ITAD BIR Ruling No. 364-12

October 24, 2012 ITAD BIR RULING NO. 364-12 Article 12 (Royalties) Philippines-Germany tax treaty Alba Romeo and Co. 7th Floor, Multinational Bancorporation Centre 6805 Ayala Avenue Makati City Attention: Atty. Prackie Jay T. Acaylar Senior Tax and Legal Consultant Gentlemen : This refers to your tax treaty relief application ("TTRA") filed on March 14, 2012 requesting confirmation that royalties paid by Software AG (Philippines), Inc. ("Software Philippines") to Software AG ("Software") are subject to income tax at the rate of 10 percent pursuant to the Agreement between the Republic of the Philippines and the Federal Republic of Germany for the Avoidance of Double Taxation with Respect to Taxes on Income and Capital ("Philippines-Germany tax treaty") . Facts Software is a foreign corporation and a resident of Germany based on its amended Articles and Memoranda of Association and on the Certificate of Residence issued by the German tax authorities on November 4, 2011. Software is located at Uhlandstrabe 12, Darmstadt, Germany. It 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 February 7, 2012. On the other hand, Software Philippines is a domestic corporation located at Unit 2202-2204, Robinsons-Equitable PCI Bank Tower, ADB Avenue corner Poveda Street, Barangay San Antonio, Pasig City, Philippines. On January 1, 2008, Software Philippines and Software entered into a Cooperation Agreement where Software grants Software Philippines an exclusive right to grant sublicenses in the Philippines to use software products belonging to and developed by Software (or its subsidiaries) and to provide maintenance services on these products. Maintenance refers to the provision of new versions, new releases and periodic fixes and error corrections for the software products. Also, Software grants Software Philippines the right to use its trademarks, service marks and trade names identifying or used in connection with the software products or its business. In consideration, Software Philippines will pay royalties to Software based on the net turnover of the software products and the maintenance services, to wit: HEIcDT Category of Product SAP Code Royalty on Royalty on License Maintenance Software's Global Product 01 30 percent 40 percent Product is transferred into Software's Global 04 0 0 Product based on a board Resolution (for the first two years after transfer of IPR) Product is transferred into Software's Global 05 30 percent 40 percent Product based on a board Resolution (for the third year and onwards) Third party product if not determined as 03 0 0 Software's Global Product Local product and local third party product 02 0 0 Product is sold by a Software's subsidiary 06 25 percent 35 percent Product sold by a subsidiary is transferred into 04 10 percent 10 percent Software's Global Product based on a board Resolution (for the first two years after transfer of IPR) Product sold by a subsidiary is transferred into 05 0 0 Software's Global Product based on a board Resolution (for the third year and onwards) The royalties are computed monthly and payable within thirty days after receipt of the relevant invoice from Software . The Agreement took effect on January 1, 2008 and will remain in effect for an initial period of one year; thereafter, the Agreement will be automatically renewed for successive periods of one year. The Agreement complies with the provisions of the Intellectual Property Code on voluntary licensing under Certificate of Compliance No. 5-2008-00072 issued by the Intellectual Property Office on July 31, 2007, valid on January 1 to December 31, 2008. The Agreement was amended on January 1, 2009 for the primary purpose of renewing the Agreement and modifying the amount of service fees payable by Software Philippines to Software . The amended Agreement likewise complies with the provisions of the Intellectual Property Code on voluntary licensing under Certificate of Compliance No. 5-2010-00004 issued on April 19, 2010, valid on January 1 to December 31, 2010, and under Certificate of Compliance No. 5-2010-00079 issued on December 3, 2010, valid on January 1 to December 31, 2010. Ruling In reply, please be informed that under Section 14 of Revenue Memorandum Order No. 72-2010 (Guidelines on the Processing of Tax Treaty Relief Applications (TTRA) Pursuant to Existing Philippine Tax Treaties) ("RMO 72-2010") , which covers income derived or accrued on November 4, 2010 and thereafter , 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 before the intended transaction or payment of income, to wit: HADTEC " SEC. 14. When and Where to File the TTRA. All tax treaty relief applications (updated BIR Forms No. 0901-D, 0901-I, 0901-R, 0901-P, 0901-S, 0901-T, 0901-O and 0901-C) relative to the implementation and interpretation of the provisions of Philippine tax treaties shall only be submitted to and received by the International Tax Affairs Division (ITAD). If the forms or any necessary documents are submitted to any other BIR Office, the application shall be considered as improperly filed. Filing should always be made BEFORE the transaction. Transaction for purposes of filing the TTRA shall mean before the occurrence of the first taxable event . Failure to properly file the TTRA with ITAD within the period prescribed herein shall have the effect of disqualifying the TTRA under this RMO ." (Emphasis ours) In relation thereto, Revenue Memorandum Order No. 1-00 (Procedures for Processing Tax Treaty Relief Application) ("RMO 1-2000") , which covers income derived or accrued before November 4, 2010 , provides that any availment of relief shall be preceded by an application filed at least fifteen days before the intended transaction or payment of income, to wit: " 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 is 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: TcAECH " 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 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) . cICHTD In view of the foregoing, since the amended Agreement that gives rise to the royalties has been in effect since January 1, 2008 , but the TTRA for this purpose was filed only on March 14, 2012 , this Office hereby DENIES relief on all royalties paid by Software Philippines to Software on and before March 14, 2012 , pursuant to Section 14 of RMO 72-2010 and Section III (2) of RMO 1-2000. Accordingly, said royalties 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, royalties paid to Software on March 15, 2012 and thereafter are subject to a reduced rate of income tax under Article 12 of the Philippines-Germany tax treaty, which 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 law of that State, but the tax so charged shall not exceed: a) 15 per cent of the gross amount of royalties arising from the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films or tapes for television or broadcasting, or b) 10 per cent of the gross amount of royalties arising from the use of, or the right to use, 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. DHaEAS For as long as the transfer of technology, under Philippine law, is subject to approval, the limitation of the tax rate mentioned under (b) shall, in the case of royalties arising in the Republic of the Philippines, only apply if the contract giving rise to such royalties has been approved by the Philippine competent authorities. 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 cinematograph films or tapes for television or 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." Under Article 12, royalties arising in the Philippines and paid to a resident of Germany may be taxed in the Philippines at a rate not to exceed (a) 15 percent if the royalties are in respect of the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films or tapes for television or broadcasting, and (b) 10 percent if the royalties are in respect of the use of, or the right to use, 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 (" know-how "), provided the contract giving rise to the royalties has been approved by the Philippine competent authorities. Accordingly, since the amended Agreement grants Software Philippines the right to use Software 's trademarks, service marks and trade names identifying or used in connection with software products belonging to and developed by Software (or its subsidiaries) and which will be sublicensed by Software Philippines to third parties, payments arising therefrom constitutes royalties for the use of trademark . Moreover, since the Agreement has been approved by the Intellectual Property Office of the Philippines, such royalties paid by Software Philippines to Software on March 15, 2012 and thereafter shall be subject to income tax at the rate of 10 percent , under paragraph 2 (b), Article 12 of the Philippines-Germany tax treaty. Finally, under Section 108 (A) of Tax Code, the royalties in question, being payments for the use of trademark 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%) . . ." CaHcET Relative thereto, Software Philippines shall withhold VAT on the royalties at the rate of 12 percent before remitting them to Software . Software 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 Software 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."