ITAD BIR Ruling No. 079-11

March 11, 2011 ITAD BIR RULING NO. 079-11 Article 13 (b) (iii) of the Philippines-United States tax treaty; Article 12 (2) (b) of the Philippines-Netherlands tax treaty; Article 12 (2) (b) of the Philippines-China tax treaty; Revenue Memorandum Circular 46-02; BIR Ruling No. 129-98; BIR Ruling No. ITAD-054-00; BIR Ruling No. ITAD-101-00; BIR Ruling No. ITAD-105-00; BIR Ruling No. ITAD-101-03; BIR Ruling No. ITAD-102-03; BIR Ruling No. ITAD-103-03 BIR Ruling No. DA-ITAD-103-07 Amalgamated Specialties Corporation Km. 21 South Superhighway Muntinlupa City, Philippines Attention: Mr. Dennis R. Llarena Vice President Gentlemen : This refers to your letter dated January 26, 2009 requesting confirmation of your opinion that the royalty fees paid by Amalgamated Specialties Corporation ("Amalgamated") to Crayola LLC (formerly known as Binney & Smith, Inc.) under the Trademark License Agreement are subject to 10 percent final withholding tax pursuant to the "most-favored-nation" clause of the Philippines-United States of America (Philippines-United States) 1 tax treaty in relation to the Philippines-Germany 2 tax treaty. HAICET It is represented that Crayola LLC is a limited liability company formed in the State of Delaware in the United States of America, with office address at Corporation Trust Center, 1209 Orange Street, Wilmington City, New Castle County, United States of America per Certificate of Formation executed on October 3, 2006; that it is not registered either as a corporation or as a partnership in the Philippines per certification issued by the Securities and Exchange Commission dated November 17, 2008; that Crayola LLC is a recognized leader in the development, manufacture and sale of various products including crayons, chalk for writing and drawing purposes and watercolors; and that Amalgamated is a domestic corporation with principal address at Km. 21 South Superhighway, Muntinlupa City, Philippines. It is further represented that on September 29, 2000, Crayola LLC and Amalgamated entered into a Trademark License Agreement ("Agreement") wherein Crayola LLC granted Amalgamated the right to manufacture and sell the Licensed Products 3 within the Philippines; that Crayola LLC agrees that Amalgamated may use the trademarks listed in Schedule "A" of the Agreement, on the particular goods listed opposite each respective trademark; that Amalgamated agrees to operate manufacturing facilities for the production of the Licensed Products with a production capacity sufficient to supply sales, and will aggressively sell and distribute the Licensed Products throughout the Philippines; that it shall also have the right to distribute the Licensed Products via electronic on-line services or other electronic media; that Amalgamated agrees to pay Crayola LLC for the trademarks licensed therein a royalty equal to the applicable percentage set forth in Schedule "B" 4 of the Agreement based on the Net Selling Price 5 of all sales of the Licensed Products sold by Amalgamated; that payment of said fees shall be made to Crayola LLC in United States Dollars and shall be payable at the official rate of exchange, as established by the Bangko Sentral ng Pilipinas, on the date the remittance is due; that said payments shall be made in respect of each calendar quarter within thirty (30) days after the end of such quarter, subject to force majeure , but in no case to exceed three months from the end of each calendar quarter; that the Agreement shall take effect on June 1, 2000, and shall be effective for a period of three (3) years, unless sooner terminated by the parties; that the Agreement shall be subject to renewal by the parties; that on November 24, 2003, Crayola LLC and Amalgamated entered into a Renewal Trademark License Agreement where both parties agreed that the Agreement shall not expire on May 31, 2003, but instead shall be renewed for an additional five-year period expiring on May 31, 2008; that the Agreement shall automatically renew for successive one-year periods thereafter, unless earlier terminated; that during the renewal period, all terms and conditions of the Agreement shall remain in full force and effect, except Article 9 6 thereof; that the Renewal Trademark License Agreement took effect on June 1, 2003; that the trademarks used in the Licensed Products are registered with the Intellectual Property Office of the Philippines under Certificate of Registration No. 4-2000-006050 dated December 23, 2004, valid for ten years beginning May 21, 2004, and under Certificate of Registration No. 4-1994-98611 dated January 24, 2000, valid for twenty years beginning January 24, 2000; and that the issue/s or transaction subject of the above request for ruling is not under investigation neither is it subject of an on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings nor a judicial appeal, per certification dated January 26, 2009 issued by Amalgamated. 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. It provides: "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 . . ., dividends, . . .: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" However, Section 32 (B) (5) of the Tax Code of 1997, as amended, provides: "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: 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 this particular case, the treaty involved is the Philippines-United States tax treaty which, in its Article 13, provides as follows, viz. : "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. HaTDAE 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" In relation to Article 13 (2) (b) (iii) or the "most-favored-nation clause" of the Philippines-United States tax treaty, Amalgamated invoked the provisions of the Philippines-Germany tax treaty. However, as ruled by the Supreme Court 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, US recipients of royalty income may not invoke the Philippines-Germany tax treaty to avail of the 10 percent preferential tax rate. The High Court thus ratiocinated: "Given the purpose underlying tax treaties and the rationale for the most favored nation clause, the concessional tax rate of 10 percent provided for in the RP-Germany Tax Treaty should apply only if the taxes imposed upon royalties in the RP-US Tax Treaty and in the RP-Germany Tax Treaty are paid under similar circumstances. xxx xxx xxx 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." Nevertheless, the Philippines-United States, Philippines-Netherlands, 7 and Philippines-China 8 tax treaties, particularly their provisions on the avoidance of double taxation show that there is a similarity on the manner of payment of taxes, that is, the allowable foreign tax credit in all treaties is the amount actually paid in the Philippines. In relation thereto, Article 12 of the Philippines-Netherlands tax treaty provides, viz. : "Article 12 ROYALTIES 1. Royalties arising in one of the States and paid to a resident of the other State may be taxed in that other State. 2. However, such royalties may also be taxed in the State in which they arise, and according to the laws of that State, but if the recipient is the beneficial owner of the royalties the tax so charged shall not exceed: a) 10 per cent of the gross amount of the royalties where the royalties are paid by an enterprise registered, and engaged in preferred areas of activities in that State; and b) 15 per cent of the gross amount of the royalties in all other cases. DSEIcT 3. The competent authorities of the States shall by mutual agreement settle the mode of application of paragraph 2. 4. 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 radio or television broadcasting, any patent, trademark, 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. xxx xxx xxx" Article 12 of the Philippines-China tax treaty 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, 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 recipients is the beneficial owner of the royalties, the tax so charged shall not exceed: (a) 15 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 including cinematograph films or tapes for television or broadcasting, or (b) 10 per cent of the gross amount of royalties arising from the use of, or the right to use, any patent, trademark, 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 (Emphasis supplied) For as long as the transfer of technology, under Philippine law, is subject to approval, the limitation of the tax rate mentioned under (b) shall, in the case of royalties arising in the Republic of the Philippines, only apply if the contract giving rise to such royalties has been approved by the Philippine competent authorities. xxx xxx xxx" Therefore, 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 and paid under similar circumstances to a resident of a third State. Relative thereto, it is noteworthy that under Article 12 (2) (b) of the Philippines-China tax treaty, the tax charged shall not exceed 10 percent of the gross amount of royalties arising from the use of, or the right to use, any patent, trademark, 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, provided, the contract giving rise to such royalties has been approved by the Philippine competent authorities, which is the Intellectual Property Office. In connection with the manner of payment of taxes, Article 23 of the Philippines-United States tax treaty reads: "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. . . . ." ESTDcC On the other hand, Article 22 of the Philippines-Netherlands tax treaty provides: "Article 22 ELIMINATION OF DOUBLE TAXATION 1. The Netherlands, when imposing tax on its residents, may include in the basis upon which such taxes are imposed the items of income which, according to the provisions of this Convention, may be taxed in the Philippines. 2. Without prejudice to the application of the provisions concerning the compensation of losses in the unilateral regulations for the avoidance of double taxation, where a resident of the Netherlands derives items of income which according to Article 6, Article 7, paragraph 6 of Article 10, paragraph 6 of Article 11, paragraph 5 of Article 12, paragraphs 1 and 2 of Article 13, Article 14, paragraph 1 of Article 15, paragraphs 1 and 3 of Article 16, paragraph 2 of Article 18 and Article 19 of this Convention may be taxed in the Philippines and are included in the basis referred to in paragraph 1, the Netherlands shall exempt such items of income by allowing a proportionate reduction of its tax. This reduction shall not, however, exceed that part of the Netherlands tax as computed before the reduction is given, which is otherwise due on the said items of income. 3. Further, the Netherlands shall allow a deduction from the Netherlands tax so computed for the items of income which according to paragraph 2 of Article 8, paragraph 2 of Article 10, paragraph 2 of Article 11, paragraph 2 of Article 12 and Article 17 of this Convention may be taxed in the Philippines to the extent that these items are included in the basis referred to in paragraph 1. The amount of this deduction shall be equal to the tax paid in the Philippines on these items of income, but shall not exceed that part of the Netherlands tax which is otherwise due on the said items of income. 4. For the purposes of paragraph 3, where the Philippine tax actually paid on interest and royalties arising in the Philippines is lower than 15 per cent, then, the tax paid in the Philippines on these items of income shall be deemed to be 15 per cent. xxx xxx xxx" and Philippines-China tax treaty provides: "Article 23 METHODS FOR THE ELIMINATION OF DOUBLE TAXATION 1. In China, double taxation shall be eliminated as follows: Where a resident of China derives income from the Philippines the amount of tax on that income payable in the Philippines in accordance with the provisions of this Agreement, may be credited against the Chinese tax imposed on that resident. The amount of the credit, however, shall not exceed the amount of Chinese tax on that income computed in accordance with the taxation laws and regulations of China. xxx xxx xxx" Article 23 of the Philippines-United States tax treaty, Article 22 of the Philippines-Netherlands tax treaty and Article 23 of the Philippines-China tax treaty, though differently worded, plainly reveal a similarity in the provisions on relief from or avoidance of double taxation to their respective residents. Thus, the tax on royalty payments to residents of United States, Netherlands, and China are paid under similar circumstances, i.e. , the amount of royalty income tax paid or accrued to the Philippines under the respective tax treaties is available as tax credit against the income tax payable in their respective countries. United States residents may, therefore, invoke the preferential tax rate of 15 percent on royalties, provided by the Philippines-Netherlands tax treaty, arising in the Philippines from June 1, 2000 to December 31, 2001, and 10 percent from January 1, 2002, as provided by the Philippines-China tax treaty having been registered with the IPO for the duration/term of 20 years from its registration on January 24, 2000, "from the use of, or the right to use, any patent, trade mark, design or model, plan, secret formula or process, . . ., or for information concerning industrial, commercial or scientific experience" under the Philippines-Netherlands and Philippines-China tax treaties, pursuant to the "most-favored-nation" clause of the Philippines-United States tax treaty. Such being the case, the payments to be received by Crayola LLC (then Binney & Smith, Inc.) from Amalgamated should be treated as royalty and thus, this Office is of the opinion and so holds that the royalty payments of Amalgamated to Crayola LLC under the subject Trademark Agreement and the Renewal to the Agreement are subject to a final withholding tax at the rate of 15 percent from June 1, 2000 to December 31, 2001, pursuant to Article 12 (2) (b) of the Philippines-Netherlands tax treaty, and 10 percent beginning January 1, 2002 up to the term of the Agreement and the Renewal to the Agreement pursuant to Article 12 (2) (b) of the Philippines-China tax treaty, in relation to Article 13 (2) (b) (iii) of the Philippines-United States tax treaty. (Revenue Memorandum Circular (RMC) No. 46-2002 dated 2 September 2002; BIR Ruling No. 129-98 dated September 10, 1998; BIR Ruling No. ITAD-054-00 dated March 7, 2000; BIR Ruling No. ITAD-101-00 dated August 7, 2000; BIR Ruling No. ITAD-105-00 dated August 7, 2000; BIR Ruling No. ITAD-101-03 dated July 24, 2003; BIR Ruling No. ITAD-102-03 dated July 24, 2003; BIR Ruling No. ITAD-103-03 dated July 24, 2003; BIR Ruling No. DA-ITAD-103-07 dated October 24, 2007) In addition to income tax, royalties for the manufacture, distribution and sale of the Licensed Products, as well as for the use of trademarks under the Agreement and the Renewal to the Agreement are subject to 12 percent [then 10 percent] value-added tax (VAT), under Section 108 (A) of the Tax Code of 1997, which 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 twelve percent 9 (12%) 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 (3) The supply of scientific, technical, industrial or commercial knowledge or information; xxx xxx xxx" With regard to the procedures for withholding and paying 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 Amalgamated shall be responsible for the withholding of the VAT on the royalties before remitting them to Crayola LLC. In remitting to the Bureau of Internal Revenue the VAT withheld on the royalties, Amalgamated shall use BIR Form No. 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld). If it is a VAT-registered taxpayer, Amalgamated 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. On the other hand, if it is a non-VAT-registered taxpayer, Amalgamated may include as part of the cost of the licensed trademarks and technical information granted to it by Crayola LLC the VAT consequently shifted or passed on to it and may treat such VAT either as expense or asset, whichever is applicable. In addition, Amalgamated is required to issue in quadruplicate the Certificate of Final Tax Withheld at Source (BIR Form No. 2306), the first three copies for Crayola LLC and the fourth copy for Amalgamated as its file copy. cTESIa This ruling is issued on the basis of the facts as represented. However, if upon investigation it shall be disclosed that the 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. Entered into force on January 1, 1983. 2. Entered into force on January 1, 1985. 3. "Licensed Products" are those products set forth in Schedule "A" of the Agreement and which are or will be manufactured by Amalgamated in the Philippines. SCHEDULE "A" Trademark Licensed Product(s) CRAYOLA crayons, pencils, poster paints, water colors, coloring and activity books, chalks, modeling materials, markers, scissors Serpentine Design * crayons, pencils, poster paints, water colors, coloring and activity books, chalks, modeling materials, markers, scissors Chevron Design * crayons, pencils, poster paints, water colors, coloring and activity books, chalks, modeling materials, markers, scissors MODEL MAGIC * modeling clay, modeling materials Anthropomorphic crayon design known as "Tip" * crayons, pencils, poster paints, water colors, coloring and activity books, chalks, modeling materials, markers, scissors * All products bearing the Serpentine Design mark, Chevron Design mark, MODEL MAGIC mark or "Tip" mark shall also bear the CRAYOLA mark. 4. SCHEDULE "B" Applicable Royalty Rates Sales from June 2000 through May 2002: six percent (6%) Sales from June 2002 through the end of the term of the Agreement: seven percent (7%) 5. "Net Selling Price" shall be defined as invoice value based on the actual sales minus (a) trade, quantity or cash discounts and brokers or agents' commissions, if any; (b) return credits and allowances; (c) any tax, excise or other government charges; and (d) freight, insurance and packaging expenses. 6. Under the Renewal Trademark License Agreement between the parties, it was agreed that Amalgamated shall pay Crayola LLC a royalty equal to seven percent (7%) of the Net Selling Price of all sales of the "Licensed Products" sold by Amalgamated. Payments of said fees shall be made to Crayola LLC in United State dollars and shall be payable at the official rate of exchange, as established by the Central Bank of the Philippines, on the date of remittance is due. Payment is hereunder shall be made in respect of each calendar quarter within thirty (30) days after the end of such quarter, subject to force majeure , but in no case to exceed three (3) months from the end of each calendar quarter. In case of termination of the Agreement, for any reason, payment shall be made to Crayola LLC within sixty (60) days after termination. 7. Entered into force on January 1, 1992. 8. Entered into force on January 1, 2002. 9. The VAT rate was increased from 10% 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.