ITAD BIR Ruling No. 230-11

September 26, 2011 ITAD BIR RULING NO. 230-11 Article 12, Philippines-Korea tax treaty; BIR Ruling No. 131-97; BIR Ruling No. DA-ITAD 75-02 Follosco Morallos & Herce Attorneys-At-Law Suite 2500, 25th Floor, 88 Corporate Center 141 Valero Street corner Sedeo Street Salcedo Village, Makati City Attention: Atty. Rachel P. Follosco Atty. Lovely E. Lim Gentlemen : This refers to your letter dated October 27, 2009 requesting confirmation that royalties paid by MYGAME.PH, INC. ("MYGAME.PH") 1 to DRAGONFLY GF COMPANY LTD. ("DRAGONFLY") are subject to income tax at a preferential rate of 15 percent pursuant to Article 12 of the Convention between the Republic of the Philippines and the Republic of Korea for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Korea tax treaty") . HCISED It is represented that DRAGONFLY is a corporation organized and existing under the laws of Korea as evidenced by its Articles of Incorporation and the Certificate of Business Registration issued by the Gangnam District Tax Office in Korea on May 26, 2006; that DRAGONFLY is situated at Dragonfly Building, 30-10 Nonhyundong, Gangnam-gu, Seoul, Korea; that DRAGONFLY is not registered as a corporation or as partnership in the Philippines based on the Certification of Non-Registration issued by the Securities and Exchange Commission on March 23, 2009; that DRAGONFLY is engaged in the manufacture and sale of computer software; development, and export and import of game software; distribution and sale of game software; network construction; homepage production; construction and processing of databases; development and sale of CD-ROM titles, data processing; Internet-related business; production and distribution of digital contents; entertainment-related business; distribution of contents copyright; mail-order business; investment in other companies engaged in the foregoing activities; and any activities incidental thereto; that, on the other hand, MYGAME.PH is a domestic corporation located at 1601 Taipan Place, F. Ortigas Jr. Road, Ortigas Center, Pasig City, Philippines; and that MYGAME.PH is engaged in recreation, games and amusement center, online gaming, computer games, video games, play stations, and other related recreational activities. It is further represented that on October 5, 2007, DRAGONFLY and MYGAME.PH (under its original name, MICROGAMING TECHNOLOGY CORPORATION) entered into an Exclusive Special Force License and Distribution Agreement where DRAGONFLY grants MYGAME.PH an exclusive, royalty-bearing and non-transferable license for service, use, promotion, distribution and marketing of the Game to End Users and to use the Technical Information for such purpose within the Philippines; that Game means the first person shooting game known as "Special Force", including, but not limited to, any patched version of the Game distributed by DRAGONFLY for, but not limited to, error correcting, updating or debugging purpose, under and only the same title; that any series or sequel to the Game other than the Philippines Version contemplated by the Agreement, which may be developed or distributed by DRAGONFLY after the execution of the Agreement, shall be clearly excluded from the scope of the Agreement; that End Users means the users of the Game through network game service system established and operated by MYGAME.PH with individually assigned ID numbers for each End User; that Technical Information means the software, know-how, data, test result, layouts, artwork, processes, scripts, concepts and other technical information on or in relation to the Game and the installation, operation, maintenance, service and use thereof; that DRAGONFLY also grants MYGAME.PH the right and license to use the Trademarks in connection with the service, use, promotion, distribution and marketing of the Game in the Philippines; that Trademarks means the trademarks, trade names, identifying marks or characteristics or other equivalent belonging to the Licensor or to the Licensee that is used on or in connection with the Game or associated manuals, promotional or sales brochures or other materials, whether registered or unregistered; that the service, use, promotion, distribution and marketing of the Game shall be made only in English language using the Philippines Version in the Philippines; that MYGAME.PH shall exert its best efforts to advertise, promote and market the Game in the Philippines; that in consideration, MYGAME.PH will pay royalties to DRAGONFLY under the following conditions: (i) The royalties are equivalent to 22 percent of the Gross Revenue beginning in the month of the commercial operation of the Game. Gross Revenue means gross sales generated by any and all methods incurred by the Game including but not limited to on-line and off-line sales, with only allowable deduction for value added taxes, but above figures does not include reduction for Channel Cost. Channel Cost means the amounts paid in connection with the distribution channels used for the Game by MYGAME.PH, specifically including, but not limited to, the Wholesalers. Wholesalers means those persons or entities, including, without limitation, PC game room operators, computer shops and convenience stores, who sell ID numbers or prepaid cards for the Game to End Users. (ii) The royalties will be paid every month. MYGAME.PH shall provide DRAGONFLY with a report each month, which shall be in a form and substance acceptable to DRAGONFLY and shall contain detailed information of the calculation of the Gross Revenue for the month concerned. (iii) MYGAME.PH shall deduct any amount of refund from royalties to be paid in the following month for royalties paid in excess of the current month. That the royalties shall be made in United States Dollars by wire transfer to the account designated by DRAGONFLY or in accordance with other method as may be mutually agreed between the parties; and that the Agreement shall become effective on October 5, 2007, and shall remain in effect for three years from the month of the commercial operations of the Game, unless terminated. aETDIc It is finally represented that the royalties subject of this ruling are not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Certification issued by the Corporate Secretary of MYGAME.PH on November 4, 2009. A. On Income tax In reply, please be informed that the royalties paid to DRAGONFLY, a foreign corporation not engaged in trade or business in the Philippines, are subject to income tax at the rate of 35 percent before January 1, 2009 and 30 percent beginning January 1, 2009. Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, 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 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): 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 provides that the royalties may be exempt or subject to a reduced rate of income tax to the extent required by any treaty obligation on the Philippines, viz. : "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, you invoke the Philippines-Korea tax treaty. Paragraphs 1, 2, 3 and 4, Article 12 thereof provide: "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. However, such royalties may 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 15 per cent of the gross amount of the royalties. TCIDSa 3. Notwithstanding the provisions of paragraph 2 hereof, the amount of tax imposed by the Philippines on the royalties paid by a company, being a resident of the Philippines, registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines to a resident of Korea, who is the beneficial owner of the royalties, shall not exceed 10 per cent of the gross amount of the royalties. 4. The term 'royalties' as used in this Article means payments of any kind received as a consideration for the use of, or right to use, any copyright of literary, artistic or scientific work, any 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, and includes payments of any kind in respect of motion picture films and works on films or videotapes for use in connection with television or tapes for the use of radio broadcasting. xxx xxx xxx" Based on the above-cited provisions, royalties arising in the Philippines and derived by a resident of Korea may be taxed in the Philippines at a rate not exceeding (a) 10 percent of the gross amount of the royalties if paid by a corporation registered with the Board of Investments (BOI) and engaged in preferred areas of activities; and (b) 15 percent of the gross amount of the royalties and in all other cases. This being the case, considering that MYGAME.PH is not a BOI registered entity, this Office is of the opinion and so holds that royalties paid by MYGAME to DRAGONFLY, beginning October 27, 2009 until October 5, 2010, unless terminated earlier, pursuant to the Agreement for the use in the Philippines of the Technical Information and the Trademarks, shall be subject to income tax at the rate of 15 percent of the gross amount thereof. (BIR Ruling No. 131-97 dated December 11, 1997; BIR Ruling No. DA-ITAD 75-02 dated May 2, 2002) B. On Value-added tax Finally, the royalties payable to DRAGONFLY are subject to value-added tax ("VAT") under Section 108 (A) of the Tax Code, as amended, thus: "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: EHaCID (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%). . . . The phrase 'sale or exchange of services shall likewise include : (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" 2 With regard to the procedures for the withholding and payment of VAT, MYGAME.PH shall withhold VAT on the royalties at the rate of 12 percent before remitting them to DRAGONFLY. In remitting to the Bureau of Internal Revenue the VAT withheld, MYGAME.PH shall use BIR Form No. 1600 (Monthly Remittance Return of VAT and Other Percentage Taxes Withheld). In addition, MYGAME.PH is required to issue in quadruplicate the Certificate of Final Tax Withheld at Source (BIR Form No. 2306), the first three copies for DRAGONFLY and the fourth copy for MYGAME.PH as its file copy. 3 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. Originally, Microgaming Technology Corporation, then MyGame1, Inc . 2. 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. 3. Pursuant to Revenue Regulations No. 16-2005 (Consolidated Value-Added Tax Regulations of 2005), as amended.