ITAD BIR Ruling No. 089-14

June 19, 2014 ITAD BIR RULING NO. 089-14 Article 12, Philippines-Germany tax treaty Castillo Laman Tan Pantaleon & San Jose Law Firm The Valero Tower, 122 Valero Street Salcedo Village, Makati City Attention: J. Gregson A. Castillo Ma. Guillermina G. Totaes Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on September 7, 2011, requesting for a ruling on the payments made by L. A. Kustom Corporation ("LA Kustom") to NBR GmbH ("NBR") , under their Sub-License Agreement ("Agreement") , pursuant to 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 NBR, with address at Dusseldorf (40221), Plange Muhle 1, Germany, is a corporation organized and existing under the laws of Germany and is a resident of Germany within the meaning of the Philippines-Germany tax treaty per the Certificate of Residence issued by the German Tax Administration on December 19, 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 dated January 16, 2012; and that, on the other hand, LA Kustom is a corporation organized and existing under the laws of the Philippines with principal address at KM 21 West Service Road, South Super Highway, Cupang, Muntinlupa City 1771. It is further represented that on July 1, 2011, NBR and LA Kustom entered into a Sub-License Service Agreement ("Agreement") whereby under the Agreement , NBR grants to LA Kustom a non-exclusive Sub-License throughout the Philippines (i) to use the Licensed Mark 1 in connection with the manufacture, advertising, promotion, marketing, distribution and sale solely of Products approved by NBR for use by LA Kustom pursuant to the Agreement , (ii) to operate and establish the Boutiques; that in consideration thereof, LA Kustom shall pay NBR a one-time minimum royalty fee of U.S.$2.2 Million Dollars for the entire length of the Agreement ; that the minimum Royalty for the renewal term, if any, shall be determined in NBR's sole discretion at the time of delivery of the Renewal Notice; and that the initial term of the Agreement shall commence as of the date hereof and continue through June 30, 2019. CASIEa 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 royalty income received by a nonresident foreign corporation which 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 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 subparagraphs 5(c): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." 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: 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. CaAcSE xxx xxx xxx" Thus, Article 12 of the Philippines-Germany tax treaty, which you invoke, may apply to the instant case. It 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 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 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 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. EDSAac xxx xxx xxx" Under paragraph 2, Article 12 of the above treaty, 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 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; and (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. In view thereof, since the subject royalty is considered as payment in consideration for the right to use "trademark, design or model, plan, secret formula or process", such royalty paid by LA Kustom to NBR under the Agreement is subject to 10 percent final withholding tax rate pursuant to Article 12 (2) (b) of the Philippines-Germany tax treaty. Moreover, as provided in Section 108 of the Tax Code of 1997, the said royalties are subject to value-added tax (VAT): "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%) 2 of gross receipts derived from the sale or exchange of services, including the use or lease of properties. xxx xxx xxx (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." EaHATD As to the procedure for the withholding and the payment of VAT, LA Kustom , being the resident withholding agent and payor in control of payment shall be responsible for the withholding of the final VAT on such royalties before making any payment to NBR. In remitting the VAT withheld, LA Kustom shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and the proof of payment thereof shall serve as documentary substantiation for the claim of input tax to be applied against the output tax that may be due from LA Kustom if it is a VAT-registered taxpayer. In case LA Kustom is a non-VAT-registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased and may treat such VAT as an "expense" or as an "asset", whichever is applicable. In addition, LA Kustom is required to issue in quadruplicate a Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies for NBR and the fourth copy for LA Kustom as its file copy. [Sections 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 of RR 8-2002; Section 7 of RR 14-2002] 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 considered null and void. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. "Licensed Mark" means the "Von Dutch and its FLYING EYEBALL design". 2. 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.