ITAD BIR Ruling No. 062-14

June 9, 2014 ITAD BIR RULING NO. 062-14 Philippines-Italy Tax Treaty SGV & Co. 6760 Ayala Avenue 1226 Makati City Attention: Mr. Reynante M. Marcelo Partner, Tax Services Gentlemen : This refers to your Tax Treaty Relief Application filed on March 20, 2012, on behalf of Perfetti Van Melle S.p.A. ("PVMS") , requesting confirmation that the royalty payments of Perfetti Van Melle Phils., Inc. ("PVMPI") to PVMS are subject to 10 percent final withholding tax pursuant to the "most-favored-nation" clause of the Convention between the Government of the Republic of the Philippines and the Government of the Republic of Italy for the Avoidance of Double Taxation with Respect to Taxes on Income and to Prevent Fiscal Evasion ("Philippines-Italy tax treaty") in relation to the Convention between the Czech Republic and the Republic of the Philippines for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Czech tax treaty") . It is represented that PVMS, with office address at Lainate, Via XXV Aprile 7, Milano, Italy, is a resident of Italy for purposes of Italian taxation per the Tax Residence Certificate issued by the Provincial Director of Orazio Andra Passamonte dated April 10, 2011; that PVMS is not registered either as a corporation or as a partnership in the Philippines per Certification of Non-Registration of Company issued by the Philippine Securities and Exchange Commission dated May 30, 2011; that PVMPI, on the other hand, is a corporation duly organized and existing under the laws of the Philippines with principal office at 11th Floor One Global Place, 5th Avenue corner 25th Street Bonifacio, Global City, Taguig City. It is further represented that on January 1, 2010, a Trademarks and Know-how Licence Agreement ("Agreement") was entered into by and between PVMS and PVMPI, whereby PVMPI has been granted a license to sell various kinds of confectionery candies, chewing gums, bubble gums, jelly candies, lollipops, lozenges and other innovative confectionery products and license to use its technological, technical marketing and commercial know-how in sales, advertisement and promotion of the Products; that the Agreement will continue in force for five years from the date of signature of PVMS and will be automatically be renewed for same periods unless it is terminated by one of the party by written notice; that PVMPI shall pay to PVMS a royalty fee based on the net sales of the following: Global Brands Royalty Percentage Chupa Chups 2.5% Regional Brands Royalty Percentage Alpenliebe 2.0% Smint Big Babol Local Brands Royalty Percentage Chlormint 1.5% Van Melle Furthermore, it is represented per sworn Certification issued by PVMPI that on December 14, 2012, PVMPI remitted royalty payments to PVMS for the period of January 1 to December 31, 2011. It is finally represented that the issue/transaction subject of the above 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 a judicial appeal of the taxpayer/s involved as evidenced by Sworn Statement issued by PVMPI on March 15, 2010. cHaDIA In reply, please be informed that royalties derived in the Philippines by a nonresident foreign corporation are, in general, covered by Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended. It provides: "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: n Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." However, Section 32 (B) (5) of the Tax Code of 1997, as amended, provides that: "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: ACcEHI 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 relation thereto, Article 12 of the Philippines-Italy tax treaty which you invoked may apply to the herein case. It 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 be taxed in the Contracting State in which they arise, and according to the law of that State, but, if the recipient is the beneficial owner of the royalties, the tax so charged shall not exceed: a) in the case of the Philippines, 15 per cent of the gross amount of the royalties, where the royalties are paid by an enterprise registered with the Philippine Board of Investments and engaged in preferred areas of activities and also royalties in respect of cinematographic films or tapes for television or broadcasting; b) in all other cases, 25 per cent of the gross amount of the royalties. 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 cinematograph films, or tapes for television or broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience." CcAITa The Additional Protocol provides: e) that, with reference to paragraph 2(b) of Article 12, if the Philippine agrees to a lower rate of tax on royalties of the same kind paid in similar circumstances to a resident of a third state, then this lower rate shall likewise be applied to residents of Italy." Pursuant to the "most-favored-nation" clause in Protocol of the Philippines-Italy tax treaty, the tax imposed on royalties derived by a resident of the Italy from sources within the Philippines shall be 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 relation thereto, worth mentioning is the case of Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc. and Court of Appeals (the S.C. Johnson case) (G.R. No. 127105 dated June 25, 1999) whereby the Supreme Court cited two conditions for the application of the "most-favored-nation" income tax rate to royalties arising in the Philippines and derived by a resident of another country (in this case, the Italy). The Court noted that, first, the royalties in question, derived by a resident of the other country (the Italy), must be of the same kind as those derived by a resident of the third country whose tax treaty with the Philippines permits the residents of the third country a "most-favored-nation" income tax rate on royalties arising in the Philippines. Second, the method employed by the other country (the Italy) in eliminating or mitigating the effects of double taxation of income or certain types of income derived by its residents from sources in the Philippines must be the same with that of the third country in question, which can be determined by taking into account and comparing the methods described in the article on elimination of double taxation in their (the other country and the third country) respective tax treaties with the Philippines. In relation to Additional Protocol (e) or the "most-favored-nation" clause of the Philippines-Italy tax treaty, PVMS invoked the provisions of the Philippines-Czech tax treaty , which in Article 12 provides, 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 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." caCEDA Under Article 12 of the Philippines-Czech tax treaty, royalties for the use or right to use of any copyright of literary, artistic or scientific work (except copyright on cinematograph films, and films or tapes for television or radio broadcasting), any patent, trade mark, 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) are subject to 10 percent income tax based on the gross amount of royalties. As for the mechanism employed in mitigating the effects of double taxation, Article 22 of the Philippines-Italy tax treaty reads: "Article 22 Method for Elimination of Double Taxation Double taxation of income shall be avoided in the following manner: xxx xxx xxx 2. If a resident of Italy owns items of income which are taxable in the Republic of the Philippines, Italy, in determining its income taxes specified in Article 2 of this Convention, may include in the basis upon which such taxes are imposed the said items of income, unless specific provisions of this Convention otherwise provide. In such a case, Italy shall deduct from the taxes so calculated the Philippine tax on income, but in an amount not exceeding that proportion of the aforesaid Italian tax which such items of income bear to the entire income. cTAaDC On the contrary no deduction will be granted if the item of income is subjected in Italy to a final withholding tax by request of the recipient of the said income in accordance with the Italian law." 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." Under the ordinary credit method, the Italy and the 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 Italy and the Czech on a particular income, the Italy and the Czech would not grant the taxpayer a full credit for the income tax imposed by the Philippines on such income. DHETIS Accordingly, the royalty fees of PVMS to PVMPI under the Agreement, being in the nature of royalties, shall be subject to income tax in the Philippines at the rate of 10 percent income tax rate based on the gross amount thereof, under additional Protocol (e) of the Philippines-Italy tax treaty, in relation to Article 12 (2) of the Philippines-Czech tax treaty. Moreover, as provided in Section 108 of the Tax Code of 1997, the said royalty payments are subject to value-added tax (VAT). It provides: "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%) 1 of gross receipts derived from the sale or exchange of services, including the use or lease of properties. xxx xxx xxx (3) The supply of scientific, technical, industrial or commercial knowledge or information; xxx xxx xxx" With regard to the procedures for the withholding and the payment of the VAT, pursuant to Sections 4 and 6 of Revenue Regulations (RR) No. 4-2002, Section 3 or RR No. 8-2002, Section 7 of RR No. 14-2002 and Section 4.114-2 of RR No. 16-05, as amended by RR No. 04-07 PVMPI shall be responsible for the withholding of VAT on the royalties fee before remitting it to PVMS. In remitting to the Bureau of Internal Revenue the VAT withheld, PVMPI shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld). If it is a VAT-registered taxpayer, PVMPI may use as documentary substantiation for its claim of input VAT the duly filed BIR Form No. 1600 and the proof of payment accompanying such form. On the other hand, if it is a non VAT-registered taxpayer, PVMPI may include as part of the cost of the royalty fees to it by, PVMS the VAT consequently shifted or passed on to it. In addition PVMPI is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies for, PVMS and the fourth copy for PVMPI as its file copy. SDEHIa 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% on 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. n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.