ITAD BIR Ruling No. 079-13

April 3, 2013 ITAD BIR RULING NO. 079-13 Article 13 (2) (b) (iii), Philippines-US tax treaty; Article 12, Philippines-UAE tax treaty SM Prime Holdings, Inc. SM Corporate Offices Bldg. A.J.W. Diokno Blvd. MOA Complex, Pasay City Attention: Cecilia R. Patricio Senior Vice President Corporate Tax Division Gentlemen : This refers to your Tax Treaty Relief Application filed on June 28, 2011, on behalf of Discovery Asia, Inc. ("Discovery") , requesting confirmation that the royalty payments of SM Prime Holdings, Inc. ("SM Holdings") to Discovery under the Trademark License Agreement ("Trademark Agreement") and Content License Agreement ("Content Agreement") are subject to 10 percent final withholding tax pursuant to Article 13 (2) (b) (iii) 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 Article 12 (2) (b) of the Agreement between the Government of the Republic of the Philippines and the Government of the United Arab Emirates for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital ("Philippines-UAE tax treaty") . CScaDH It is represented that Discovery , with main office address at 1013 Centre Road City of Wilmington, County of New Castle, State of Delaware, United States of America, is a corporation duly organized and existing under the laws of the United States (US) and is a US resident for purposes of US taxation as certified by the Internal Revenue Service, Philadelphia, USA on April 11, 2011; that it is not registered either as a corporation or as a partnership in the Philippines per Certification of Non-Registration of Company issued by the Securities and Exchange Commission (SEC) dated June 13, 2011; and that SM Holdings is a corporation organized and existing under the laws of the Philippines, with office address at SM Corporate Office Building, A.J.W. Diokno, MOA Complex, Pasay City. Moreover, it is represented that on October 15, 2010, the Singapore office of Discovery located at 3 Changi Business Park Vista, #03-01, Singapore 486051, hereinafter referred to as Discovery-SO , as the "Licensor" , entered into a Trademark License Agreement ("TLA") with SM Holdings , as the "Licensee" , whereby Discovery-SO granted to SM Holdings , for a term of three (3) years, the non-transferable, non-assignable, non-exclusive license (without the right to sub-license unless approved in writing by the Licensor) to use the "Licensed Property" 1 in connection with the operation of the Themed Gallery and the Science Discovery Center in the Philippines, strictly in accordance with the express terms of the TLA; and that the royalties and payments of the Licensee in consideration of the Licensor's grant shall be a "Minimum Guarantee" in the amount of Fifty thousand US Dollars (USD$50,000.00) payable per Payment Schedule , as follows: Date Amount Upon Licensee's signature US$12,500.00 On or before 30 June 2011 US$12,500.00 On or before 30 June 2012 US$12,500.00 On or before 30 June 2013 US$12,500.00 It is further represented, that concurrent with the execution of the TLA on October 15, 2010, and as a condition precedent for the effectivity of the TLA, a Content License Agreement ("CLA") was also entered into between Discovery-SO , as the Licensor and SM Holdings , as the Licensee, whereby Discovery-SO granted to SM Holdings during the Licensed Period of three (3) years the non-transferable, non-assignable, non-exclusive license (without the right to sub-license) to exhibit Programmes 2 on a video wall in the Themed Gallery 3 within the Science Discovery Center, 4 and to use the Licensed Property in connection with such exhibition strictly in accordance with the terms of the CLA; that subject to the approval rights set forth in the CLA, Licensor further grants to Licensee the right to use the title of, trailer of, if any, and excerpts (not to exceed two (2) minutes in length in the aggregate) from each Programme and, solely to extent of Licensor's rights therein, the name, voice and likeness of and biographical material concerning all persons appearing in or connected with that Programme for promotional, advertising, publicity and trade purposes of Licensee in connection with exhibition of the Programme; and that in consideration of the grant, Licensee shall pay to Licensor a Minimum Guarantee of Fifty thousand US Dollars (US$50,000.00) ($1,562.50 per Programme hour) payable per the aforementioned Payment Schedule. It is finally represented, as certified by the Senior Vice-President of SM Holdings on June 22, 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. In reply, please be informed that royalty payments to a nonresident foreign corporation are, in general, covered by Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended. It provides: "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 . . ., royalties . . .: 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: EcSaHA 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 accordance with the foregoing, the Article 13 of the Philippines-US tax treaty, which you invoked, may apply to the instant case. 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: (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 US from sources within the Philippines shall be the lowest rate of Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State. In relation thereto, worth mentioning is the case of Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc. and Court of Appeals (the S.C. Johnson case) (G.R. No. 127105 dated June 25, 1999) whereby the Supreme Court cited two conditions for the application of the " most-favored-nation " income tax rate to royalties arising in the Philippines and derived by a resident of another country (in this case, the US). The Court noted that, first, the royalties in question, derived by a resident of the other country (the US), 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 US) in eliminating or mitigating the effects of double taxation of income or certain types of income derived by its residents from sources in the Philippines must be the same with that of the third country in question, which can be determined by taking into account and comparing the methods described in the article on elimination of double taxation in their (the other country and the third country) respective tax treaties with the Philippines. In relation to Article 13 (2) (b) (iii) or the " most-favored-nation " clause of the Philippines-US tax treaty, SM Holdings invoked the provisions of the Philippines-UAE tax treaty, which in Article 12 provides, viz. : "Article 12 Royalties 1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. 2. However, the royalties may also be taxed in the Contracting State in which they arise and according to the laws of that State, but if the beneficial owner of the royalties is a resident of the other Contracting State, the tax so charged shall not exceed 10 per cent of the gross amount of the royalties. The competent authorities of the Contracting States shall, by mutual agreement, settle the mode of application of this limitation. TDCcAE 3. The term 'royalties' as used in this Article means payment 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 and films or tapes for television or radio 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" Under Article 12 of the Philippines-UAE tax treaty, royalties for the use or right to use of any copyright of literary, artistic or scientific work including cinematographic films and films or tapes for television or radio broadcasting, any patent, trademark, design or model, plan, secret formula or process, or any industrial, commercial or scientific equipment or for information concerning industrial, commercial or scientific experience are subject to 10 percent income tax based on the gross amount of royalties. As for the mechanism employed in mitigating the effects of double taxation, Article 23 of the Philippines-US 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. . . . ." Likewise, Article 22 of the Philippines-UAE tax treaty provides, viz. : "Article 23 Elimination of Double Taxation 1. In the case of the Philippines, double taxation shall be eliminated as follows: Subject to the laws of the Philippines and the limitations thereof regarding the allowance of a credit against Philippine tax of tax payable in any country other than the Philippines, United Arab Emirates tax payable in respect of income derived from the United Arab Emirates shall be allowed as credit against the Philippine tax payable in respect of that income; 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, the US and the 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 the US and the UAE on a particular income, the US and the UAE would not grant the taxpayer a full credit for the income tax imposed by the Philippines on such income. Accordingly, the fees of SM Holdings to Discovery under the TLA and the CLA, from the date of filing of this application on June 28, 2011 onwards, 5 being in the nature of royalties, shall be subject to income tax in the Philippines at the rate of 10 percent income tax rate based on the gross amount thereof, under Article 13 (2) (b) (iii) of the Philippines-US tax treaty, in relation to Article 12 (2) (a) of the Philippines-UAE tax treaty. However, fees paid to Discovery prior to the date of filing of the TTRA shall be subject to regular income tax rate of 20 percent as provided under Section 28 (B) (1) of the Tax Code. CSTDEH Moreover, as provided in Section 108 of the Tax Code of 1997, as amended, the said royalty payments are subject to value-added tax (VAT), thus: "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%) 6 of gross receipts derived from the sale or exchange of services, including the use or lease of properties. xxx xxx xxx (3) The supply of scientific, technical, industrial or commercial knowledge or information; xxx xxx xxx" With regard to the procedures for the withholding and the payment of 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 SM Holdings shall be responsible for the withholding of VAT on the royalty fee before remitting it to Discovery . In remitting to the Bureau of Internal Revenue the VAT withheld, SM Holdings shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld). If it is a VAT-registered taxpayer, SM Holdings 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, SM Holdings may include as part of the cost of the royalty fees to it by Discovery the VAT consequently shifted or passed on to it. In addition, SM Holdings is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies for Discovery and the fourth copy for SM Holdings 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. "Licensed Property" means Discovery Channel and associated representations, names, logos, movements, artworks, photographs and other materials. 2. "Programmes" means a total of thirty-two (32) Programmes from the List ( the list contains the available Licensed Property titles controlled by Licensor which may be amended from time to time at Licensor's sole discretion ) from Gallery Exhibition. 3. "Themed Gallery" a Licensed Property-themed space (as licensed by Licensor to Licensee under the TLA) in the Science Discovery Center. 4. "Science Discovery Center" The Nido Fortified Science Discovery Center operated and run by Licensee at Southside Entertainment Mall, J.W. Diokno Boulevard, Mall of Asia Complex, CBP IA, Pasay City. 5. Pursuant to Section 14, Revenue Memorandum Order No. 72-2010 (Guidelines on the Processing of the Tax Treaty Relief Application). 6. 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.