ITAD Ruling No. 003-05

January 6, 2005 ITAD RULING NO. 003-05 Philippines-United States, Article 13 (2) (b) (iii) Philippines-China, Art. 12 (2) (b) NIRC, Sec. 108; RMC No. 46-2002 BIR Ruling Nos. DA-ITAD-16-04; 142-03 Pangilinan Britanico Sarmiento & Franco Law Offices 7th Floor, Banco de Oro Plaza, 8737 Paseo de Roxas, 1226 Makati City Attention: Kennedy B . Sarmiento/ Marie Hope S . Jamero Gentlemen : This refers to your letter dated September 21, 2004, on behalf of your client, Shrimpworks Co., Inc. (Shrimpworks), requesting confirmation that the royalty payments made by Shrimpworks to Bubba Gump Shrimp Co. International, LLC (Bubba Gump) are subject to the withholding tax rate of ten percent (10%) pursuant to the "most-favored-nation" clause of the Philippines-United States tax treaty in relation to the Philippines-China tax treaty. It is represented that Bubba Gump is a non-resident foreign corporation duly organized and existing under the laws of the State of Nevada, USA, with office address located at 940 Calle Negocio Suite 250 San Clemente CA 92673, USA; that it is organized for the purpose of licensing certain rights of operation relating to a chain of sit-down, family-style, full service seafood restaurants known as Bubba Gump Shrimp Co. restaurants as well as related retail merchandise ships attached thereto having a theme based upon the motion' picture, "Forrest Gump";that it is not registered either as a corporation or as a partnership licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated June 16, 2004; that Shrimpworks is a corporation duly organized and existing under the laws of the Philippines with principal address at 20th Floor, 1st E-Bank Building, 8737 Paseo de Roxas, Makati City; that on May 8, 2004, Shrimpworks and Bubba Gump entered into a Franchise Agreement (FA) and an Area Development Agreement (ADA) which were registered with the Intellectual Property Office on September 1, 2004 under Certificate of Compliance Nos. 5-2004-00069 and 5-2004-00068, respectively; that under the Franchise Agreement, Bubba Gump grants to Shrimpworks a franchise for one (1) restaurant in Makati City, Philippines and all areas covered within the 10-mile radius located in the Philippines pursuant to the ADA only: (i) to develop and operate the restaurant; (ii) to use the system and display the trademarks in connection with the restaurant pursuant to the terms and conditions of the Agreement; and (iii) to use and exploit trademarks, on a non-exclusive basis, in connection with the sale of certain articles of merchandise as approved in writing by Bubba Gump, solely at the restaurant; that under the ADA, Bubba Gump grants to Shrimpworks an exclusive right to develop, own and continuously operate three (3) restaurants in the Philippines during the term of the Agreement; that in consideration of the foregoing grant of rights and licenses, Shrimpworks agrees to pay the following to Bubba Gump: (1) Royalties under the Franchise Agreement: (a) Food and Beverages Five percent (5%) of one hundred percent (100%) of the Gross Revenue from sales of food and beverages; (b) Merchandise Ten percent (10%) of one hundred percent (100%) of the Gross Revenue from sales of merchandise (on or off premises);(c) Other Revenue Five Percent (5%) of one hundred percent (100%) of all other Restaurant income, including, without limitation, the gross charges and entertainment revenue from vending machines and the like; and (2) Development Fee under the Area Development Area Fifty Thousand United States Dollars ($50,000),non-refundable, as consideration for the opportunity to develop Bubba Gump Restaurants in the Philippines. In reply, please be informed that Article 13 of the Philippines-United States tax treaty provides, viz : "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 .(Emphasis supplied) "(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. "xxx xxx xxx" and, in relation thereto, Article 12 of the Philippines-China tax treaty provides, viz : "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 recipient is the beneficial owner of the royalties, 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. ADaSEH 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. "xxx xxx xxx" Based on the above-mentioned provisions, the tax imposed on royalties derived by a resident of the United States from sources within the Philippines shall be 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. Relative thereto, it is noteworthy that under Article 12(2)(b) of the Philippines-China tax treaty, the tax charged shall not exceed 10% of the gross amount of royalties. 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 . ITAD 118-01 dated February 23, 2001 and BIR Ruling No . ITAD 109-02 dated May 30, 2002 ) A perusal of the Philippines-United States and Philippines-China tax treaties, particularly their provisions on the avoidance of double taxation, shows a similarity in the manner of payment of taxes, that is, the allowable foreign tax credit on both treaties is the amount actually paid in the Philippines. Such being the case, this Office is of the opinion and so holds that the royalty payments of Shrimpworks under the said Franchise Agreement are subject to final withholding tax at the rate of 10% pursuant to the "most-favored-nation" provision of the Philippines-United States tax treaty in relation to the Philippines-China tax treaty effective January 1, 2002. [ Revenue Memorandum Circular (RMC) No . 46-2002 dated September 2, 2002 ; BIR Ruling No . DA-ITAD 101-03 dated July 24, 2003 ] Shrimpworks shall deduct and withhold the tax at the time the royalty income payment is paid or payable, or the income payment is accrued or recorded as an expense or asset, whichever is applicable, and whichever comes first. The term "payable" refers to the date the obligation become due, demandable, or legally enforceable. [ Section 4 Time of Withholding, Revenue Regulations (RR) No . 12-2001 ] Moreover, the said royalty payments by Shrimpworks to Bubba Gump shall be subject to the 10% value-added tax (VAT) under Section 108 of the Tax Code. Accordingly, Shrimpworks, being the resident withholding agent and payor in control of the payment, shall be responsible for the withholding of the 10% final VAT on such royalty before making any payment to Bubba Gump. In remitting the VAT withheld, Shrimpworks 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 Shrimpworks upon filing its own VAT return, if it is a VAT-registered taxpayer. In case Shrimpworks is a non-VAT registered taxpayer, the passed, on VAT withheld shall form part of the service purchased which may be treated as "expense" or "asset", whichever is applicable. In addition, Shrimpworks is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate upon request of Bubba Gump, the first three copies thereof to be given to Bubba Gump and the fourth copy to be retained by Shrimpworks as its file copy. [ Section 4 & 6, RR No . 4-2000 ; Section 3, RR No . 8-2002 ; Section 7, RR No . 14-2002 ] This ruling is issued on the basis of the facts as represented. However, if upon investigation it shall be disclosed that the facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. cEHITA Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner, Legal Service