and 290 of the National Internal Revenue Code of 1997, as Amended, and Creating Therein New Title XIII, and for Other Purposes" or the CREATE Law. 2. G.R. No. 127105, June 25, 1999, 309 SCRA 87. 3. G.R. No. 203346, September 9, 2020. 4. Section 3 (b) of Revenue Memorandum Circular No. 44-2005. 5. Sec. 4.105-3, Revenue Regulations (RR) No. 16-2005, otherwise known as Consolidated Value-Added Tax Regulations of 2005. 6. Sec. 108 (A) of the National Internal Revenue Code (Tax Code), as amended. 7. Sec. 108 (B) of the Tax Code, as amended. 8. Sec. 109 of the Tax Code, as amended. 9. 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). 10. Now BIR Form No. 1600-VT (Monthly Remittance Return of Value-Added Tax Withheld).