ITAD BIR Ruling No. 205-12

May 24, 2012 ITAD BIR RULING NO. 205-12 Article 12 (Royalties) and 24 (Elimination of Double Taxation) Philippines-Norway tax treaty Punongbayan and Araullo Certified Public Accountants 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue Makati City Attention: Fulvio D. Dawilan Tax Partner Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on May 29, 2007 requesting confirmation that royalties paid by Norwegian Training Center-Manila of the Norwegian Maritime Foundation of the Philippines ("Norwegian Training") to Ship Manoeuvering Simulator Center AS ("Ship Maneuvering") and Frank Mohn Services A/S ("Frank Mohn") are exempt from income tax pursuant to the Convention between the Republic of the Philippines and the Kingdom of Norway for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital ("Philippines-Norway tax treaty") . Facts Ship Maneuvering and Frank Mohn are corporations organized and existing under the laws of Norway based on their Certificates of Registration issued by the Bronnoysund Register Centre in Norway on November 24, 2006 and July 17, 2006, respectively. Ship Maneuvering is located at Ladehammerveien 4, 7041, Trondheim, Norway. Frank Mohn is located at Hardangerveien 150, Slotthaug, N 5851 Bergen, Norway. Both are not registered as corporations or partnerships in the Philippines based on the Certificates of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission on May 11 and 10, 2007, respectively. On the other hand, Norwegian Training is a domestic corporation situated at NTC-M Building, TESDA Complex, East Service Road, Taguig City, Philippines. Norwegian Training was organized to establish, sponsor, support and maintain non-degree, special or continuing courses to upgrade the knowledge, qualification, and training of Filipino seafarers working on board Norwegian-owned, controlled, managed or operated vessels in coordination with maritime institutions and enterprises in the Philippines and abroad, which in effect will assist in the transfer of advanced maritime technological and scientific knowledge to qualified Filipino citizens and institutions. On January 2, 2006, Norwegian Training and Ship Maneuvering entered into a Service Agreement where Ship Maneuvering agreed to conduct the following courses at Norwegian Training 's premises in Manila: 1. Ship Maneuvering Simulator Courses (5 days) 2. Dynamic Positioning Simulator Courses (5 days) 3. Offshore Crane Simulator Courses (10 days) TAaHIE 4. LNG/LPG Cargo Handling Courses (5 days) Ship Maneuvering will provide the professional content of the courses and master training manual programs, drawings, overheads, CBT's video programs; update of course materials; training of instructors; upgrading of training equipment and software; and new equipment and software as necessary. In consideration, Norwegian Training will pay Ship Maneuvering an annual service fee of US$130,000.00 plus 50 percent of the net revenue generated from the use of the above-mentioned Simulators software, to be paid quarterly. The Agreement took effect on January 2, 2006 and is in effect indefinitely. On January 2, 2006, Norwegian Training and Frank Mohn entered into a Memorandum of Agreement where Frank Mohn agreed to conduct the following courses at Norwegian Training 's premises in Manila: 1. Frank Mohn II Special Course 2. Frank Mohn III Advanced Course (10 days) 3. Frank Mohn IV Advanced Course (5 days) 4. Frank Mohn V Advanced Course (5 days) Frank Mohn will provide the professional content of the courses and master training manual programs, drawings, overheads, CBT's video programs; update of course materials; training of instructors; upgrading of training equipment; and new equipment as necessary. In consideration, Norwegian Training will pay Frank Mohn an annual service fee of 40 percent of gross revenue generated from administering the above courses to which a course fee will be charged by Norwegian Training as follows: 1. Frank Mohn II Course: Member US$550.00, Non-Member US$610.00. 2. Frank Mohn III Course: Member US$550.00, Non-Member US$610.00. 3. Frank Mohn IV Course: Member US$295.00, Non-Member US$320.00. 4. Frank Mohn V Course: Member US$275.00, Non-Member US$320.00. The service fee will be paid semi-annually. The Memorandum took effect on January 2, 2006 and is in effect indefinitely. Norwegian Training will market and administer the above-mentioned courses in the Philippines. Ruling 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 fifteen days before the intended transaction or payment of income, to wit: "III. Policies: In order to achieve the above-mentioned objectives, the following policies shall be observed: ATcaEH 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) 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 upheld by the Supreme Court in a Resolution (G.R. No. 168531) dated February 18, 2008. Furthermore, the necessary requirement 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. Case No. EB 456 dated May 29, 2009), CBK Power Company Ltd. vs. Commissioner of Internal Revenue (C.T.A. Case Nos. 6699, 6844 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). In view of the foregoing, since the subject TTRA was filed on May 29, 2007, and the Service Agreement and the Memorandum of Agreement which permit Norwegian Training to administer the subject maritime courses in the Philippines were in effect on January 2, 2006, this Office hereby DENIES relief on service fees paid by Norwegian Training to Ship Maneuvering and Frank Mohn before the fifteenth day of filing the TTRA, or on June 13, 2007, in accordance with Section III (2) of RMO 1-2000. Accordingly, said fees shall be subject to income tax at the rate of 35 percent under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, to wit: SATDHE "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, the service fees Office paid on June 13, 2007 and thereafter are subject to relief under paragraphs 1 and 2 of Article 12 of the Philippines-Norway tax treaty, to wit: "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 if such resident is the beneficial owner of the royalties. 2. Such royalties may also be taxed in the Contracting State in which they arise, and according to the law of that State. However, when the royalties are taxable in the other Contracting State, the tax so charged shall not exceed: a) in Norway, 10 per cent of the gross amount of the royalties including rentals or the rates referred to in subparagraph 2(b)(ii) below, and b) in the Philippines, (i) 25 per cent of the gross amount of the royalties, including 25 per cent of the gross rentals or amount paid for the use of, or the right to use, motion picture films, films or tapes for radio or television broadcasting; (ii) 7.5 per cent of the gross rentals or amount paid for the use of or the right to use containers, or (iii) the lowest rate of the Philippine tax that may be imposed on royalties of the same kind paid in similar circumstances to a resident of a third State. " Accordingly, the service fees, as royalties, are subject to the lowest rate of income tax that may be imposed on royalties of the same kind arising in the Philippines and paid in similar circumstances to a resident of a third State ("most-favored-nation treatment") . Since the maritime courses developed by and belonging to Ship Manoeuvering and Frank Mohn are copyrighted works, the fact that Norwegian Training has the right to administer these courses to the public makes Norwegian Training to be exercising the right to communicate these works to the public, being a copyright or economic right protected under Section 177.6 of the Intellectual Property Code, to wit: EcASIC "177. Copyright or Economic Rights. Subject to the provisions of Chapter VIII, copyright or economic rights shall consist of the exclusive right to carry out, authorise or prevent the following acts: 177.1. Reproduction of the work or substantial portion of the work; 177.2. Dramatization, translation, adaptation, abridgment, arrangement or other transformation of the work; 177.3. The first public distribution of the original and each copy of the work by sale or other forms of transfer of ownership; 177.4. Rental of the original or a copy of an audiovisual or cinematographic work, a work embodied in a sound recording, a computer program, a compilation of data and other materials or a musical work in graphic form, irrespective of the ownership of the original or the copy which is the subject of the rental; 177.5. Public display of the original or a copy of the work; and 177.6. Other communication to the public of the work. " (Emphasis ours) Relative thereto, under paragraph 4, Article 12 of the treaty, payments for the use of, or the right to use, a copyright constitute royalties, to wit: "4. 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, 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." (Emphasis ours) Concerning the application of a most-favored-nation treatment on 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) ("S.C. Johnson case"), required two conditions for such treatment to apply. First, royalties arising in the Philippines and paid to a resident of the second State (in this case, Norway) 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 the royalties, the second State 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: "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 . aSIAHC 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 German 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, there is 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") effective January 1, 2004. Under paragraph 2 (b), Article 12 thereof, royalties (except royalties for the use of, or the right to use, any copyright of cinematograph films, and films or tapes for television or radio broadcasting) arising in the Philippines and paid to a resident of Czech are subject to income tax at the rate of 10 percent, to wit: "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." Concerning the first requirement, under the article on Royalties of the Philippines-Norway and the Philippines-Czech tax treaties, copyright is among those intangible properties where payments for the use of, or the right to use, thereof give rise to royalties. Concerning the second requirement, under the article on Relief from Double Taxation of these treaties, income tax paid or withheld in the Philippines on royalties arising therein and paid to a resident of Norway and a resident of Czech are allowed as tax credit or deduction against the income tax of these residents in these countries, to wit: "Article 24 ELIMINATION OF DOUBLE TAXATION In Norway: xxx xxx xxx 2. Where a resident of Norway derives items of income which, in accordance with the provisions of Articles 8, 10, 11, 12, 16 and 22 may be taxed in the Philippines. Norway shall allow as a deduction from the tax on the income of that person an amount equal to the tax paid in the Philippines. Such deductions shall not, however, exceed that part of the tax, as computed before the deduction is given, which is attributable to such items of income derived from the Philippines." "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: aSDCIE 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." Accordingly, the service fees paid by Norwegian Training to Ship Manoeuvering and Frank Mohn under the Agreement and the Memorandum and made on June 13, 2007 and thereafter shall be subject to income tax at the rate of 10 percent, pursuant to paragraph 2 (b) (iii), Article 12 of the Philippines-Norway tax treaty, in relation to paragraph 2, Article 24 of that treaty, and paragraph 2 (b), Article 12, and paragraph 2, Article 22 of the Philippines-Czech tax treaty. Finally, under Section 108 (A) of the Tax Code, the fees in question, being payments for the lease of intangible property (copyright) in the Philippines, are subject to value-added tax ("VAT"), to wit: "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, 1 raise the rate of value-added tax to twelve percent (12%). . ." Relative thereto, Norwegian Training shall withhold VAT on the service fees at the rate of 12 percent before remitting them to Ship Manoeuvering and Frank Mohn. Norwegian Training shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form and its accompanying proof of payment shall serve as documentary substantiation for Norwegian Training 's claim of input tax on the fees. Otherwise, if Norwegian Training is not a VAT-registered taxpayer, it may treat such VAT as an asset or expense, whichever is applicable. VAT withheld shall be remitted within 10 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. ADcEST Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. The VAT rate was increased to 12 percent beginning 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."