ITAD BIR Ruling No. 182-12

May 3, 2012 ITAD BIR RULING NO. 182-12 Articles 12 (Royalties) and 23 (Relief from Double Taxation) Philippines-United States tax treaty; Articles 12 (Royalties) and 23 (Methods for the Elimination of Double Taxation) Philippines-China tax treaty Sycip Gorres Velayo and Co. 6760 Ayala Avenue 1226 Makati City Attention: Veronica A. Santos Tax Division Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on January 4, 2011 requesting confirmation that royalties paid by Footwear Specialty Retailers, Inc. ("Footwear Specialty") to Collective Brands International Franchising LLC ("Collective Brands") (formerly Collective Brands Philippines Franchising LLC) are subject to income tax at the rate of 10 percent pursuant to 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-United States tax treaty") , in relation to 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"). ATHCac Facts Collective Brands is a corporation organized and existing under the laws of the United States based on its Articles of Organization, as amended, and on the Certificate of Residence issued by the Internal Revenue Service on June 14, 2010. Collective Brands is situated at 3231 Southeast 6th Avenue, Topeka, Kansas, United States. Collective Brands is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission on August 13, 2010. On the other hand, Footwear Specialty is a domestic corporation situated at 4th Floor, Midland Buendia Building, 403 Sen. Gil Puyat Avenue, Makati City, Philippines. On November 30, 2009, Collective Brands and Footwear Specialty entered into an Agreement where Collective Brands granted Footwear Specialty development and distribution rights to operate Payless ShoeSource Stores within the Philippines. Collective Brands and its affiliates have developed methods of operating retail stores which operate under the trademark and service mark 'PAYLESS SHOESOURCE' and specialize in the sale of footwear and related products and services. Payless ShoeSource Stores feature distinctive and uniform color schemes, business formats, signs, constructions, graphics, equipment, layouts, systems, methods, procedures, design and marketing and advertising standards and formats, and a value-orientated, rack, customer self-selection business concept all of which Collective Brands may modify from time to time (the " Payless ShoeSource System "). Collective Brands and its affiliates operate, and license others to operate, Payless ShoeSource Stores using the Payless ShoeSource System and certain trademarks, service marks, logos and other commercial symbols ("Marks") . In consideration, Footwear Specialty shall pay Collective Brands the Global Marketing Contribution Fee based on the percentage of net revenue of all its Payless ShoeSource Stores in the Philippines. The applicable percentage for the fee is 7 percent of net revenue of zero to US$85,000,000.00 and 6.5 percent of net revenue of over US$85,000,000.00. The Global Marketing Contribution Fee is computed quarterly and payable within 15 days after the end of each quarter. CaTcSA The grant of development and distribution rights by Collective Brands to Footwear Specialty is contained in a separate Development Agreement, which governs the operation of each Payless ShoeSource Store within the Philippines. The licensing of intellectual property rights is contained in a separate Technology Transfer Arrangement, which governs the use by Footwear Specialty of the subject intellectual property belonging to Collective Brands. On November 30, 2009 , pursuant to the Agreement, Collective Brands and Footwear Specialty entered into a separate Development Agreement for Payless ShoeSource where Collective Brands granted Footwear Specialty the right to develop, own and operate Payless ShoeSource Stores at standard relation locations within the Philippines, such as street locations, shopping centers and shopping malls, and at military bases. In consideration, Footwear Specialty will pay the following fees to Collective Brands : 1. Initial Store Design Fee of US$5,000.00 in respect of each of the first ten Payless ShoeSource Stores opened within the Philippines, payable within 30 days from the completion of the design advice in exchange for Collective Brands providing design advice in connection with the development of each of those stores including ceiling, floor, shop-front, elevation and electrical layout. 2. Subsequent Store Design Fee of US$5,000.00 in respect of each of subsequent Payless ShoeSource Stores opened within the Philippines, payable in the same manner and on the same terms and conditions as the Initial Store Design Fee. 3. Subsequent Store Review Fee of US$1,000.00 in respect of the review of each store design in connection with the development of a Payless ShoeSource Store, payable within 30 days from the completion of such review of the Payless ShoeSource Store. The Development Plan for the Payless ShoeSource Stores is as follows: Development Period 1 2 3 4 5 6 (2010) (2011) (2012) (2013) (2014) (2015) Minimum 5 15 130 50 60 70 Aggregate Stores Minimum Purchases (in Thousand US Dollars) (2010) (2011) (2012) (2013) (2014) (2015) Philippines 522 2,009 4,379 7,729 10,835 13,057 Minimum Purchases Units (By Thousands) (2010) (2011) (2012) (2013) (2014) (2015) Philippines 87 335 730 1,288 1,806 2,176 First Renewal Period Development Period 7 8 9 10 11 (2016) (2017) (2018) (2019) (2020) Minimum 80 90 100 100 100 Aggregate Stores The Development Agreement has an initial term up to the 6th Development Period following the execution of the Agreement. The Agreement will be automatically renewed thereafter for another period of five years. On November 30, 2009 , pursuant to the original Agreement, Collective Brands and Footwear Specialty entered into a Technology Transfer Arrangement where Collective Brands granted Footwear Specialty a limited, nontransferable and non-assignable license to use the Intellectual Property in the Philippines. Intellectual Property means trademarks, service marks, copyrights, trade secrets, know-how, ideas and concepts belonging to Collective Brands or its affiliates. The following Marks are subject of the Arrangement: CcHDaA 1. 'American Eagle' 2. 'Airwalk' 3. 'Bogo' 4. 'Bundles' 5. 'City Sneaks' 6. 'Coasters' 7. 'Cross Trekkers' 8. 'Dyelights' 9. 'Fioni' 10. 'Fresh Green Fashion' 12. n 'Hunter's Bay' 13. 'I Sapatos' 14. 'I Shoes' 15. 'Ko Sapatos' 16. 'Lower East Side' 17. 'Minicci' 18. 'Montego Bay Club' 19. 'Payless Shoesource' 20. 'Plusheez' 21. 'Predictions' 22. 'Rugged Outback' 23. 'Safe T Step' 24. 'Smarfit' 25. 'Spotlights' 26. 'State Street' 27. 'Teeny Toes' 28. 'Unforgettable Moments' 29. 'Zoe and Zac' On June 1, 2010, Collective Brands and Footwear Specialty entered into a Supplemental Agreement to the Technology Transfer Arrangement for the purpose of inserting a provision on taxes in the Arrangement. The Technology Transfer Arrangement and its Supplemental Agreement comply with the provisions of the Intellectual Property Code on Voluntary Licensing under Certificate of Compliance No. 5-2010-00028 issued by the Intellectual Property Office on July 9, 2010, valid from November 30, 2009. Ruling In reply, please be informed that under Section 14 of Revenue Memorandum Order No. 72-2010 (Guidelines on the Processing of Tax Treaty Relief Applications (TTRA) Pursuant to Existing Philippine Tax Treaties) ("RMO 72-2010") , which covers income derived or which accrued on November 4, 2010 and thereafter, 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 before the first taxable event subject of the TTRA, to wit: "Section 14. When and Where to File the TTRA. All tax treaty relief applications (updated BIR Forms No. 0901-D, 0901-I, 0901-R, 0901-P, 0901-S, 0901-T, 0901-O and 0901-C) relative to the implementation and interpretation of the provisions of Philippine tax treaties shall only be submitted to and received by the International Tax Affairs Division (ITAD). If the forms or any necessary documents are submitted to any other BIR Office, the application shall be considered as improperly filed. Filing should always be made BEFORE the transaction. Transaction for purposes of filing the TTRA shall mean before the occurrence of the first taxable event . Failure to properly file the TTRA with ITAD within the period prescribed herein shall have the effect of disqualifying the TTRA under this RMO ." (Emphasis ours) Also, under Section III (2) of Revenue Memorandum Order No. 1-00 (Procedures for Processing Tax Treaty Relief Application) ("RMO 1-2000") , which covers income derived or which accrued before November 4, 2010 , any availment of relief shall be preceded by an application filed at ITAD at least 15 days before the intended transaction or payment of income, to wit: CSAaDE "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) In view of the foregoing, since the subject TTRA was filed on January 4, 2011 , and the original Agreement, the Development Agreement, and the Technology Transfer Arrangement that give rise to the payment of certain fees all took effect on November 30, 2009 , this Office hereby DENIES relief on fees paid by Footwear Specialty to Collective Brands on and before the filing of the TTRA on January 4, 2011 , pursuant to Section 14 of RMO 72-2010 and Section III (2) of RMO 1-2000. Accordingly, said fees shall be subject to income tax at the rate of 30 percent under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, to wit: "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 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: Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." On the other hand, fees paid on January 5, 2011 and thereafter, being royalties, are subject to relief under paragraph 2 (a) (iii), Article 13 of the Philippines-United States tax treaty, where they are subject to the lowest rate of income tax imposed on royalties of the same kind paid to a resident of a third State under similar circumstances ("most-favored-nation treatment") , to wit: "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 ." (Emphasis ours) In relation to the most-favored-nation treatment, 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) ("S.C. Johnson case") , required two conditions for this treatment to apply. First, royalties arising in the Philippines and paid to a resident of the United States must be of the same class as those derived in the Philippines by a resident of a third State to which the tax treaty between the Philippines and the third State subjects such royalties to a most-favored-nation treatment. Second, in eliminating or mitigating the effects of double taxation on royalties, the United States must allow to its resident the same amount of tax credit or deduction as that allowed by the third State to the latter's resident against the income tax due of that resident in the third State with respect to the royalties. Pertinent portion of this ruling reads: cSTHaE "The purpose of a most favored nation clause is to grant to the contracting party treatment not less favorable than that which has been or may be granted to the 'most favored' among other countries. The most favored nation clause is intended to establish the principle of equality of international treatment by providing that the citizens or subjects of the contracting nations may enjoy the privileges accorded by either party to those of the most favored nation. The essence of the principle is to allow the taxpayer in one state to avail of more liberal provisions granted in another tax treaty to which the country of residence of such taxpayer is also a party provided that the subject matter of taxation, in this case royalty income, is the same as that in the tax treaty under which the taxpayer is liable. Both Article 13 of the RP-US Tax Treaty and Article 12 (2) (b) of the RP-West Germany Tax Treaty, above-quoted, speaks of tax on royalties for the use of trademark, patent, and technology. The entitlement of the 10% rate by U.S. firms despite the absence of a matching credit (20% for royalties) would derogate from the design behind the most favored nation clause to grant equality of international treatment since the tax burden laid upon the income of the investor is not the same in the two countries. The similarity in the circumstances of payment of taxes is a condition for the enjoyment of most favored nation treatment precisely to underscore the need for equality of treatment . We accordingly agree with petitioner that since the RP-US Tax Treaty does not give a matching tax credit of 20 percent for the taxes paid to the Philippines on royalties as allowed under the RP-West Germany Tax Treaty, private respondent cannot be deemed entitled to the 10 percent rate granted under the latter treaty for the reason that there is no payment of taxes on royalties under similar circumstances ." (Emphasis ours) For this purpose, you cite the Philippines-China tax treaty. Under paragraph 2 (b), Article 12 thereof, royalties (except royalties for 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) arising in the Philippines and paid to a resident of China are subject to income tax at the rate of 10 percent, provided the contract giving rise to the royalties has been approved by the Philippine competent authorities, to wit: caIEAD "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 ." Concerning the first requirement, royalties for the use of the Payless ShoeSource System and the Marks, being essentially royalties for the use of trade mark, design, model or plan , are within the definition of royalties under the Royalties article of the Philippines-United States and the Philippines-China tax treaties, to wit: United States: "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." China: "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 cinematography films, or films or tapes for radio or television 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." cAHIST Concerning the second requirement, under the Relief from Double Taxation article of these treaties, income tax paid or withheld in the Philippines on royalties arising therein and paid to a resident of the United States and a resident of China is allowed as a tax credit or deduction against the income tax of these residents in their respective countries, to wit: United States: "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 . . ." China: "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." In view of the foregoing, and considering that the Technology Transfer Arrangement and its Supplemental Agreement are approved by the Intellectual Property Office, the Global Marketing Contribution Fee, the Initial Store Design Fee, the Subsequent Store Design Fee and the Subsequent Store Review Fee paid by Footwear Specialty to Collective Brands on January 5, 2011 and thereafter shall be subject to income tax at the rate of 10 percent, pursuant to paragraph 2 (a) (iii), Article 13 of the Philippines-United States tax treaty, in relation to paragraph 2, Article 12 (b) of the Philippines-China tax treaty. Finally, under Section 108 (A) of the Tax Code, the fees in question, being payments for the use of intangible properties (trade mark, design, model or plan) in the Philippines, are subject to value-added tax ("VAT"), to wit: aEHADT "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, 1 raise the rate of value-added tax to twelve percent (12%) . . ." Accordingly, Footwear Specialty shall withhold VAT on these fees at the rate of 12 percent before remitting them to Collective Brands. Footwear Specialty shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). If it is a VAT-registered taxpayer, the duly filed BIR Form No. 1600 and its accompanying proof of payment shall serve as documentary substantiation for Footwear Specialty 's claim of input tax on the fees. Otherwise, Footwear Specialty may treat such VAT as an asset or expense, whichever is applicable. VAT withheld shall be remitted within ten days following the end of the month the withholding was made. 2 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 percent 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. 2. Pursuant to Section 4.112-2 of Revenue Regulations No. 16-2005 (Consolidated Value-Added Tax Regulations of 2005) , as amended by Revenue Regulations No. 4-2007 (Amending Certain Provisions of Revenue Regulations No. 16-2005, As Amended, Otherwise Known as the Consolidated Value-Added Tax Regulations of 2005) , which provides: "SEC. 4.114-2. Withholding of VAT on Government Money Payments and Payments to Non-Residents. xxx xxx xxx (b) The government or any of its political subdivisions, instrumentalities or agencies including GOCCs, as well as private corporations, individuals, estates and trusts, whether large or non-large taxpayers, shall withhold twelve percent (12%) VAT, starting February 1, 2006, with respect to the following payments: (1) Lease or use of properties or property rights owned by non-residents; and (2) Services rendered to local insurance companies with respect to reinsurance premiums payable to non-residents; and (3) Other services rendered in the Philippines by non-residents. In remitting VAT withheld, the withholding agent shall use BIR Form No. 1600 Remittance Return of VAT and Other Percentage Taxes Withheld. VAT withheld and paid for the non-resident recipient (remitted using BIR Form No. 1600), which VAT is passed on to the resident withholding agent by the non-resident recipient of the income, may be claimed as input tax by said VAT-registered withholding agent upon filing his own VAT Return, subject to the rule on allocation of input tax among taxable sales, zero-rated sales and exempt sales. The duly filed BIR Form No. 1600 is the proof or documentary substantiation for the claimed input tax or input VAT. Nonetheless, if the resident withholding agent is a non-VAT taxpayer, said passed-on VAT by the non-resident recipient of the income, evidenced by the duly filed BIR Form No. 1600, shall form part of the cost of purchased services, which may be treated either as an 'asset' or 'expense', whichever is applicable, of the resident withholding agent. VAT withheld under this Section shall be remitted within ten (10) days following the end of the month the withholding was made." n Note from the Publisher: Copied verbatim from the official copy. Missing Item No. "11".