ITAD BIR Ruling No. 075-14

June 10, 2014 ITAD BIR RULING NO. 075-14 Article 13 (Royalties), Philippines-USA tax treaty Punongbayan & Araullo 19th and 20th Floors Tower 1, The Enterprise Center 6766 Ayala Avenue 1200 Makati City Attention: Lina P. Figueroa Principal, Tax Advisory & Compliance Gentlemen : This refers to your tax treaty application ("TTRA") filed on July 12, 2013, requesting confirmation that royalties paid by TelePhilippines, Inc. ("TelePhilippines") to Teleperformance Group, Inc. ("Teleperformance") are subject to income tax at the rate of 10% pursuant to 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-USA tax treaty) . CEcaTH It is represented that Teleperformance is a non-resident foreign corporation organized and existing under the laws of United States of America with business address at 1601 Washington Avenue, Suite 400, Miami Beach, FL 33180, USA; that it is not registered as a corporation or a partnership in the Philippines per certification of non-registration issued by the Securities and Exchange Commission on July 8, 2013; and that, on the other hand, TelePhilippines is a domestic corporation organized and existing under the laws of the Philippines with principal address at 12 Floor, Octagon Building, San Miguel Avenue, Ortigas Center, Pasig City. It is also represented that on January 1, 2009, Teleperformance and TelePhilippines entered into an Intangible and Proprietary Property Licensing Agreement (Agreement) whereby Teleperformance grants to TelePhilippines a non-exclusive, non-transferable, royalty-bearing, limited license (with the right to sublicense only as provided under the Agreement): 1. To use the Trademarks in connection with the Services in the Territory and, as applicable from time to time, the Additional Territories, subject to the terms and conditions of this Agreement; 2. To (i) reproduce, create derivative works of, distribute, publicly perform, publicly display, digitally transmit, and otherwise use the Intangible Property in any medium or format and (ii) use, make, and have made any product and perform any process; 3. To internally use the object code version of the Software in connection with the Services in the Territory and, as applicable from time to time the Additional Territories, in each case subject to the terms and conditions of this Agreement. It is further represented that Teleperformance further grants to TelePhilippines the right to sublicense the rights in the Intangible Property granted to TelePhilippines to each TelePhilippines Subsidiary, whether in the Territory or in an Additional Territory, subject to the prior consent of Teleperformance and TelePhilippines ; that as consideration for the rights granted under this Agreement, TelePhilippines shall pay Teleperformance an annual royalty payable in quarterly installments in an amount equal to 2.7% of the aggregate Accumulated Gross Revenues of TelePhilippines and each TelePhilippines Subsidiary. The royalty shall be paid to Teleperformance within 15 calendar days following the end of each calendar quarter, based upon the aggregate Accumulated Gross Revenues of TelePhilippines each TelePhilippines Subsidiary from the immediately preceding quarter and any of the aggregate Accumulated Gross Revenues of TelePhilippines each TelePhilippines Subsidiary from any other calendar quarters with respect to which the royalty has not been paid; that on July 19, 2013 TelePhilippines remitted through BDO Karrivin Plaza-Chino Roces Avenue Extension Branch the amount of US$ One Million Two Hundred Thousand Seven Hundred Ninety One (US$1,260,791.00) n to JP Morgan Chase Bank N.A. in favor of Teleperformance per notarized certification issued by BDO on August 14, 2013. It is finally represented that, per sworn statement issued by TelePhilippines on June 28, 2013, that the issue or transaction subject of this request for ruling is not under investigation, on-going audit, administrative protest, claims for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal. SaIEcA In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended, applies, in general, to royalties derived in the Philippines by a nonresident foreign corporation. 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 interest, 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%). (Emphasis supplied) xxx xxx xxx" However, said income derived by a nonresident foreign corporation may be exempt or partially exempt from income tax pursuant to a treaty obligation to which the Philippine government is bound. Thus, Section 32 (B) (5) of the Tax Code of 1997, as amended provides, viz. : "SEC. 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." Thus, the Philippines-USA tax treaty, which you invoked may apply in this case. It provides: HADTEC "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" Under Section 2 (b) (iii) of the above-quoted provision, the Philippines may tax the royalties paid by a resident thereof to a company which is a resident of USA at the lowest rate of the Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State, this is also called as the " most-favored-nation " clause. DEAaIS For this purpose, Article 12 Section 2 (a) of the Philippines-UAE tax treaty applies which imposes a tax not exceeding 10 percent of the gross amount of the royalties payable by a Philippine company to a resident of UAE, to wit: "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. xxx xxx xxx" In relation thereto, 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 (SC) 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. (BIR Ruling No. DA-ITAD-52-03 dated April 8, 2003) . Furthermore, the Supreme Court required two conditions for this clause to apply. First, the royalties arising in the Philippines and paid to a resident of the United States must be of the same kind as those derived in the Philippines by a resident of a third State and to which the tax treaty between the Philippines and the third State subjects the latter royalties to a most-favored-nation treatment, which is currently at 10 percent. Second, the royalties paid to the United States resident must be paid under similar circumstances vis--vis those royalties paid to the resident of the third State, which can be determined by considering the amount of foreign tax credit or deduction which the United States and the third State allow its residents with respect to the royalties. In this connection, the royalties are not paid under similar circumstances if the credit or deduction allowed by the third State is more than the actual amount of income tax of 10 percent as that provided in the article on Royalties of the treaty between the Philippines and the third State. The pertinent portion of the S.C. Johnson case reads: TEAcCD "The purpose of a most favored nation clause is to grant to the contracting party treatment not less favorable than that which has been or may be granted to the 'most favored' among other countries. The most favored nation clause is intended to establish the principle of equality of international treatment by providing that the citizens or subjects of the contracting nations may enjoy the privileges accorded by either party to those of the most favored nation. The essence of the principle is to allow the taxpayer in one state to avail of more liberal provisions granted in another tax treaty to which the country of residence of such taxpayer is also a party provided that the subject matter of taxation, in this case royalty income, is the same as that in the tax treaty under which the taxpayer is liable. Both Article 13 of the RP-US Tax Treaty and Article 12(2)(b) of the RP-West Germany Tax Treaty, above-quoted, speaks of tax on royalties for the use of trademark, patent, and technology. The entitlement of the 10% rate by U.S. firms despite the absence of a matching credit (20% for royalties) would derogate from the design behind the most favored nation clause to grant equality of international treatment since the tax burden laid upon the income of the investor is not the same in the two countries. The similarity in the circumstances of payment of taxes is a condition for the enjoyment of most favored nation treatment precisely to underscore the need for equality of treatment. We accordingly agree with petitioner that since the RP-US Tax Treaty does not give a matching tax credit of 20 percent for the taxes paid to the Philippines on royalties as allowed under the RP-West Germany Tax Treaty, private respondent cannot be deemed entitled to the 10 percent rate granted under the latter treaty for the reason that there is no payment of taxes on royalties under similar circumstances." Concerning the first condition, the non-exclusive, non-transferable, royalty-bearing, limited license (i) to use the Trademarks of Teleperformance ; (ii) to reproduce, create derivative works of, distribute, publicly perform, publicly display, digitally transmit, and otherwise use the Intangible Property in any medium or format; and (iii) to use, make, and have made any product and perform any process, (iv) to internally use the object code version of the Software, are within the definition of royalties under the articles on royalties under the Philippines-USA and Philippines-UAE tax treaties. Hence, the first condition is satisfied. The second condition is likewise satisfied as paragraph 1, Article 23 of the Philippines-USA tax treaty, and paragraph 2, Article 23 of the Philippines-UAE tax treaty 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. The said provisions provide, to wit: USA: aHCSTD "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. xxx xxx xxx" UAE: "Article 23 Elimination of Double Taxation xxx xxx xxx 2. In the case of the United Arab Emirates, double taxation shall be eliminated as follows: Where a resident of the United Arab Emirates derives income which in accordance with the provisions of this Agreement, may be taxed in the Philippines, the United Arab Emirates shall allow as a deduction from tax on income of that person an amount equal to the tax on income paid in the Philippines." Under the ordinary credit method, USA and UAE (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 USA and UAE on a particular income, USA and UAE would not grant the taxpayer a full credit for the income tax imposed by the Philippines on such income. cACEaI Accordingly, the royalties paid by TelePhilippines to Teleperformance are subject to the preferential tax rate of 10 percent based on the gross amount thereof pursuant to the Article 13 of the Philippines-USA tax treaty, in relation to Article 12 of the Philippines-UAE tax treaty. As regards the imposition of the VAT on royalties paid to Teleperformance , please be informed further that Section 108 of the Tax Code of 1997, as amended, 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 of services in the Philippines for others for a fee . . . 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" Accordingly, TelePhilippines , being the resident withholding agent and payor in control of the payment, shall be responsible for the withholding of the 12 percent final VAT on such royalty before making any payment to Teleperformance . In remitting the VAT withheld, TelePhilippines 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 TelePhilippines upon filing its own VAT return, if it is a VAT-registered taxpayer. In case TelePhilippines 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, TelePhilippines 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 Teleperformance upon its request and the fourth copy to be retained by TelePhilippines 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 foregoing 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. EHDCAI Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes n Note from the Publisher: Copied verbatim from the official copy. Discrepancy between amount in words and in figures.