ITAD BIR Ruling No. 295-12

July 26, 2012 ITAD BIR RULING NO. 295-12 Articles 13 (Royalties) and 23 (Relief from Double Taxation), Philippines-United States of America tax treaty Punongbayan and Araullo 20th Floor, Tower 1 The Enterprise Center 6766 Ayala Avenue Makati City Attention: Eleanor L. Roque Tax Principal Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on July 29, 2010 requesting confirmation that royalties paid by IBM Philippines, Inc. ("IBM Philippines'') to International Business Machines Corporation ("IBM") 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") . Facts IBM is a foreign corporation in the United States based on its Restated Certificate of Incorporation filed at the State of New York in the United States on May 27, 1992. IBM is located at New Orchard Road, Armonk, New York, United States. IBM is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration of Company issued by the Securities and Exchange Commission on May 13, 2010. On the other hand, IBM Philippines is a domestic corporation located at 2nd to 4th Floors, IBM Plaza, 8 Eastwood Avenue, Eastwood City Cyberpark, E. Rodriguez Jr. Avenue, Barangay Bagumbayan, Quezon City, Philippines. On January 1, 1988, IBM Philippines and IBM entered into an Agreement where IBM granted IBM Philippines a non-exclusive right to (i) license and distribute copies of the IBM Programs for use by customers, (ii) to use the IBM Programs in revenue producing activity, (iii) to use these programs internally, (iv) to make or have made copies of these programs for distribution to affiliated companies or for translation or modification of the programs, and (v) to allow IBM Philippines' customers to use, make copies of and modify the IBM Programs pursuant to IBM Philippines' agreements with its customers. IBM Programs means programs protected by IBM's patents, mask work rights or copyrights, other than or in addition to IBM Philippines' patents, mask work rights and copyrights, which are marketed by IBM or its subsidiaries, and licensed, authorized or otherwise provided to IBM Philippines. In addition, IBM granted IBM Philippines the right to use IBM's trademarks on or in association with the IBM Programs. IBM granted IBM Philippines access to and use of knowledge and technical know-how that it has relating to the reproduction, use, modification, marketability, education of users, service and maintenance of the IBM Programs. In consideration, IBM Philippines will pay IBM a fee of 40 percent of all revenues, including discounts and allowances, billed or accrued during each calendar month by IBM Philippines authorized, licensed, or distributed to any non-affiliated party, and an additional fee of 40 percent of the price that IBM Philippines would bill a third party for the licensing or authorizing the use of the IBM Programs for each copy thereof which IBM Philippines uses internally. The fees are computed and payable every month. The fees for a particular month are due on the last day of the following month. The Agreement had an initial term of one year and continues in effect indefinitely thereafter. HAaDTI The Agreement was amended on March 17, 2002. The fee of 40 percent of all revenues generated by IBM Philippines in authorizing, licensing, or distributing the IBM Programs was increased to 60 percent. Moreover, the fees are payable in United States dollars and due within thirty days after the last day of each month. 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. HTaSEA 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, 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. 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 Agreement that gives rise to the fees has been in effect on January 1, 1988, but the TTRA for this purpose was filed only on July 29, 2010, this Office hereby DENIES relief on all fees paid by IBM Philippines to IBM before August 13, 2010, pursuant to Section III (2) of RMO 1-2000. Accordingly, said fees shall be subject to income tax 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 fees, as royalties , paid to IBM on August 13, 2010 and thereafter are subject to the lowest rate of income tax imposed on royalties of the same kind arising in the Philippines and paid to a resident of a third State under similar circumstances ("most-favored-nation treatment") , under paragraph 2 (b) (iii), Article 13 of the Philippines-United States tax treaty, which provides: "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 xxx xxx xxx b) In the case of the Philippines, the least of: xxx xxx xxx (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." The fees are treated as royalties since, under the Agreement, IBM granted IBM Philippines the right to exploit the copyright in the IBM Programs by allowing IBM Philippines to (i) license and distribute copies of the IBM Programs to customers, (ii) to use the IBM Programs in revenue producing activity, (iii) to use these programs internally, (iv) to make or have made copies of the programs for distribution and for translation or modification of the programs, and (v) to allow IBM Philippines' customers to use, make copies of and modify the IBM Programs. Also, IBM granted IBM Philippines the right to use IBM's trademarks on or in association with the IBM Programs, and to have access and to use IBM's knowledge and technical know-how relating to the reproduction, use, modification, marketability, education of users, service and maintenance of the IBM Programs. With respect to the most-favored-nation treatment, the Supreme Court, 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") , required two conditions for this treatment to apply. First, the royalties arising in the Philippines and paid to a resident of the United States must be of the same kind as those derived in the Philippines by a resident of a third State and to which the tax treaty between the Philippines and the third State subjects the latter royalties to a most-favored-nation treatment, which is currently at 10 percent. Second, the royalties paid to the United States resident must be paid under similar circumstances vis--vis those royalties paid to the resident of the third State, which can be determined by considering the amount of foreign tax credit or deduction which the United States and the third State allow its residents with respect to the royalties. In this connection, the royalties are not paid under similar circumstances if the credit or deduction allowed by the third State is more than the actual amount of income tax of 10 percent as that provided in the article on Royalties of the treaty between the Philippines and the third State. The pertinent portion of the S.C. Johnson case 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) STcDIE For this purpose, we cite 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 ("Philippines-United Arab Emirates tax treaty") effective January 1, 2009. With respect to the first condition, under paragraphs 1, 2 and 3, Article 12 of the Philippines-United Arab Emirates tax treaty, royalties for the use of, or the right to use, copyright, information concerning industrial, commercial or scientific experience ("know-how") , and trademark, to which fees paid by IBM Philippines to IBM under the Agreement are generally assimilated to, and royalties for the use of, or the right to use, other types of intangible properties, are subject to the lowest rate of income tax 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." With respect to the second condition, under paragraph 1, Article 23 of the Philippines-United States tax treaty, and paragraph 2, Article 23 of the Philippines-United Arab Emirates tax treaty, the foreign tax credit or deduction which the United States and the United Arab Emirates allow its residents with respect to income (except dividends paid to a United States resident) arising in the Philippines and subjected to income tax therein is limited to the actual amount of tax imposed in the Philippines, which in the case of royalties is 10 percent under Article 12 of the Philippines-United Arab Emirates tax treaty, and, consequently, under Article 13 of the Philippines-United States tax treaty, 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. " " 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." (Emphasis ours) DHIaTS In view of the foregoing, the royalties paid by IBM Philippines to IBM on August 13, 2010 and thereafter shall be subject to income tax at the rate of 10 percent, pursuant to paragraph 2 (b) (iii), Article 13 of the Philippines-United States tax treaty, in relation to paragraph 2, Article 12 of the Philippines-United Arab Emirates tax treaty. Finally, under Section 108 (A) of Tax Code, as amended, the royalties in question, being payments for the lease of intangible properties ( copyright, trademark and 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, IBM Philippines shall withhold VAT on the royalties at the rate of 10 percent (before February 1, 2006) and 12 percent (on February 1, 2006 and thereafter) before remitting them to IBM. IBM 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 accompanying proof of payment shall serve as documentary substantiation for IBM Philippines' claim of input tax on the royalties; otherwise, 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; 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."