ITAD BIR Ruling No. 084-16

April 6, 2016 ITAD BIR RULING NO. 084-16 Article 12 of the Philippines-Germany tax treaty Dedon Manufacturing, Inc. Zone 7, Birds of Paradise, Riverside Canduman Mandaue City Attention: Ms. Grace A. Cabradilla Finance Director Gentlemen : This refers to your tax treaty relief application on the royalty payments received by Dedon GmbH ("Dedon") from Dedon Manufacturing, Inc. ("DMI") in accordance with Article 12 of the Agreement between the Republic of the Philippines and the Federal Republic of Germany for the Avoidance of Double Taxation with Respect to Taxes on Income and Capital ("Philippines-Germany tax treaty") It is represented that Dedon is a foreign corporation and a resident of the Republic of Germany based on the certification issued by the Finanzamt/Tax Office Lneburg on May 12, 2015; that Dedon is not registered as a corporation or partnership in the Philippines based on the Certificate of Non-Registration of Company issued by the Securities and Exchange Commission on April 23, 2015; and that, on the other hand, DMI is a corporation organized an existing under the laws of the Philippines. It is further represented that on September 22, 2009, Dedon and DMI entered into a Royalty Agreement ("Agreement") whereby Dedon grants DMI the professional services of various designers of unique and classic indoor and outdoor utility models of furniture collections, described as follows: Designer Collection Royalty % Harry & Camilla ZOFA 4% of FOB Cebu Price BONNEVILLE Nick Thompkins IN YANG 5% of FOB Cebu Price PHOENIX DAYDREAM PANAMA TANGO ORBIT Richard Frinier BARCELONA 7% of FOB Cebu Price PLANTER ACCESSORIES MARRAKESH HEMISPHERE SPA HOLIDAY FUTURE COLLECTION FOR DEDON 5% of FOB Cebu Price EOOS STREAM SUMMER CLOUD 4% of FOB Cebu Price SLIM LINE Massaud SEA SHELL 5% of FOB Cebu Price GREEN WALL That Dedon accredited DMI as its exclusive manufacturer of the designs and collections of the Designers; and that DMI is allowed to sell directly the manufactured designs and collections of the Designers to local customers wherein a royalty is to be charged. Royalty payments shall be made every quarter pursuant to Clause 5 of the Agreement. 1 It is finally represented that the royalties subject of this ruling are not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Sworn Certification issued by the Finance Director of DMI on November 6, 2015. In reply, please be informed that the Section 28 (B) (1) of the National Internal Revenue Code of 1997 ( "Tax Code" ),as amended, provides that royalties paid to Dedon ,being a foreign corporation not engaged in trade or business in the Philippines, are subject to income tax at the rate of 30 percent, thus: "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 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): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). acEHCD xxx xxx xxx However, Section 32 (B) (5) of the Code, provides that such royalties may be exempt or subject to a reduced rate to the extent required by any treaty obligation on the Philippines, thus: "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" With respect to a treaty, what you invoke for this purpose is the Philippines-Germany tax treaty. Paragraphs 1 and 2, Article 12 thereof provide: "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 law of that State, but the tax so charged shall not exceed: a) 15 per cent of the gross amount of 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 percent of the gross amount of royalties arising from the use of, or the right to use, 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. 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. 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 cinematograph films or tapes for television or 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. xxx xxx xxx" Based on the aforequoted provisions, royalties arising in the Philippines and paid to a resident of Germany may be taxed in the Philippines at a rate not to exceed: (a) 15 percent of the gross amount of 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, 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. Accordingly, since the royalties to be paid by DMI to Dedon under the Agreement, being essentially royalties arising from the use of, or the right to use, design or model, this Office is of the opinion and so holds that the royalty payments shall be subject to 10 percent of the gross amount of the royalties pursuant to paragraph 2 (b) of the Philippines-Germany tax treaty. Furthermore, the royalties in question, being payments for the use or lease of (intangible) properties in the Philippines are subject to value-added tax ("VAT"). Section 108 (A) of the Tax Code of 1997, as amended, 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%) 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" 2 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 DMI shall be responsible for the withholding of the VAT on the royalties before remitting them to Dedon .In remitting to the Bureau of Internal Revenue the VAT withheld on the royalties, DMI shall use BIR Form No. 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld).In addition, DMI are required to issue in quadruplicate the Certificate of Final Tax Withheld at Source (BIR Form No. 2306),the first three copies for Dedon and the fourth copy for DMI as their respective file copies. SDHTEC 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. (ROYALTY FEE RATE OF THE DESIGNER) x (FOB Cebu Price) Cebu Price means total Sales received by DMI from its invoice to Dedon at the close of each month. 2. Republic Act No. 9337 (An Act Amending Sections 27, 28, 34, 106, 107, 108, 109, 110, 111, 112, 113, 114, 116, 117, 119, 121, 148, 151, 236, 237 and 288 of the National Internal Revenue Code of 1997, as Amended, and for Other Purposes), which was signed into law on May 24, 2005 and became effective on November 1, 2005, amended Section 108 (A) to read as: "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 gross receipts derived from the sale or exchange of services, including the use or lease of properties selling price or gross value in money of the goods or properties sold, bartered or exchanged, such tax to be paid by the seller or transferor: 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: (i) Value-added tax collection as a percentage of Gross Domestic Product (GDP) of the previous year exceeds two and four-fifth percent (2 4/5%);or (ii) National government deficit as a percentage of GDP of the previous year exceeds one and one-half percent (1 1/2%). ...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" 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.