ITAD BIR Ruling No. 101-11

March 21, 2011 ITAD BIR RULING NO. 101-11 Art. 13, Philippines-United States of America Tax Treaty; BIR Ruling No. ITAD-127-06; BIR Ruling No. DA-ITAD-032-08; BIR Ruling No. DA-ITAD-105-08; BIR Ruling No. DA-ITAD-024-09; BIR Ruling No. DA-ITAD-060-07 Sycip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: R.C. Vinzon Tax Services Gentlemen : This refers to your letter dated December 2, 2008 requesting confirmation of your opinion that the royalties paid by IMS Health Philippines, Inc. (IMS-Philippines) to IMS Software Services, Ltd. (IMS-US) are subject to preferential tax rate of 10 percent of the gross amount of royalty payments in accordance with the "most-favored nation" clause of the Philippines-United States of America (Philippines-US) tax treaty in relation to the provisions of the Philippines-China tax treaty. It is represented that IMS-US is a corporation organized and existing under the laws of the United States of America as evidenced by its Certificate of Incorporation; that its principal office is at Corporation Trust Center, 1209 Orange Street, Country of New Castle, Wilmington, DE 19801, U.S.A.; that IMS-US is not registered either as a corporation or as a partnership in the Philippines as confirmed by the Certification of Non-Registration of Corporation/Partnership dated January 16, 2009 issued by the Securities and Exchange Commission; that, on the other hand, IMS-Philippines is a domestic company with principal office at 15th Floor BPI Buendia Center Building, Sen. Gil Puyat Avenue, Makati City. It is further represented that on January 6, 2006, IMS-US and IMS-Philippines entered into an Intangible Property License Agreement (Agreement) whereby IMS-US grants IMS-Philippines the exclusive right to use, develop, and enjoy the Intangible Property, 1 Improvements, 2 and Know-How 3 in the Territory, 4 subject to the terms and conditions of the Agreement ; that IMS-Philippines shall not assign, sublicense, make available or otherwise transfer or disclose any right to use, develop, or otherwise enjoy the Intangible Property without the express written consent of IMS-US; that IMS-Philippines assigns and transfers to IMS-US all legal right, title and interest of the IMS-Philippines to all of the Know-How and Improvements developed or acquired by IMS-Philippines related to the Intangible Property during the term of the Agreement ; that the parties agreed that the royalties due to IMS-US shall be due and payable on a calendar quarter basis; that the Agreement shall commence on the effective date, and, unless terminated sooner as hereinafter provided, shall continue from the effective date and the Agreement shall automatically renew each year, unless either party gives notice of its intention not to renew at least sixty (60) days prior to the renewal; and that the issue or transaction subject of above application 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. TIaDHE 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 payments received by nonresident foreign corporations. 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 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%). xxx xxx xxx" 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. xxx xxx xxx" In relation thereto, the provisions of the Philippines-US tax treaty may apply to your instant request for relief particularly its Article 13, which 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. SETaHC 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. 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. xxx xxx xxx" Paragraph 2 (b) (iii) above provides that royalties arising in the Philippines and derived by a resident of the United States shall be subject to the lowest rate of Philippine income tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State (commonly known as the most-favored-nation tax treatment on royalties). The Supreme Court, in Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc. and Court of Appeals (G.R. No. 127105 dated June 25, 1999), has cited two conditions for royalties arising in the Philippines and derived by a resident of another country (in this case, the United States) to be qualified for a most-favored-nation tax treatment. 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 which is subject to the most-favored-nation tax treatment under the existing tax treaty between the Philippines and the third country. Second, the mechanism employed by the other country (the United States) in mitigating the effects of double taxation of foreign-sourced income derived by its residents must be the same with that employed by the third country, which can be determined by taking into account and comparing the respective articles on Elimination of Double Taxation of the other country (the United States) and the third country under their respective tax treaties with the Philippines. CcHDSA In looking for a third country which grants a most-favored-nation tax treatment on royalties, you cited the People's Republic of China, particularly, the Agreement between the Government of the Republic of the Philippines and the Government of the People's Republic of China for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (Philippines-China tax treaty) which entered into force on March 23, 2001, and whose provisions on taxes apply on income derived or which accrued beginning January 1, 2002. Article 12 of this 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 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. xxx xxx xxx" According to paragraph 2, royalties arising in the Philippines and derived by a resident of the People's Republic of China are subject to income tax at the rate of (a) 15 percent of the gross amount of the royalties for 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 radio broadcasting, or (b) 10 percent of the gross amount of the 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. TCHcAE Applying the Philippines-China tax treaty, the royalty fees to be paid by IMS-Philippines to IMS-US for the right to use the Intangible Property, Improvements, and Know-How, may be subject to 10 percent based on the gross amount thereof, provided the two conditions for the most-favored-nation tax treatment on royalties (as described above) are both satisfied. On whether the first condition is satisfied, we note that under paragraph 3, Article 13 of the Philippines-US tax treaty quoted below, payments received as a consideration for the use or the right to use of 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 Licensed Patents, Licensed Trademark and Technical Information, are assimilated, (respectively) are all considered 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." In the same manner, although lacking a separate paragraph for the definition of royalties in its article, paragraph 2 (a), Article 12 of the Philippines-China tax treaty, as quoted above, provides that royalties arising from the use or the right to use of patents, information concerning industrial, commercial or scientific experience (know-how), and copyright of literary, artistic or scientific work, among others, are subject to income tax rate of 10 percent of the gross amount thereof. This being the case, the first condition for the most-favored-nation tax treatment of royalties is satisfied, which requires the royalties derived by a resident of the US must be of the same kind as those derived by a resident of China. As to the second condition, under paragraph 1, Article 23 of the Philippines-US tax treaty below, the mechanism employed in mitigating the effects of double taxation of income from foreign source is the ordinary credit method. It provides: "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. HCTAEc xxx xxx xxx" Under the ordinary credit method, the US (as country of residence) would limit a taxpayer's allowable tax credit to that portion of the taxpayer's tax liability in the US that is attributable to the income that is taxed in the Philippines (the country of source or country of situs). As a result of this limitation, if the Philippines has an effective tax rate that exceeds the effective tax rate of the US on a particular income, the US would not grant the taxpayer a full credit for the income tax imposed by the Philippines on such income. In the same manner, under paragraph 1, Article 23 of the Philippines-China tax treaty below, it can be seen that that ordinary credit method is also employed by China as a mechanism for mitigating the effects of double taxation of income derived by its residents from foreign sources, thus: "Article 23 METHODS FOR THE ELIMINATION OF DOUBLE TAXATION 1. In China, double taxation shall be eliminated as follows: Where a resident of China derives income from the Philippines the amount of tax on that income payable in the Philippines in accordance with the provisions of this Agreement, may be credited against the Chinese tax imposed on that resident. The amount of the credit, however, shall not exceed the amount of the Chinese tax on that income computed in accordance with the taxation laws and regulations of China. 2. In the Philippines, double taxation shall be eliminated as follows: Subject to the laws of the Philippines and the limitations thereof regarding the allowance of a credit against Philippine tax of tax payable in any country other than the Philippines. Chinese tax payable in respect of income derived from China shall be allowed as credit against the Philippine tax payable in respect of that income. xxx xxx xxx" This being the case, the second condition for the most-favored-nation tax treatment on royalties, which requires that the mechanism employed by the US in mitigating the effects of double taxation of income derived by its residents from foreign sources must be the same with that employed by China, is also satisfied. In fine, by reason that the conditions for the most-favored-nation tax treatment on royalties laid down by the Supreme Court in the S.C. Johnson case are both satisfied, royalty fees to be paid by IMS-Philippines to IMS-US for the use or the right to use the Intangible Property, Improvements, and Know-How, is subject to 10 percent income tax based on the gross amount thereof. (BIR Ruling No. ITAD 127-06 dated October 23, 2006; BIR Ruling No. DA-ITAD-032-08 dated May 9, 2008; BIR Ruling No. DA-ITAD 105-08 dated December 12, 2008; BIR Ruling No. DA-ITAD 024-09 dated February 27, 2009; and BIR Ruling No. DA-ITAD 060-07 dated May 11, 2007) aTIEcA Finally, as regards value-added tax (VAT), the royalties for the use or the right to use the Intangible Property, Improvements, and Know-How to be paid by IMS-Philippines to IMS-US are subject to VAT under Section 108 (A) of the National Internal Revenue Code of 1997 (Tax Code), as amended, 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. . . . 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" 5 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 IMS-Philippines shall be responsible for the withholding of the VAT on the royalties before remitting them to IMS-US. In remitting to the Bureau of Internal Revenue the VAT withheld on the royalties, IMS-Philippines shall use BIR Form No. 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld). If a VAT-registered taxpayer, IMS-Philippines may use as documentary substantiation for its claim of input VAT the duly filed BIR Form No. 1600 and the proof of payment accompanying it. In addition, IMS-Philippines is required to issue in quadruplicate the Certificate of Final Tax Withheld at Source (BIR Form No. 2306), the first three copies for IMS-US and the fourth copy for IMS-Philippines 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. Intangible Property shall mean new and improved software infrastructure systems, enhanced and expanded global offerings, expanded data panels, consulting methodologies, processes, state-of-the-art global business practices and marketing capabilities, including associated trademarks, service marks and trade names. 2. Improvements shall mean any findings, discoveries, inventions, additions, modifications, formulations, or changes made by either Licensor or Licensee during the term of the Agreement that relate to the Intangible Property. 3. Know-How shall mean any and all technical information presently available or generated during the term of the Agreement that relates to the Intangible Property, Improvements or Offerings. 4. Territory shall mean the area within the geographic area of [ ]. 5. 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.