ITAD BIR Ruling No. 254-12

June 8, 2012 ITAD BIR RULING NO. 254-12 Article 13 (Royalties) Philippines-United States of America tax treaty Punongbayan and Araullo 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue 1200 Makati City Attention: Eleanor L. Roque Tax Principal Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on May 8, 2009 requesting confirmation that royalties paid by Golden Arches Development Corporation ("Golden Arches") to McDonald's Corporation ("McDonald's") are subject to income tax at the rate of 10 percent pursuant to 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-United States tax treaty"). Basic Facts McDonald's is a foreign corporation organized and existing under the laws of the United States and is a resident thereof based on the Certificate of Residence issued by the Internal Revenue Service of the United States on January 31, 2009. McDonald's is situated at One McDonald's Plaza, Oak Brook, Illinois, United States. McDonald's is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Corporation/Partnership issued by the Securities and Exchange Commission on May 7, 2009. On the other hand, Golden Arches is a domestic corporation situated at 17th Floor, Citibank Center Building, Paseo de Roxas, Makati City, Philippines. McDonald's has developed and operates a restaurant system ("McDonald's System") , which includes proprietary rights in certain valuable trade names, service marks, trademarks (such as the trade names 'McDonald's' and 'McDonald's Hamburgers' ), designs, color schemes for restaurant buildings, signs, equipment layouts, formulas and specifications for certain food products, method of inventory and operation control, bookkeeping and accounting, and manuals covering business practices and policies. McDonald's System is operated and advertised widely in the United States and in many other countries throughout the world. On February 8, 2005, McDonald's Restaurant's Operations, Inc. , a Delaware corporation, and George T. Yang and Kenneth S. Yang ("Messrs. Yangs") entered into a Shareholders' Agreement, which provides for the governance of the relationship among the major shareholders of Golden Arches and for the conditions of ownership, operation and management of Golden Arches. In order to provide for the successful continuation and expansion of the McDonald's restaurant business in the Philippines after the equity restructuring of Golden Arches on March 17, 2005, McDonald's granted Messrs. Yangs a new and non-exclusive license to continue to use the McDonald's System in the Philippines subject to the terms and conditions of the Master License Agreement below. On March 17, 2005, McDonald's and Messrs. Yangs entered into a Master License Agreement where McDonald's granted the latter a non-exclusive right, license, and privilege ("License") to: (1) adopt and use the McDonald's System in restaurants already opened and to be constructed in the Philippines ("Restaurants") in accordance with the terms and conditions of the Agreement, (2) advertise to the public that it is a licensee of McDonald's, (3) adopt and use (but only in conjunction with the sale at the Restaurants of those food and beverage products which have been designated by McDonald's ) the trade names, trademarks and services marks, which McDonald's shall designate, from time to time, to be part of the McDonald's System, (4) to use McDonald's proprietary information in order to design, construct or cause to be constructed and operate McDonald's Restaurants, (5) manufacture, or cause to be manufactured, and use all proprietary equipment therefor, and (6) (subject to the prior written consent and approval of McDonald's ) lease or sublease Restaurants which have already been developed by Messrs. Yangs at the time of entering into the Agreement or which may in the future be developed by Messrs. Yangs pursuant to the terms of the Agreement in favor of individual or corporate franchisees which have been approved by McDonald's. McDonald's shall grant to each sub-franchisee an operating license in the form then generally used by McDonald's in its international operations, and the term of the license therefor shall be ten years or the term of the lease or sub-lease, whichever is shorter. The License granted by McDonald's to Messrs. Yangs shall be twenty years from the effectivity of the Agreement on March 17, 2005, and that any renewal or extension of the License shall be discussed mutually by the parties on the eleventh year of the franchise. As of date, Messrs. Yangs has 152 Company Operated Restaurants (with the earliest since September 27, 1981) and 91 Sub-Franchised Restaurants (with the earliest since November 17, 1985) throughout the Philippines. TIHCcA In consideration, Messrs. Yangs shall pay McDonald's the following: 1. For each of the 152 Company-Operated Restaurants, a nonrefundable franchise fee ("Franchise Fee") of US$45,000.00 (or the current Franchise Fee set by McDonald's in Asia for a twenty-year franchise term but not longer than the term of the Agreement) on the twentieth anniversary of the Restaurant, and an additional franchise fee of US$22,500.00 (or the then current Franchise Fee set by McDonald's in Asia for a ten-year franchise term) upon renewal of the franchise for another ten years, and payable within thirty days after each anniversary or renewal. 2. For a future Company-Operated Restaurant, an initial franchise fee ("Initial Franchise Fee") of US$45,000.00 for a term of twenty years (or the then current Franchise Fee set by McDonald's in Asia for a twenty-year franchise term but not longer than the term of the Agreement), or an initial franchise fee of US$22,500.00 for a term of ten years (or the then current Franchise Fee set by McDonald's in Asia for a ten-year franchise term). 3. For each of the 91 Sub-Franchised Restaurants, a nonrefundable franchise fee ("Franchise Fee") of US$45,000.00 (or the then current Franchise Fee set by McDonald's in Asia for a twenty-year franchise term but not longer than the term of the Agreement) on the twentieth anniversary of the Restaurant, and an additional franchise fee of US$22,500.00 (or the then current Franchise Fee set by McDonald's in Asia for a ten-year franchise term) upon renewal of the franchise for another ten years, payable within thirty days after each anniversary or renewal. 4. For a future Sub-Franchised Restaurant, an initial franchise fee ("Initial Franchise Fee") of US$22,500.00 for a term of ten years (or the then current Franchise Fee set by McDonald's in Asia for a ten-year franchise term). 5. A royalty of 5 percent ("Royalty") based on the gross sales of each Restaurant, payable within ten days after the end of each month and during the first ten years of the Agreement. On March 17, 2005, Messrs. Yangs and Golden Arches entered into an Assignment and Consent to Assignment where the former, with the consent of McDonald's , transferred all their rights, titles, and interests in the License under the Master License Agreement to Golden Arches. As of that date, the shares of stock of Golden Arches are held by George T. Yang (24.20 percent), Kenneth S. Yang (26.8 percent) and Alliance Global Group, Inc. (49 percent). 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 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: ICHcaD 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 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). In view of the foregoing, since the Master License Agreement which allows Golden Arches to, among others, adopt and use the McDonald's System in existing and future restaurants in the Philippines took effect on March 17, 2005, and will remain in effect for twenty years, or up to March 16, 2025, but since the subject TTRA was filed only on May 8, 2009, this Office hereby DENIES relief on the franchise fees, initial franchise fees and royalties paid by Golden Arches to McDonald's before May 23, 2009, pursuant to Section III (2) of RMO 1-2000. Accordingly, these payments shall be subject to income tax at the rate provided under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, to wit: SIaHDA "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 franchise fees, initial franchise fees and royalties paid by Golden Arches to McDonald's on May 23, 2009 and thereafter, being royalties in respect of the use of trade mark, design or model, plan, secret formula or process, or information concerning industrial, commercial or scientific experience ("know-how") , shall be subject to income tax at the lowest rate of income tax or most-favored-nation treatment under paragraph 2 (a) (iii), in relation to paragraph 3, Article 13 of the Philippines-United States tax treaty, to wit: "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, (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." 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 films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or other like right or property, or for information concerning industrial, commercial or scientific experience. The term "royalties" also includes gains derived from the sale, exchange or other disposition of any such right or property which are contingent on the productivity, use, or disposition thereof. SEcITC In relation to the most-favored-nation treatment, 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") , the Supreme Court required two conditions for such treatment to apply. First, royalties arising in the Philippines and paid to a resident the United States must be the same as those derived by a resident of a third State where the latter's tax treaty with the Philippines subjects royalties arising in the Philippines and paid to a resident of the third State to a most-favored-nation treatment. Second, the method employed by the United States in eliminating or mitigating the effects of double taxation of royalties paid to a resident of the United States must be the same as that employed by the third State in eliminating or mitigating the effects of double taxation of royalties paid to a resident of that State. 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 . 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 Germany 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 Agreement between the Government of the Republic of the Philippines and the Government of the United Arab Emirates for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital effective January 1, 2009. Under paragraphs 1, 2 and 3, Article 12 thereof, royalties arising in the Philippines in respect of trade mark, design or model, plan, secret formula or process, know-how, and so forth, are subject to income tax in the Philippines 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, the 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 10 per cent of the gross amount of the royalties. The competent authorities of the Contracting States shall, by mutual agreement, settle the mode of application of this limitation. 3. The term "royalties" as used in this Article means payment 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 and films or tapes for television or radio broadcasting, 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 . " (Emphasis ours) ASaTHc Moreover, under paragraph 2, Article 23 of the tax treaty, in eliminating or mitigating the effects of double taxation, the United Arab Emirates shall allow as a deduction or credit against the income tax due in the United Arab Emirates with respect to the royalties, the amount of income tax paid on the royalties in the Philippines, to wit: "Article 23 ELIMINATION OF DOUBLE TAXATION xxx xxx xxx 2. In the case of the United Arab Emirates, double taxation shall be eliminated as follows: Where a resident of the United Arab Emirates derives income which in accordance with the provisions of this Agreement, may be taxed in the Philippines, the United Arab Emirates shall allow as a deduction from tax on income of that person an amount equal to the tax on income paid in the Philippines ." (Emphasis ours) The same is true in the case of the United States. Under paragraph 1, Article 23 of the Philippines-United States tax treaty, in eliminating or mitigating the effects of double taxation of royalties arising in the Philippines and paid to a resident of the United States, the United States shall allow as a deduction or credit against the income tax due in the United States the amount of income tax paid on the royalties in the Philippines, to wit: "Article 23 RELIEF FROM DOUBLE TAXATION Double taxation of income shall be avoided in the following manner: 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 . . . " (Emphasis ours) This being so, the franchise fees, initial franchise fees and royalties paid by Golden Arches to McDonald's on May 23, 2009 and thereafter shall be subject to income tax at the rate of 10 percent. Finally, under Section 108 (A) of the Tax Code, the fees and royalties in question, being payments for the use of intangible properties (know-how, trade mark, design or model, plan, secret formula or process) 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. HSIDTE (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, 1 raise the rate of value-added tax to twelve percent (12%) . . ." Accordingly, Golden Arches shall withhold VAT on the fees and royalties at the rate of 10 percent (before February 1, 2006) and 12 percent (beginning February 1, 2006 and thereafter) before remitting them to McDonald's. Golden Arches shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). If it is a VAT-registered taxpayer, the duly filed BIR Form No. 1600 and its accompanying proof of payment shall serve as documentary substantiation for Golden Arches' claim of input tax on the fees and royalties. Otherwise, Golden Arches 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. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. The VAT rate was increased to 12 percent 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. 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."