ITAD Ruling No. 041-02

April 5, 2002 ITAD RULING NO. 041-02 RP-US, Article 13 RP-Netherlands, Article 12 NIRC, Sec. 108(A)(1) & (3) BIR Ruling No. ITAD-54-00 Quisumbing Torres Law Firm 11th Floor, Pacific Star Bldg. Makati Ave. cor. Sen. Gil Puyat Avenue 1200 Makati City Attention: Atty. Jose R. Sandejas Atty. Franklin Prestuosa Gentlemen : This refers to your letter dated June 14, 2000 requesting confirmation of your opinion that the royalty payments by Schering-Plough Corporation (SPC) and Essex Pharmaceuticals, Inc. (Essex) to your client, Schering-Plough International, Inc. (Schering), are subject to the Philippine tax at the reduced rate of 15 percent pursuant to the " most-favored-nation " clause of the RP-US tax treaty. It is represented that Schering is a non-resident foreign corporation duly organized and existing under the laws of the State of Delaware, USA with principal office address at 200 Galloping Hill Road, Kenilworth, New Jersey, USA; that it is not registered either as a corporation or as a partnership licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated June 7, 2001; that SPC and Essex are domestic corporations duly organized and existing under Philippine laws both with principal office address at 12th Floor San Miguel Properties Centre, St. Francis St., Ortigas Centre, Mandaluyong City; that on April 1, 1994, Schering and SPC entered into a Trademark and License Agreement whereby the former appointed SPC as the importer and processor of Schering substances and products in the Philippines set forth in Schedule A of the Agreement and granted SPC the non-exclusive right to use its trademarks set forth in Schedule B of the Agreement; that the said Agreement was duly registered with the Bureau of Patents, Trademarks and Technology Transfer on September 19, 1994 under Certificate of Registration No. 1614 and valid for ten years from April 1, 1994 to March 31, 2004; that, on the other hand, on August 31, 2000, Schering and Essex entered into a Licensing Agreement whereby the former likewise appointed Essex the importer and processor of Schering substances and products in the Philippines as set forth in Schedule A of the Agreement and granted the non-exclusive right to use its trademarks set forth in Schedule B of the Agreement; that the said agreement shall be effective until December 31, 2004; that the provisions; terms and conditions of the License Agreement between Schering and SPC are the same in all material respect with the provisions, terms and conditions of the License Agreement between Schering and Essex; and that in consideration of the aforementioned rights conferred upon SPC and Essex under their respective Agreements, SPC and Essex shall pay to Schering, on a quarterly basis, a royalty of 5 percent based on the total value of their respective net sales of Schering products. In reply, please be informed that the "most-favored-nation" clause provision of the RP-US tax treaty, as found in Article 13, paragraph (2)(b)(iii), reads as follows: "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 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" On the other hand, Article 12(2)(b) of the RP-Netherlands tax treaty provides: "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 per cent of the gross amount of the royalties in all other cases. "xxx xxx xxx" Based on the foregoing, 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. The royalties arising from the Philippines and paid to a resident of the Netherlands 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 cases other than royalties paid by an enterprise registered in preferred areas of activities in the Philippines. The term "royalties" as used in this Article means any payment of any kind received as a consideration for the use of, or 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. Hence, the "most-favored-nation clause of the RP-US tax treaty must be interpreted not only in relation to Article 12 of the RP-Netherlands tax treaty but also in connection with the provisions on the elimination of double taxation of both. A perusal of the RP-US and the RP-Netherlands tax treaties, particularly their provisions on the avoidance of double taxation, shows that there is 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, and since SPC and Essex are not registered and engaged in preferred areas of activities in the Philippines, this Office is of the opinion and so holds that the royalty payments by SPC and Essex to Schering are subject to the preferential tax rate of 15% of the gross amount of royalties pursuant to the "most-favored-nation" provision of the RP-US tax treaty in relation to RP-Netherlands tax treaty. (BIR Ruling No. ITAD-54-00 dated March 7, 2000) Moreover, the above royalty payments by SPC and Essex 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 the implementing 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, SPC and Essex shall be responsible for the withholding of income tax at the rate of 15% of the gross amount of royalties. Moreover, SPC and Essex shall also be responsible for the withholding of the value-added tax (VAT) at the rate of 10% of the contract amount by filing a separate return using BIR Form No. 1600, which, if duly validated, shall be sufficient evidence in claiming input tax credit. 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