ITAD BIR Ruling No. 237-15

July 27, 2015 ITAD BIR RULING NO. 237-15 Article 12 and Article 7 in relation to Article 5, Philippines-Singapore Tax Treaty Calalang Law Office Unit 1401, 14th Floor Espaa Tower Espaa, Manila Attention: Atty. Ciriaco S. Calalang Gentlemen : This refers to your tax treaty relief application filed on September 28, 2011 requesting confirmation that: (1) royalty fees paid by NORTH WING FUSION FOOD, INC. ("North Wing") to THAI EXPRESS CONCEPTS PTE. LTD. ("Thai Express") are subject to preferential tax rate of 25 percent pursuant to Article 12 (2) (c) of the Convention between the Republic of the Philippines and the Republic of Singapore for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Singapore tax treaty"); (2) and the service fees paid by Thai Express to Thai Express are in the nature of business profits and are therefore exempt from Philippine income tax pursuant to Article 7, in relation to Article 5, of the same tax treaty. HTcADC Facts It is represented that Thai Express is a corporation organized and existing under the laws of Singapore and is a resident thereof based on the Certificate of Residence issued by the Inland Revenue Authority of Singapore on January 3, 2012; that Thai Express is located at 2 Alexandra Road #05-04/05 Delta House Singapore 159919; that Thai Express is not registered as corporation or partnership in the Philippines based on the Certificate of Non-Registration of Company issued by the Securities and Exchange Commission on October 19, 2011; and that North Wing is a domestic corporation situated at 21 A. Roces Avenue, Paligsahan, Quezon City, Philippines primarily engage in operating restaurants, acquiring and holding franchise for sub-franchising and managing restaurants. It is further represented that on September 27, 2011, Thai Express and North Wing entered into a Master Franchise Development Agreement ("Agreement"); that Thai Express is the owner of the trade name and trademark "Xin Wang Hong Kong Cafe" and certain related trade names, trademarks, service marks, logotypes, insignias and designs; that Thai Express granted North Wing limited and qualified right, on an equity-owned and/or on a sub-franchise basis, to develop Restaurants in the Philippines subject to the compliance of the terms under the Agreement; that the Agreement shall have an initial term of ten (10) years commencing on September 27, 2011 and ending on the date falling ten years thereafter; that in consideration thereof, North Wing agrees to pay Thai Express the following fees: 1) Royalty fee on the franchise fee of US$3,375 for each Restaurant opened during the first five (5) years of the Agreement for the use of trademarks, proprietary marks and the System; 2) Market Launch Fee for the marketing service provisions including the set-up provisions for the launching of the restaurant, management systems and procedures, back office process service operation, provision of trainings and instructions to the management staff and kitchen staff, and technical assistance in market launching of the restaurants; 3) Store Opening Fee for the technical assistance in selecting location for opening restaurant; and 4) Advertising Expenditure for the service provision in taking in-charge over the advertising requirements ( i.e. , yellow page advertising requirements, minimum advertising weight by market) and the grand opening campaign in the market. aScITE It is finally represented that the fees subject of the application 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 Managing Director of North Wing on November 12, 2011. Ruling In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code ("Tax Code") of 1997, as amended, provides that the fees paid to Thai Express , being a foreign corporation not engaged in trade or business in the Philippines, are subject to income tax in the Philippines at the rate of 30 percent, thus: "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) and (d): n Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). HEITAD xxx xxx xxx" However, under Section 32 (B) (5) of the Code, such fees may be exempt from income tax or subject to a reduced rate to the extent required by any treaty obligation on the Philippines, thus: "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" You invoke relief under the Philippines-Singapore tax treaty. Inasmuch as the contract giving rise to the payments is a franchise agreement, which in nature is a mixed contract, the relevant provisions of the Philippines-Singapore tax treaty are found in Article 12 (Royalties) and Article 7 (Business Profits), in relation to Article 5 (Permanent Establishment). Paragraph (2) (b) of Article 12 of the treaty states: ATICcS "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 law of that State, but, if the recipient is the beneficial owner of the royalties, the tax so charged shall not exceed: a) in the case of the Philippines, 15 per cent of the gross amount of the royalties, where the royalties are paid by an enterprise registered with the Philippine Board of Investments and engaged in preferred areas of activities and also royalties in respect of cinematographic films or tapes for television or broadcasting; b) in the case of Singapore, where the royalties are approved under the Economic Expansion Incentives (Relief from Income Tax) Act of Singapore, the royalties shall be exempt; c) in all other cases, 25 per cent of the gross amount of the royalties. 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 tapes for television or 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. TIADCc xxx xxx xxx" Based on the foregoing provisions, royalties arising in the Philippines and paid to a resident of Singapore may be taxed in the Philippines at a rate not to exceed: (a) 15 percent of the gross amount of the royalties if the company paying the royalties is registered with the Board of Investments ("BOI") and engaged in preferred areas of activities and also royalties in respect of cinematographic films or tapes for television or broadcasting; or (b) 25 percent of the gross amount of the royalties in all other cases. The term "royalties" 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, any patent, trade mark, design or model, plan, secret formula or process, and know-how. A franchise agreement covers both know-how and the provision of technical assistance, where the franchisor imparts his knowledge and experience to the franchisee and, in addition, provides him varied technical assistance, which, in certain cases, is backed up with financial assistance and the supply of goods. Based on the OECD Commentary to Article 12, "the appropriate course of action to take with a mixed contract is, in principle, to break down, on the basis of the information contained in the contract or by means of a reasonable apportionment, the whole amount of the stipulated consideration according to the various parts of what is being provided under the contract, and then apply to each part of it so determined the taxation treatment proper thereto. If, however, one part of what is being provided constitute by far the principal purpose of the contract and the other parts stipulated therein are only of an ancillary and largely unimportant character, then the treatment applicable to the principal part should generally be applied to the whole amount of the consideration." AIDSTE In practice, it can be difficult to distinguish between payments for know-how (royalty) and payments for the provision of services. The following criteria are relevant for purposes of making distinction: Contracts for the supply of know-how concern information that already exists or concern the supply of that type of information after its development or creation and include specific provisions concerning the confidentiality of that information. In the case of contracts for the provision of services , the supplier undertakes to perform services which may require the use, by that supplier, of special knowledge, skill and expertise but not the transfer of such special knowledge, skill or expertise to the other party. In most cases involving the supply of know-how, there would generally be very little more which needs to be done by the supplier under the contract other than to supply existing information or reproduce existing material. On the other hand, a contract for the performance of services would, in the majority of cases, involve a very much greater level of expenditure by the supplier in order to perform his contractual obligations. (OECD Commentary on Article 12 paragraph 11.3 pages 225-226) Payments for exclusivity, which means that franchisor agrees not to supply or grant anyone else that information or right, for example the use of trademark, should generally fall under the definition of royalties. Exclusive distribution rights, meaning payments that are solely made in return for obtaining the exclusive distribution rights of a product or service in a specific territory do not generally constitute royalties. Examples of payments which should therefore not be considered to be received as consideration for the provision of know-how but, rather, for the provision of services, include: Payments obtained as consideration for after-sales service, Payments for services rendered by a seller to the purchaser under a warranty, AaCTcI Payments for pure technical assistance , Payments for a list of potential customers, when such a list is developed specifically for the payer out of generally available information (a payment for the confidential list of customers to which the payee has provided a particular product or service would, however, constitute a payment for know-how as it would relate to the commercial experience of the payee in dealing with these customers), Payments for an opinion given by an engineer, an advocate or an accountant, Payments for advice provided electronically, for electronic communications with technicians or for accessing, through computer networks, a trouble-shooting database such as a database that provides users of software with non-confidential information in response to frequently asked questions or common problems that arise frequently. In the Agreement executed between North Wing and Thai Express , fees were separately billed and breakdown into the following items: 1. Royalty fee; 2. Market Launch Fee; 3. Store Opening Fee; and 4. Advertising Expenditure. The fees represent payments for the use of know-how and the payments for the provision of services. A close examination of the Agreement reveals that the fees are paid for the following: 1. Royalty fees are paid in consideration of North Wing's right to use the trademarks, proprietary marks and the System of Thai Express; EcTCAD 2. Market Launch fees are paid in consideration of marketing services provision in the market launching of the restaurant business including the provision of trainings and instructions both to the management and kitchen staff in relation to the management systems and procedures, back office process (reporting and accounting) back of the house kitchen operation and the front of the house service operation; 3. Store Opening fees are paid for the selection of location per restaurant opening; and 4. Advertising fee are paid in consideration for handling the advertising requirements ( i.e. , yellow page advertising requirements, minimum advertising weight by market). Based on the foregoing only royalty fees are considered as royalties under the treaty while Market Launch fee, Store Opening fee and Advertising Expenditure are payments for services. Thus, they are considered as business profits and taxed under Article 7 of the tax treaty. Paragraph (1) of Article 7 provides: "Article 7 Business Profits 1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on or has carried on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment. HSAcaE xxx xxx xxx" Based on the foregoing, the profits of an enterprise which is a resident of Singapore shall be taxable only in Singapore unless such enterprise carries on business in the Philippines through a permanent establishment situated therein. If the Singaporean enterprise carries on business as aforesaid, the profits of such enterprise may be taxed in the Philippines to the extent that such profits are attributable to that permanent establishment. Applying this to the instant case, the fees to be received by Thai Express for the provisions of services in the Philippines shall be taxable in the Philippines only if it has a permanent establishment in the Philippines to which said fees may be attributable. For purposes of determining the existence of a permanent establishment, Article 5 of the same tax treaty provides: "Article 5 Permanent Establishment 1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business in which the business of the enterprise is wholly or partly carried on. 2. The term 'permanent establishment' includes specially but is not limited to: a) A seat of management; b) A branch; c) An office; d) A store or other sales outlet; HESIcT e) A factory; f) A workshop; g) A warehouse, in relation to a person providing storage facilities for others; h) A mine, quarry, or other place of extraction of natural resources; i) A building site or construction or assembly project or installation project or supervisory activities in connection therewith, provided such site, project or activity continues for a period more than 183 days; and j) The furnishing of services, including consultancy services, by a resident of one of the Contracting States through employees or other personnel, provided activities of that nature continue (for the same or a connected project) within the other Contracting State for a period or periods aggregating more than 183 days. xxx xxx xxx" Based on the foregoing paragraphs, Thai Express is deemed to have a permanent establishment if it has a fixed place of business in the Philippines through which its business is wholly or partly carried on, such as, a store or other sales outlet, a branch, an office, a factory, a workshop, a warehouse, in relation to a person providing a storage facilities for others, a mine, quarry, or other place of extraction of natural resources, or a building site or construction or assembly project or installation project or supervisory activities continues for a period more than 183 days, or if it furnishes services, including consultancy services, through employees or other personnel, provided activities of that nature continue (for the same or a connected project) for a period or periods aggregating more than 183 days. caITAC Accordingly, since Thai Express is not engaged in trade or business in the Philippines to which a fixed place of business such as a seat of management, a branch, an office is necessary, and since it did not provide the services in the Philippines for a period or periods aggregating more than 183 days (in fact, personnel of North Wing were sent to Singapore to undergo training on November 17-20, 2011), Thai Express is not deemed to have a permanent establishment with respect to such services. This being the case, the service fees to be paid by North Wing to Thai Express ( i.e. , Market Launch fee, Store Opening fee and Advertising Expenditure) are exempt from income tax, pursuant to paragraphs 1, Article 7, in relation to paragraph 2 of Article 5, of the Philippines-Singapore tax treaty. As regards the royalty income, since North Wing is not registered with the BOI and the royalties in question are not in respect of the use of or the right to use cinematograph films or tapes for television or broadcasting, such royalties to be paid by North Wing to Thai Express under the Agreement, being essentially royalties for the use of, or the right to use of, the proprietary marks and trademarks of Thai Express , are subject to income tax at the rate of 25 percent of the gross amount of the royalties pursuant to Article 12 paragraph 2 (c) of the same treaty. Finally, the royalties and the service fees, being payments for the use of intangible properties (patent, trademark, know-how) and for the provision of services in the Philippines, shall be subject to value-added tax ("VAT") under Section 108 (A) of the Tax Code, 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%). . ." ICHDca Relative thereto, North Wing shall withhold VAT at the rate of 12 percent before remitting them to Thai Express. North Wing shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and its accompanying proof of payment shall serve as documentary substantiation for North Wing claim of input tax on the royalties. Otherwise, if North Wing 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 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 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 corporation, individuals, estates and trust, 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; (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: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.