ITAD Ruling No. 018-01

February 23, 2001 ITAD RULING NO. 018-01 RP-US - Art. 13 RP-Germany - Arts. 12 & 24 Joaquin Cunanan & Co . 14/F Multinational Bancorporation Centre 6805 Ayala Avenue, Makati City Attention: Atty . George J . Lavadia Principal, Tax and Corporate Services Gentlemen : This refers to your letter dated September 22, 1998 on behalf of your client, B&C Philippines, Inc. (Philippine Branch) (B&C), requesting confirmation of your opinion that its royalty payments to Bain & Company, Inc. (BAIN) are subject to the preferential tax rate of ten percent (10%) as provided under the RP-US Tax Treaty. It is represented that BAIN is a non-resident foreign corporation organized and existing under the laws of the State of Massachusetts; that it is not registered as a corporation/partnership in the Philippines as per certification dated September 15, 1998 issued by the Securities and Exchange Commission; that B&C, Inc. Philippines (B&CIP) is likewise a non-resident foreign corporation organized and existing under the laws of the State of Massachusetts; that B&CIP has a branch in the Philippines, B&C; that on January 01, 1998, BAIN entered into a Royalty Agreement with B&C, whereby BAIN will allow B&C to use in the Philippines the professional techniques and know-how, both computerized and not, which have been developed by BAIN relative to consulting systems, strategies, and techniques, as well as the Experience Center, client video workshops, worldwide databases and professional manuals; that in consideration for the grant of such technology and privilege, BAIN shall be entitled to receive royalty payments; and that the Royalty Agreement complies with the provisions of Section 87 and 88 of the Intellectual Property Code (IPC) as certified by the Intellectual Property Office (IPO) under Certificate of Compliance No. 5-1998-00028. Based on the foregoing representations, it is now your opinion that pursuant to Article 13(2)[b](iii) of the RP-US Tax Treaty, which 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) ... ... ... (b) In the case of the Philippines, the least of: (i) 25 percent of the gross amount of 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, trademark, 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 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, considering that the lowest rate given to a third State is 10% as provided in Article 12(2)[b] of the RP-Germany Tax Treaty, 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 law of that State, but the tax so charged shall not exceed: (a) ... ... ... (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. 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" the royalties arising as a consequence of the Royalty Agreement between B&C and BAIN is subject to 10 % final withholding tax since said Agreement is duly registered and approved by the Intellectual Property Office of the Department of Trade and Industry. In reply, please be informed that the above-quoted Article 13(2)(b)(iii) of the RP-US Tax Treaty, otherwise known as the "most favored nation clause", must be interpreted not only in relation to Article 12 of the RP-Germany Tax Treaty but also in connection with Article 24 of the same treaty, to wit: "Article 24 Relief from Double Taxation "1. Tax shall be determined in the case of the resident of the Federal Republic of Germany as follows: xxx xxx xxx "b) Subject to the provisions of German tax law regarding credit for foreign tax, there shall be allowed as a credit against German income and corporation tax payable in respect of the following items of income arising in the Republic of the Philippines, the tax paid under the laws of the Philippines in accordance with this Agreement on: xxx xxx xxx "dd) royalties, as defined in paragraph 3 of Article 12; xxx xxx xxx "c) For the purpose of the credit referred in subparagraph b) the Philippine tax shall be deemed to be xxx xxx xxx "cc) in the case of royalties for which the tax is reduced to 10 or 15 percent according to paragraph 2 of Article 12, 20 percent of the gross amount of such royalties . (Emphasis supplied) xxx xxx xxx The Supreme Court has ruled in Commissioner of Internal Revenue vs. S.C. Johnson and Son Inc. and Court of Appeals (June 25, 1999) that unlike the RP-US Tax Treaty, the RP-Germany Tax Treaty allows a matching credit of twenty percent (20%) of the gross amount of such royalties arising in the Philippines against German income and corporation tax, where the tax rate is reduced to a range of ten to fifteen percent under such treaty. Therefore, the taxes on royalties under the RP-US Tax Treaty are not paid under circumstances similar to those in the RP-Germany Tax Treaty because of the absence of the said matching credit provision in the former convention. In so ruling, the Highest Tribunal further declares: "The purpose of a most favored nation clause is to grant to the contracting party treatment not less favorable than that which has been or may be granted to the 'most favored' among other countries. The most favored nation clause is intended to establish the principle of equality of international treatment by providing that the citizens or subject of the contracting nations may enjoy the privileges accorded by either party to those of the most favored nation. The essence of the principle is to allow the taxpayer in one state to avail of more liberal provisions granted in another tax treaty to which the country of residence of such taxpayer is also a party provided that the subject matter of taxation, in this case royalty income, is the same as that in the tax treaty under which the taxpayer is liable. Both Article 13 of the RP-U S Tax Treaty and Article 12(2)(b) of the RP-W est Germany Tax Treaty, above-quoted, speaks of tax on royalties for the use of trademark, patent and technology. The entitlement of the 10% rate by U.S. firms despite the absence of a matching credit (20% for royalties) would derogate from the design behind the most favored nation clause to grant equality of international treatment since the tax burden laid upon the income of the investor is not the same in the two countries. The similarity in the circumstances of payment of taxes is a condition for the enjoyment of most favored nation treatment precisely to underscore the need for equality of treatment." AICTcE The foregoing Supreme Court decision has become final and executory on September 10, 1999. Moreover, the said decision and its doctrine shall be applied prospectively as provided in BIR Ruling No. 163-99 dated October 20, 1999. Such being the case, your application to avail of the 10% preferential tax rate on royalty payments to be received by BAIN from your client B&C is hereby granted, but only so much of the payments made from January 01, 1998 to September 10, 1999. With respect to royalty payments made after September 10, 1999 and onwards, the 10% tax rate shall no longer be applicable for being contrary to the above-mentioned doctrine. In view of this, a new tax treaty relief application may be filed for transactions covering the said period applying the "most favored nation clause" of the RP-US Tax Treaty in relation with other RP Tax Treaties. Moreover the said royalty payments shall be subject to 10% value-added tax (VAT) pursuant to Section 108(A)(1) and (3) of the Tax Code and that B&C shall, before making payment of royalties to BAIN, withhold and remit to this Bureau the said 10% VAT due thereon, by filing a separate VAT return using BIR Form No. 1600 for and on behalf of BAIN. The duly validated VAT declaration/return is sufficient evidence for B&C in claiming input tax credit. (Section 4.110-3(b) of Revenue Regulation No. 7-95) This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation it will be disclosed that the facts are different, then, this ruling shall be considered null and void. Very truly yours, (SGD.) RENE G. BAEZ Commissioner of Internal-Revenue