ITAD BIR Ruling No. 312-14

November 4, 2014 ITAD BIR RULING NO. 312-14 Articles 5 and 7, Philippines-Singapore Tax Treaty Du-Baladad and Associates 20th Floor, Chatham House, Rufino corner Valero Streets Salcedo Village, Makati City Attention: Atty. Benedicta Du-Baladad Gentlemen : This refers to your tax treaty relief application filed on July 19, 2012, requesting confirmation that the income payments by Bank of Philippine Islands ("BPI") to Softplus Pte. Ltd. ("Softplus") are subject to the preferential rate pursuant to the Convention between the Republic of the Philippines and the Republic of Singapore for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income. ("Philippines-Singapore tax treaty"). It is represented that Softplus is a resident of Singapore with principal address at 190 Middle Road #19-05, Singapore based on the Certificate of Residence issued by the Assistant Commissioner of the Corporate Tax Division on July 20, 2012; that Softplus is not registered either as a corporation or as a partnership in the Philippines, as shown in the Certification of Non-Registration of Company dated May 30, 2012 issued by the Securities and Exchange Commission; and that on the other hand, BPI is a domestic banking institution with principal address at BPI Head Office Building, Ayala Avenue corner Paseo de Roxas, Makati City. It is further represented that on May 29, 2012; Softplus and an authorized distributor of cfSOFTWARE (as licensor) and BPI (as user) entered into a Proprietary Software Perpetual License Agreement ("Agreement"), whereby Softplus grants to BPI a non-transferable and non-exclusive perpetual license to use the proprietary computer software, pcMainframe, on the central processing unit located at the BPI Makati Office; that the products may only be used for, by and on behalf of BPI, and only (i) on data owned by BPI, (ii) for BPI's internal purposes and (iii) at the installation site and on the designated CPUs specified; that the simultaneous use of the products at any other site or on any other CPU is prohibited, unless expressly contracted for between Softplus and BPI; that Softplus agrees to maintain the products in an operable condition according to the current published specifications for the products for the initial period without additional charge to BPI; that Softplus will furnish the product in machine-readable object code form and provide documentation to BPI containing detailed specifications for the installation and use of the product; that for and in consideration of the said license, BPI shall pay Softplus maintenance fee of US$20,794.50 per year and license fee in the amount of US$20,250; that all amounts payable under the Agreement, including any taxes or other charges described below, are invoiced by Softplus and are to be paid in full by BPI within ten days after receipt of the invoice therefor; that BPI shall pay a late payment charge of 1.5% per month, or the maximum rate permitted by applicable law, whichever is less, on any unpaid amount for each calendar month or fraction thereof that any payment to Softplus in arrears; that the services to be performed by Softplus under the Agreement are not to be performed in the Philippines pursuant to the Certification issued by the Vice President of BPI dated June 22, 2012; and that as of July 13, 2012, no payment has been made with respect to the maintenance fee agreed upon in the Agreement based on the Certification issued by the Vice President of BPI on even date. cCaEDA It is finally represented that the payments subject of this ruling are not under investigation, on-going audit, administrative protest, claim for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal, based on the Sworn Statement issued by the Vice President of BPI on May 14, 2012. In reply, please be informed that Section 28 (B) (1) of the National Internal Revenue Code (Tax Code) of 1997, as amended, applies, in general, to income derived in the Philippines by a non-resident foreign corporation: "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 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): n Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%). xxx xxx xxx" 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 treaty obligation binding upon the Government of the Philippines. DaEATc xxx xxx xxx" The Bureau of Internal Revenue has issued two Revenue Memorandum Circulars (RMC) that govern the taxation of software payments. The first Circular (RMC 77-2003) covers software payments made as of November 18, 2003 and until the effectivity of the second Circular and generally treats software payments as royalties. It provides "Definition of Royalties Includes Payments for the Use of Software: The term 'royalties' as generally used 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, or films or tapes used 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. The term 'use' as contained herein shall include the reselling or distribution of software. Software is generally assimilated as a literary, artistic or scientific work protected by the copyright laws of various countries including the Philippines; thus payments in consideration for the use of, or the right to use, a copy or a copyrighted article relating to software are generally royalties." On the other hand, the second Circular (RMC 44-2005) covers payments made as of September 8, 2005 and onwards and substantially amends the first Circular by treating software payments either as business income, royalties, rental income, or capital gains, depending on the nature of the transaction out of which such payments are made. It provides: "Section 5. Characterization of Transactions. The character of payments received in a transaction involving the transfer of computer software depends on the nature of the rights that the transferee acquires under the particular arrangement regarding the use and exploitation of the program. cCSDTI a. Transfer of copyright rights. (emphasis supplied) A transfer of software is classified as a transfer of a copyright right if, as a result of the transaction, a person acquires any one or more of the rights described below: i. The right to make copies of the software for purposes of distribution to the public by sale or other transfer of ownership, or by rental lease or lending; ii. The right to prepare derivative computer programs based upon the copyrighted software; iii. The right to make a public performance of the software; iv. The right to publicly display the computer program; or v. any other rights of the copyright owner, the exercise of which by another without his authority shall constitute infringement of said copyright. The determination of whether a transfer of a copyright right in a software is a sale or exchange of property is made on the basis of whether, taking into account all facts and circumstances, there has been a transfer of all substantial rights in the copyright. A transaction that does not constitute a sale or exchange because not all substantial rights have been transferred will be classified as a license generating royalty income. When only copyright rights are transferred, payments made in consideration therefor are royalties. On the other hand, when copyright ownership is transferred, payments made in consideration therefor are business income. b. Transfer of copyrighted articles. (emphasis supplied) A copyrighted article incorporating a software includes a copy of the software from which the work can be perceived, reproduced, or otherwise communicated, either directly or with the aid of a machine or device. The copy of the software may be fixed in the magnetic medium of a floppy disk or a CD-ROM, or in the main memory or hard drive of a computer, or in any other medium. HcACST If a person acquires a copy of a software but does not acquire any of the rights described above (or only acquires a de minimis grant of such rights), and the transaction does not involve the provision of services or of know-how, the transfer of the copy of the software is classified solely as a transfer of a copyrighted article and payments for which constitute business income. c. After-sales services. Contracts for the use of software are often accompanied with the provision of services ( e.g., installation, maintenance, and customization of the software) by personnel of the relevant foreign licensor/owner of the relevant local subsidiary, reseller, and distributor. Payments as consideration for after-sales service in a mixed contract are not royalties alone, but will include income from services. The appropriate course to take with such a contract is, in principle, to break down, on the basis of the information contained in the contract or by means of a reasonable apportionment, the whole amount of the stipulated payments according to the various parts of what is being provided under the contract, and then to apply to each part of it so determined the taxation treatment proper thereto. Thus, the part of the payments representing the use of the software will be treated as royalties and taxable as such and the other part of the payments representing the provision of services will be treated as income from services and taxable as such. If, however, one part of what is being provided constitutes by far the principal purpose of the contract and the other parts stipulated therein are only of an ancillary and largely unimportant character, then the treatment applicable to the principal part should generally be applied to the whole amount of the consideration. xxx xxx xxx" The substantial difference between the two Circulars lies in the characterization of payment from the purchase of a copyrighted article incorporating a software. Under the first Circular, payment for the purchase of any software is treated as royalties and taxable as such, while under the second Circular, the payment for software may be treated as business income (or business profits) and taxable as such, depending on circumstances as described above. Since what is being transferred to BPI is only a copy of a software for its use, and since there will be no transfer of ownership thereto including pertinent rights protected under relevant intellectual property laws, Revenue Memorandum Circular (RMC) 44-2005, particularly the Section 5b thereof which states that "If a person acquires a copy of a software but does not acquire any of the rights described above (or only acquires a de minimis grant of such rights), and the transaction does not involve the provision of services or of know-how, the transfer of the copy of the software is classified solely as a transfer of a copyrighted article and payments for which constitute business income" will apply to the instant case. TSacAE As you have invoked the provisions of the Philippines-Singapore tax treaty, we apply Article 7 and, in relation thereto, Article 5 of the same tax treaty on the subject fees, which provide: "Article 7 Business Profits 1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on or has carried on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment. xxx xxx xxx" "Article 5 Permanent Establishment 1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business in which the business of the enterprise is wholly or partly carried on. 2. The term 'permanent establishment' includes specially but is not limited to: a) A seat of management; b) A branch; c) An office; d) A store or other sales outlet; e) A factory; f) A workshop; g) A warehouse, in relation to a person providing storage facilities for others; h) A mine, quarry, or other place of extraction of natural resources; i) A building site or construction or assembly project or installation project or supervisory activities in connection therewith, provided such site, project or activity continues for a period more than 183 days; and j) The furnishing of services, including consultancy services, by a resident of one of the Contracting States through employees or other personnel, provided activities of that nature continue (for the same or a connected project) within the other Contracting State for a period or periods aggregating more than 183 days. xxx xxx xxx ." (Underscoring supplied) Based on the aforequoted, the profits of a Singapore enterprise shall be taxable only in Singapore unless such enterprise carries on business in the Philippines through a permanent establishment situated therein. If the Singapore enterprise carries on business as aforesaid, the profits of such enterprise may be taxed in the Philippines but only so much of them as is attributable to that permanent establishment. Applying this to the instant case, the fees received by Softplus from BPI for the services pursuant to the Agreement, shall be taxable in the Philippines only if it has a permanent establishment in the Philippines in connection with the activities giving rise to such income. Inasmuch as it is represented that the services shall not be performed in the Philippines based on the Certification of the Vice President of BPI, then Softplus is deemed not to have a permanent establishment in the Philippines to which payment of the service fees may be attributed and is therefore exempt from Philippine income tax. STcADa 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 Bureau of Internal Revenue Footnotes n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.