ITAD BIR Ruling No. 147-13

May 24, 2013 ITAD BIR RULING NO. 147-13 Article 12, Philippines-Switzerland tax treaty Manabat Delgado Amper & Co. 5th Floor Salamin Building 197 Salcedo Street, Legaspi Village Makati City Attention: Atty. Walter L. Abela, Jr. Director, Tax and Corporate Services Gentlemen : This refers to your tax treaty relief application filed on December 3, 2009, on behalf of SGS Philippines, Inc. ("SGS PH") , requesting confirmation that the fees paid to SGS Group Management SA ("SGS Group") under the Network Access Agreement ("Network Agreement") entered into between them are in the nature of business profits not subject to Philippine income tax under Article 7 of the Convention between the Republic of the Philippines and the Swiss Confederation for the Avoidance of Double Taxation with Respect to Taxes on Income ("Philippines-Switzerland tax treaty") . CETIDH It is represented that SGS Group , address at Place des Alpes 1, 1211 Geneva, Switzerland, is a resident of Switzerland for tax purposes under number 060.785.031; that SGS Group is not registered either as a corporation or as a partnership in the Philippines as shown in the Certification of Non-Registration of Company issued by the Securities and Exchange Commission on July 13, 2009; that SGS Group has undertaken to assume the development of the SGS network as well as to establish a unified culture with increased knowledge sharing relating to the operation of a business in the inspection, verification, testing and certification industry to develop SGS Group into a unified global organisation which meets the requirements of its customers; and that SGS PH, on the other hand, is a corporation duly organized and existing under Philippine Laws with office address located at 2nd Floor Alegria Bldg., 2226 Chino Roces Avenue, Pasong Tamo, Makati City. It is further represented that on October 15, 2008, SGS PH and SGS Group entered into a Network Agreement whereby SGS PH engaged SGS Group to provide all or any of the network access services for the benefit of SGS PH during the term of the agreement which include, but are not limited to, the following: Development and implementation of strategy for the SGS Group; 1 Access to various best practices for business operations at a preferential rate; Development of certification and accreditation practices and procedures; Business know-how to reduce operating costs; Support for strategic acquisitions; Back-office know-how and improvement of best practices and tools for back-office functions as well as access to various back-office services at a preferential rate; Development of human resources tools; Central purchasing functions; and Implementation and supporting of information and communication systems. DIESHT That for the duration of the Agreement, SGS Group has to employ directly or indirectly personnel sufficient in number and of professional competences to perform the various types for network access services covered by the Network Agreement; that SGS Group is obliged to assume sole responsibility for the remuneration and any other benefits with respect to such persons; that in consideration of the network access services, SGS PH and SGS Group acknowledged and agreed to determine the compensation for the network access services on the basis of the Third Party Revenues 2 for the current year; that compensation to SGS Group shall be settled within 30 days following the receipts of invoice; that, per Certification issued by SGS PH, no personnel of SGS Group was assigned to render services in the Philippines; that the network access fee percentage as indicated in Appendix 1 of the Network Agreement is 3%; and that the Network Agreement shall be valid for a period of five years and, after the first contractual period, will automatically be extended for one year at each time, unless terminated by either SGS PH or SGS Group giving at least 6 months notice in writing prior to the end of the term. It is finally represented that the issues or transactions subject of the above request for ruling 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 of the taxpayer/s involved per the Certificate issued by SGS PH dated October 16, 2009. 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 income derived in the Philippines by a nonresident foreign corporation. 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, . . . profits and income, . . .: 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: IacHAE "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, Article 12 of the Philippines-Switzerland tax treaty provide, 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 the tax so charged shall not exceed 15 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 and films and tapes for television or radio broadcasting, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience. xxx xxx xxx" Article 12 (3) of the Philippines-Switzerland tax treaty extends the meaning of royalties to cover payments for information concerning industrial, commercial or scientific experience. The main type of information covered by this provision alludes to the concept of "know-how". There is no precise definition of the term "know-how" but it generally corresponds to undivulged information of an information of an industrial, commercial or scientific nature arising from previous experience, which has practical application in the operation of an enterprise and from the disclosure of which an economic benefit can be derived. 3 Much like trademarks and patents, know-how is proprietary information or knowledge that assists or improves a commercial activity. However, it is not registered for protection in the manner of patents or trademarks. 4 cHITCS Since payments for "know-how" fall outside the ordinary meaning of royalties, e.g., payments for use of or right to use patents and trademarks, the characterization of such income is commonly confused with payments for services, which are generally classified as business profits under tax treaties. To distinguish between these two kinds of income, the following commentaries of the Organization for Economic Co-operation and Development Model Tax Convention on Income and on Capital (Condense Version, July 17, 2008) mention: "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: 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 to 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." (page 187) The main distinctive feature of know-how, therefore, is that it is an asset and, as such, it is something which is already in existence and is not something brought into being in pursuance of the particular contract. 5 In contrast, a contract for services requires the contractor to apply special skills and knowledge, for his own purposes, in order to bring a product into existence. To determine whether the information provided under the Network Access Agreement between SGS Group and SGS PH constitutes know-how or provision of services, we examine the pertinent provisions of the Agreement. ECaScD Under the Agreement, SGS Group agrees to provide SGS PH access to the SGS network. In so doing, SGS Group provides SGS PH, under non-disclosure conditions, information on the procedures, methods and techniques of inspection, verification, testing and certification, which information is not generally known to other offices or organizations with similar purpose. This information includes, among others, business know-how to reduce operating costs, best practices for business operations, and development of certification and accreditation practices and procedures. Significantly, this information will enable SGS PH to improve its operations and meet the high standards set and adhered to for many years with the SGS group of companies. Moreover, it is provided in the Agreement that the right, title and interest in the information remain exclusively with SGS Group . It is evident from the foregoing that the information provided by SGS Group to SGS PH under the Agreement is know-how. The product, i.e., information, has already been created and is already in existence at the time the parties entered in to contract. Secondly, the information is transferred by SGS Group for the use of SGS PH. Thirdly, all rights and interest in the information remain exclusively with SGS Group and what is provided to SGS PH is merely the access or the right to use the information. Finally, the information provided to SGS PH is undivulged; it is imparted to SGS PH so it can use it for its own account and improve its commercially activity. Clearly, the transaction between SGS Group to SGS PH involves the provision of know-how. As such the payments made by SGS PH in consideration of the network access services provided by SGS Group pursuant to the Agreement are considered as royalties under Article 12 (3) of the Philippines-Switzerland tax treaty. Relative thereto, please be informed that under Section III (2) of Revenue Memorandum Order No. 1-00 (Procedures for Processing Tax Treaty Relief Application) ("RMO 1-2000") , any availment of tax treaty relief (exemption from income tax or reduction of tax) shall be preceded by an application filed at the International Tax Affairs Division ("ITAD") of this Bureau at least 15 days before the intended transaction or payment of income, thus: "III. Policies: In order to achieve the above-mentioned objectives, the following policies shall be observed: xxx xxx xxx 2. Any availment of the tax treaty relief shall be preceded by an application by filing BIR Form No. 0901 (Application for Relief from Double Taxation) with ITAD at least 15 days before the transaction i.e., payment of dividends, royalties, etc., accompanied by supporting documents justifying the relief. . ." (Emphasis ours) IDScTE This condition was emphasized by the Court of Tax Appeals in Mirant (Philippines) Operations Corporation vs. Commissioner of Internal Revenue (C.T.A. Case No. 6382 dated June 7, 2005) where it ruled: " However, it must be remembered that a foreign corporation wishing to avail of the benefits of the tax treaty should invoke the provisions of the tax treaty and prove that indeed the provisions of the tax treaty applies to it, before the benefits may be extended to such corporation . In other words, a resident or non-resident foreign corporation shall be taxed according to the provisions of the National Internal Revenue Code, unless it is shown that the treaty provisions apply to the said corporation, and that, in cases the same are applicable, the option to avail of the tax benefits under the tax treaty has been successfully invoked. Under Revenue Memorandum Order 01-2000 of the Bureau of Internal Revenue, it is provided that the availment of a tax treaty provision must be preceded by an application for a tax treaty relief with its International Tax Affairs Division (ITAD). This is to prevent any erroneous interpretation and/or application of the treaty provisions with which the Philippines is a signatory to. The implementation of the said Revenue Memorandum Order is in harmony with the objectives of the contracting state to ensure that the granting of the benefits under the tax treaties are enjoyed by the persons or corporations duly entitled to the same. The Court notes that nowhere in the records of the case was it shown that petitioner indeed took the liberty of properly observing the provisions of the said order. Petitioner quotes various BIR, as well as ITAD, Rulings issued to several foreign corporations seeking for a tax relief from the office of the respondent. However, not any one of these rulings pertains to the petitioner. It must be stressed that BIR rulings are issued based on the facts and circumstances surrounding particular issue/issues in question and are resolved on a case-to-case basis. It would be thus erroneous to invoke the ruling of the respondent in specific cases, which have no bearing to the case of petitioner. " (Emphasis ours) This decision was also upheld by the Supreme Court in a Resolution (G.R. No. 168531) dated February 18, 2008. Furthermore, the necessary requirement laid down in RMO 1-2000 is reiterated in subsequent rulings of the Court of Tax Appeals: Deutsche Bank AG Manila Branch vs. Commissioner of Internal Revenue (C.T.A. EB Case No. 456 dated May 29, 2009), CBK Power Company Ltd. vs. Commissioner of Internal Revenue (C.T.A. Case Nos. 6699, 68844 and 7166 dated March 29, 2010) and Manila North Tollways Corporation vs. Commissioner of Internal Revenue (C.T.A. Case No. 7864 dated April 12, 2011) . HaDEIc In view of the foregoing, royalties paid by SGS PH to SGS Group before December 18, 2009 6 are hereby DENIED relief for having been filed beyond the 15-day period prescribed by the RMO. Accordingly, the subject royalties shall be subject to income tax at the rate provided for under Section 28 (B) (1) of the Tax Code of 1997, as amended. However, relief is hereby GRANTED on royalties paid by SGS PH to SGS Group on December 18, 2009 onwards , and the same shall be subject to income tax at a reduced rate of not exceeding 15 percent of the gross amount thereof, pursuant to Article 12 (2) of the Philippines-Switzerland tax treaty. Moreover, the said royalty payments by SGS PH to SGS Group shall be subject to the 12% value-added tax (VAT) under Section 108 of the Tax Code, as amended, which provides as follows: "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 (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 No. 4-2002, Section 3 of Revenue Regulations No. 8-2002, and Section 7 of Revenue Regulations No. 14-2002, SGS PH shall be responsible for the withholding of VAT on the royalty fee before remitting it to SGS Group . In remitting to the Bureau of Internal Revenue the VAT withheld, SGS PH shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld). If it is a VAT-registered taxpayer, SGS PH 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, SGS PH may include as part of the cost of the royalty fees to it by SGS Group the VAT consequently shifted or passed on to it. In addition, SGS PH is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies for SGS Group and the fourth copy for SGS PH 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. THAECc Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. "SGS Group" shall mean SGS S.A. and all its affiliated companies. 2. "Third Party Revenues" shall mean for a period the total third party revenues generated by Client which shall be computed in accordance with the SGS Group Financial Manual as revised for time to time. 3. Paragraph 11, Commentary on Article 12 (Royalties), OECD Model Tax Convention and on Capital (Condensed Version), July 2010. 4. Paragraph 6.5 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration, July 2010. 5. Tax treaty Characterization Issues (Report to Working Party No. 1 of the OECD Committee on Fiscal Affairs) by the Technical Advisory Group on Treaty Characterisation of Electronic Commerce Payments; February 1, 2011. 6. December 18, 2009 is the 15th day from December 3, 2009 (date of filing of TTRA). 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 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%). xxx xxx xxx" 8. The VAT rate was increased to 12% on February 1, 2006 pursuant to Republic Act No. 9337 and 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.