ITAD Ruling No. 029-03

February 6, 2003 ITAD RULING NO. 029-03 RP-US Tax Treaty, Article 13 RP-Netherlands Tax Treaty, Article 12 BIR Ruling No. ITAD 107-01 Fiesta Greetings 160 Alfonso XIII Street San Juan, Metro Manila Attention: Erlinda P. Plaza Chief Accountant Gentlemen : This refers to your letter dated August 20, 2002 requesting for the availment of 15% tax rate on the royalty payments of Fiesta Greetings, Inc. (FGI) to American Greetings, Corporation (AGC) pursuant to the "most favored nation" clause of the RP-US tax treaty in relation to the RP-The Netherlands tax treaty. It is represented that AGC is a non-resident foreign corporation duly organized and existing under the laws of Cleveland, State of Ohio, U.S.A. with office at One American Road, Cleveland, OH 441144; that it is not registered either as a corporation or as a partnership and has not been licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated November 11, 2002; that FGI is a corporation duly organized and existing under Philippine laws with principal office at 160 Alfonso XIII Street, San Juan, Metro Manila; that on April 15, 2000, AGC and FGI entered into a Copyright License Agreement whereby AGC granted to FGI a copyright license to produce copies of such works of authorship all previously published by AGC's parent company; that in consideration for the copyright licensed rights, FGI shall pay a royalty rate at five percent (5%) of Net Sales of Licensed Products as follows: Greetings Cards Gift Wrap Gift Trims Stationery and Notes Calendars Party Goods Decorative Stickers Social Stationery 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, or for information concerning industrial, commercial or scientific experience. The terms 'royalties' also include 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. HcTIDC In this light, Article 12 (Royalties) of the RP-Netherlands Tax Treaty provides, viz: " 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 percent of the gross amount of the royalties in all other cases. (Emphasis supplied) "3. The competent authorities of the States shall by mutual agreement settle the mode of application of paragraph 2. "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. "xxx xxx xxx" 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. A perusal of the RP-US and the RP-Netherlands tax treaty 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 treaties is the amount actually paid in the Philippines. Such being the case, and since AGC is not registered and engaged in preferred areas of activities in the Philippines, royalties arising in the Philippines and payable to FGI are subject to Philippine tax at the rate of 15 per cent (15%) pursuant to Article 13(2)(b)(iii) of the RP-US tax treaty in relation to Article 12(2)(b) of the RP-Netherlands tax treaty. (BIR Ruling No. ITAD 107-01 dated October 30, 2001) Moreover, the above royalty payments to AGC 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, FGI being the payor in control of the payment shall be responsible for the withholding of VAT on such fees on behalf of AGC by filing a separate VAT return for and on behalf of AGC 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 FGI if it is a VAT-registered taxpayer. In case FGI 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, FGI is required to issue the Certificate of Creditable Tax Withheld at Source (BIR Form 2307) in quadruplicate upon request of AGC, the first three copies thereof to be given to AGC and the fourth copy to be retained by FGI as its file copy. (Articles 4 & 6, Revenue Regulations 4-2002) In fine, FGI shall be responsible for the withholding of income tax at the rate of 15% of the gross amount of royalties and the value-added tax at the rate of 10% of the contract amount. AECacS 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. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service