ITAD BIR Ruling No. 056-13

March 13, 2013 ITAD BIR RULING NO. 056-13 Article 13 (2) b) (iii), Philippines-United States of America tax treaty; Article 12, Philippines-Czech tax treaty Canelle Food Corporation 6th Floor, Room 602 S & L Building 1500 Roxas Boulevard, Ermita Manila 1000 Attention: Rene E. Santos President Gentlemen : This refers to your letter dated December 8, 2009, applying for relief from double taxation on the royalty payments made by Canelle Food Corporation ("Canelle") to Cinnabon, Inc. ("Cinnabon") pursuant to Article 13 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 ("Philippines-United States tax treaty") . cAHITS It is represented that Cinnabon is a nonresident foreign corporation organized and existing under the laws of the United States of America with principal address at 200 Glendrige Point Parkway, Suite 200 Atlanta GA; that it is not registered either as a corporation or partnership in the Philippines per certification issued by the Securities and Exchange Commission dated December 2, 2009; and that, on the other hand, Canelle is a corporation organized and existing under the laws of the Philippines with principal address at 6th Floor S&L Building, 1500 Roxas Boulevard, Ermita, Manila. It is further represented that on July 7, 1999, an agreement entitled "Cinnabon Development Agreement (International)" was entered into between Cinnabon , as 'Franchisor', and Southwest Maritime Corporation (SMC), a corporation organized under Philippine laws, as 'Developer', whereby Cinnabon grants SMC the exclusive rights to establish and operate an aggregate of Seventy (70) franchised units of Cinnabon and to use the Cinnabon System and Proprietary Marks solely in connection therewith, at specific locations to be designated in and in accordance with the terms and conditions set forth in separate franchise agreements; that, in relation to the above Development Agreement, an "Assignment and Assumption Agreement" was entered into on October 7, 1999 by and among Cinnabon , as 'Franchisor', SMC, as 'Assignor' and Canelle , as 'Assignee' whereby, SMC assigned to Canelle all right, title and interest held by SMC in and to the Development Agreement, to which assignment Cinnabon had consented; that, moreover, on January 4, 2007, an 'Amendment to the Development Agreement' (Amendment) was entered into by and between Cinnabon , as 'Franchisor' and Canelle , now as 'Developer', whereby pertinent provisions of the Development Agreement were amended including Section 1.01 by deleting the words "Seventy (70) Franchised Units" and replacing them with "Thirty (30) Franchised Units; that in consideration of the right granted to Canelle herein to establish operate the first five (5) CINNABON Bakeries, Canelle shall pay to Cinnabon non-refundable franchise fees of Thirty Thousand U.S. Dollars (U.S.$30,000.00) per CINNABON Bakery where Two Thousand Four Hundred and No/100 U.S. Dollars (U.S.$2,400.00) per CINNABON Bakery is payable upon execution of the Agreement, and Twenty-Seven Thousand Six Hundred and No/100 U.S. Dollars (U.S.$27,600.00) per CINNABON Bakery is payable no later than execution of each franchise agreement for a CINNABON Bakery; that in consideration of the right granted to Canelle herein to establish and operate the sixth (6th) through Twelfth (12th) CINNABON Bakeries, Canelle shall pay to Cinnabon non-refundable franchise fees of Twenty-Five Thousand U.S. Dollars (U.S.$25,000.00), per CINNABON Bakery where Two Thousand Four Hundred and No/100 U.S. Dollars (U.S.$2,400.00) per CINNABON Bakery is payable upon execution of the Agreement, and Twenty-Two Thousand Six Hundred and No/100 U.S. Dollars (U.S.$22,600.00) per CINNABON Bakery is payable no later than execution of each franchise agreement for a CINNABON Bakery; that in consideration of the right granted to Canelle herein to establish and operate the Thirteenth (13th) through Thirtieth (30th) CINNABON Bakeries, Canelle shall pay to Cinnabon non-refundable franchise fees of Twenty-One Thousand U.S. Dollars (U.S.$21,000.00) per CINNABON Bakery where Seven Thousand Seven Hundred Thirty-Three and 33/100 U.S. Dollars (U.S.$7,733.33) is payable per CINNABON Bakery upon execution of the Agreement, and Thirteen Thousand Two Hundred Sixty-Six and 67/100 U.S. Dollars (U.S.$13,266.67) per CINNABON Bakery is payable no later than execution of each franchise agreement for a CINNABON Bakery; that the total fees payable upon execution of the Development Agreement shall be a non-refundable fee of One Hundred Sixty-Eight Thousand and No/100 U.S. Dollars (U.S.$168,000.00); and that, based on a copy of the summary of proof of payments (with attached bank remittances), royalties were made by Canelle to Cinnabon on the following dates: October 23, 2009, December 22, 2009, November 3, 2011, November 17, 2011, December 22, 2011, January 20, 2012, March 2, 2012 and March 23, 2012. It is finally represented 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 per Sworn Statement issued by Canelle dated January 28, 2010. Relative thereto, please be informed that under Section III (2) of Revenue Memorandum Order No. 1-00 (Procedures for Processing Tax Treaty Relief Application) ("RMO 1-2000") , 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 at least 15 days before the intended transaction or payment of income, thus: "III. Policies: In order to achieve the above-mentioned objectives, the following policies shall be observed: IDTSEH xxx xxx xxx 2. Any availment of the tax treaty relief shall be preceded by an application by filing BIR Form No. 0901 (Application for Relief from Double Taxation) with ITAD at least 15 days before the transaction i.e., payment of dividends, royalties, etc., accompanied by supporting documents justifying the relief . . ." (Emphasis ours) This condition was 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. 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) ICcDaA This decision was also upheld by the Supreme Court in a Resolution (G.R. No. 168531) dated 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. EB 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, this Office hereby DENIES relief on royalty payments by Canelle to Cinnabon under the agreement, made before December 23, 2009 , 1 since the TTRA was filed beyond the 15-day period prescribed by the RMO. Accordingly, said royalty payments shall be subject to income tax at the rate provided under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") as amended, to wit: "SEC. 28. Rates of Income Tax on Foreign Corporations . . . . (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%)." However, relief is hereby GRANTED on royalty payments made on December 23, 2009 and thereafter . Thus, they shall be subject to income tax at a reduced rate of 10 percent of the gross amount thereof, pursuant to paragraph 2 (b) (iii), Article 13 of the Philippines-United States tax treaty. It provides: "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." IAEcCT and, in relation thereto, Article 12 (2) (a) of the Philippines-Czech Republic tax treaty, which you invoked, 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. 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. The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of these limitations." In the case of Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc. and Court of Appeals , G.R. No. 127105, promulgated on June 25, 1999, the Supreme Court interpreted the "most favored-nation" clause, particularly the phrase "paid under similar circumstances", as referring to the manner of payment of taxes and not to the subject matter of the tax which is royalties. In this regard, Article 23 of the Philippines-United States tax treaty provides as follows: SEIaHT "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. For the purpose of applying the United States credit in relation to taxes paid or accrued to the Philippines, the rules set forth in Article 4 (Source of Income) shall be applied to determine the source of income. For purposes of applying the United States credit in relation to taxes paid or accrued to the Philippines, the taxes referred to in paragraphs 1(b) and 2 of Article 1 (Taxes Covered) shall be considered to be income taxes." On the other hand, Article 22 of the Philippines-Czech tax treaty provides as follows: "Article 22 Elimination of Double Taxation 1. 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." As provided under their respective articles on Elimination of Double Taxation of their tax treaties with the Philippines, the United States and Czech Republic, both employ the same mechanism in mitigating the effects of double taxation of foreign-sourced income derived by their residents, that is, the ordinary credit method. IEcaHS 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. Furthermore, the fees paid by Canelle to Cinnabon under the Agreement are subject to the 10% 2 value-added tax (VAT) pursuant to Section 108 of the Tax Code of 1997, as amended. It provides: "Section 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. . . . The phrase 'sale or exchange of services' shall likewise include: xxx xxx xxx (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 (3) The supply of scientific, technical, industrial or commercial knowledge or information; xxx xxx xxx" Accordingly, Canelle , being the payor in control of the payment shall be responsible for the withholding of VAT on such fees on behalf of Cinnabon by filing a separate VAT return for and on behalf of Cinnabon using BIR Form No. 1600 (Monthly Remittance Return of Value-Added tax and Other Percentage Taxes Withheld). The duly filed BIR Form 1600 and proof of payment thereof shall serve as sufficient basis for the claim of input tax to be applied against the output tax that may be due from Canelle , if it is a VAT-registered taxpayer. In case Canelle is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased or treated as an "expense" or an "asset", whichever is applicable. In addition, Canelle is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies thereof to be given to Cinnabon upon its request, and the fourth copy to be retained by Canelle as its file copy. [Section 4.110-3 (b), Revenue Regulations (RR) No. 7-95, as amended by RR Nos. 4-02, 8-02, and 14-02 (now Section 4, 114-2 (b), RR No. 16-05); Section 4.114 (D), RR No. 2-98, as last amended by RR No. 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. HESIcT Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. December 23, 2009 is the 15th day after filing of the TTRA on December 8, 2009. 2. Effective February 1, 2006 rate is 12%.