ITAD BIR Ruling No. 073-12

February 16, 2012 ITAD BIR RULING NO. 073-12 Art. 13, Philippines-US tax treaty; Art. 12, Philippines-Czech Republic tax treaty; BIR Ruling No. ITAD 126-11; BIR Ruling No. ITAD 19-10 Luis Caete & Co. 3F Oftana Building Jasmin Corner Don Mariano Cui Streets Cebu City, Philippines Attention: Luis A. Caete Authorized Representative Gentlemen : This refers to your tax treaty relief application filed on July 28, 2009 requesting confirmation that royalties paid by Fil-Am Foods, Inc. ("FAF") to Land O' Lakes, Inc. ("LOL") are subject to preferential tax rate of 10 percent in accordance with the "most-favored-nation" clause 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-US tax treaty") in relation to the provisions of the Convention between the Republic of the Philippines and the Czech Republic 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 LOL [formerly registered under the name of Land O' Lakes Farmland Feed LLC and amended to Land O' Lakes Purina Feed LLC ("LOLPF") and further amended and restated to Land O' Lakes, Inc.) ], with principal office at 4001 Lexington Avenue North, Arden Hills, Minnesota 55126, United States of America, is a resident of United States of America with TIN: 41-0365145 per certification issued by the Internal Revenue Service on September 27, 2010; that LOL is not registered either as a corporation or as a partnership in the Philippines as confirmed by the Certification of Non-Registration of Corporation/Partnership dated November 17, 2008 issued by the Securities and Exchange Commission; that LOL had developed and is the owner of certain information and expertise with respect to certain aspects of the formulation, manufacture, marketing and utilization of animal feeds; that, on the other hand, FAF is a domestic company with principal office at Aboitiz Corporate Center, Gov. Manuel A. Cuenco Ave., Cebu City, Philippines; that FAF is registered with the Board of Investments (BOI) with Certificate of Registration No. 2004-061 on May 21, 2004; and that FAF registered as non-pioneer of expanding producer of animal feeds. It is further represented that on May 21, 2008, LOL and FAF executed a Support Agreement Feed Manufacturing & Marketing ("Feed Ingredients & Formulation"), effective on January 1, 2008 and shall continue until December 31, 2012, whereby LOL and FAF agreed as follows: EcSCHD 1. That LOL will provide FAF support services in Nutrition Feed Manufacturing and Veterinary Services, particularly: a. Feed Manufacturing; b. Swine Nutrition; c. Poultry Nutrition; d. Veterinary Services/Support; 2. That LOL will make available and provide FAF with access to LOL's feed formulation system, NIR ingredient calibrations, ingredient analysis, NIR Analysis consultation, formulation support, ingredient usage analysis, and ingredient knowledge in the same manner and similar to what is currently being provided and/or made available to FAF as of the commencement date of the Agreement; that the access shall be defined as the ability to utilized pull-down menus in order to derive least-cost formulations; and 3. That in consideration FAF shall pay LOL a base fee of $75,000/year, which will cover up to 100,000 manufactured metric tons; that for manufactured tons in the range of 100,000 manufactured metric tons/year to 199,999 metric tons/year, the fee will be $0.40 per metric ton; that for manufactured tones in excess of 200,000 metric tons/year, the fee will be $0.30 per metric/ton; that the base fee is to be paid on a pro-rated basis of $6,250.00 per month; that once FAF manufactures greater than 100,000 metric tons per year, the additional charge of $0.40 or $0.30, per metric ton, as appropriate, will be added to the monthly base payment; that the previous twelve month volume will be the basis for the monthly billing throughout the year and the additional charge due will be reconciled at year end based on actual volume for the current year; that in addition, FAF shall pay LOL, $500 per month for NIR consultation, formulation and ingredient knowledge, technical support and consultation. It is finally represented, based on the Sworn Statement by the same Corporate Secretary on June 19, 2009, that the transaction involving directly or indirectly the same parties which are the subject of the request for ruling was under audit at that time pursuant to a letter of authority issued by the BIR, but no audit findings nor assessment notices have been issued with finality with respect to the subject transaction per Assistant Corporate Secretary's certificate dated June 19, 2009. CSaITD 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: 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. EcaDCI 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) 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, since the Agreement that gives rise to the royalties is in effect beginning January 1, 2008, and the subject TTRA was filed only on July 28, 2009, this Office hereby DENIES relief on those royalties paid by FAF to LOL before July 28, 2009, the date of filing of the TTRA. Said royalties shall be subject to income tax at the rate provided for under Section 28 (B) (1) of the Tax Code, i.e., 35 percent for payments before January 1, 2009, and, 30 percent for payments after January 1, 2009, viz.: "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 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): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). CDcHSa xxx xxx xxx" However, all royalties accruing from January 1, 2009 and payable after 15 days from the date of the filing of the TTRA on July 28, 2009 are hereby GRANTED relief and the same shall be subject to income tax at a reduced rate of 10 percent of the gross amount thereof, pursuant to the most-favored-nation clause of the Philippines-US tax treaty in relation to the Philippines-Czech tax treaty. (BIR Ruling No. ITAD 126-11 dated April 15, 2011; BIR Ruling No. ITAD-19-10 dated August 20, 2010) Article 13 of the Philippines-US tax treaty 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. xxx xxx xxx" Paragraph 2 (b) (iii) above provides that royalties arising in the Philippines and derived by a resident of the United States shall be subject to the lowest rate of Philippine income tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State (commonly known as the most-favored-nation tax treatment of royalties). The Supreme Court, in Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc. and Court of Appeals (G.R. No. 127105 dated June 25, 1999), has cited two conditions for royalties arising in the Philippines and derived by a resident of another country (in this case, the United States) to be qualified for a most-favored-nation tax treatment. First, the royalties in question derived by a resident of the other country (the United States) must be of the same kind as those derived by a resident of the third country which are subject to the most-favored-nation tax treatment under the existing tax treaty between the Philippines and the third country. Second, the mechanism employed by the other country (the United States) in mitigating the effects of double taxation of foreign-sourced income derived by its residents must be the same with that employed by the third country, which can be determined by taking into account and comparing the respective articles on Elimination of Double Taxation of the other country (the United States) and the third country under their respective tax treaties with the Philippines. In looking for a third country which grants a most-favored-nation tax treatment on royalties, you cited the Czech Republic, particularly, the Philippines-Czech tax treaty, which entered into force on September 23, 2003, and whose provisions on taxes apply on income derived or which accrued beginning January 1, 2004. Article 12 of this tax 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. 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 percent 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; IEHDAT b) 15 percent 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. xxx xxx xxx" According to paragraph 2, royalties arising in the Philippines and derived by a resident of Czech are subject to income tax at the rate of (a) 10 percent 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 (except those for cinematograph films, and films or tapes for television or radio broadcasting), 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, or (b) 15 percent of the gross amount of the royalties for 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. Applying the Philippines-Czech tax treaty, the royalty fee to be paid by FAF to LOL, for the use or the right to use of technical information with respect to certain aspects of the formulation, manufacturing, marketing and utilization of animal feeds, may be subject to 10 percent based on the gross amount thereof, provided the two conditions for the most-favored-nation tax treatment of royalties (as described above) are both satisfied. On whether the first condition is satisfied, we note that under paragraph 3, Article 13 of the Philippines-US tax treaty quoted below, payments received as a consideration for the use or the right to use of patents, information concerning industrial, commercial or scientific experience (know-how), and copyright of literary, artistic or scientific work (to which the royalty fee for the use or the right to use of the Licensed Patents, Licensed Trademark and Technical Information, are assimilated, (respectively) are all considered royalties, thus: "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." SCEHaD In the same manner, although lacking a separate paragraph for the definition of royalties in its article, paragraph 2 (a), Article 12 of the Philippines-Czech tax treaty, as quoted above, provides that royalties arising from the use or the right to use of patents, information concerning industrial, commercial or scientific experience (know-how), and copyright of literary, artistic or scientific work, among others, are subject to income tax rate of 10 percent of the gross amount thereof. This being the case, the first condition for the most-favored-nation tax treatment of royalties is satisfied, which requires the royalties derived by a resident of the US must be of the same kind as those derived by a resident of Czech. As to the second condition, under paragraph 1, Article 23 of the Philippines-US tax treaty below, the mechanism employed in mitigating the effects of double taxation of income from foreign source is the ordinary credit method. It provides: "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. TSEHcA xxx xxx xxx" Under the ordinary credit method, the US (as country of residence) would limit a taxpayer's allowable tax credit to that portion of the taxpayer's tax liability in the US 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 US on a particular income, the US would not grant the taxpayer a full credit for the income tax imposed by the Philippines on such income. In the same manner, under paragraph 2, Article 22 of the Philippines-Czech tax treaty below, it can be seen that that ordinary credit method is also employed by Czech as a mechanism for mitigating the effects of double taxation of income derived by its residents from foreign sources, thus: "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 the tax on the remaining income of such resident, take into account the exempted income. TcSCEa xxx xxx xxx" This being the case, the second condition for the most-favored-nation tax treatment of royalties, which requires that the mechanism employed by the US in mitigating the effects of double taxation of income derived by its residents from foreign sources must be the same with that employed by Czech, is also satisfied. Finally, as regards value-added tax (VAT), the royalties for the use or the right to use of technical information with respect to certain aspects of the formulation, manufacturing, marketing and utilization of animal feeds to be paid by FAF to LOL are subject to VAT under Section 108 (A) of Tax Code of 1997, as amended, to wit: "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. . . . 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" With regard to the procedures for the withholding and the payment the VAT, Sections 4 and 6 of Revenue Regulations No. 4-2000, Section 3 of Revenue Regulations No. 8-2002, and Section 7 of Revenue Regulations No. 14-2002, provide that FAF shall be responsible for the withholding of the VAT on the royalties before remitting them to LOL. In remitting to the Bureau of Internal Revenue the VAT withheld on the royalties, FAF shall use BIR Form No. 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld). If a VAT-registered taxpayer, FAF may use as documentary substantiation for its claim of input VAT the duly filed BIR Form No. 1600 and the proof of payment accompanying it. In addition, FAF is required to issue in quadruplicate the Certificate of Final Tax Withheld at Source (BIR Form No. 2306), the first three copies for LOL and the fourth copy for FAF as its file copy. cTCEIS 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.