ITAD BIR Ruling No. 081-14

June 10, 2014 ITAD BIR RULING NO. 081-14 Article 13, Philippines-US Tax Treaty SM Prime Holdings, Inc. SM Corporate Offices Bldg. A.J.W. Diokno Blvd. MOA Complex, Pasay City Attention: Ms. Cecilia R. Patricio Atty. John L. Itoh Authorized Representative Gentlemen : This refers to your Tax Treaty Relief Application filed on November 22, 2011, on behalf of Evans and Sutherland Computer Corporation ("E&S") , requesting confirmation that the royalty payments of SM Prime Holdings, Inc. ("SM Holdings") to E&S under their Program Sublicense Agreement ("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") . EHSAaD It is represented that E&S, with office address at 770 Komas Drive, salt Lake City, UT 84108, United States of America, is a resident of the United States of America (US) for purposes of US taxation per certification issued by the Field Director, Accounts Management of the Internal Revenue Service, Philadelphia dated April 4, 2011; that E&S is not registered either as a corporation or as a partnership in the Philippines per Certification of Non-Registration of Company issued by the Philippine Securities and Exchange Commission dated November 16, 2011; that SM Holdings , on the other hand, is a corporation duly organized and existing under the laws of the Philippines with principal office at SM Corporate Offices, Bldg. A. JW Diokno Blvd., Mall of Asia Complex, Pasay City. It is further represented that on May 5, 2011, a Program Sublicense ("Agreement") is made by and between E&S and SM Holdings whereby E&S, having granted by the Adler Planetarium (Adler) a license to reproduce and distribute various Program, 1 grants SM Holdings a nontransferable, nonexclusive license to exhibit the Program at the SM Holdings ' doomed theater, and to use the Program Materials 2 to promote the Program, in accordance with the terms of the Agreement; that the title to and ownership of the Program and Program Materials will at all times remain with Alder, including all rights in patents, copyrights, trade secrets and other intellectual property rights applicable to the Program and Program Materials, and as such all rights will remain vested in Adler; the Agreement will continue in effect for a term of five (5) years unless terminated earlier; that SM Holdings shall pay to E&S a fee of Twenty Thousand US Dollars (US$20,000.00) upon signing of the Agreement. It is finally represented that the issue/transaction subject of the above 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 a 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: TIDHCc "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 accordance with the foregoing, Article 13 of the Philippines-US tax treaty may apply to the subject payments. 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. ACHEaI 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. 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; DaTHAc 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, the royalty payments of SM Holdings to E&S for the exclusive right and license to exhibit the Programs and to use the Program Materials under the Agreement may be subject to 10 percent based on the gross amount thereof, provided that 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." This being the case, royalties to be paid by SM Holdings for the grant of license under the Agreement, being considered royalties for the use of copyrights, patents, trademarks, and information concerning industrial, commercial or scientific experience (know-how), including cinematographic films or films or tapes used for radio or television broadcasting under paragraph 3, Article 13 of the Philippines-US tax treaty, are subject to the "most-favored-nation" tax rate of 10 percent based on the gross amount thereof pursuant to paragraph 2 (a), Article 12 of the Philippines-Czech tax treaty. 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: ScaATD "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. 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." SaCIAE 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. In fine, the two requirements for the "most-favored-nation" income tax rate in the S.C. Johnson case are completely satisfied under the Philippines-Czech tax treaty in relation to royalties arising in the Philippines and derived by a resident of the US. Accordingly, the royalty fees of SM Holdings to E&S under the Agreement, 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 of the Philippines-US tax treaty, in relation to Article 12 (2) of the Philippines-Czech tax treaty. 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: CTAIDE "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%) 3 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 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 SM Holdings shall be responsible for the withholding of VAT on the royalties fee before remitting it to E&S. 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, E&S 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, E&S 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. "Program" full dome planetarium video programs produced by Adler that are completely finished, fully edited and titled and fully synchronized with English language dialog and music and ready for general domed theater release and public exhibition. 2. "Program Materials" trailers, educational guides, and promotional materials specific to the Programs. 3. 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.