ITAD BIR Ruling No. 073-13

March 15, 2013 ITAD BIR RULING NO. 073-13 Articles 13 & 23, Philippines-US tax treaty, in relation to Article 12, Philippines-Czech tax treaty; Section 28, Tax Code of 1997, as amended Puyat Jacinto & Santos 12/F VGP Center 6772 Ayala Avenue Makati City Attention: Anya M. Palileo Tax Division Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on January 26, 2010 requesting confirmation that the royalty payments by Unilogix, Inc. ("Unilogix") to Golden Spoon Franchising, Inc. ("GSF") are subject to the preferential tax rate of 10 percent, pursuant to the Philippines-US tax treaty. 1 It is represented that GSF is a nonresident foreign corporation duly organized and existing under the laws of the United States of America with office address at 30212 Tomas State 365, Racho Santa Margarita CA, 92688, United States of America (US);that it is registered as a US taxpayer as evidenced by a certification issued by the Internal Revenue Service, Department of the Treasury, Philadelphia dated January 20, 2009; that it is not registered either as a corporation or as a partnership in the Philippines as shown in the Certification of Non-Registration of Company issued by the Securities and Exchange Commission on July 9, 2009; and that, on the other hand, Unilogix is a corporation duly organized and existing under the laws of the Philippines, with business address at Bayer H-1 Bay 3K, 14 West Service Road, South Super Highway, Paraaque City. It is further represented that GSF and Unilogix entered into a Master License Agreement ("Master Agreement") on May 19, 2009, whereby GSF grants to Unilogix the exclusive right, franchise, and license to act as Master Licensee for the Protected Area; 2 that under the Master Agreement, Unilogix will have the requisite authority, subject to GSF's review and approval, to grant Sublicenses 3 to Sublicensees 4 in the Protected Area under individual "Unit Sublicense Agreements" 5 in accordance with the terms and conditions of Section 1.03 and the "Production Schedule" attached to the Master Agreement as Exhibit 1; that Unilogix will be responsible for training and on-going support of GSF and will have the right to use, in connection with the operation of said business, the License System 6 and the Proprietary Marks; 7 that in consideration of such Master Agreement, Unilogix shall pay GSF an initial master license fee amounting to US$375,000.00 payable as follows: CSHcDT i) US$195,000 by wire transfer from a United States bank on the effective date of the Master Agreement pursuant to GSF's wire transfer instruction, which number represents 100% of the fee for the first store and 50% of the fee for the remaining 24 stores under the Master Agreement ii) On each anniversary date of the Master Agreement, the remaining initial master license fees due and payable shall be as follows: Current Year Fee Cumulative Fee One (1) year from the effective date US$15,000 US$210,000 Two (2) years from the effective date US$37,500 US$247,500 Three (3) years from the effective date US$37,500 US$285,000 Four (4) years from the effective date US$37,500 US$322,000 Five (5) years from the effective date US$52,500 US$375,000 It is finally represented, based on the Sworn Certification by the same Corporate Secretary on April 29, 2011, that the transaction subject of the 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 of the taxpayer/s involved. 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. .. " (Underscoring ours) TAHcCI 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. " (Underscoring 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) . caIACE In view of the foregoing, this Office hereby DENIES relief on the royalties paid by Unilogix to GSF before February 10, 2010. 8 Accordingly, said royalties shall be subject to income tax at the rate provided under Sections 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%). " (Underscoring supplied) However, all royalties payable on February 10, 2010 and thereafter 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 Article 13 of the Philippines-US tax treaty in relation to Philippines-Czech 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: AcIaST (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. xxx xxx xxx" Pursuant to the "most-favored-nation" clause in Article 13 (2) (b) (iii) of the Philippines-US tax treaty, the tax imposed on royalties derived by a resident of the United States 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, it is noteworthy that in 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), the Supreme Court has 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 United States). The Court noted that, 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 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 United States) 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. ECaTAI In looking for a tax treaty that grants the "most-favored-nation" income tax rate that may apply on royalties arising in the Philippines and derived by a resident of another country, the provisions of 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") ,effective January 1, 2004, may be considered. Concerning the first requirement in the S.C. Johnson case, Article 12 of the Philippines-Czech 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 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." Under the article on royalties of the Philippines-Czech tax treaty, the lowest or the "most-favored-nation" rate of Philippine income tax that may be imposed on royalties arising in the Philippines and derived by a resident of Czech is 10 percent of the gross amount of the royalties, which covers royalties for the use of, or the right to use, 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). Applying the Philippines-Czech tax treaty, Unilogix will have to pay royalties to GSF for the exclusive right, franchise and license to act as Master Licensee for the Protected Area and the right to use, in connection with the operation of said business, the License System and the Proprietary Marks under the Master Agreement, 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 noted that under paragraph 3, Article 13 of the Philippines-US tax treaty quoted below, payment received as a consideration for the use of or the right to use, 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 Master License, License System and the Proprietary Marks are assimilated) all concerned 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." cDCaTH Concerning the second requirement in the S.C. Johnson case, the respective articles on elimination of double taxation of the Philippines-US and the Philippines-Czech tax treaties provide as follows: United States: "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." Czech: "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. aTAEHc 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." A perusal of the methods of relief or elimination of double taxation in both tax treaties reveals that the United States and Czech employ the ordinary credit method in eliminating double taxation of income or certain types of income derived by their residents from sources in the Philippines. Under this 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 the United States and in Czech which is attributable to the income that is taxed in the Philippines ( the country of source or situs of the income ).As a result of this limitation, if the Philippines has an effective tax rate that exceeds the effective income tax rate of the United States and Czech on an income or on certain types of 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 or on such certain types of income. In the United States, this is described in the following statement: "...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".And in Czech: "...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". In subparagraph (b), Article 22 of the Philippines-Czech tax treaty, it is noteworthy that Czech (as a country of residence) would retain the right to take into account the amount of income exempted in Czech for the purpose of determining the tax to be imposed on the rest of the income of its taxpayers. This provision, which would apply only when a particular type of income is taxable or may be taxed only in the Philippines (the country of source or situs of the income) but not in Czech, is not relevant to income such as royalties which, as clearly provided in Article 12 of the Philippines-Czech tax treaty above, may be taxed in the Philippines and in Czech. 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%) 9 of gross receipts derived from the sale or exchange of services, including the use or lease of properties. cADEIa 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 Unilogix shall be responsible for the withholding of VAT on the royalties fee before remitting it to GSF. In remitting to the Bureau of Internal Revenue the VAT withheld, Unilogix shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld).If it is a VAT-registered taxpayer, Unilogix 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, Unilogix may include as part of the cost of the royalty fees to it by, GSF the VAT consequently shifted or passed on to it. In addition Unilogix is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies for, GSF and the fourth copy for Unilogix as its file copy. 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. 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. 2. "Protected Area" the Republic of the Philippines. 3. "Sublicenses" third license and service third party unit franchises. 4. "Sublicensees" operator of third party unit franchises. 5. "Unit Sublicense Agreements" the standard form of which must be acceptable to Licensor. 6. "License System" Develop system and procedure for the operation by licensees of retail frozen Yogurt Outlets that sell proprietary Golden spoon natural yogurt and assorted toppings and accessories supplied by designated vendors and approved suppliers, using the Marks, operational technique, service concepts and proprietary information owned or authorized to be used by and identified. 7. "Proprietary Marks" License from the trademark proprietor and its affiliated company Golden Spoon Assets, Inc. ("GSA") to offer on a worldwide basis franchised licenses in and to the trademark "Golden Spoon Frozen Yogurt" and other trademarks, trade names, logo-types, insignias and commercial symbols pertaining thereto, including any necessary translations thereof relevant or appropriate for the Protected Area. 8. February 10, 2010 is the 15th day after filing the TTRA on January 26, 2010. 9. 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.