ITAD BIR Ruling No. 320-14

December 15, 2014 ITAD BIR RULING NO. 320-14 Article 13, Philippines-US tax treaty A.M. Sison Jr. & Partners Law Office Suite 2002-A Security Bank Centre 6776 Ayala Avenue 1226 Makati City Attention: Atty. Atonio L. Cardio Representative Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on 21 March 2013, requesting confirmation of your opinion that the royalty payments made by Hanesbrand Philippines ("HPH") to HBI Branded Apparel Limited ("HBI") , are subject to 10% preferential income tax rate under 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 1 ("Philippines-USA tax treaty") . Facts It is represented that HBI is a foreign corporation organized and existing under the laws of United States, with business address at 1000 East Hanes Mill Road, Winston-Salem, North Carolina as evidenced by the Certificate of Residence dated 04 June 2012, which was authenticated by the Vice Consul of the Republic of the Philippines, for the District of Columbia and the States of Alabama, Florida, Georgia, Kentucky, Maryland, North Carolina, South Carolina, Tennessee, Virginia, and West Virginia, dated 24 January 2013; that HBI 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 dated 04 February 2013; and that, on the other hand, HPH is duly organized and existing under the laws of the Philippines, with business address at Lot 2C Dona Irenea St. Ireneville, I Sucat, Paraaque City. It is further represented that HBI and HPH entered into an Intercompany License Agreement ("Agreement") , effective 01 January 2007, which was subsequently amended on 27 August 2008, whereby HPH shall manufacture, sell and distribute the following products with Trademarks "Products": Trademark Goods ALIVE Class: 25 Int. Hoisery and pantyhose BEEFY-T Class: 25 Int. Shirts BEEFY-T LOGO Class: 25 Int. Men's and boy's T-shirts, T-shirt apart from the mark as shown BODY FORCE Class: 25 Int. Leotards, ankle tights, bike shorts, capri pants, t-shirts, shorts, crop tops, warm-up pants and warm-up tops GIRL'S ATTITUDE Class: 09 Int. Eyewear Class: 14 Int. Watches and timepieces Class: 18 Int. Bags Class: 24 Int. Towels Class: 25 Int. Underwear, boxer shorts, T-shirts, V-neck T-shirts, tank tops, footwear, sleepwear and swimwear HICON PATCH Class: 25 Int. Hosiery, shoes, slippers, socks, pantyhose, tights, leggings, shorts, shirts, pants, sweatshirts, sweatpants, caps, scarves, jackets, sleepwear, gloves, mittens, thermal tops and bottoms, lingerie, T-shirts, briefs, panties and bras HANES Class: 03 Int. Fragrances and toiletries Class: 18 Int. Bags Class: 24 Int. Bedding, towels, comforters, pillow cases and blankets Class: 25 Int. Footwear and shorts Class: 25 Int. Infants', childrens', mens' and ladies' knitted and woven athletic shirts, t-shirts, shorts, briefs, union suits, gym shorts, shirts and drawers, jackets, pants, jerseys, sweaters, sport shirts, sweatshirts, pajamas, sleepers, stretch play suits, rompers, sleeping bags, topper sets, gowns, kimonos, sacques, panties, vests, dress shirts, baseball uniforms, football uniforms, basketball uniforms, athletic uniforms, socks, stockings, anklets, foot socks and pantyhose. HANES BASICS Class: 25 Int. Underwear and T-shirts HANES CLASSICS (STYLIZED) Class: 25 Int. Underwear specifically men's and boy's undershirts, boxers and briefs, and t-shirts HANES HER WAY Class: 25 Int. Panties, lingerie, hats, scarves, gloves, hosiery, tights, shirts, shorts and pants HANES IN DESIGN Class: 25 Int. Thermal tops and bottoms, shirts, underwear for men, women and children HANES Logo Class: 25 Int. Ladies' seamless hosiery HANES SPORT Class: 25 Int. Shirts, sportshirts, T-shirts, shorts, sweatpants, tank tops and muscle shirts RUNNER DESIGN Class: 25 Int. Shirts, sportshirts, T-shirts, shorts, sweatpants, tank tops and muscle shirts It is further represented that HPH shall pay a percentage rate of 5% on the Net Sales of all Licensed Products sold; that HPH paid the royalties to HBI via telegraphic transfer as evidenced by: A. Certificate of Outward Remittance issued by Bank of America N.A., Manila Branch, executed on 22 August 2013, on the following dates and amounts: Period Covered Amount of Royalties Rate Payment Date Remitted Jul. 2011-Sep. 2011 USD65,920.96 43.70 November 29, 2011 Oct. 2011-Dec. 2011 USD95,439.49 42.78 February 24, 2012 Jan. 2012-Jun. 2012 USD188,650.08 42.33 August 30, 2012 B. Certification issued by Citibank N.A. executed on 09 September 2013, covering the period from June 2009 to August 2011, on the following dates and amounts: Value Date Amount (PhP) June 29, 2009 5,148,979.56 May 18, 2010 3,044,546.12 May 25, 2010 2,428,509.73 July 26, 2010 3,085,493.57 February 2, 2011 2,812,788.02 May 23, 2011 3,795,007.09 August 25, 2011 5,820,685.71 C. Certification issued by Citibank N.A. executed on 16 September 2013, covering the period from November 2008 to March 2010, on the following dates and amounts: Value Date Amount (USD) November 17, 2008 278,319.30 November 17, 2008 17,191.48 March 5, 2010 65,438.65 It is finally represented that the transactions subject of this ruling are not subject of 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 executed by the Chief Finance Officer of HPH on 18 March 2013. Ruling A. On income Tax In reply, please be informed that under Section 28 (B) (1) of the National Internal Revenue Code of 1997 ("Tax Code") , as amended, the royalty fees paid to HBI are subject to income tax at the rate of 30 percent, thus: "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 percent (30%) 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." n However, under Section 32 (B) (5) of the Tax Code, such royalty fees may be exempt from income tax or subject to a reduced rate to the extent required by any treaty obligation on the Philippines, thus: TDAcCa "SEC. 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." With respect to a treaty, HBI invoked the most favoured nation clause under Article 13 (2) (b) (iii) of the Philippines-US 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 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. xxx xxx xxx" 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. 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, HBI invoked the Philippines-Czech tax treaty, 2 Article 12 thereof 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; STIHaE 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. xxx xxx xxx" Concerning the first requirement, royalties for the use of the Licensed Trademarks solely in conjunction with the manufacture, marketing, sale and distribution of the products are essentially royalties within the definition of royalties under the article on Royalties of the Philippines-US and the Philippines-Czech tax treaties, to wit: 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-US 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, viz. : 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." In view of the foregoing, the royalty payments made to HBI are subject to preferential tax rate of ten percent (10%) pursuant to Article 13 of the Philippines-US tax treaty in relation to Article 12 of the Philippines-Czech tax treaty. aSITDC B. On value-added tax The royalties paid to HBI, being payments for the use or lease of (intangible) property in the Philippines, is subject to value-added tax (VAT) 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 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%) . . ." 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. Please be guided accordingly. Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner Bureau of Internal Revenue Footnotes 1. Its provisions on taxes apply on income derived or which accrued beginning January 1, 1983. 2. Convention between the Republic of the Philippines and the Czech Republic for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, Date of effectivity of taxes on income: January 1, 2004. n Note from the Publisher: The phrase "and (d) above" no longer appears in RA 9337, the law amending this provision.