ITAD BIR Ruling No. 234-15

July 27, 2015 ITAD BIR RULING NO. 234-15 Article 12, Philippines-Korea tax treaty Tantoco Villanueva De Guzman & Llamas Law Offices 4th & 6th Floors, Filipino Building 135 Dela Rosa Street, Legaspi Village Makati City Attention: Atty. Cristina M. F. Villanueva Atty. Michael Dennis D. Rayala Gentlemen : This refers to your tax treaty relief application filed on April 4, 2012, on behalf of ZEPETTO, CO. ("Zepetto"), requesting confirmation that the royalty payments by LEVEL UP! INC. ("Level Up") to Zepetto are subject to a preferential tax rate of 10 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"). SDHTEC It is represented that Zepetto is a corporation organized and existing under the laws of Korea and is a resident of Korea based on the Certificate of Residence issued by the Mapo District Tax Office of the National Tax Service dated May 4, 2012; that Zepetto 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 April 12, 2012; that it is engaged in development, manufacture and sales of game software and hardware; that, on the other hand, Level Up is a domestic corporation duly organized and existing under Philippine laws; and that Level Up is duly registered with the Board of Investments (BOI) as pioneer new IT service firm in the field of an application service provider. It is further represented that on April 1, 2012, Zepetto, IP E-Game Ventures, Inc. and Level Up entered into a Novation Agreement wherein Zepetto, as the Licensor under the April 1, 2011 Software Development and License Agreement (License Agreement) it had with IP E-Game, the Licensee, consented to the assignment of the License Agreement to Level Up as the "new Licensee"; that under the novated Licensed Agreement, Zepetto grants to Level Up the exclusive rights to market and distribute the online game, POINT BLANK, to end users and the use of technical information for such purposes in the Philippines including the right and license to use the trademarks and intellectual property in connection with the license; that in consideration of the license and other right granted, Level Up shall make payments of License Fees to Zepetto, as follows: a) First Initial Payment One Hundred Thousand Dollars (US$100,000); b) Second Initial Payment Fifty Thousand Dollars (US$50,000.00) start of Open Beta Test; c) Third Initial Payment Fifty Thousand Dollars (US$50,000.00) start of the Commercial Service; d) Incentive Payment One Hundred Thousand Dollars (US$100,000) payable when the number of peak concurrent users of the Game reaches ten-thousand (10,000); e) Monthly Royalty Twenty-seven percent (27%) of gross revenue upon commencement of commercial services continuing for the term of the agreement; AScHCD f) Advertising Payments 1 30% of the Net of the Advertising Revenue. It is finally represented, based on the Sworn Statement by Level Up on April 2, 2012, that the transaction subject of the request for ruling is not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal of the taxpayer/s involved; and, that per the Sworn Certification dated May 3, 2012 issued by Level Up, no payment of royalties have been paid yet to Zepetto as of April 4, 2012. In reply, please be informed that royalties derived in the Philippines by a nonresident foreign corporation are, in general, covered by Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended. 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 . . .: 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 that: "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: AcICHD 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-Korea tax treaty which you invoked may apply to the herein case. It provides: "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. 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. TAIaHE 5. The provisions of paragraphs 1, 2 and 3 shall not apply if the beneficial owner of the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties arise, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the right or property in respect of which the royalties are paid is effectively connected with such permanent establishment or fixed base. In such a case, the provisions of Article 7 (Business Profits) or Article 14 (Independent Personal Services), as the case may be, shall apply. xxx xxx xxx" Based on the foregoing, royalty payments to a resident of Korea arising in the Philippines may be taxed at the preferential tax rate of either (i) 15 percent of the gross amount of the royalties; or (2) 10 percent of the gross amount of the royalties if the royalties are 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. Such being the case, since Zepetto is a resident of Korea and Level Up is BOI-registered enterprise engaged in preferred pioneer areas of investment, this Office is of the opinion and so holds that the royalty payments by Level UP to Zepetto under the said Agreement shall be subject to 10 percent of the gross amount of the royalties, pursuant to Article 12 (3) of the Philippines-Korea tax treaty. 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): "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 (12%) 2 of gross receipts derived from the sale or exchange of services, including the use or lease of properties. cDHAES 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, Level Up shall be responsible for the withholding of VAT on the royalties before remitting them to Zepetto. In remitting to the Bureau of Internal Revenue the VAT withheld, Level Up shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld). If it is a VAT-registered taxpayer, Level Up 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, Level Up may include as part of the cost of the royalty fees to it by Zepetto the VAT consequently shifted or passed on to it. In addition, Level Up is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies for Zepetto and the fourth copy for Level Up 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. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. "Advertising Revenue" means any revenue actually collected from advertisers with respect to advertisements included inside the play area of the Game (including product placement, loading and log-in/log-out pages) in the Territory, but shall not include revenue arising from advertisements posted on web pages for the Games but outside the play area for the Game. Advertising Revenue shall not include any fees paid to third party agents in connection with such advertising business, discounts, etc. payable to the third parties as well as any and all relevant taxes. 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.