ITAD BIR Ruling No. 232-12

June 5, 2012 ITAD BIR RULING NO. 232-12 Article 13 (2) (b) (iii), Philippines-US Tax Treaty; Article 12, Philippines-China Tax Treaty; BIR Ruling No. ITAD-078-11; BIR Ruling No. ITAD-127-06 Isla Lipana & Co. 29th Floor, Philamlife Tower 8767 Paseo de Roxas 1226 Makati City Attention: Mary Assumption Bautista-Villareal Principal, Tax Services Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on May 28, 2010, on behalf of Mead Johnson & Company ("MJ-US") , requesting confirmation that its royalty income from Mead Johnson Nutrition (Philippines), Inc. ("MJ-PH") is subject to the preferential tax rate of 10 percent pursuant to Article 13 of 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-US 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") . It is represented that MJ-US, with address at 2400 W. Lloyd Expressway, Evansville, IN 47721-0001, United States of America (US), is a foreign corporation organized and existing under the laws of the US and is a resident thereof for tax purposes as evidenced by a certification issued by the Department of the Treasury, Internal Revenue Service, Philadelphia dated March 10, 2008; that MJ-US 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 February 2, 2010; and that MJ-PH, on the other hand, is a domestic corporation organized and existing under the laws of the Philippines, with office address at 2390 Don Chino Roces Avenue, Makati City. HCEcAa It is further represented that on July 1, 2009, a Trademark License Agreement ("TLA") was entered into by and between MJ-US and MJ-PH whereby MJ-US grants MJ-PH the exclusive, non-transferable, non-assignable right to use 1 the Trademarks on all the products and services covered by the trademarks listed in Exhibit A 2 of the TLA; that in consideration for the grant of the license, MJ-PH shall pay MJ-US royalty of five percent (5%) calculated as a percentage of the Net Sales 3 of each product; and that the initial term of the TLA shall be three (3) years from the Effective Date 4 thereof and shall automatically continue thereafter on a year-to-year basis unless terminated by either party thirty (30) days prior written notice to the other. It is also represented, based on Certificate of Compliance No. 5-2009-00072 issued by the Philippines' Intellectual Property Office (IPO) on July 1, 2009, that the Trademark Agreement between MJ-PH and MJ-US complies with the provisions of Sections 87 and 88 of Chapter IX, Part II of the Intellectual Property Code (Republic Act No. 8293) on Voluntary Licensing which is valid for three years (3) from July 1, 2009 to June 30, 2012. Finally, it is represented that the issue or transaction subject of the above application 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 as evidenced by the Sworn Statement issued MJ-PH on June 19, 2009. 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 . . ." (Underscoring ours) HCDAac 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." (Underscoring 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. 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) . IDEScC In view of the foregoing, this Office hereby DENIES relief on the royalties paid by MJ-PH to MJ-US before June 12, 2010 , which is 15 days after the subject TTRA was filed on May 28, 2010 as prescribed under RMO 1-2000. Accordingly, said royalties shall be subject to income tax at the rate provided under Sections 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 . . . . (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%)." (Underscoring supplied) However, all royalties paid after 15 days from the date of the filing of the TTRA on May 28, 2010 are hereby GRANTED relief and the same shall be subject to income tax at a reduced rate of 10 percent of the gross amount thereof, pursuant to Article 13 of the Philippines-US tax treaty in relation to the Philippines-China tax treaty. It provides: "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, TAHcCI (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, xxx xxx xxx" Pursuant to Article 13 (2) (b) (iii) of the Philippines-US tax treaty, the tax imposed on royalties derived by a resident of the United States from sources within the Philippines shall be 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. In this light, Article 12 (Royalties) of the Philippines-China 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 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 ScTaEA 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. 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. xxx xxx xxx" In the case of Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc. and Court of Appeals, G.R. No. 127105, promulgated on June 25, 1999 , the Supreme Court interpreted the "most-favored-nation" clause, particularly the phrase "paid under similar circumstances", as referring to the manner of payment of taxes and not to the subject matter of the tax which is royalties. (BIR Ruling No. 101-03 dated 24 July 2003) In this regard, Article 23 of the Philippines-US tax treaty provides, viz. : "Article 23 RELIEF FROM DOUBLE TAXATION Double taxation of income shall be avoided in the following manner: DcIHSa 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" On the other hand, Article 23 of the Philippines-China tax treaty provides, viz. : "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." DaECST Article 23 of the Philippine tax treaties with the US and China both reveal a similarity in the provision on relief from or avoidance of double taxation to their respective residents. Thus, the tax on royalty payments to residents of the US and China is paid under similar circumstances, i.e. , the amount of royalty income tax paid or accrued to the Philippines under the respective tax treaties is available as tax credit against the income payable in their respective countries. It bears stressing, however, that another important requirement that should be complied with before 10 percent rate of withholding tax on royalties remitted to a resident of the US and China may be availed of is the approval by the proper Philippine competent authority of the contracts which give rise to the royalties. In this regard, the valid Certificate of Compliance of the subject TLA issued by the IPO, in accordance with law, is hereby construed as an approval by the proper Philippine competent authority of the contract. Moreover, as provided in Section 108 of the Tax Code of 1997, as amended, the said royalty payments are subject to value-added tax (VAT), 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%) 5 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 VAT, pursuant to Sections 4 and 6 of Revenue Regulations (RR) No. 4-2002, Section 3 or RR No. 8-2002, Section 7 of RR No. 14-2002 and Section 4.114-2 of RR No. 16-05, as amended by RR No. 04-07 MJ-PH shall be responsible for the withholding of VAT on the royalty fee before remitting it to MJ-US. In remitting to the Bureau of Internal Revenue the VAT withheld, MJ-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, MJ-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, MJ-PH may include as part of the cost of the royalty fees to it by MJ-US the VAT consequently shifted or passed on to it. In addition, MJ-PH is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies for MJ-US and the fourth copy for MJ-PH as its file copy. DHITSc 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. "Use" of the Trademark will be understood as the use, manufacture, distribution or sale of the Products in the Territory by MJ-PH on the terms and conditions set forth in the TLA. 2. "Exhibit A" Products/Trademarks Mead Johnson, Mead Johnson Nutrition ; The entire family of brands and brand extensions in all forms, including but not limited to Enfamil, Enfamil LIPIL, Enfamil NEXT STEP LIPIL, Enfamil Premium, Enfalac A+, Enfapro Premium, Enfamil Gentrease, Enfamil ProSobee, Enfamil LactoFree, Enfamil A.R., Enfamil HA, Enfamil Premature, Enfacare, Enfacare A+, Enfagrow, Enfapro, Enfapro A+; Nutramigen, Nutramigen LIPIL, Nutramigen AA, Nutramigen A+, Pregestimil, Pregestimil A+; Tempra; Alacta, Alactamil, Alactagrow; Lactum 1+, Lactum 3+, Lactum 6+; Sustagen Jr., Sustagen School, Sustagen Kid, Sustagen Premium; Polyvisol, Polyviflor . 3. "Net Sales" shall mean the proceeds actually derived from the sale of a Product by MJ-PH to a third party, less normal and customary cash and trade discounts, transportation charges, returns and allowances, value-added taxes not ultimately recovered by MJ-PH and agent's commissions, if any, paid or allowed by MJ-PH directly in connection with the sales of the Products. 4. "Effective date" is July 1, 2009. 5. 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.