ITAD BIR Ruling No. 269-12

June 27, 2012 ITAD BIR RULING NO. 269-12 Articles 13 (2) (b) (iii), Philippines-United States of America tax treaty; Article 12, Philippines-Czech tax treaty Mary Kay, Inc. 16251 Dallas Parkway Addison, Texas, USA 75001 Attention: Patrick Cargo Vice President, Corporate Tax Gentlemen : This refers to your Tax Treaty Relief Application ("TTRA") filed on January 30, 2012, applying for relief from double taxation on the royalty payment made by Mary Kay Philippines, Inc. ("MK-Phil") to Mary Kay, Inc. ("MK-USA") , 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-United States tax treaty") . It is represented that MK-USA with principal address at 16251 Dallas Parkway, Addison, Texas, USA 75001, is a resident of the United States of America based on the certification issued by the Internal Revenue Service, Department of the Treasury on March 28, 2011; that it is not registered either as a corporation or partnership in the Philippines per certification issued by the Securities and Exchange Commission dated September 30, 2011; and that, on the other hand, MK-Phil is a corporation organized and existing under the laws of the Philippines with principal address at 2nd Floor Allegro center, 2284 Pasong Tamo Ext., Makati City 1231. It is further represented that on March 1, 2010, a Software License Agreement ("Agreement") was entered into between MK-USA and MK-Phil whereby MK-USA grants MK-Phil a limited, non-exclusive, non-transferable, perpetual limited license to use the Software 1 in connection with its business operations; that in consideration of the grant of license and the use of the Software provided to MK-Phil, there shall be a one-time License fee of US$717,157.99, but, MK-Phil may make partial payment of the License fees and the full License fee amount must be paid within three (3) years of MK-USA's invoice; that the Agreement shall terminate automatically, without notice to MK-Phil, upon MK-Phil's failure to cure its non fulfillment of any material obligation within 10 business days of receipt of written notice from MK-USA demanding cure. It is finally represented, based on the Sworn Statement issued by MK-Phil on December 14, 2011, 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. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, applies in general to royalties derived in the Philippines by a nonresident foreign corporation. 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 interest, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed and determinable annual, periodic or casual gains subject to tax under subparagraphs 5(a): Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%)." ESCacI However, Section 32 (B) (5) of the Tax Code of 1997, as amended, provides: "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 obligation binding upon the Government of the Philippines." Thus, Article 13 of the Philippines-United States tax treaty provides as follows: "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." and, in relation thereto, Article 12 (2) (a) of the Philippines-Czech Republic tax treaty, which you invoked, 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. 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 beneficial owner of the royalties is a resident of the other Contracting State, the tax so charged shall not exceed: a) 10 per cent of the gross amount of the royalties arising from the use of, or the right to use, any copyright of literary, artistic or scientific work, other than that mentioned in sub-paragraph (b), 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; b) 15 per cent of the gross amount of the royalties arising from the use of, or the right to use, any copyright of cinematograph films, and films or tapes for television or radio broadcasting. The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of these limitations." 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. DA-ITAD-52-03 dated April 8, 2003) AcHCED In this regard, Article 23 of the Philippines-United States tax treaty provides as follows: "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 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." On the other hand, Article 22 of the Philippines-Czech tax treaty provides as follows: "Article 22 ELIMINATION OF DOUBLE TAXATION 1. In the case of a resident of the Czech Republic, double taxation shall be eliminated as follows: a) The Czech Republic, when imposing taxes on its residents, may include in the tax base upon which such taxes are imposed the items of income which according to the provisions of this Convention may also be taxed in the Philippines, but shall allow as a deduction from the amount of tax computed on such a base an amount equal to the tax paid in the Philippines. Such deduction shall not, however, exceed that part of the Czech tax, as computed before the deduction is given, which is appropriate to the income which, in accordance with the provisions of this Convention, may be taxed in the Philippines. b) Where in accordance with any provision of the Convention income derived by a resident of the Czech Republic is exempt from tax in the Czech Republic, the Czech Republic may nevertheless, in calculating the amount of tax on the remaining income of such resident, take into account the exempted income." As provided under their respective articles on Elimination of Double Taxation of their tax treaties with the Philippines, the United States and Czech Republic, both employ the same mechanism in mitigating the effects of double taxation of foreign-sourced income derived by their residents, that is, the ordinary credit method. Under the ordinary credit method, the United States and Czech (as countries of residence) would limit a taxpayer's allowable tax credit to that portion of the taxpayer's tax liability in their countries that is attributable to the income that is taxed in the Philippines (the country of source or country of situs). As a result of this limitation, if the Philippines has an effective tax rate that exceeds the effective tax rate of the United States and Czech on a particular income, the United States and Czech would not grant the taxpayer a full credit for the income tax imposed by the Philippines on such income. Relative thereto, please be informed that Section 14 of Revenue Memorandum Order ("RMO") No. 72-2010, published in the Manila Bulletin on October 20, 2010, and effective November 4, 2010, provides that: " Section 14. When and Where to File the TTRA. All tax treaty relief applications (updated BIR Forms No. 0901-D, 0901-I, 0901-R, 0901-P, 0901-S, 0901-T, 0901-O and 0901-C) relative to the implementation and interpretation of the provisions of Philippine tax treaties shall only be submitted to and received by the International Tax Affairs Division (ITAD). If the forms of any necessary documents are submitted to any other BIR office, the application shall be considered as improperly filed. DCTSEA Filing should always be made BEFORE the transaction. Transaction for purposes of filing the TTRA shall mean before the occurrence of the first taxable event. Failure to properly file the TTRA with ITAD within the period prescribed herein shall have the effect of disqualifying the TTRA under this RMO. " (Emphasis Supplied) In view thereof, since the TTRA was filed only on January 30, 2012, after the date of effectivity of the Agreement which was on March 1, 2010, this Office hereby DENIES relief on all payments under the Agreement made on or before the filing of the TTRA on January 30, 2012 in violation of the requirement under RMO 72-2010 that filing of the TTRA should be made BEFORE the transaction, that is the payment of license fees. Accordingly, said payments shall be subject to tax at the rate provided for in Section 28 of the above-cited Tax Code of 1997, as amended. However, license fees paid after the filing of the TTRA on January 30, 2012 are GRANTED relief under Article 13 of the Philippines-United States tax treaty, in relation to Article 12 of the Philippines-Czech tax treaty. Accordingly, said payments are subject to the preferential tax rate of 10 percent based on the gross amount thereof pursuant to the Philippines-United States tax treaty, in relation to the Philippines-Czech tax treaty. Moreover, the said royalty payment by MK-Phil to MK-USA are subject to the 12% value-added tax (VAT) under Section 108 of the Tax Code, as amended, which provides as follows: "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 the 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, raise the rate of value-added tax to twelve percent (12%), after any of the following conditions has been satisfied: xxx xxx xxx The phrase 'sale or exchange of services' means the performance of all kinds or services in the Philippines for others for a fee, remuneration or consideration, including . . . . 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" Accordingly, MK-Phil, being the resident withholding agent and payor in control of the payment, shall be responsible for the withholding of the 12 percent final VAT on such royalty before making any payment to MK-USA. In remitting the VAT withheld, MK-Phil 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 proof of payment thereof shall serve as documentary substantiation for the claim of input tax by MK-Phil upon filing its own VAT return, if it is a VAT-registered taxpayer. In case MK-Phil is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of goods or properties purchased which may be treated as an "expense" or as an "asset", whichever is applicable. In addition, MK-Phil is required to issue the Certificate of Final Income Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies thereof to be given to MK-USA upon its request and the fourth copy to be retained by MK-Phil as its file copy. [Section 4.110.3 (b), Revenue Regulations No. (RR) 7-95, as amended by RR 08-02 (now Section 4.114-2, RR 16-05, as amended by RR 04-07)] 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. TEHIaD Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue Footnotes 1. "Software" shall mean the SAM E-Commerce 4.0 Software.