ITAD BIR Ruling No. 101-14

June 30, 2014 ITAD BIR RULING NO. 101-14 Article 13, Philippines-US Tax Treaty Dow Chemical Pacific Limited 23/F 6750 Ayala Avenue Makati City Attention: Atty. Rebecca R. Pales Attorney-in-Fact Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed December 4, 2012, on behalf of Rohm and Haas Company ("RHC"), requesting confirmation that its royalty income from Rohm and Haas Philippines, Inc. ("RHPI") is subject to the preferential tax rate provided under Article 13 of the Convention between the Government of the Republic of the Philippines and the Government of the United States of America with Respect to Taxes on Income ("Philippines-US tax treaty"). It is represented that RHC, with address at 100 Independent Mall, West Philadelphia, Pennsylvania, United States of America (US), is a foreign corporation organized and existing under the laws of the US and is a resident thereof for tax purposes as evidenced by a certification issued by the Department of the Treasury, Internal Revenue Service, Philadelphia dated March 26, 2012; that RHC's license to transact business in the Philippines was revoked on January 26, 2011 for non-compliance of reportorial requirements as shown in the Certificate of Corporate Filing/Information issued by the Securities and Exchange Commission on November 8, 2011; and that RHPI, on the other hand, is a domestic corporation organized and existing under the laws of the Philippines, with office address at Aguilar Avenue, CAA Road, Las Pias City. It is further represented that on January 1, 2007, RHC and RHPI entered into a Royalty Agreement which either party may, at its sole option, terminate the Agreement in whole by giving sixty (60) days prior written notice to each party; that RHC grants RHPI a non-exclusive right to use all technology and rights, know-how, inventions, toxicological data, environmental data, health data, safety data, processes and trade secrets, including all improvements and modifications thereto, owned or held, now or in the future, under an exclusive license or a non-exclusive license, with the right to sublicense directly or indirectly by RHC, including the rights to use the "Rohm and Haas" corporate name and "Flask Logo", patents and trademarks and copyrights related to the licensed products as valid on January 1, 2007 as Exhibit A of the Agreement; for the rights granted in the Agreement to RHPI to use the intellectual property and the "Rohm and Haas" corporate name and "Flask Logo", RHPI shall pay a royalty of six (6) percent net sales of licensed products and its sublicensee's net sales of licensed products; that royalties for licensed products are not payable until the gross profit margin on manufactured licensed products exceeds fifteen percent (15%) in the aggregate; that for each one percent (1%) gross profit margin increment over fifteen percent, a one percent (1) royalty is due and payable, up to the royalty rate of six percent (6%); and that on December 28, 2012, RHPI remitted to RHC the royalty payments for the first quarter of 2012 and the second quarter of 2013 per sworn certification issued by the Hongkong and Shanghai Banking Corporation Limited on January 9, 2013. aCSTDc Finally, it is 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 a judicial appeal as evidenced by the Sworn Statement issued RHPI on November 21, 2012. In reply, please be informed that royalty payments to a nonresident foreign corporation are, in general, covered by Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended. 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 . . ., royalties . . .: 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 accordance with the foregoing, the provision of the Philippines-US tax treaty may apply to the subject payments, Article 13 of which provides: ACIDSc "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. 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" Pursuant to the "most-favored-nation" clause in Article 13 (2) (b) (iii) of the Philippines-US tax treaty, the tax imposed on royalties derived by a resident of the US from sources within the Philippines shall be 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. CScTED In relation thereto, worth mentioning is the case of Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc. and Court of Appeals ( the S.C. Johnson case) (G.R. No. 127105 dated June 25, 1999) whereby the Supreme Court cited two conditions for the application of the "most-favored-nation" income tax rate to royalties arising in the Philippines and derived by a resident of another country (in this case, the US). The Court noted that, first, the royalties in question, derived by a resident of the other country (the US), must be of the same kind as those derived by a resident of the third country whose tax treaty with the Philippines permits the residents of the third country a "most-favored-nation" income tax rate on royalties arising in the Philippines. Second, the method employed by the other country (the US) in eliminating or mitigating the effects of double taxation of income or certain types of income derived by its residents from sources in the Philippines must be the same with that of the third country in question, which can be determined by taking into account and comparing the methods described in the article on elimination of double taxation in their (the other country and the third country) respective tax treaties with the Philippines. In relation to Article 13 (2) (b) (iii) or the "most-favored-nation" clause of the Philippines-US tax treaty, pertinent are the provisions of the Philippines-UAE tax treaty. Its Article 12 provides, viz. : "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, the royalties may also be taxed in the Contracting State in which they arise and according to the laws of that State, but if the beneficial owner of the royalties is a resident of the other Contracting State, the tax so charged shall not exceed 10 per cent of the gross amount of the royalties. The competent authorities of the Contracting States shall, by mutual agreement, settle the mode of application of this limitation. 3. The term 'royalties' as used in this Article 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. CTacSE xxx xxx xxx" Under Article 12 of the Philippines-UAE tax treaty, royalties for the use or right to use of 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 any industrial, commercial or scientific equipment or for information concerning industrial, commercial or scientific experience are subject to 10 percent income tax based on the gross amount of royalties. As for the mechanism employed in mitigating the effects of double taxation, Article 23 of the Philippines-US tax treaty reads: "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. . . ." Likewise, Article 22 of the Philippines-UAE tax treaty provides, viz. : "Article 23 Elimination of Double Taxation 1. In the case of 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, United Arab Emirates tax payable in respect of income derived from the United Arab Emirates shall be allowed as credit against the Philippine tax payable in respect of that income; 2. In the case of the United Arab Emirates, double taxation shall be eliminated as follows: Where a resident of the United Arab Emirates derives income which in accordance with the provisions of this Agreement, may be taxed in the Philippines, the United Arab Emirates shall allow as a deduction from tax on income of that person an amount equal to the tax on income paid in the Philippines." HCATEa Under the ordinary credit method, the US and the UAE (as countries of residence) would limit a taxpayer's allowable tax credit to that portion of the taxpayer's tax liability in their countries 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 and the UAE on a particular income, the US and the UAE would not grant the taxpayer a full credit for the income tax imposed by the Philippines on such income. In view thereof, payments being royalties for the use of copyrights, patents, trademarks, and information concerning industrial, commercial or scientific experience (know-how) paid by RHPI to RHC shall be subject to income tax at the reduced rate of 10 percent preferential rate of the gross amount thereof, pursuant to paragraph 2 (b), Article 13 of the Philippines-US tax treaty in relation to Philippines-UAE tax treaty. Moreover, as provided in Section 108 of the Tax Code of 1997 as amended, the said royalty payments are subject to value-added tax (VAT). It 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%) 1 of gross receipts derived from the sale or exchange of services, including the use or lease of properties. xxx xxx xxx (3) The supply of scientific, technical, industrial or commercial knowledge or information; xxx xxx xxx" With regard to the procedures for the withholding and the payment of the VAT, pursuant to Sections 4 and 6 of Revenue Regulations (RR) No. 4-2002, Section 3 or RR No. 8-2002, Section 7 of RR No. 14-2002 and Section 4.114-2 of RR No. 16-05 as amended by RR No. 04-07 RHPI shall be responsible for the withholding of VAT on the royalties fee before remitting it to RHC. In remitting to the Bureau of Internal Revenue the VAT withheld, RHPI shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld). If it is a VAT-registered taxpayer, RHPI may use as documentary substantiation for its claim of input VAT the duly filed BIR Form No. 1600 and the proof of payment accompanying such form. On the other hand, if it is a non VAT-registered taxpayer, RHPI may include as part of the cost of the royalty fees to it by, RHC the VAT consequently shifted or passed on to it. In addition RHPI is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies for, RHC and the fourth copy for RHPI as its file copy. EHcaAI 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. The VAT rate was increased to 12% on February PMB 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.