ITAD BIR Ruling No. 109-14

July 21, 2014 ITAD BIR RULING NO. 109-14 Article 12, Philippines-Singapore tax treaty; Section 28 (B) (1) in relation to Section 32 (B) (5) of the Tax Code of 1997, as amended OBS Restaurant Philippines Corporation Unit 109 Heartland Building, 1144 Chino Roces Avenue Makati City Attention: Remedios B. Abcede Finance and Accounting Manager Gentlemen : This refers to your tax treaty relief application (TTRA) filed on March 26, 2012 requesting confirmation that the subfranchise fees and royalty payments by OBS Restaurant Philippines Corporation ("OBS") to Universal Success Restaurants Pte. Ltd. ("Universal SG") are subject to preferential tax rate pursuant to the Convention between the Republic of the Philippines and the Republic of Singapore for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Singapore tax treaty"). It is represented that Universal SG is a resident of Singapore with address at 8 Temasek Boulevard, #40-01A, Singapore, based on the Certificate of Residence dated June 12, 2012, issued by the Inland Revenue Authority of Singapore; that Universal SG is not registered as a corporation or as a partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission dated May 16, 2012; and that on the other hand, OBS is a domestic corporation with address at Unit 109 Heartland Building, 1144 Chino Roces Avenue, Makati City. It is further represented that on April 12, 2010, Universal SG and OBS entered into a Subfranchise Agreement ("Agreement") whereby Universal SG , having been granted by Outback Steakhouse International, L.P. the license to operate a distinctive system for the establishment and operation of full-service restaurants featuring a specialized menu and full bar service, grants OBS the subfranchise of the same and operate the Outback Steakhouse Restaurant located in Alabang, Muntinlupa City and the use of the proprietary marks and system; that for and in consideration of the said subfranchise, OBS shall pay Universal SG a one-time franchise fee in the amount of US$4,175.00 and a monthly royalty fee equal to 8% of the gross sales of OBS for the respective preceding month which shall be due on or before the 10th day of every month; and that first payment of the fees under the Agreement was made on February 16, 2011 based on the Wiring Instructions prepared by the Treasury Officer and Accounting Manager of OBS on even date. SDHETI It is finally represented that the subject income payments are not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or a judicial appeal based on the Affidavit issued by OBS on March 23, 2012. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code of 1997 (" Tax Code "), as amended, provides: "SEC. 28. Rates of Income Tax on Foreign Corporations. . . . (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, such royalties may be exempt or subject to a reduced rate to the extent required by any treaty obligation on the Philippines. Section 32 (B) (5) of the Code provides: "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: (5) Income Exempt under Treaty. Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines." Thus, you invoke the Philippines-Singapore tax treaty. With respect to royalties, Paragraphs 1, 2, and 3 Article 12 thereof provide: DIAcTE "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, if the recipient is the beneficial owner of the royalties, the tax so charged shall not exceed: a) in the case of the Philippines, 15 per cent of the gross amount of the royalties, where the royalties are paid by an enterprise registered with the Philippine Board of Investments and engaged in preferred areas of activities and also royalties in respect of cinematographic films or tapes for television or broadcasting; b) in the case of Singapore, where the royalties are approved under the Economic Expansion Incentives (Relief from Income Tax) Act of Singapore, the royalties shall be exempt; c) in all other cases, 25 per cent of the gross amount of the royalties. 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 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." Under paragraph 2 of Article 12 of the Philippines-Singapore tax treaty, royalties arising in the Philippines and paid to a resident of Singapore may be taxed in the Philippines at a rate not to exceed 15 per cent of the gross amount of the royalties, where the royalties are paid by an enterprise registered with the Philippine Board of Investments and engaged in preferred areas of activities and also royalties in respect of cinematographic films or tapes for television or broadcasting, but in all other cases, the rate shall be 25 per cent of the gross amount of the royalties. THEDcS Accordingly, since OBS is not registered with the Philippine Board of Investments and the fees do not arise in respect of cinematographic films or tapes for television or broadcasting, such fees made by OBS to Universal SG under the Agreement shall be subject to 25 percent of the gross amount of the royalties based on paragraph 2 (c) of Article 12 of the Philippines-Singapore tax treaty. Under tax treaties, payments for the supply of services are treated as business profits, unless they are otherwise treated as royalties when they concern the use of know-how or any other intangible property (copyright, patent, trademark, design or model, plan, secret formula or process design). To distinguish between payments for the supply of services and payments for know-how, the following commentaries of the Organisation for Economic Co-operation and Development ("OECD") Model Tax Convention on Income and on Capital (Condensed Version, July 2010) mention: "11.1. In the know-how contract, one of the parties agrees to impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public. It is recognized that the grantor is not required to play any part himself in the application of the formulas granted to the licensee and that he does not guarantee the result thereof. 11.2. This type of contract thus differs from contracts for the provision of services, in which one of the parties undertakes to use the customary skills of his calling to execute work himself for the other party. Payments made under the latter contracts generally fall under Article 7. 11.3. The need to distinguish these two types of payments, i.e. , payments for the supply of know-how and payments for the provision of services, sometimes gives rise to practical difficulties. The following criteria are relevant for the purpose of making that distinction: SacTCA Contracts for the supply of know-how concern information of that kind described in paragraph 11 that already exists or concern the supply of that type of information after its development or creation and include specific provisions concerning the confidentiality of that information . In the case of contracts for the provision of services , the supplier undertakes to perform services which may require the use, by that supplier, of special knowledge, skill and expertise but not the transfer of such special knowledge, skill or expertise to the other party. In most cases involving the supply of know-how , there would generally be very little more which needs to be done by the supplier under the contract other than to supply existing information or reproduce existing material. On the other hand, a contract for the performance of services would, in the majority of cases, involve a very much greater level of expenditure by the supplier in order to perform his contractual obligations. For instance, the supplier, depending on the nature of the services to be rendered, may have to incur salaries and wages for employees engaged in researching, designing, testing, drawing and other associated activities or payments to sub-contractors for the performance of similar services. 11.4. Examples of payments which should therefore not be considered to be received as consideration for the provision of know-how but, rather, for the provision of services, include: payments obtained as consideration for after-sales service, payments for services rendered by a seller to the purchaser under a warranty, payments for pure technical assistance, payments for a list of potential customers, when such a list is developed specifically for the payer out of generally available information (a payment for the confidential list of customers to which the payee has provided a particular product or service would, however, constitute a payment for know-how as it would relate to the commercial experience of the payee in dealing with these customers), IcHSCT payments for an opinion given by an engineer, an advocate or an accountant, and payments for advice provided electronically, for electronic communications with technicians or for accessing, through computer networks, a trouble-shooting database such as a database that provides users of software with non-confidential information in response to frequently asked questions or common problems that arise frequently." (Pages 225-226) In this case, payments under the Agreement concern information of that kind described in paragraph 11 quoted above which already exists or concern the supply of that type of information after its development or creation and include specific provisions concerning the confidentiality of that information and that there would generally be very little more which needs to be done by Universal SG under the Agreement other than to supply existing information or reproduce existing material for use of OBS. Furthermore, the royalty payments made by OBS are subject to the 12% value-added tax (VAT) pursuant to Section 108 of the National Internal Revenue Code of 1997, as amended. Accordingly, OBS, being the payor in control of the payment shall be responsible for the withholding of VAT on the said royalty payments on behalf of Universal SG by filing a separate VAT return for and on behalf of Universal SG using BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form 1600 and proof of payment thereof shall serve as sufficient basis for the claim of input tax to be applied against the output tax that may be due from OBS, if it is a VAT registered taxpayer. In case OBS is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased or treated as an "expense" or an "asset", whichever is applicable. In addition, OBS is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies thereof to be given to Universal SG upon its request, and the fourth copy to be retained by OBS as its 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)] aTDcAH 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 n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.