ITAD Ruling No. 036-02

April 1, 2002 ITAD RULING NO. 036-02 Article 13, RP-US tax treaty Article 12, RP-Russia tax treaty BIR Ruling No. ITAD-121-00 Laya Mananghaya & Co. Certified Public Accountants and Management Consultants 22/F Antel 1000 Corporate Centre 139 Valero Street, Salcedo Village Makati City 1227 Attention: Remigio A. Noval Partner, Tax and Corporate Services Charlene O. Ang Assistant Manager, Tax and Corporate Services Gentlemen : This refers to your application for relief from double taxation dated October 8, 2001, on behalf of your client, FAZOLI'S SYSTEM, INC. (FSI), requesting confirmation of your opinion that royalties paid by REAL FAST, INC. (RFI) to FSI are subject to the preferential tax rate of 15%, pursuant to Article 13 of the RP-US tax treaty in relation to the RP-Russia tax treaty. It is represented that RFI is a corporation duly organized and existing under the laws of the Philippines with principal office at 7th Floor, Ramcar Center, 80-82 Roces Avenue, Diliman, Quezon City; that FSI is a corporation organized and existing under and by virtue of the laws of the Commonwealth of Kentucky with principal office address at 2470 Palumbo Drive, Lexington, Kentucky, 40509-1117, USA; that FSI is not registered either as a corporation or as a partnership and has not been licensed to do business in the Philippines, as per certification dated October 4, 2001, issued by the Securities and Exchange Commission; that RFI and FSI entered into two (2) agreements, namely: (1) Area Development Agreements (ADA), as amended, dated December 19, 2001, whereby RFI was granted the exclusive rights to develop up to twenty (20) Fazoli's Restaurants in the Philippines, and (2) Site Franchise Agreement (SFA), as amended, dated December 19, 2000, whereby FSI grants RFI, the franchise rights to own and operate a Fazoli Restaurant at an identified location under and utilizing associated Trademarks and Intellectual Property Rights under such agreements, and RFI undertakes to develop, own and operate the restaurants and has or will receive valuable training regarding the promotional, operational, sales and marketing methods and techniques of FSI and its affiliates' system for the operation of Fazoli Restaurants; that the ADA and SFA have complied with the provisions of the Intellectual Property Code on Voluntary Licensing as per Certificate of Compliance Nos. 5-2001-00018 and 5-2001-00017, respectively, dated March 15, 2001 issued by the Intellectual Property Office of the Department of Trade and Industry; and that in consideration of the said grants under the ADA and SFA, RFI shall pay FSI royalties in accordance therewith. In reply, please be informed that under the "most-favored-nation" clause [Article 13, paragraph (2)(b)(iii)] provision 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 Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State. Article 12, paragraph 2 of the RP-Russia tax treaty provides that royalties arising from the Philippines may also be taxed according to its laws, but the tax so charged shall not exceed 15 per cent of the gross amount of royalties. The term "royalties" as used in this Article means any payment of any kind received as a consideration for the use of, or the right to use, any patent, trademark, design or model, secret formula or process, or for the use of, or the right to use of, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience. 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. A perusal of the RP-US and RP-Russia tax treaties, particularly their provisions on the avoidance of double taxation, shows a similarity in 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, your opinion that the royalties paid by RFI to FSI are subject to tax at the rate of 15 per cent pursuant to the "most-favored-nation" provision of the RP-US tax treaty in relation to the RP-Russia tax treaty is hereby confirmed. (BIR Ruling No. ITAD-121-00) Furthermore, under Section 108 of the said Code, the royalty payments to be remitted by RFI is subject to the 10% value-added tax. Section 4.102-1 (b) of Revenue Regulations No. 7-95 provides that: "The VAT on rental and/or royalties payable to non-resident foreign corporations or owners for the sale of services and use or lease of properties in the Philippines shall be based on the contract price agreed upon by the licensor and the licensee. The licensee shall be responsible for the payment of VAT on such rentals and/or royalties in behalf of the non-resident foreign corporation or owner by filing a separate VAT declaration/return (BIR Form No. 1600 Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld) for this purpose. The duly validated VAT declaration/return is sufficient evidence in claiming input tax credit by the licensee." In view of all the foregoing, RFI 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. This ruling is issued based on the foregoing facts as represented. If upon investigation it shall be disclosed that the said facts are different, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service