ITAD BIR Ruling No. 308-12

August 10, 2012 ITAD BIR RULING NO. 308-12 Article 13 (Royalties), Philippines-United States tax treaty; BIR Ruling No. ITAD 126-11 Isla Lipana and Co. 29th Floor, Philamlife Tower 8767 Paseo de Roxas Makati City Attention: Mary Assumption S. Bautista-Villareal Principal, Tax Services Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on January 9, 2006 requesting confirmation that royalties paid by the branch office in the Philippines of Nu Skin Enterprises Philippines, Inc. ("Nu Skin Philippines") (formerly, Nu Skin Philippines, Inc. ) to NSE Products, Inc. ("NSE Products") (formerly Nu Skin Europe, Inc. ) 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 NSE Products is a corporation organized and existing under the laws of the United States, based on its Certificate of Incorporation filed at the Office of the Secretary of State of Delaware in the United States on May 25, 1995, as amended on June 15, 2005. NSE Products is situated at 1209 Orange Street, Washington, New Castle, Delaware, United States. NSE Products is not registered as a corporation or partnership in the Philippines based on the Certification of Non-Registration issued by the Securities and Exchange Commission ("SEC") on November 24, 2005. Likewise, Nu Skin Philippines is a corporation organized and existing under the laws of the United States, but is licensed to engage in trade or business in the Philippines based on its amended SEC License No. A1997-6813 issued on March 4, 2005. Nu Skin Philippines is situated at 1209 Orange Street, Washington, New Castle, Delaware, United States. Its branch office in the Philippines ("Nu Skin Philippines-Philippine Branch") is situated at 15th Floor, Octagon Center, 41 San Miguel Avenue, Ortigas Center, Pasig City, Philippines. HEISca On January 1, 2004, Nu Skin International, Inc. ("Nu Skin International") and Nu Skin Philippines entered into an Amended and Restated Trademark Licensing Agreement where Nu Skin International continued to grant Nu Skin Philippines an exclusive license to use in the Philippines the Licensed Marks and Names on the Licensed Products and Services. Licensed Marks and Names means service marks, trademarks, logos or devices (or combination thereof) and commercial valuable marks, names or devices (or combination thereof) belonging to Nu Skin International. Nu Skin International is a corporation organized and existing under the laws of the United States, based on its Articles of Incorporation. Nu Skin is situated at 2214 North Canyon Road, Provo, Utah, United States. Licensed Products and Services means Nu Skin Philippines' products, commercial materials, starter kits and other products and services approved by Nu Skin International. In consideration, Nu Skin Philippines will pay royalties to Nu Skin International equal to 5 percent of the former's net sales of the Licensed Products and Services. The royalties will be paid within 60 days after the end of each month. Penalty charges on late payment are imposed at the rate of 10 percent per annum (or at another rate specified by Nu Skin International ) multiplied by the number of days from the due date to the actual date of payment over a number of 360 days. The Amended and Restated Agreement took effect on January 1, 2004 and remained in effect initially for one year or up to December 31, 2004. The Agreement is automatically renewed thereafter and will remain in effect indefinitely. On July 1, 2005, Nu Skin International and Nu Skin Philippines entered into an Assignment of Trademark Licensing Agreements where Nu Skin International assigned to NSE Products its rights and obligations under the Amended and Restated Agreement. 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: 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: aCcEHS " 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 a Resolution (G.R. No. 168531) dated 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) . TcSAaH In view of the foregoing, since the Amended and Restated Agreement was in effect between Nu Skin Philippines and NSE Products from July 1, 2005 to present, but the subject TTRA was filed on January 9, 2006 , this Office hereby DENIES relief on any income payments made by Nu Skin Philippines to NSE Products before the fifteenth day of the filing of the TTRA, or on January 24, 2006 , pursuant to RMO 1-2000. Accordingly, said payments 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 of 1997") , 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, royalties paid by Nu Skin Philippines to NSE Products on January 24, 2006 and thereafter are subject to the lowest rate of income tax or most-favored-nation treatment under paragraph 2 (a) (iii), 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: IDASHa (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 ." (Emphasis ours) In relation 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 such treatment to apply. First , royalties arising in the Philippines and paid to a resident the United States must be of the same class as those derived in the Philippines by a resident of a third State to which the tax treaty between the Philippines and the third State subjects such royalties to a most-favored-nation treatment. Second, in eliminating or mitigating the effects of double taxation on the royalties, the United States must allow to its resident the same amount of tax credit or deduction as that allowed by the third State to the latter's resident against the income tax due of that resident in the third State with respect to the royalties. 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 . ICDSca 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 Convention between the Czech Republic and the Republic of the Philippines for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income ("Philippines-Czech tax treaty") effective January 1, 2004 . Under paragraphs 1 and 2, Article 12 thereof, royalties arising in the Philippines and paid to a resident of Czech are subject to income tax 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." Concerning the first requirement , royalties for the use of the Licensed Marks and Names as used on the Licensed Products and Services, being essentially royalties for the use of a trademark , are within the definition of royalties under the article on Royalties of the Philippines-United States and the Philippines-Czech tax treaties, to wit; CHaDIT United States: "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." Czech: "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." Concerning the second requirement , under the article on Relief from Double Taxation of the Philippines-United States and the Philippines-Czech tax treaties, income tax paid or withheld in the Philippines on royalties arising therein and paid to residents of the United States and Czech are allowed as tax credit or deduction against the income tax of these residents in these countries, to wit; aTHCSE United States: " 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 . . ." Czech: " Article 22 ELIMINATION OF DOUBLE TAXATION xxx xxx xxx 2. 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." IaAEHD Accordingly, royalties for the use of the Licensed Marks and Names and penalty charges (interest on late payments) paid by Nu Skin Philippines to NSE Products under the Amended and Restated Agreement before January 24, 2006 shall be subject to income tax at the rate of 35 percent under Section 28 (B) (1) of the Tax Code of 1997. On the other hand, royalties and penalty charges paid to NSE Products on January 24, 2006 and thereafter shall be subject to income tax at the rate of 10 percent , pursuant to paragraph 2 (a) (iii), Article 13 of the Philippines-United States tax treaty, in relation to paragraph 2, Article 12 of the Philippines-Czech tax treaty. (BIR Ruling No. ITAD 126-11 dated April 15, 2011) Finally, under Section 108 (A) of the Tax Code, the royalties in question, being payments for the use of intangible property (trade mark) 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 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, Nu Skin Philippines shall withhold VAT on the royalties at the rate of 10 percent (before February 1, 2006) and 12 percent (beginning February 1, 2006 and thereafter) before remitting them to NSE Products . Nu Skin 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 Nu Skin Philippines' claim of input tax on the royalties. Otherwise, Nu Skin Philippines 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 aSACED 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."