ITAD Ruling No. 052-03

April 8, 2003 ITAD RULING NO. 052-03 RP-US tax treaty Article 13 RP-Netherlands tax treaty Article 12 BIR Ruling ITAD 41-02 Joaquin Cunanan & Co. 29th Floor, Philamlife Tower 8767 Paseo de Roxas Makati City 1226 Attention: George J. Lavadia Principal, Tax Services Department Gentlemen : This refers to your application for relief from double taxation dated July 11, 2001 on behalf of your client, Nalco Chemical Company Philippines, Inc. (NCCPI), requesting for a refund in the amount of P3,247,106.00, representing the overpaid royalty taxes for the period January 1993 to August 1995, pursuant to the RP-US tax treaty in relation to the RP-Netherlands tax treaty. It is represented that NCCPI is a domestic corporation duly organized and existing under Philippine laws with principal address at 148 Amorsolo Street, Legaspi Village, Makati City; that Nalco Chemical Company (NCC) is a non-resident foreign corporation organized under the laws of the State of Delaware, USA; that per Renewal of Licensing Agreement dated February 8, 1993 between NCC and NCCPI, the latter was granted the right to continue utilizing licensed know-how, patents and trade marks of NCC in the manufacture, sale and use of the specialty chemical products by NCCPI; that NCCPI will pay a fee of five per cent (5%) of its net sales plus a bonus royalty of two per cent (2%) of net foreign exchange earnings; that the Renewal Agreement was registered with the Intellectual Property Office of the Department of Trade and Industry under Certification of Registration No. 1464, valid for five (5) years from February 15, 1993 to February 14, 1998; that during the period January 1993 to August 1995, the royalty payments remitted by NCCPI to NCC were subjected to 25% withholding tax pursuant to Revenue Memorandum Circular No. 39-92; that you are of the opinion that NCCPI is entitled to a refund of overpaid withholding taxes on royalty representing the difference between the 25% tax collected and the 15% tax that ought to have been remitted; that on your November 29, 1999 letter, in case the S.C. Johnson case shall be applied retroactively, the 15% withholding tax rate provided under the tax treaty of the Philippines with The Netherlands may be used in relation to the "most favored nation clause" of the RP-US tax treaty. In reply, please be informed that Article 13(2)[b](iii) of the RP-US tax treaty, provides 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) 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. "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" In relation to the above, 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 "most favored nation" clause found under 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 Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State. Relative thereto, it will be noted that 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 NCCPI is not registered and engaged in preferred areas of activities in the Philippines, this Office is of the opinion and so holds that the royalties paid by NCCPI to NCC under the Renewal 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 RP-Netherlands tax treaty. ( BIR Ruling No. DA-ITAD 41-02 dated April 5, 2002 ) However, the said royalty payments by NCCPI to NCC shall be subject to 10 percent value-added tax (VAT) pursuant to Section 108(A)(1) and (3) of the Tax Code of 1997. The VAT on rental and/or royalties 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 on behalf of the non-resident foreign corporation or owner by filing a separate VAT declaration/return for this purpose. The duly validated VAT declaration/return is sufficient evidence in claiming input tax credit by the licensee (Section 4.102-1(b), Revenue Regulations No. 7-95). Accordingly, NCCPI shall be responsible for the withholding of income tax at the rate of fifteen percent (15%) of the gross amount of royalties and the VAT at the rate of ten percent (10%) of the contract amount. This ruling is issued based on the foregoing facts as represented and is rendered only for the purpose of determining whether NCCPI is entitled to the benefits of the RP-US tax treaty. The determination on whether your request for tax refund should be given due course is upon the Office which will be conducting the investigation for that purpose. Thus, the docket pertaining thereto (including a copy of this ruling) shall be indorsed to the proper Office for processing and investigation. DSAICa Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service