ITAD BIR Ruling No. 045-10

October 5, 2010 ITAD BIR RULING NO. 045-10 Articles 13 & 23, Philippines-United States tax treaty; Article 12, Philippines-Bahrain tax treaty; Articles 12 & 22, Philippines-Czech tax treaty; BIR Ruling No. ITAD-127-06; BIR Ruling No. DA-ITAD-060-07; BIR Ruling No. DA-ITAD-032-08 Chevron Philippines Inc. 6/F 6750 Ayala Avenue 1226 Makati City, Philippines Attention: Raissa Rodriguez-Bautista Leo L. San Juan Gentlemen : This refers to your letter dated May 14, 2009, requesting for relief from double taxation and confirmation of your opinion that the royalty payments by Chevron Philippines Inc. (CPI) to Chevron U.S.A., Inc. (CUSA) under the Project Olympic Software License Agreement (Agreement) are subject to ten percent (10%) final withholding tax pursuant to Article 13 (2) (b) (iii) of the Philippines-United States tax treaty in relation to Article 12 (2) (b) of the Philippines-Bahrain tax treaty. aEIcHA It is represented that CUSA, with principal office address at 6001 Bollinger Cyn Road, San Ramon, California 94583, USA with TIN: 25-0527925, is a nonresident foreign corporation and a resident of the United States of America for purposes of U.S. taxation, as evidenced by a Certification dated February 9, 2009, issued by the Department of Treasury, Internal Revenue Service, Philadelphia, PA, USA, signed by Ivy S. McChesney, Field Director, Accounts Management; that it is not registered either as a corporation or as a partnership in the Philippines per certification issued by the Securities and Exchange Commission (SEC) dated December 17, 2008; that CPI is a corporation organized and existing under the laws of the Philippines, with office address at 6th Floor, 6750 Building, Ayala Avenue, 1200 Makati City. It is further represented that on July 1, 2008 CUSA and CPI entered into a Agreement, whereby CUSA, grants to CPI a limited, non-transferable, non-exclusive license and right to use the Project Olympic Software; that the Project Olympic represents a complete overhaul of the Enterprise Resource Planning systems used by Chevron's Global Downstream organization; that it will harmonize the data and standardize the processes used in the 109 countries in which Global Downstream operates; that the Project Olympic Software has fourteen primary functions: 1. Manage Accounting and Control Data 2. Provide Decision Support 3. Manage Plant, Equipment, and Facilities 4. Manage Human Resources 5. Market and Sell Products and Services 6. Manage Logistics 7. Manage Lubricants Supply Chain 8. Refine and Product Products 9. Project Management 10. Manage Capital and Risk 11. Perform Order Management EcDTIH 12. Procure Materials and Services 13. Manage Retail Real Estate 14. Manage Supply and Trading That CPI shall annually pay the License Fee to CUSA in twelve equal monthly installments for a period of ten years beginning on July 1, 2008, in the amount of US$5,800.00 for the first year of the term of this Agreement. For each subsequent year, CUSA shall calculate the License Fee based on the total number of user seats employed and the total charges for Project Olympic that are projected to be incurred over the course of the project. CUSA notify CPI of the amount of the annual License Fee within thirty (30) days prior to the first billing of such year's License Fee. It is finally represented 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 7 (B) (2) of Revenue Memorandum Circular No. 44-2005 provides, viz. : "Section 7. Modes of Acquiring Software and the Relevant Tax Treatment Thereof. xxx xxx xxx B. Acquisition of copyright rights xxx xxx xxx 2. By an End-user xxx xxx xxx h. Directly from the foreign owner and/or licensor of the software. A local end-user may acquire license to use software directly from the foreign licensor/owner of the software. Payments made by the end-user to the licensor/owner are royalties subject to 32 percent income tax based on the gross amount thereof, imposed on royalties derived by a nonresident foreign corporation (Section 28[B][1], NIRC of 1997), which amount shall be withheld and collected by the end-user making the payments (Section 2.57-1[I][1], RR No. 2-98). ADCETI However, if the foreign licensor/owner is a resident of a country which has an existing tax treaty with the Philippines, royalties paid thereto are subject to the reduced tax rates on royalties under the relevant tax treaty, provided the condition prescribed therein are complied with by the licensor/owner." In relation thereto, Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended 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 . . ., royalties, . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" Based on the above provision of RMC 44-2005, in relation to Section 28 (B) (1) of the Tax Code of 1997, as amended, payment by CPI for acquisition of license to use software directly from CUSA are, in general, subject to thirty-five percent (35%) income tax, based on the gross amount thereof. Nonetheless, 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: 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. TcCSIa xxx xxx xxx" In this particular case, the treaty involved is the Philippines-United States tax treaty which, in its Article 13, provides as follows, viz. : "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. 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. aScITE xxx xxx xxx" In relation to Article 13 (2) (b) (iii) or the most-favored-nation clause of the Philippines-United States tax treaty, CPI invoked the provisions of the Philippines-Bahrain tax treaty, viz. : "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: a) 15 per cent of the gross amount of royalties arising from the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films or tapes for television or broadcasting, or b) 10 per cent of the gross amount of royalties in all other cases. xxx xxx xxx" Under Article 12 of the Philippines-Bahrain 1 tax treaty, royalties arising from the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films or tapes for television or broadcasting, are subject to fifteen percent (15%), or 10% in all other cases. Applying the Philippines-Bahrain tax treaty, the royalty fee paid by CPI to CUSA for the use of the Project Olympic Software will be subject to 15%. Nevertheless, applying the "most-favored-nation" clause, the tax rate of 10% can be granted based on the Philippines-Czech tax treaty. Article 12 of the said treaty provides: "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. SACHcD 2. However, such 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: a) 10 per cent of the gross amount of the royalties arising from the use of, or the right to use, any copyright of literary, artistic or scientific work, other than that mentioned in sub-paragraph (b), any patent, trade mark, design or model, plan, secret formula or process, or from the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience; b) 15 per cent of the gross amount of the royalties arising from the use of, or the right to use, any copyright of cinematograph films, and films or tapes for television or radio broadcasting. xxx xxx xxx" Under Article 12 (2) (a) of the Philippines-Czech tax treaty, royalties for information concerning industrial, commercial or scientific experience; royalties for the use or right to use of any copyright of literary, artistic or scientific work; and any patent, trade mark, design or model, plan, secret formula or process, or any industrial, commercial or scientific equipment, are subject to 10% income tax based on the gross amount of royalties. As for the mechanism employed in mitigating the effects of double taxation, Article 23 of the Philippines-United States tax treaty reads: "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. . . . ." cCSDaI Likewise, Article 22 of the Philippines-Czech tax treaty provides, viz. : "Article 22 ELIMINATION OF DOUBLE TAXATION xxx xxx xxx 2. In the case of a resident of the Czech Republic, double taxation shall be eliminated as follows: a) The Czech Republic, when imposing taxes on its residents, may include in the tax base upon which such taxes are imposed the items of income which according to the provisions of this Convention may also be taxed in the Philippines, but shall allow as a deduction from the amount of tax computed on such a base an amount equal to the tax paid in the Philippines. Such deduction shall not, however, exceed that part of the Czech tax, as computed before the deduction is given, which is appropriate to the income which, in accordance with the provisions of this Convention, may be taxed in the Philippines. b) Where in accordance with any provision of the Convention income derived by a resident of the Czech Republic is exempt from tax in the Czech Republic, the Czech Republic may nevertheless, in calculating the amount of tax on the remaining income of such resident, take into account the exempted income." Under the ordinary credit method, the United States and Czech (as countries of residence) would limit a taxpayer's allowable tax credit to that portion of the taxpayer's tax liability in their countries that is attributable to the income that is taxed in the Philippines (the country of source or country of situs). As a result of this limitation, if the Philippines has an effective tax rate that exceeds the effective tax rate of the United States and Czech on a particular income, the United States and Czech would not grant the taxpayer a full credit for the income tax imposed by the Philippines on such income. Based on the foregoing, this Office is of the opinion and so holds that the license fees to be paid by CPI to CUSA under the Agreement are subject to 10% income tax rate based on the gross amount thereof, under Article 13 (2) (b) (iii) of the Philippines-United States tax treaty, in relation to Article 12 (2) (a) of the Philippines-Czech tax treaty. (BIR Ruling No. ITAD-127-06 dated October 23, 2006; BIR Ruling No. ITAD-060-07 dated May 11, 2007; BIR Ruling No. ITAD-032-08 dated May 9, 2008) Moreover, the said royalty payments by CPI to CUSA 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: 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; CHcESa xxx xxx xxx" 2 Accordingly, CPI, 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 CUSA. In remitting the VAT withheld, CPI 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 CPI upon filing its own VAT return, if it is a VAT-registered taxpayer. In case CPI 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, CPI 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 CUSA upon its request and the fourth copy to be retained by CPI 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) ] 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. Entered into force on January 1, 2004. 2. 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.