ITAD BIR Ruling No. 282-12

July 17, 2012 ITAD BIR RULING NO. 282-12 Article 11 (Royalties), Philippines-United Kingdom of Great Britain and Northern Ireland tax treaty; BIR Ruling No. ITAD 146-11 Isla Lipana and Co. 29th Floor, Philamlife Tower 8767 Paseo de Roxas Makati City Attention: Alexander B. Cabrera Managing Partner, Tax Services Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on October 3, 2008 requesting confirmation that royalties paid by Misys International Banking Systems, Inc. ("Misys Philippines") to Misys International Banking Systems Ltd. ("Misys") are subject to income tax at the rate of 25 percent pursuant to the Convention between the Government of the Republic of the Philippines and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital Gains ("Philippines-United Kingdom tax treaty") . Facts Misys is a foreign corporation and a resident of the United Kingdom based on its Certificate of Residence issued by the Revenue and Customs Office of the United Kingdom on January 25, 2008. Misys is located at Burleigh House, Chapel Oak, Salford Priors, Evesham, England, United Kingdom. Misys 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 6, 2008. On the other hand, Misys Philippines is a domestic corporation located at 29th Floor, Philamlife Tower, 8767 Paseo de Roxas, Makati City, Philippines. On June 1, 2007, Misys Philippines and Misys entered into three separate License Agreements where Misys granted Misys Philippines a non-exclusive right to sublicense certain computer program in the Philippines. In the process, Misys will supply to Misys Philippines the systems know-how of the programs consisting of information techniques and procedures to enable Misys Philippines to properly install the programs for each end-user, and supply to Misys Philippines all modifications, improvements and enhancements of the programs. In consideration, Misys Philippines will pay license fees to Misys consisting of an initial license fee and a recurring license fee based on a percentage of the price charged by Misys Philippines to each end-user of the programs. The fees are computed every quarter and payable on February 28, May 31, August 31 and November 30 of each year. The Agreement had an initial term of one year from June 1, 2007 to May 31, 2008, and is automatically renewed thereafter for additional periods of one year. The computer programs and their corresponding license fees are as follows: First Agreement Computer Program Initial License Fee Recurring License Fee Wholesale Banking Systems Midas 43 percent 50 percent Midas DBA 43 percent 50 percent Midas 38, 36, 34 43 percent 50 percent Midas ABS 43 percent 50 percent Midas PLUS 43 percent 50 percent Equinox 43 percent 50 percent KIBS 43 percent 50 percent Trade Finance Systems LEO 43 percent 50 percent CATS 43 percent 50 percent Local Products 10 percent 10 percent Custom-build modifications 10 percent 10 percent Second Agreement Computer Program Initial License Fee Recurring License Fee Midas Trader (formerly City Dealer) 50 percent 50 percent Financial Messenger/Meridian 50 percent 50 percent Middleware Citydesk 50 percent 50 percent Market Watch 50 percent 50 percent Global Manager risk vision 50 percent 50 percent Risk Vision Data 50 percent 50 percent Risk Vision Exposure 50 percent 50 percent Risk Vision BASEL II Module 50 percent 50 percent Risk Vision CARMA 50 percent 50 percent Risk Vision VAPI Module 50 percent 50 percent Third Agreement Computer Program Initial License Fee Recurring License Fee Equation 50 percent 50 percent Equation Plus 50 percent 50 percent Trade Innovation 57 percent 55 percent First 50 percent 50 percent Eximbills 40 percent 50 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 fifteen 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 . . ." (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 is upheld by the Supreme Court in Resolution G.R. No. 168531 on February 18, 2008. Furthermore, this requirement 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) . CHIaTc In view of the foregoing, since the three License Agreements that give rise to the license fees have been in effect on June 1, 2007, but the TTRA for this purpose was filed only on October 3, 2008, this Office hereby DENIES relief on such fees paid by Misys Philippines to Misys before the fifteenth day of filing the TTRA on October 18, 2008. Accordingly, these fees shall be subject to income tax at the rate of 35 percent under Section 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. 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 license fees paid by Misys Philippines to Misys on October 18, 2008 and thereafter are considered royalties and subject to relief under paragraphs 1, 2 and 3, Article 11 of the Philippines-United Kingdom tax treaty, to wit: "Article 11 ROYALTIES 1. Royalties arising in a Contracting State which are derived and beneficially owned by a resident of the other Contracting State may be taxed in that other State. 2. Such royalties may also be taxed in the Contracting State in which they arise, and according to the law of that State. However, the tax so charged shall not exceed: a) 15 per cent of the gross amount of the royalties, where the royalties are paid: (i) by an enterprise registered with the Philippine Board of Investments and engaged in preferred areas of activity or (ii) in respect of cinematograph films or tapes for television or radio broadcasting. b) in all other cases, 25 per cent of the gross amount of the royalties." 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 cinematograph films, and 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." Under Article 11, royalties arising in the Philippines and paid to a resident of the United Kingdom may be taxed in the Philippines at a rate not to exceed: (a) 15 percent if the royalties are paid by an enterprise registered with the Board of Investments and engaged in preferred areas of activity, or if the royalties are paid in respect of cinematograph films or tapes for television or radio broadcasting, and (b) 25 percent in all other cases. Royalties 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 cinematograph films, and 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 ("know-how") . Accordingly, since Misys Philippines, the payor, is not registered with the Board of Investments as such, and the license fees in question are not paid in respect of the use of, or the right to use, cinematograph films or tapes for television or radio broadcasting, but in respect of know-how inasmuch as Misys will supply to Misys Philippines the systems know-how of the computer programs and all modifications, improvements and enhancements thereto, such fees as royalties paid by Misys Philippines to Misys on October 18, 2008 and thereafter shall be subject to income at the rate of 25 percent, pursuant to paragraph 2 (b), Article 11 of the Philippines-United Kingdom tax treaty. (BIR Ruling No. ITAD 146-11 dated May 10, 2011) On the characterization of the license fees as royalties, the following commentaries of the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (Condensed Version, July 22, 2010) mention: IEDHAT "11.5 In the particular case of a contract involving the provision, by the supplier, of information concerning computer programming, as a general rule the payment will only be considered to be made in consideration for the provision of such information so as to constitute know-how where it is made to acquire information constituting ideas and principles underlying the program, such as logic, algorithms or programming languages or techniques, where this information is provided under the condition that the customer not disclose it without authorisation and where it is subject to any available trade secret protection." (Page 226) Finally, under Section 108 (A) of the Tax Code, the royalties in question, being payments for the use of intangible property (know-how) 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. (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%) . . ." Relative thereto, Misys Philippines shall withhold VAT on the royalties at the rate of 12 percent before remitting them to Misys. Misys Philippines 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 Misys Philippines' claim of input tax on the royalties. Otherwise, Misys Philippines 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; 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."