ITAD BIR Ruling No. 126-11

April 15, 2011 ITAD BIR RULING NO. 126-11 Article 13, Philippines-United States tax treaty; Article 12, Philippines-Czech tax treaty; BIR Ruling No. 19-10 Baniqued & Baniqued Attorneys at Law 8/F Jollibee Centre, San Miguel Avenue Pasig City 1605 Attention: Atty. Terence Conrad H. Bello Atty. Cheryll Ann R. Trinidad Gentlemen : This refers to your tax treaty relief application filed on December 18, 2009 on behalf of your client, SuccessFactors, Inc. ("SF"), requesting confirmation that payments to be made by Aboitiz & Company, Inc. ("Aboitiz") to SF under a certain "Subscription Agreement" ("Agreement") are payments for "know-how", and therefore, royalties, which are subject to 10 percent income tax, pursuant to the "most-favored-nation" clause under Article 13 of the Convention between the Government of the Republic of the Philippines and the Government of the United States of America for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital Gains ("Philippines-United States tax treaty") in relation to the Convention between the Republic of the Philippines and the Czech Republic for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Czech tax treaty") . ECAaTS It is represented that SF, with office address at 1500 Fashion Island Blvd., Suite 300, San Mateo, CA 94404, is a resident of the United States of America (US) for purposes of US taxation, with TIN: 94-3398453, per certification issued by the Field Director, Accounts Management of the Internal Revenue Service, Philadelphia dated May 18, 2009; that SF is not registered either as a corporation or as a partnership in the Philippines per Certification of Non-Registration of Company issued by the Philippine Securities and Exchange Commission dated September 17, 2009; that Aboitiz, on the other hand, is a corporation duly organized and existing under the laws of the Philippines with principal office at Aboitiz Corporate Center, Gov. Manuel A. Cuenco Avenue, Kasambangan, Cebu City. It is further represented that on February 15, 2008, Aboitiz and SF entered into an Agreement whereby SF shall make the Hosted Service 1 available to Aboitiz and its Users 2 in accordance with the Agreement and the applicable Schedule A 3 mutually entered into from time to time; that under the Agreement, Aboitiz is responsible for all activities conducted under its User logins and for its Users' compliance with the Agreement ; that Aboitiz shall use the Hosted Service solely for its internal business purposes, in compliance with applicable law, and shall not: (i) resell, sublicense, lease, time-share or otherwise make the Hosted Services available to any third party; (ii) send or store infringing or unlawful material; (iii) send or store Malicious Code; (iv) attempt to gain unauthorized access to, or disrupt the integrity or performance of, the Hosted Services or the data contained therein; (v) modify, copy or create derivative works based on the Hosted Service; (vi) reverse engineer the Hosted service; (vii) access the Hosted Service for the purpose of building a competitive product or service or copying its features or user interface; (viii) use the Hosted Service, or permit it to be used, for purposes of product evaluation, benchmarking or other comparative analysis intended for publication without SF's prior written consent; or (ix) permit access to the Hosted Service by a direct competitor of SF. Moreover, it is represented that, as between the parties, SF shall retain all ownership rights in the Hosted Service and the Work Product, 4 and Aboitiz shall retain all ownership rights in the Customer Data and Customer Confidential Information; that Aboitiz may export its Customer Data from the Hosted Service at any time during its subscription term; that SF grants Aboitiz a royalty-free, fully paid-up, nonexclusive, perpetual, irrevocable, worldwide, transferable (only to a successor in interest by way of merger, reorganization or sale of all or substantially all assets or equity), sublicensable license to use, copy, modify, or distribute, including by incorporating into the Hosted service, any suggestions, enhancement requests, recommendations or other feedback provided by Aboitiz or its Users relating to the operation of the Hosted Service; that the first year's subscription and implementation fees specified in each Schedule A of the Agreement will be invoiced upon execution of such Schedule A, and are due and payable upon receipt of such invoice; that the subsequent years' fees under such Schedule A are due and payable annually in advance; that except as otherwise provided, all amounts are in US dollars, all payments shall be made in US dollars, all purchases under the Agreement are non-cancelable, and all fees are non-refundable; commencing on the effective date and continues until all User subscriptions granted in accordance with the Agreement have expired or been terminated; that, except as otherwise provided, the fees stated in each Schedule A of the Agreement shall be effective during the subscription term specified in that Schedule A, including for purchases of additional Users; that the Agreement commences on the Effective date 5 and continues until all User subscriptions granted in accordance with the Agreement have expired or been terminated; and that initial invoice amount under initial Schedule A is US$62,568.00, and, the initial subscription term is 3 years. It is finally represented that the issue/transaction subject of the above request for ruling 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 of the taxpayer/s involved. In reply, please be informed that royalties derived in the Philippines by a nonresident foreign corporation are generally subject to tax as provided for under Section 28 (B) (1) of the National Internal Revenue Code of 1997 (NIRC of 1997), as amended. It provides: IDTcHa "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 . . . 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 NIRC of 1997 provides, viz. : "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: 6 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." In relation thereto, Article 13 the Philippines-United States tax treaty which you invoked, may apply to the instant case. It provides, viz. : "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" Based on the above provision, royalties arising in the Philippines derived by a resident of the United States are generally subject to a preferential tax of 25 percent of the gross amount of royalties; however, royalties are subject either to 15 percent of the gross amount of royalties if the payor is a corporation registered with the Philippine Board of Investments and engaged in preferred areas of activities, or, at 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 (commonly known as the most-favored-nation tax treatment of royalties). DCScaT In relation to the most-favored-nation tax treatment of 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 subject to 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 are subject to a most-favored-nation tax treatment under the existing tax treaty between the Philippines and the third country. Secondly , 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. In the instant case, the third country invoked as granting the lowest treatment on royalties is the Czech Republic (Czech). Accordingly, Article 12 of the Philippines-Czech tax treaty 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, 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 beneficial owner of the royalties is a resident of the other Contracting State, the tax so charged shall not exceed: a) 10 per cent of the gross amount of the royalties arising from the use of, or the right to use, any copyright of literary, artistic or scientific work, other than that mentioned in sub-paragraph (b), 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; b) 15 per cent of the gross amount of the royalties arising from the use of, or the right to use, any copyright of cinematograph films, and films or tapes for television or radio broadcasting. The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of these limitations. xxx xxx xxx" (Emphasis supplied) According to paragraph 2, royalties arising in the Philippines and derived by a resident of Czech are subject to income tax at the rate of 10 percent if the royalties arising from the use of, or right to use, any copyright of literary, artistic or scientific work (except those for cinematograph films, and films or tapes for television or radio broadcasting), 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; or 15 percent of the gross amount of the royalties for royalties arising from the use of, or the right to use, any copyright or cinematograph films, and films or tapes for television or radio broadcasting. Applying the Philippines-Czech tax treaty in relation to the most-favored-nation clause of the Philippines-United States tax treaty, the royalties of Aboitiz to SF for information concerning industrial, commercial or scientific experience ( i.e. , the use by Aboitiz of SF's 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 of royalties (as described above) are both satisfied. As to the first condition, it is worthy to note that under paragraph 3, Article 13 of the Philippines-United States tax treaty, 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 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, trademark, 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." TcDAHS 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-Czech 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 that royalties derived by a resident of the United States must be of the same kind as those derived by a resident of Czech. As to the second condition, the mechanism employed in mitigating the effects of double taxation of income derived from foreign sources is the ordinary credit method under paragraph 1, Article 23 of the Philippines-United States tax treaty. It provides, viz. : "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. xxx xxx xxx" Under the ordinary credit method, the United States (as country of residence) would limit a taxpayer's allowable tax credit to that portion of the taxpayer's tax liability in the United States 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 United States on a particular income, the United States would not grant the taxpayer a full credit for the income tax imposed by the Philippines on such income. Likewise, the mechanism employed by Czech in mitigating the effects of double taxation of income derived by its residents from foreign sources is also the ordinary credit method under paragraph 2, Article 22 of the Philippines-Czech tax treaty. It provides, viz. : "Article 22 ELIMINATION OF DOUBLE TAXATION xxx xxx xxx 2. In the case of a resident of the Czech Republic, double taxation shall be eliminated as follows: a) The Czech Republic, when imposing taxes on its residents, may include in the tax base upon which such taxes are imposed the items of income which according to the provisions of this Convention may also be taxed in the Philippines, but shall allow as a deduction from the amount of tax computed on such a base an amount equal to the tax paid in the Philippines. Such deduction shall not, however, exceed that part of the Czech tax, as computed before the deduction is given, which is appropriate to the income which, in accordance with the provisions of this Convention, may be taxed in the Philippines. b) Where in accordance with any provision of the Convention income derived by a resident of the Czech Republic is exempt from tax in the Czech Republic, the Czech Republic may nevertheless, in calculating the amount of tax on the remaining income of such resident, take into account the exempted income." cCAIDS This being the case, the second condition for the most-favored-nation tax treatment of royalties, which requires that the mechanism employed by the United States in mitigating the effects of double taxation of income derived by its residents from foreign sources must be the same with that employed by Czech, is also satisfied. In fine, since the two conditions for the most-favored-nation tax treatment of royalties laid down by the Supreme Court in the S.C. Johnson case are both satisfied under the Philippines-United States and the Philippines-Czech tax treaties, this Office is of the opinion and so holds that the royalties of Aboitiz to SF under the Agreement are subject to 10 percent preferential tax based on the gross amount thereof, pursuant to the Philippines-United States tax treaty in relation to the Philippines-Czech Republic tax treaty. (BIR Ruling No. ITAD-19-10 dated August 20, 2010) Moreover, as provided in Section 108 of the NIRC of 1997, the said royalties are subject to value-added tax (VAT): "SEC. 108. 7 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%) 8 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; xxx xxx xxx" As to the procedure for the withholding and the payment of VAT, Aboitiz , 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 SF. In remitting the VAT withheld, Aboitiz 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 Aboitiz if it is a VAT-registered taxpayer. In case Aboitiz 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, Aboitiz 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 SF and the fourth copy for Aboitiz 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 facts as represented. However, if upon investigation, it shall be disclosed that the actual facts are different having a different tax treatment, 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. "Hosted Service" means the hosted, on-demand, Web-based performance and talent management service offered by SuccessFactors, including updates thereto from time to time. 2. "Users" means Aboitiz' and its Affiliates' employees, agents, contractors, consultants or other individuals who are authorized by Aboitiz to use the Hosted Service and/or whose information is stored on the Hosted Service. 3. "Schedule A" pertains to the annexes of schedule of Pricing and Purchases attached to the Agreement. 4. "Work Product" means all work product developed or created by SF during the course of providing support, implementation, consulting, training or other professional services to Aboitiz. 5. "Effective date" of the Agreement is February 15, 2008. 6. TITLE II TAX ON INCOME. 7. Section 108 was amended by 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, 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: 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%). xxx xxx xxx 8. 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.