ITAD Ruling No. 016-04

February 20, 2004 ITAD RULING NO. 016-04 RP-US, Arts. 13 (2) (b) (iii) RP-China, Art. 12 (2) (b) NIRC, Sec. 108; RMC 46-2002 Sycip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: Joel L. Tan-Torres Tax Division Gentlemen : This refers to your letter dated December 8, 2003, on behalf of your client, Kimberly-Clark Philippines, Inc. (KCPI), requesting confirmation that the royalty payments of KCPI to its licensors, Schweitzer-Mauduit International, Inc. (SMII) and Kimberly-Clark Worldwide, Inc. (KCWI), both residents of the United States of America, are subject to the withholding tax rate of ten percent (10%) pursuant to the "most-favored-nation" clause of the RP-US tax treaty in relation to the RP-China tax treaty. It is represented that SMII is a non-resident foreign corporation duly organized and existing under the laws of the State of Delaware, USA, with executive office located at 1400 Holcomb Bridge Road, Roswell, Georgia 30076-2199, USA; that KCWI is a non-resident foreign corporation duly organized and existing under the laws of the State of Delaware, USA, with executive office located at Neenah, Wisconsin, USA, USA; that SMII and KCWI are not registered either as a corporation or as a partnership and have not been licensed to do business in the Philippines per certifications issued by the Securities and Exchange Commission both dated October 22, 2003; that KCPI is a corporation duly organized and existing under the laws of the Philippines with principal address at 32/F The Enterprise Center, Tower 1, Ayala Avenue, Makati City; that KCPI and SMII entered into a License and Technological and Marketing Assistance Agreement dated December 3, 1996 which was registered with the Intellectual Property Office under Certificate of Registration No. 1518-A dated December 29, 1997; that pursuant to the said Agreement, SMII granted to KCPI the following rights; (1) An exclusive license to use the Licensed Trademarks and Patents in manufacturing, converting and packaging of cigarette papers and other specialty papers in the Philippines and; (2) A non-exclusive license under the Licensed Patents in the distribution and sale of Licensed Products as specified in Appendix A of the Agreement to customers and distributors and through sales representatives of Licensee's choice in the Philippines and elsewhere which are approved by Licensor; that in consideration thereof, KCPI shall pay to SMII royalty at the rate of one and one-half percent (1.5%) on the total new sales of the licensed products in addition to which a payment of one percent (1%) shall be made on total net sales of new cigarette and other specialty papers; that KCPI and KCWI entered into a License and Technical Assistance Agreement dated November 1, 1998, whereby the latter granted the former the following rights; (1) An exclusive nontransferable sublicense, without the right to further sublicense, to use each Licensed Trademark and Patents and the proprietary information obtained by Licensor in connection with the manufacture, conversion, packaging of each licensed products, to wit: tissue paper, table napkins, paper towels, sanitary products, diapers, baby cologne, baby powder, cotton buds and balls and other absorbent products and; (2) A non-exclusive nontransferable sublicense, without the right to further sublicense, to use each Licensed Trademark and Patents and the proprietary information obtained by Licensor in the distribution and sale of each Product in the territory and to Licensor approved outlets in the Export Territory; that in consideration thereof, KCPI shall pay to KCWI, royalty at the rate of two percent (2%) of net sales for tissue products and three percent (3%) of net sales for personal care products. In reply, please be informed that Article 13 of the RP-US 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, of 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 RP-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 the 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. For as long as 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 RP-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.N. 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 the BIR Ruling No. ITAD 109-02 dated May 30, 2002 ) Such being the case, this Office is of the opinion and so holds that the royalty payments of SMII and KWCI under the said License Agreements are subject to final withholding tax at the rate of 10% pursuant to the "most favored nation" provision of the RP-US tax treaty in relation to the RP-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] KCPI 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] aHTCIc Moreover, the said royalty payment by KCPI to SMII and KCWI shall be subject to the 10% value-added tax (VAT) under Section 108 of the Tax Code. Accordingly, KCPI, 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 SMII and KCWI. In remitting the VAT withheld, KCPI shall use 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 documentary substantiation for the claim of input tax by KCPI 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, KCPI is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of SMII and KCWI, the first three copies thereof to be given to SMII and KCWI and the fourth copy to be retained by KCPI 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. 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. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner, Legal Service