ITAD Ruling No. 015-01

February 16, 2001 ITAD RULING NO. 015-01 Arts. 1, 3, 12 & 27 RP-Netherlands Law Offices Platon Martinez Flores San Pedro & Leao 6th and 7th Floors, Tuscan Building, 114 Herrera street Legaspi Village, Makati City Attention: Atty . Carlos G . Platon and Atty . Anthony Brett M . Abenir Gentlemen : This refers to your letter dated November 11, 1998, requesting confirmation of your opinion that remittances made to Subway Partners C . V . ( SPCV ) by the Franchisee , Mr. Edison Liang and Ms. Tiffany G. del Rosario, are subject to the preferential tax rate of 15 percent pursuant to Article 12 (Royalties) of the Philippines-Netherlands Tax Treaty. DACTSH It is represented that SPCV is a limited partnership organized and existing under the laws of the Netherlands Antilles with principal office located in Curacao, the Netherlands Antilles; that on October 28, 1996, a Franchise Agreement was entered into by and between SPCV (the " Company ") and Mr. Edison Liang and Ms. Tiffany G. del Rosario (the " Franchisee "), both individual residents of the Philippines; that under the Agreement , the Company grants to the Franchisee : (a) access to the Company's licensed recipes, formulas, food preparation procedures, business methods, business forms, business policies and body of knowledge pertaining to the operation of a sandwich shop, including the loan of a copy of the Company's Operations Manual; (b) access to information pertaining to new developments and techniques in the Company's sandwich business; and (c) a limited non-exclusive license to use of the Company's licensed rights in and to its services marks and trademarks in connection with the operation of one sandwich shop to be located at a site approved by the Company and the Franchisee ; that the Franchise Fee, Weekly Royalty (equal to 8 percent (8 %) of the gross sales from each sandwich shop which it operates throughout the term of the Agreement ), and the other promises by the Franchisee contained in the Agreement constitute the sole consideration to the Company for the use by the Franchisee of its licensed body of knowledge, systems and trademark rights. Based on the foregoing, it is your opinion that royalties to be paid by the Franchisee to SPCV are subject to a tax rate of 15 percent pursuant to paragraph 2(b), Article 12 of the Philippines-Netherlands Tax Treaty: "Article 12 ROYALTIES 1. Royalties arising in one of the States and paid to a resident of the other State may be taxed in that other State. 2. However, such royalties may also be taxed in the 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) 10 per cent of the gross amount of the royalties where the royalties are paid by an enterprise registered, and engaged in preferred areas of activities in that State; and b) 15 per cent of the gross amount of the royalties in all other cases. 3. . . . 4. 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 radio or television 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." EHASaD xxx xxx xxx" In reply thereto, please be informed of paragraph 1, Article 3 of the same Treaty. "Article 3 GENERAL DEFINITIONS 1. In this Convention, unless the context otherwise requires: a) the term "State" means the Netherlands or the Philippines, as the context requires; the term "States" means the Netherlands and the Philippines; b) the term "the Netherlands" comprises the part of the Kingdom of the Netherlands that is situated in Europe and the part of the sea bed and its sub-soil under the North Sea, over which the Kingdom of the Netherlands has sovereign rights in accordance with international law; c) the term "Philippines" used in a geographical sense means the national territory comprising the Republic of the Philippines; xxx xxx xxx" A perusal of paragraphs 1(a), 1(b) and 1(c), Article 3 of the Convention between the Republic of the Philippines and the Kingdom of the Netherlands for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (hereinafter referred to as the "Convention" or the "Treaty") reveals that the Contracting States to the Treaty are the Republic of the Philippines and "the Kingdom of the Netherlands that is situated in Europe." DTAHSI It is general knowledge that the Charter of the Kingdom of the Netherlands, drawn up in 1954, sets out the ties that bind the Kingdom's three partner countries, namely: the Netherlands in Europe, the Netherlands Antilles (comprising Bonaire, Curacao, Saba, St. Eustatius and St. Maarten), and Aruba; the last two island countries are situated north of Venezuela within the vicinity of the Caribbean Sea and the Gulf of Mexico. Since 1986, these three countries have had equal representation in the Kingdom, similar to that of a federation. Generally, the Kingdom concludes international agreements on behalf of the partner governments affected, but in close collaboration with them. In relation to the foregoing, it must be noted, however, that paragraph 1 of Article 27 in relation to Article 3(1)(b) of the said Convention provides; "Article 27 TERRITORIAL EXTENSION 1. This Convention may be extended either in its entirety or with any necessary modifications to the Netherlands Antilles and/or to Aruba. 2. . . ." Article 27 is not self-executory. As evident in the language used, "[t]his Convention may be extended either in its entirety or with any necessary modifications to the Netherlands Antilles . . . (emphasis supplied)," it is incumbent upon the Contracting States (the Philippines and the Netherlands in Europe) to perform the operative act of bringing the Netherlands Antilles within the scope of the said Convention. This may be accomplished either by way of exchange of diplomatic notes or by way of formally negotiating a Protocol. This explanation is concordant with Article 31 of the Vienna Convention on the Law of Treaties which provides that, "[a] treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose." At this juncture, it may be well to add that definitions in a treaty are carefully drafted precisely to avoid the need for interpretation. If the Contracting States did in fact intended to automatically extend the coverage of the Convention to the Netherlands Antilles and Aruba, in that case those States could have readily included the territories in question in the definition of the territory of the "Kingdom of the Netherlands" under Article 3(b) without the necessity of adding Article 27. Moreover, a treaty for the avoidance of double taxation is in the nature of a tax exemption which should be construed in strictissimi juris . ACcISa As of the moment, the Republic of the Philippines and the Kingdom of the Netherlands have not exchanged diplomatic notes yet on the matter or negotiated a Tax Protocol to bring the Netherlands Antilles and Aruba within the purview of the Convention. Such being the case, royalties to be paid by the Franchisee , Mr. Edison Liang and Ms. Tiffany G. del Rosario, to SPCV , a resident of Netherlands Antilles, are subject to thirty-two percent (32%) tax on royalties under Section 28(B)(1) of the National Internal Revenue Code of 1997 ( Tax Code of 1997 ), contrary to your opinion that such royalties are subject to the preferential tax treaty rate of fifteen percent (15%). Finally, the royalty payments of the Franchisee to SPCV are subject to 10 percent (10%) VAT imposed under Section 108(A)(3) of the Tax Code of 1997 based on the contract price. The Franchisee shall be responsible for the payment of VAT on the royalties on behalf of SPCV by filing a separate VAT declaration/return using BIR Form 1600. The duly validated VAT declaration/return is sufficient evidence in claiming input tax credit. (Section 4.102-1(b) of Revenue Regulations No. 7-95) Very truly yours, (SGD.) RENE G. BAEZ Commissioner of Internal Revenue