ITAD Ruling No. 004-03

January 16, 2003 ITAD RULING NO. 004-03 RP-US tax treaty Art. 13 RP-Russia tax treaty Art. 12 Tax Code of 1997 Sec. 108 BIR Ruling No. ITAD-121-00 Diversion Foods, Inc . DII Bldg., 150 San Vicente Road Brgy. San Vicente, San Pedro, Laguna Attention: Rose J . Santiago Finance Manager Gentlemen : This refers to your letter dated August 28, 2002 requesting confirmation of your opinion that the royalty payments by your company to Carl Karcher Enterprises, Inc. (CKE) are subject to the preferential tax rate of fifteen percent (15%) pursuant to the "most-favored-nation" clause of the RP-US tax treaty in relation to the RP-Russia tax treaty. It is represented that CKE is a non-resident foreign corporation duly organized and existing under the laws of the United States of America with principal office at 1200 North Harbor Blvd. Anaheim, California; that it is not registered either as a corporation or as a partnership and has not been licensed to do business in the Philippines as evidenced by Certificate of Non-Registration issued by the Securities and Exchange Commission dated March 21, 2002; that CKE is the owner of certain trademarks, service marks, trade names, related insignia and trade secrets used in connection with the operation of "Carl's Jr. Restaurants"; that Diversion Foods, Inc. (DFI) is a corporation duly organized and existing under Philippine laws; that on October 10, 1998, a Master Franchise Development Agreement was entered into by and between CKE, through its regional agent, Carl's Jr. Asian Development Corp. Ltd., and DFI (formerly Diversion Industries, Inc.) whereby CKE granted DFI the exclusive right to operate Carl's Jr. Restaurants and the right to use its commercial names, trademarks, related insignia and proprietary information; that under the Agreement, CKE will also provide DFI the support and assistance to enable the latter to own and operate Carl's Jr. Restaurants; and that in consideration of the aforementioned rights granted to DFI, DFI shall pay CKE a royalty of 3.5% to 4.5%, depending on the annual gross sales, based on the gross sales of the licensed restaurants operated by DFI during the 10 year term of the Agreement. In reply, please be informed that Article 13 of the RP-US tax treaty provides as follows: "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) . . . (b) In the case of the Philippines, the least of: (i) 25 percent of the gross amount of the royalties, AIHTEa (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" Under the "most-favored-nation" clause found in Article 13(2)(b)(iii) of the RP-US tax treaty, the tax imposed on royalties derived by a resident of the United States from sources within the Philippines shall be 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. In this light, Article 12 of the RP-Russia tax treaty, which became effective on January 1, 1998, 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, the royalties may also be taxed in the Contracting State in which they arise and according to the laws of the State, but the tax so charged shall not exceed 15 per cent of the gross amount of royalties. "(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 and films and 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. "xxx xxx xxx" 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. Hence, the "most-favored-nation" clause of the RP-US tax treaty must be interpreted not only in relation to Article 12 of the RP-Russia tax treaty but also in connection with the provisions on the elimination of double taxation of both. A perusal of the RP-US and the RP-Russia tax treaties, particularly their provisions on the avoidance of double taxation, shows a similarity on the manner of payment of taxes, that is, the allowable foreign tax credit on both treaties is the amount actually paid in the Philippines. ( BIR Ruling No. ITAD-121-00 dated August 29, 2000 ) Such being the case, and since DFI is not registered and engaged in preferred areas of activities in the Philippines, this Office is of the opinion and so holds that the royalty payments by DFI to CKE are subject to the preferential tax rate of 15% of the gross amount of royalties pursuant to the "most-favored-nation" provision of the RP-US tax treaty in relation to the RP-Russia tax treaty. DFI 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 No. 12-2001 ) Moreover, the above royalty payments to CKE shall be subject to the 10 percent value added tax (VAT) pursuant to Section 108(A)(1) and (3) of the Tax Code of 1997. Accordingly, DFI being the payor in control of the payment shall be responsible for the withholding of VAT on such fees on behalf of CKE by filing a separate VAT return for and on behalf of CKE using BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form 1600 and proof of payment thereof shall serve as sufficient basis for the claim of input tax to be applied against the output tax that may be due from DFI if it is a VAT-registered taxpayer. In case DFI is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased or treated as expense, whichever is applicable. In addition, DFI is required to issue the Certificate of Creditable Tax Withheld at Source (BIR Form 2307) in quadruplicate upon request of CKE, the first three copies thereof to be given to CKE and the fourth copy to be retained by DFI as its file copy. ( Sections 4 & 6, Revenue Regulations 4-2002 ) 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. THaDAE Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service