ITAD Ruling No. 021-05

March 11, 2005 ITAD RULING NO. 021-05 Article 13, Philippines-United States tax treaty Article 12, Philippines-China tax treaty Tax Code of 1997, Section 108 RMC No. 46-2002 dated September 2, 2002 BIR Ruling No. DA-ITAD 101-03 Joaquin Cunanan & Co . 29th Floor Philamlife Tower 8767 Paseo de Roxas 1226 Makati City Attention: George J. Lavadia Principal, Tax Services Gentlemen : This refers to your letter dated September 10, 2004, on behalf of your client, Nalco Philippines, Inc. (NPI), formerly Ondeo Nalco Philippines, Inc., requesting confirmation that the license fees paid by NPI to Ondeo Nalco Company (ONC) and Ondeo Nalco Energy Services LP (ONES) are subject to the preferential tax rate of ten percent (10%) as provided for under Article 13(2)(b)(iii) of the Philippines-United States of America (Philippines-United States) tax treaty in relation to Article 12(2)(b) of the Philippines-China tax treaty. It is represented that ONC (now Nalco Company) and ONES (now Nalco Energy Services, Inc.) are nonresident foreign corporations both existing and organized under the laws of the State of Delaware, United States of America; that both are not registered as corporations or partnerships licensed to do business in the Philippines per certifications issued by the Securities and Exchange Commission dated August 2, 2004 and December 29, 2004; that NPI is a corporation organized and existing under the laws of the Philippines with office address at 12th Floor, Asian Star Building, Asian Drive cor. Singapura Lane Filinvest Corporate City, Alabang, Muntinlupa City; that NPI is primarily engaged in the manufacture and sale of certain specialty chemical products and related services in the oil and gas industry and the hydrocarbon processing industries and other related services; that on February 1, 2003, NPI entered into two (2) Technical Assistance and License Agreements (TALAs), one with ONC and the other with ONES; that on June 25, 2004, First Amendments to the two TALAs were signed by the respective parties and made integral part thereof; that under the TALAs, ONC and ONES extended licenses to NPI under their patents, technical information, know-how and trademarks and provided certain assistance and services in accordance with the terms contained therein; that in consideration for the grant of the licenses, ONC and ONES shall each be entitled to receive running license fees equivalent to five percent (5%) of the net sales price of all goods and services sold by NPI; and that the TALAs have been certified by the Intellectual Property Office to comply with the provisions of Sections 87 and 88, Chapter IX, Part II of the Intellectual Property Code on Voluntary Licensing. 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. caTIDE "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 . (Emphasis supplied) 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. "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 cinematography films, or films or tapes for radio or television broadcasting, any patent, trade mark, 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" Pursuant to the aforequoted "most-favored-nation" clause under Article 13(2)(b)(iii) of the Philippines-United States 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 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, pursuant to Article 12(2)(b) of the Philippines-China tax treaty, the tax charged shall not exceed 10% 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. DEHaAS It is noteworthy that 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. DA-ITAD-101-03 dated July 24, 2003) A plain reading of the Philippines-China tax treaty and the Philippines-United States tax treaty provisions on the avoidance of the 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. Such being the case, this Office is of the opinion and so holds that the license fees paid by NPI to ONC and ONES, now Nalco Company and Nalco Energy Services, Inc. respectively, under the two TALAs are royalties subject to the preferential tax rate of 10% based on the gross amount thereof pursuant to Article 13(2)(b)(iii) of the Philippines-United States tax treaty in relation to Article 12(2)(b) of the Philippines-China tax treaty. [(Revenue Memorandum Order No. 46-2002 dated September 2, 2002) (DA-ITAD-101-03 dated July 24, 2003)] Moreover, the subject license fees of NPI to ONC and ONES are subject to 10% value-added tax (VAT) pursuant to Sec. 108 of the Tax Code of 1997. Accordingly, NPI being the resident withholding agent and payor in control of the payment shall be responsible for the withholding of the 10% VAT on such license fees before making any payment to ONC and ONES. In remitting the VAT withheld, NPI 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 the proof of payment thereof shall serve as documentary substantiation for the claim of input tax by NPI upon filing its own VAT return, if it is a VAT-registered taxpayer. In case NPI is a non-VAT registered taxpayer, the passed on VAT withheld shall form part of the cost of the service purchased which may be treated as "expense" or "asset" whichever is applicable. In addition, NPI is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate upon request of ONC and ONES, the first three copies thereof to be given to ONC and ONES and the fourth copy to be retained by NPI as its file copy. [Section 4 & 6, Revenue Regulations (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. aEHTSc Very truly yours, Commissioner of Internal Revenue By: (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal and Inspection Group