ITAD Ruling No. 002-02

January 7, 2002 ITAD RULING NO. 002-02 Article 13, RP-India Tax Treaty ITAD-67-00 Indo Phil Textile Mills, Inc . Unit A 32nd Floor, Rufino Pacific Tower 6784 Ayala Avenue cor Herrera St. Makati City Attention: Mr . B . L . Gupta Senior Finance Manager Gentlemen : This refers to your application for relief from double taxation dated July 9, 2001, requesting confirmation of your opinion that the fees to be paid by Indo Phil Textile Mills, Inc. (IPTMI), Indo Phil Cotton Mills, Inc. (IPCMI) and Indo Phil Acrylic Manufacturing Corp. (IPAMC) to Mr. S.B. Agarwal for expert technical and consultancy services are considered royalties, subject to the preferential tax rate of 15%, pursuant to Article 13 of the RP-India tax treaty, and that said payments are deductible business expenses and subject to the 10% value added tax (VAT), pursuant to the National Internal Revenue Code (Tax Code) of 1997. It is represented that Mr. Agarwal is a citizen and resident of India, and is doing business as a single proprietor under the name and style of "SBA Associates", a company established and registered in India, with address at Sainara, 17 Cuffe Parade, Mumbai 400005, India; that Mr. Agarwal is a textile industry expert with almost 35 years of experience in the business, having held high positions in renowned international cotton firms, and has established a reputation for providing highly reliable and valuable consultancy and advisory services to various textile yarn manufacturing firms located in several countries and his passport states that it is not valid for employment which is an indication that he has no permanent establishment in the Philippines; that IPTMI, IPCMI and IPAMC are corporations duly organized and existing under the laws of the Philippines with office address at Unit A, 32/F, Rufino Towers, 6784 Ayala Avenue, Makati City; that the said corporations are engaged in textile business and are registered with the Board of Investments; that on May 15, 2001, a Service Agreement was entered into by and between Mr. Agarwal and IPTMI, IPCMI and IPAMC; that the said Service Agreement was amended on June 9, 2001; that under the amended Agreement, Mr. Agarwal shall render consultancy services consisting of (1) reviewing plans for the execution and implementation of development plans time schedules and suggesting alternatives for a trouble-free running of the plant, and (2) providing timely market and technical updates on developments in the business of global textile industry as well as developments in yarn business that may be adapted in the business and operations of the said corporations; that Mr. Agarwal has been performing the said services to IPTMI, IPCMI and IPAMC in India effective May 15, 2001 to date as evidenced by the certification submitted by the latter dated October 8, 2001; that the said Agreement shall be effective until December 31, 2001; that in consideration of the said services, Mr. Agarwal shall receive a total amount of One Hundred Twenty Thousand Five Hundred US Dollars (US$120,500) to be paid as follows: US$50,000 on June 30, 2001, US$50,000 on September 30, 2001, and US$20,500 on December 31, 2001; and that the fee will be shared by the corporations as follows: US$50,000 for IPTMI, US$40,000 for IPCMI, and US$30,500 for IPAMC. In reply, please be informed that the RP-India tax treaty provides as follows: "Article 13 "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 be taxed in the Contracting State in which they arise and according to the laws of that State, but if the recipient is the beneficial owner of the royalties, the tax so charged shall not exceed 15 per cent of the gross amount of the royalties provided that such royalties are payable. (i) in the case of the Philippines, by an enterprise which is registered with the Board of Investment, and (ii) in the case of India, by an enterprise in pursuance of any collaboration agreement approved by the government of India. "3. The term 'royalties' as used in this Article means payments of any kind received as a consideration for the use of, or 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 for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning, industrial, commercial or scientific experience . (emphasis supplied). STaCcA xxx xxx xxx It must be noted that the tax treaty defines " royalties " to include "payments of any kind received as a consideration for information concerning industrial, commercial or scientific experience ." According to the Commentaries of the ORGANIZATION FOR ECONOMIC COOPERATION AND DEVELOPMENT (OECD) Committee on Fiscal Affairs on the Model Tax Convention [par. 11, Commentary on Article 12 (Royalties), 1998, p. 151], such information alludes to the concept of "know-how". The definition of know-how, which has been adopted by the said Committee, is " all the undivulged technical information, whether capable of being patented or not, that is necessary for the industrial reproduction of a product or process, directly and under the same conditions; inasmuch as it is derived from experience, know-how represents what a manufacturer cannot know from mere examination of the product and mere knowledge of the progress of technique ." In the know-how contract, one of the parties agrees to impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public. This type of contract thus differs from contracts for the provision of services, in which one of the parties undertakes to use the customary skills of his calling to execute work for the other party. Thus, payments obtained as consideration for after-sales service, for services rendered by a seller to the purchaser under a guarantee, or pure technical assistance, or for an opinion given by an engineer, an advocate or an accountant, do not constitute royalties within the meaning of paragraph 3. Such payments generally fall under Article 7 or Article 15, as the case may be. (BIR Ruling ITAD No. 67-00) Thus, the payments for the said expert technical and consultancy services rendered by Mr. Agarwal to IPTMI, IPCMI and IPAMC under the amended Service Agreement is not within the purview of royalties as defined under Article 13 of the RP-India tax treaty: On the other hand, Article 15 of the same tax treaty provides, viz: "Article 15 "Independent Personal Services "1. Income derived by a resident of a Contracting State in respect of professional services or other independent activities of a similar character shall be taxable only in that State except in the following circumstances when such income may also be taxed in the other Contracting State: a) If he has a fixed base regularly available to him in the other Contracting State for the purpose of performing his activities; in that case only so much of the income as is attributable to that fixed base may be taxed in that other Contracting State; or b) The recipient is present in the other State for period or periods not exceeding in the aggregate 183 days in the relevant 'calendar year' in the case of the Republic of the Philippines or 'previous year' in the case of Republic of India. "2. The term 'professional services' includes especially independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, surgeons, lawyers, engineers, architects, dentists and accountants. Notwithstanding the inclusion of the word "not" in paragraph 1(b) of Article 15, a fair reading of the whole Article and as generally applied in all other tax treaties bearing on similar tax situation, services performed in a Contracting State where the income arises for period or periods not exceeding 183 days in the aggregate during the relevant calendar year is not taxable in that Contracting State. Such being the case, since the subject services were performed by Mr. Agarwal entirely in India, as represented, the same are not taxable in the Philippines pursuant to Article 15(1)(b) of the RP-India tax treaty, contrary to your opinion that the same are royalties subject to the fifteen percent (15%) preferential tax rate under Article 13. Moreover, the payment for the aforementioned services shall not be subject to VAT, pursuant to Section 108(A) of the Tax Code of 1997. Further, the payment of services fees by IPTMI, IPAMC and IPCMI to Mr. Agarwal may qualify as deduction from the former's gross income provided all the requirements for deductibility of an expense under Section 34 of the Tax Code of 1997 are present and that proof is shown that the said services are ordinary, necessary and actually resulted in benefits to the business operation of IPTMI, IPAMC and IPCMI. (BIR Ruling No. ITAD-54-01 dated June 11, 2001). This ruling is issued based on the foregoing facts as represented. If upon investigation, it shall be discovered that the facts are different, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) EDMUNDO P. GUEVARA Deputy Commissioner Legal and Inspection Group