ITAD Ruling No. 044-03

March 10, 2003 ITAD RULING NO. 044-03 Art. 12, RP-Netherlands BIR Ruling No. DA-ITAD 152-00 Siguion Reyna Montecillo & Ongsiako 4th and 6th Flrs. Citibank Center 8741 Paseo de Roxas Makati City Attention: Rafael E. Khan Jocelyn R. Esguerra Gentlemen : This refers to your letter dated January 23, 2002 seeking confirmation of your opinion that the royalties and service fees paid by Swedish Match Philippines, Inc. (SMP) to Swedish Match Lighters, BV (SMLBV) are subject to ten per cent (10%) preferential tax rate under the RP-Netherlands tax treaty. TECcHA It is represented that SMLBV is a non-resident foreign corporation duly organized and existing under the laws of The Netherlands, with office address at A.H.G. Fokkerstraat 5-NL-9403 AM Assen, The Netherlands; that it is not registered either as a corporation or as a partnership and has not been licensed to do business in the Philippines as evidenced by the Certificate of Non-Registration issued by the Securities and Exchange Commission dated February 8, 2002; that SMP is a corporation duly organized and existing under the Philippine laws with office address at Phimco Compound, F. Manalo St., Sta. Ana, Manila; that SMP is registered with the Board of Investment as an expanding producer of gas helper and energy cell products on a preferred non-pioneer status per Certificate of Registration No. 87-1285 dated February 18, 1987 and Certificate of Registration No. EP-90-756 dated February 12, 1991; that SMP and SMLBV entered into a Sub-License Agreement dated September 10, 1999 whereby SMP was granted the use of "CRICKET" technology and trade name for a consideration of US$465,000 for the period January 1, 2000 to December 31, 2000 and US$350,000 for January 1, 2001 onwards, per succeeding calendar years; that SMP and SMLBV also entered into a Management Services Agreement dated March 1, 2000 whereby SMLBV shall provide continuing advice and assistance to SMP in the areas of general management, human resources, finance, data processing, quality control, engineering, warehousing and distribution, purchasing and business development of manufacturing facilities; that under the said contract, SMP will pay SMLBV service fees computed according to the formula provided in the agreement; and that pursuant to said Management Service Agreement, two employees of SMLBV in the name of Hendrik Otten and Johan Willem Kleijn were assigned to SMP to perform the services for a period not exceeding 180 days as shown in the attached photocopies of their passports. Invoking BIR Ruling No. DA-ITAD 152-00 dated October 30, 2000, the service fees paid under the Management Services Agreement constitute royalties, in accordance with Article 12(2)(a) of the RP-Netherlands tax treaty and as such are subject to the preferential tax rate of 10 per cent (10%). In reply, please be informed that Article 12 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 per cent of the gross amount of the royalties in all other cases. "xxx xxx xxx "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." Based on the aforequoted provisions, the royalty payments will be taxed at a rate not to exceed 10% of the gross amount if the payer is an enterprise registered and engaged in preferred areas of activities and, in all other cases, fifteen percent (15%) of the gross amount of the royalties. Inasmuch as SMP is registered with the BOI as preferred non-pioneer enterprise in the production/manufacture and export of its products, this Office hereby confirms your opinion that the royalty payments under the Sub-License Agreement by SMP to SMLBV are subject to the preferential tax rate of 10% of the gross amount of royalties pursuant to Article 12(2)(a) of the RP-Netherlands tax treaty. (BIR Ruling No. DA-ITAD 152-00 dated October 30, 2000) It will be noted that, in classifying as royalties payments received in consideration for information concerning industrial, commercial, or scientific experience, paragraph 2 alludes to the concept of "know-how" which is all the undivulged technical information, whether capable of being patented or not, that is necessary for the industrial reproduction of a product or process, directly and under the same conditions; inasmuch as it is derived from experience, know-how represents what a manufacturer cannot know from mere examination of the product and mere knowledge of the progress of technique." In the know-how contract, one of the parties agrees to impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public. This type of contract thus differs from contracts for the provision of services in which one of the parties undertakes to use the customary skills of his calling to execute work himself for the other party. Thus, payments obtained as consideration for "after-sales service", for services rendered by a seller to the purchaser under a guarantee, for pure technical assistance, or for an opinion given by an engineer, an advocate or an accountant, do not constitute royalties within the meaning of paragraph 4 of Article 12 of the RP-Netherlands Tax Treaty. Such payments generally fall under Article 7 or Article 14. Under the Management Service Agreement, there is no transfer of technology in this country as the service fees to be paid by SMP to SMLBV constitute as payment for the aforementioned technical support services performed in the Philippines which fees shall not be considered as royalties but shall constitute compensation for labor or personal service performed in the Philippines and therefore considered income from sources within the Philippines pursuant to Article 42(A)(4)(f) of the Tax Code of 1997. In this connection, Article 5(2)(h) of the RP-Netherlands tax treaty, in relation to Section 28(B)(1) of the Tax Code of 1997, provides that notwithstanding the absence of a fixed place of business, a permanent establishment may still be deemed to exist should the duration of stay of the enterprise's personnel in the Philippines through whom the services of said enterprise are rendered exceeds in the aggregate 183 days within any twelve-month period. Documents presented show that SMLBV sent only two personnel in the name of Hendrik Otten and Johan Willem Kleijn who performed the services stipulated under the Management Service Agreement whose duration of stay in the Philippines did not exceed in the aggregate 183 days within a twelve-month period. Such being the case and considering that SMLBV has no permanent establishment in the Philippines, this Office is of the opinion and so holds that the services fees paid by SMP to SMLBV are exempt from Philippine income tax and consequently to the withholding tax under Section 28(B)(1) of the Tax Code of 1997. HDTSCc Moreover, the royalty payments and the service fees for the actual services rendered in the Philippines paid by SMP to SMLBV are subject to 10% value-added tax pursuant to Section 108 of the Tax Code of 1997. Accordingly, SMP, being; the resident withholding agent and payor in control of payment shall be responsible for the withholding of the 10% final VAT on such fees before making any payment to SMLBV. In remitting the VAT withheld, SMP shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax & Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and proof of payment thereof shall serve as documentary substantiation for the claim of input tax to be applied against the output tax that may be due from SMP if it is a VAT-registered taxpayer. In case SMP 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", or "asset" whichever is applicable. In addition, SMP is required to issue the Certificate of Creditable Tax Withheld at Source (BIR Form No. 2307) in quadruplicate upon request of SMLBV, the first three copies thereof be given to SMLBV and the fourth copy to be retained by SMP as its file. [Sections 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 of RR 8-2002; Section 7 of RR 14-2002] As regards the salaries which Mr. Otten and Mr. Kleijn of SMLBV may derive in rendering technical assistance to SMP, Article 15 of the same tax treaty provides: " ARTICLE 15 DEPENDENT PERSONAL SERVICES "1. Subject to the provisions of Article 16, 17, 18, 19 and 20 salaries, wages and other similar remuneration derived by a resident of one of the States in respect of an employment is exercised in the other State. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other State. "2. Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of one of the States in respect of an employment exercised in the other State shall be taxable only in the first-mentioned State if: a) the recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in the fiscal year concerned, and b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State, and c) the remuneration is not borne by a permanent establishment or a fixed base which the employer has in the other State. "xxx xxx xxx" Thus, the salaries, wages or similar remuneration which Mr. Otten and Mr. Kleijn may derive in rendering technical assistance to SMP in the areas of general management, human resources, finance, data processing, quality control, engineering, warehousing and distribution, purchasing and business development of manufacturing facilities from January 1, 2000 onwards, may be exempt from Philippine income tax if all the conditions set forth in subsections (a) (b) and (c) of Article 15(2) are satisfied. Otherwise, the said income shall be subject to the rate of tax provided for under Section 25(A) as non-resident alien engaged in trade or business within the Philippines or Section 24(A)(1)(c) as resident alien, both of the Tax Code of 1997, as the case may be. (BIR Ruling No. ITAD 141-00) 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