ITAD BIR Ruling No. 337-13

December 6, 2013 ITAD BIR RULING NO. 337-13 Article 12 (Royalties), Philippines-Hungary tax treaty Sycip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: Atty. Wilfredo U. Villanueva Authorized Representative Gentlemen : This refers to your tax treaty application ("TTRA") filed on April 19, 2013, requesting confirmation that royalties paid by Del Monte Philippines, Inc. ("Del Monte") to Alcor Hungary Szolgaltato KFT ("Alcor") are subject to income tax at the rate of 10% pursuant to the Convention between the Government of the Republic of the Philippines and the Government of the Republic of Hungary with respect to Taxes on Income, as amended (Philippines-Hungary tax treaty) . THCSAE It is represented that Alcor is a non-resident foreign corporation organized and existing under the laws of Hungary and is a resident thereof for tax treaty purposes with business address at 1074 Budapest, Dohany, Utca 12, Hungary; that it is not registered as a corporation or a partnership in the Philippines per certification of non-registration issued by the Securities and Exchange Commission on April 22, 2013; and that, on the other hand, Del Monte is a domestic corporation organized and existing under the laws of the Philippines with principal address at 2/F Building 3, Bonifacio High Street, Taguig City. It is represented that on March 27, 2013, Alcor and Del Monte entered into a License and Technical Assistance Agreement ("Agreement") which shall last ten (10) years commencing on the agreed effective date of February 1, 2013; that it was agreed that Alcor shall grant to Del Monte an exclusive right and non-transferable sub-license to use the Trade Marks within the Philippines on or in connection with the production, manufacture, sale, distribution, packaging, advertising, and promotion of the Licensed Products within the Philippines; that Alcor shall send competent technicians to advise and assist Del Monte in all aspects of the manufacture, product testing, marketing, distribution and/or sale of Licensed Products; that throughout the existence of the Agreement and for a period of five years thereafter, Del Monte shall receive and maintain all the Licensed Technology as confidential; that in consideration for the rights conferred on and technical assistance made available to Del Monte by Alcor in accordance with the terms of this Agreement, and for the duration of the Agreement, Del Monte agrees to pay Alcor a royalty equivalent to 6% of Net Sales; and that on July 30, 2013 Del Monte through ANZ Manila has effected an outward remittance to ING Bank NV Hungary Branch in favor of Alcor the amount of Five Million Two Hundred Seventy Thousand Six Hundred Forty-Seven and 86/100 US Dollars (US$5,270,647.86). It is finally represented that, per sworn statement issued by Del Monte on April 16, 2013, that the issue or transaction subject of this request for ruling is not under investigation, on-going audit, administrative protest, claims for refund or issuance of a tax credit certificate, collection proceedings, or judicial appeal. 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 royalties derived in the Philippines by a nonresident foreign corporation. It provides: " 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 interest, 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):Provided, That effective January 1, 2009, the rate of income tax shall be thirty percent (30%).(Emphasis supplied) aDICET xxx xxx xxx" However, said income derived by a nonresident foreign corporation may be exempt or partially exempt pursuant to a treaty obligation to which the Philippine government is bound. Thus, Section 32 (B) (5) of the Tax Code of 1997, as amended provides, viz. : "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." Thus, the Philippines-Hungary tax treaty, which you invoked may apply in the herein case. It provides: Article 11 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. Such royalties may also be taxed in the Contracting State in which they arise and according to the laws of that State. However, if the recipient is the beneficial owner of the royalties, the tax so charged shall not exceed the lesser of: a) 15 percent of the gross amount of the royalties, b) the lowest rate of Philippine tax that may, under similar circumstances, be imposed on royalties derived by 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, 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 and includes payments of any kind in respect of motion picture films and works on films or videotapes or video cassettes for use in connection with television or tapes for the use of radio broadcasting. Under Section 2 (b) the above-quoted provision, the Philippines may tax the royalties paid by a resident thereof to a company which is a resident of Hungary at the lowest rate of the Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State, this is also called as the " most-favored-nation " clause. aCcADT For this purpose, Article 12, Section 2 (a) of the PH-Czech tax treaty applies which imposes a tax not exceeding 10 percent of the gross amount of the royalties payable by a Philippine company to a resident of the Czech, 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, 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; 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. In relation thereto, in the case of Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc. and Court of Appeals , G.R. No. 127105, promulgated on June 25, 1999, the Supreme Court interpreted the "most-favored-nation" clause, particularly the phrase "paid under similar circumstances", as referring to the manner of payment of taxes and not to the subject matter of the tax which is royalties. (BIR Ruling No. DA-ITAD-52-03 dated April 8, 2003) In this regard, Article 22 of the Philippines-Hungary tax treaty provides as follows: Article 22 Elimination of Double Taxation xxx xxx xxx 2. In the case of Hungary, double taxation shall be eliminated as follows: a) where a resident of Hungary derives income which, in accordance with the provisions of this Convention may be taxed in the Philippines, Hungary shall, subject to the provisions of sub-paragraphs (b) and (c) exempt such income from tax. IDESTH b) where a resident of Hungary derives items of income which, in accordance with the provisions of Articles 9, 10 and 11 may be taxed in the Philippines, Hungary shall allow as a deduction from the tax on the income of that resident an amount equal to the tax paid in the Philippines. Such deduction shall not, however, exceed that part of the tax, as computed before the deduction is given which is attributable to such items of income derived from the Philippines. xxx xxx xxx On the other hand, Article 22 of the Philippines-Czech tax treaty provides as follows: 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. b) Where in accordance with any provision of the Convention income derived by a resident of the Czech Republic is exempt from tax in the Czech Republic, the Czech Republic may nevertheless, in calculating the amount of tax on the remaining income of such resident, take into account the exempted income. As provided under their respective articles on Elimination of Double Taxation of their tax treaties with the Philippines, Hungary and Czech Republic, both employ the same mechanism in mitigating the effects of double taxation of foreign-sourced income derived by their residents, that is, the ordinary credit method. Under the ordinary credit method, Hungary and Czech (as countries of residence) would limit a taxpayer's allowable tax credit to that portion of the taxpayer's tax liability in their countries that is attributable to the income that is taxed in the Philippines (the country of source or country of situs ).As a result of this limitation, if the Philippines has an effective tax rate that exceeds the effective tax rate of Hungary and Czech on a particular income, Hungary and Czech would not grant the taxpayer a full credit for the income tax imposed by the Philippines on such income. Accordingly, the royalties paid by Del Monte to Alcor are subject to the preferential tax rate of 10 percent based on the gross amount thereof pursuant to the Article 11 of the Philippines-Hungary tax treaty, in relation to Article 12 of the Philippines-Czech tax treaty. As regards the imposition of the VAT on royalties paid to Alcor , please be informed further that Section 108 of the Tax Code of 1997, as amended, provides as follows: HSAcaE "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 the 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%),after any of the following conditions has been satisfied: xxx xxx xxx The phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for others for a fee, ....The phrase 'sale or exchange of services' shall likewise include: (1) The lease or the use of or the right or privilege to use any copyright, patent, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or right; xxx xxx xxx" Accordingly, Del Monte ,being the resident withholding agent and payor in control of the payment, shall be responsible for the withholding of the 12 percent final VAT on such royalty before making any payment to Alcor .In remitting the VAT withheld, Del Monte shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld).The duly filed BIR Form No. 1600 and proof of payment thereof shall serve as documentary substantiation for the claim of input tax by Del Monte upon filing its own VAT return, if it is a VAT-registered taxpayer. In case Del Monte is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of goods or properties purchased which may be treated as an "expense" or as an "asset",whichever is applicable. In addition, Del Monte is required to issue the Certificate of Final Income Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies thereof to be given to Alcor upon its request and the fourth copy to be retained by Del Monte as its file copy. [Section 4.110.3 (b), Revenue Regulations No. (RR) 7-95, as amended by RR 08-02 (now Section 4.114-2, RR 16-05, as amended by RR 04-07)]. This ruling is issued on the basis of the foregoing 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. EHCcIT Very truly yours, (SGD.) KIM S. JACINTO-HENARES Commissioner of Internal Revenue