ITAD BIR Ruling No. 088-16

April 27, 2016 ITAD BIR RULING NO. 088-16 Article 12 (Royalties), Philippines-Korea tax treaty Fortun Narvasa & Salazar 23rd Floor, Multinational Bancorporation Centre 6805 Ayala Avenue Makati City Attention: Atty. Ma. Carmen D. Babista-Lazaro Partner Gentlemen : This refers to your tax treaty relief application filed on November 22, 2013 requesting confirmation that royalties paid by Kyochon-Philippines, Inc. ("Kyochon-Philippines") to Kyochon Food & Beverage Co., Ltd. ("Kyochon F&B") are subject to income tax at the rate of 15 percent pursuant to the Convention between the Republic of the Philippines and the Republic of Korea for the avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income ("Philippine-Korea tax treaty"). Facts Kyochon F&B is a foreign corporation and a resident of the Korea based on its Articles of Incorporation and on the Certificate of Residence issued by the Gumi District Tax Office in Korea on December 16, 2013. Kyochon F&B is located at 114-10, Won-Dong, Osan-Si, Gyeonggi-Do, Korea. It is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration issued by the Securities and Exchange Commission on November 25, 2013. On the other hand, Kyochon-Philippines is a domestic corporation located at Penthouse, Annapolis Tower, 43 Annapolis Street, Greenhills, San Juan, Philippines. Kyochon F&B has achieved extensive public acceptance of, and a favorable reputation and extensive goodwill worldwide for the Stores (Chicken Restaurants) operated under its developed system and under the trade name and mark KyoChon 1 Kyochon-Philippines, recognizing the advantages of the system, entered into a Master Franchise Agreement with Kyochon F&B on November 7, 2013. Under the Master Franchise Agreement, Kyochon F&B granted Kyochon-Philippines the right, obligation and license to: (1) exercise the right to develop and operate Kyochon chicken restaurants in the Philippines (Operational Rights), and (2) use the system, trademarks, trade, trade dress, business information, trade secrets, and the works (excluding Kyochon F&B's proprietary retail information system) solely in conjunction with the operational rights; provided, however that, Kyochon F&B's grant of rights is made in reliance on the personal attributes of Kyochon-Philippines' owners/shareholders, managers, and directors stated in the Agreement. The license granted by Kyochon F&B to Kyochon-Philippines shall be for ten years from the effective date of the Agreement on November 7, 2013, and shall be automatically renewed for 10 years, subject to conditions set forth in the Agreement. During the first three calendar years following the effective date of the Agreement, Kyochon-Philippines shall open and operate or cause to be opened and maintained in the operation in the Philippines the number of the Stores in accordance with the Development Schedule: DETACa Development Expiration Date of Cumulative Minimum Total Period the Development Number of Stores Located in the Period Philippines Which Franchisee Shall Have Open and in Operation 1. One (1) year after the 2 Effective Date 2. Two (2) years after the 4 Effective Date 3. Three (3) years after 6 the Effective Date During the Development Schedule, Kyochon-Philippines shall develop Stores only within the market areas of the Philippines. In consideration, Kyochon-Philippines shall pay Kyochon F&B the following: 1. Non-refundable Master Franchise Fee in the amount of US$400,000.00, payable as follows: a. First Payment: 25 percent of the Master Franchise Fee or US$100,000.00 for the Term, shall be paid within 30 days from the Effective Date. b. Second Payment: 25 percent of the Master Franchise Fee or US$100,000.00 for the Term, shall be paid within 15 days of the first Store opening. If the Franchisee cannot open the first Store within 6 months from the Effective Date, then Kyochon-Philippines shall immediately pay to Kyochon F&B the Second Payment. c. Third Payment: the remaining balance of the Master Franchise Fee of US$200,000.00 shall be paid in installments in the amount of US$20,000.00 each payable upon the opening of the first 10 Stores. If Kyochon-Philippines opens less than 10 Stores by June 30, 2015, then Kyochon-Philippines shall immediately pay Kyochon F&B the remaining balance on such date. 2. Royalty Fee of the aggregate amount equal to 3 percent of the Monthly Gross Sales of each Store in the Philippines on the basis of POS, payable on or before the last Business Day of each month following the month in which Monthly Gross Sales and Other Income were generated, without demand, set off, counterclaim or deduction whatsoever; and 3. Security Deposits no later than 30 days prior to the opening of the first Store in the Philippines and on January 1 of each year thereafter during the Term of the Agreement: a. US$10,000.00 if the total number of the Stores opened and operating in the Philippines does not exceed 10; or b. In the amount increased by US$5,000.00 for up to 10 additional Stores each after exceeding the first 10 Stores. It is finally represented that the issue or transaction subject of the above application is 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 Statement issued by the Chairman of Kyochon-Philippines on November 21, 2013. Ruling In reply, please be informed that under Section 28 (B) (1) of the Tax Code, royalties paid to a foreign corporation not engaged in trade or business in the Philippines are subject to income tax at the rate of 30 percent, to wit: "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 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) and (d) above: n Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)" However, under Section 32 (B) (5) of the Tax Code, such royalties are exempt or partially exempt to the extent required by any treaty obligation on the Philippines, to wit: "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, you invoke the Philippines-Korea tax treaty. Paragraphs 1, 2 and 4, 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 if such resident is the beneficial owner of the royalties. 2. However, such royalties may 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 15 per cent of the gross amount of the royalties. 3. Notwithstanding the provisions of paragraph 2 hereof, the amount of tax imposed by the Philippines on the royalties paid by a company, being a resident of the Philippines, registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines to a resident of Korea, who is the beneficial owner of the royalties, shall not exceed 10 per cent of the gross amount of the royalties. 4. The term "royalties" as used in this Article means payments of any kind received as a consideration for the use of, or right to use, any copyright of literary, artistic or scientific work, 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, and includes payments of any kind in respect of motion picture films and works on films or videotapes for use in connection with television or tapes for the use of radio broadcasting." aDSIHc Under paragraphs 1, 2 and 3, Article 12 of the Philippines-Korea tax treaty, royalties arising in the Philippines and paid to a resident of the Korea are subject to income tax in the Philippines at a rate not to exceed 10 percent if paid by a company registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines. Otherwise, 15 percent on the gross amount of the royalties. The term royalties 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 ("know-how"), and includes payments of any kind in respect of motion picture films and works on films or videotapes for use in connection with television or tapes for the use of radio broadcasting. In view of the foregoing, since royalties in general are subject to income tax at the rate of 15 percent under the Philippines-Korea tax treaty, the Non-refundable Master Franchise Fee and royalties paid by Kyochon-Philippines to Kyochon F&B under the Master Franchise Agreement for the exercise of Operational Rights and use of the system, trademarks, trade, trade dress, business information, trade secrets of the trademark ' KyoChon ' shall be subject to income tax at the rate of 15 percent, pursuant to paragraph 2, Article 12 of the Philippines-Korea tax treaty. Finally, under Section 108 (A) of the Tax Code, the fees and royalties in question, being payments for the use of intangible properties (know-how, trade mark, design or model, plan, secret formula or process) in the Philippines, are subject to value-added tax ("VAT"), to wit: "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: Provided, that the President, upon the recommendation of the Secretary of Finance, shall, effective January 1, 2006, 2 raise the rate of value-added tax to twelve percent (12%). . ." Relative thereto, Kyochon-Philippines shall withhold VAT on the fees and royalties at the rate of 12 percent before remitting them to Kyochon F&B. Kyochon-Philippines shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). If it is a VAT-registered taxpayer, the duly filed BIR Form No. 1600 and accompanying proof of payment shall serve as documentary substantiation for Kyochon-Philippines' claim of input tax on the royalties; otherwise, it may treat such VAT as an asset or expense, whichever is applicable. VAT withheld shall be remitted within ten days following the end of the month the withholding was made. 3 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. "Trademarks" includes the trade name and mark KyoChon and such other trademarks, service marks, trade names, emblems, logos, designs, labels, signs, and symbols belonging to Franchisor on or in connection with the System, Stores, Products and/or Services. 2. The VAT rate was increased to 12 percent beginning 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. 3. Pursuant to Section 4.112-2 of Revenue Regulations No. 16-2005 (Consolidated Value-Added Tax Regulations of 2005), as amended by Revenue Regulations No. 4-2007 (Amending Certain Provisions of Revenue Regulations No. 16-2005, as Amended, Otherwise Known as the Consolidated Value-Added Tax Regulations of 2005), which provides: "SEC. 4.114-2. Withholding of VAT on Government Money Payments and Payments to Non-Residents. xxx xxx xxx (b) The government or any of its political subdivisions, instrumentalities or agencies including GOCCs, as well as private corporation, individuals, estates and trust, whether large or non-large taxpayers, shall withhold twelve percent (12%) VAT, starting February 1, 2006, with respect to the following payments: (1) Lease or use of properties or property rights owned by non-residents; and (2) Services rendered to local insurance companies with respect to reinsurance premiums payable to non-residents; and (3) Other services rendered in the Philippines by non-residents. In remitting VAT withheld, the withholding agent shall use BIR Form No. 1600 Remittance Return of VAT and Other Percentage Taxes Withheld. VAT withheld and paid for the non-resident recipient (remitted using BIR Form No. 1600), which VAT is passed on to the resident withholding agent by the non-resident recipient of the income, may be claimed as input tax by said VAT-registered withholding agent upon filing his own VAT Return, subject to the rule on allocation of input tax among taxable sales, zero-rated sales and exempt sales. The duly filed BIR Form No. 1600 is the proof or documentary substantiation for the claimed input tax or input VAT. Nonetheless, if the resident withholding agent is a non-VAT taxpayer, said passed-on VAT by the non-resident recipient of the income, evidenced by the duly filed BIR Form No. 1600, shall form part of the cost of purchased services, which may be treated either as an 'asset' or 'expense', whichever is applicable, of the resident withholding agent. VAT withheld under this Section shall be remitted within ten (10) days following the end of the month the withholding was made." n Note from the Publisher: Copied verbatim from the official document. The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.