ITAD BIR Ruling No. 087-15

March 25, 2015 ITAD BIR RULING NO. 087-15 Article 12 (Royalties), Philippines-China tax treaty CSI Hotels, Inc. 2225 Tolentino St. Pasay City Attention: Wang Yung Gentlemen : This refers to your tax treaty application ("TTRA") filed on March 14, 2013, requesting confirmation that royalties paid by CSI Hotels Incorporated ("CSI") to Jinjiang Inn Co., Ltd. ("Jinjiang") 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 Peoples Republic of China with respect to Taxes on Income . It is represented that Jinjiang is a corporation organized and existing under the laws of China with principal address at Room 101-103, 1121 Pujian Road, Pudong New Area, Shanghai, China and is a resident thereof within the meaning of Philippines-China tax treaty based on a Certificate of Registration as Taxpayer issued on July 18, 2013 by the Shanghai Huangpu District State Administration of Tax and Huangpu Office of Shanghai Local Tax Bureau; 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 dated April 11, 2012; that it is registered with the Intellectual Property Office of the Philippines on October 23, 2006 with a trademark of Jin Jiang Inn + Device and with certification number 4-2005-010450; and that, on the other hand, CSI, an affiliate of Liwayway Marketing Corporation (Liwayway), is a corporation organized and existing under the laws of the Philippines with principal address at 2225 Tolentino St., Pasay City. It is also represented that on September 2, 2011, Jinjiang and CSI entered into a Brand License Contract ("Agreement") by which Liwayway acted as a surety; that under the Agreement, Jinjiang grants to CSI the exclusive right and license to operate Jinjiang Inn chain hotels within the Philippines as the licensed territory and CSI may develop its own Regular Chains and Franchise Chains according to the development targets in the License Term as specified in the Agreement ; that Jinjiang licenses CSI to use the Licensed trademarks, trade name and mark and name the Regular Chains and Franchise Chains in the Philippines, provide technical specifications on operation and management and help CSI meet the unified operation standards in accordance with the Agreement ; that Jinjiang warrants that it is entitled to grant the license to CSI and that the use of the Licensed Brand in accordance with the terms of this Agreement shall not infringe the intellectual property rights of any third party; that Jinjiang shall charge brand license fees for the hotels that CSI is licensed to operate under the licensed brand and that CSI shall pay on time the amount as set out in the Agreement ; that within 30 days after the Agreement is executed, CSI shall make a lump sum payment of US$150,000 as the brand license fee for the License Term; that for each chain CSI develops successfully, CSI shall pay Jinjiang US$5,000 for each chain within sixty (60) days as the hotel software usage fee; that CSI shall pay Jinjiang US$800 for each chain annually as the software upgrade and maintenance fees. The first payment of software upgrade and maintenance fees shall be made before March 31st of the year following the one when CSI successfully develops such chain and the same shall apply to the payment in the subsequent years; that all information CSI obtains from its dealings with Jinjiang , regardless of its form and aim, shall be deemed as trade secret. However, the trade secret does not include: SEcAIC 1. Information that has been known to the public on the execution date of the Agreement ; 2. Information that can be proved to have been obtained by CSI on the date Jinjiang conveys the information to CSI; and 3. Information that is disclosed to CSI by a third party who has the right to do so. The parties also agreed that the Agreement shall be effective for 15 years from September 2, 2011 to September 1, 2026 and the Parties may early terminate or extend it in accordance with the Agreement ; that on September 28, 2011; that per notarized bank certification issued by BDO and a sworn certification issued by CSI, on September 28, 2011 Liwayway, the affiliate and surety of CSI, paid the amount of One Hundred Twelve Thousand Five Hundred US Dollars (USD112,500) to Jinjiang as CSI had no US Dollar account at that time. However, Liwayway charged CSI the equivalent conversion to Philippine Peso in the amount of Four Million Eight Hundred Ninety-Nine Thousand Three Hundred Seventy-Five (P4,899,375.00) per DM dated September 28, 2011; and that subsequently on November 17, 2011 CSI paid Liwayway the amount of P4,899,375.00 per UCPB Check. It is finally represented that, per sworn statement issued by the president of CSI on November 29, 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. 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." With respect to a treaty that may be invoked by Jinjiang and other residents of China, there is the Philippines-China tax treaty. Sections 1, 2 & 3 of Article 12 of the said treaty 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 laws of that State, but if the recipient is the beneficial owner of the royalties, 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 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. 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 cinematography films, or films or tapes for radio or television 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. 4. The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties arise, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the right or property in respect of which the royalties are paid is effectively connected with such permanent establishment or fixed base. In such case the provisions of Article 7 or Article 14, as the case may be, shall apply." Based on the above-quoted provisions, the Philippines may tax the royalties paid by a resident thereof to a company which is a resident of China at a rate not exceeding 15 percent if the royalties are paid in respect of the use of or the right to use cinematograph films and films or tapes for radio and television broadcasting; and 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. However, paragraphs 1 and 2 will not apply if Jinjiang has a permanent establishment in the Philippines. In relation thereto, paragraphs 1, 2 and 3 of Article 5 of the treaty define a permanent establishment as follows: SCHTac "Article 5 Permanent Establishment 1. For the purposes of this Agreement, the term "permanent establishment" means a fixed place of business through which the business of an enterprise is wholly or partly carried on. 2. The term "permanent establishment" includes especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; and f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources. 3. The term "permanent establishment" likewise encompasses: a) a building site, a construction, assembly or installation project or supervisory activities in connection therewith, but only where such site, project or activities continue for a period of more than 6 months; b) an installation, drilling rig or ship used for the exploration of natural resources, but only if so used for a period of more than three months; and c) the furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only where activities of that nature continue (for the same or a connected project) within the country for a period or periods aggregating more than 6 months within any twelve-month period." Accordingly, since Jinjiang is not engaged in trade or business in the Philippines to which an office or a branch is necessary, and it has no building site, installation and do not render services in the Philippines for a period of more than 6 months, then Jinjiang does not have a permanent establishment in the Philippines. In view thereof and considering that the royalties paid by CSI to Jinjiang represent consideration for the use of the trademarks and trade names of Jinjiang , this Office is of the opinion and so holds that such royalty fees are subject to the 10 percent final withholding tax rate pursuant to Article 12 (2) (b) of the Philippines-China tax treaty. As regards the imposition of the VAT on royalties paid to Jinjiang , 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%) 1 of gross receipts derived from the sale or exchange of services, including the use or lease of properties. HScCEa 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, CSI, 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 Jinjiang . In remitting the VAT withheld, CSI 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 CSI upon filing its own VAT return, if it is a VAT-registered taxpayer. In case CSI 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, CSI 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 Jinjiang upon its request and the fourth copy to be retained by CSI 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. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. Effective February 1, 2006 the rate shall be 12%.