ITAD Ruling No. 040-02

April 2, 2002 ITAD RULING NO. 040-02 RP-US, Arts. 13 & 23 RP-Denmark, Arts. 12 & 23 NIRC, Sec. 108 (A)1 & 3 BIR Ruling No. DA-ITAD-046-01 Punongbayan & Araullo Ernst & Young International 20th Floor, Tower 1 6766 Ayala Avenue 1200 Makati City Attention: Ms. Marivic C. Espao Tax Partner Gentlemen : This refers to your letter dated June 26, 2001, on behalf of your client, SAS INSTITUTE (Philippines), INC. ("SAS-Phil"), requesting confirmation that the royalty payment of SAS-Phil to SAS INSTITUTE INC. ("SAS-US") is subject to the withholding tax rate of fifteen percent (15%) pursuant to the "most-favored-nation" clause of the RP-US tax treaty [Article 13(2)(b)(iii)] in relation to the RP-Denmark tax treaty. It is represented that SAS-US is a corporation organized and existing under the laws of the State of North Carolina, USA; that it is not licensed to engage in business in the Philippines per Securities and Exchange Commission (SEC) certification dated February 28, 2001; that SAS-Phil, on the other hand, is a subsidiary of SAS-US organized and existing under the laws of the Philippines, registered with the SEC under Registration No. 189609 dated April 22, 1991; that SAS-Phil is primarily engaged in the business of servicing and licensing SAS System Computer Software, providing training, developing computer programs, dealing with computer systems, software; hardware, literature and supplies either as principal or agent; that on December 01, 1998, SAS-Phil and SAS-US entered into a Master License Agreement whereby the latter grants the former the right to market, sublicense and distribute certain commercial software and publications of the latter; that in consideration for the grant of license, SAS-Phil agreed to pay SAS-US, on a monthly basis or as otherwise provided, a percentage of the fees that may be collected from the customers, calculated as fifty percent (50%) of the appropriate first year license fee, 50% of the appropriate renewal license fee, and 50% of the appropriate upgrade fee, according to the applicable Institute License Fee Schedule. Based on the foregoing, it is your opinion that pursuant to Article 13 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) 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, considering that the lowest rate given to a third State is 15% as provided in Article 12(2) of the RP-Denmark 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, the 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 15 per cent of the gross amount of the royalties. The competent authorities of the Contracting States may by mutual agreement settle the mode of application of this limitation." the payments made by SAS-Phil to SAS-US pursuant to the Master License Agreement are royalties subject to 15% preferential withholding tax. In reply, please be informed that under the provisions of the RP-US tax treaty on the definition of royalties, the payments of SAS-Phil to SAS-US for the latter's grant of the right to sublicense and market the software are considered royalties. Moreover, under the "most favored nation" clause [Article 13(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(2) of the RP-Denmark tax treaty provides that royalties arising from the Philippines and paid to a resident of Denmark may also be taxed in the Philippines but the tax so charged shall not exceed 15 per cent 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. 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. Thus, under the most favored nation clause of the RP-US tax treaty, U.S. recipients of royalty income are not entitled to the lower rate of 10% enjoyed by the German recipients under the RP-West Germany tax treaty as it was declared that the payment of taxes was made under different circumstances. Moreover, the aforementioned decision and its doctrine are applied prospectively. (BIR Ruling No. 163-99 dated October 20, 1999) A perusal of the RP-US and RP-Denmark tax treaties, particularly their provisions on the avoidance of double taxation, shows 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 royalty payments of SAS-Phil. to SAS-US under the Master License Agreement are subject to tax at the rate of 15% pursuant to the "most favored nation" provision of the RP-US tax treaty in relation to the RP-Denmark tax treaty. (BIR Ruling No. ITAD-046-01 dated May 11, 2001) Moreover, the said royalty payments shall be subject to the 10% value-added tax (VAT) under Section 108(A)(1) and (3) of the Tax Code of 1997. Section 4.102-1(b) of Revenue Regulation 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." Accordingly, SAS-Phil. shall, before making payment of royalties to SAS-US, withhold and remit to this Bureau the value-added tax at the rate of 10% of the contract amount and the income tax at the rate of 15% of the gross amount of royalties. This ruling is issued on the basis of the foregoing facts as represented. However, if upon investigation it shall be disclosed that the 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