ITAD Ruling No. 062-02

April 24, 2002 ITAD RULING NO. 062-02 RP-US Article 13 & 23 RP-Denmark Article 12 & 23 Sec. 108 of NIRC of 1997 RR No. 7-95 Punongbayan & Araullo 20TH Floor, Tower I The Enterprise Center 6766 Ayala Avenue 1200 Makati City, Phils. Attention: Atty. Vic C. Mamalateo Tax Partner Gentlemen : This refers to your letter dated April 3, 2001, requesting for the issuance of a ruling confirming your opinion that the payments made by Sybase-Phils to Sybase-US are royalty payments subject to the 15% preferential tax rate under Article 13, paragraph 2(b)(iii) of the RP-United States tax treaty in relation to Article 12, paragraph 2 of the RP-Denmark tax treaty, and that the royalty payments remitted by Sybase-Phils to Sybase-US are subject to 10% value added tax (VAT). It is represented that Sybase-US is a corporation duly organized and existing under and by virtue of the laws of the United States of America, and is not registered either as a corporation or as a partnership and not licensed to do business in the Philippines as evidenced by Certificate of Non-Registration issued by the Securities and Exchange Commission dated April 4, 2001; that Sybase-Phils is a corporation duly organized and existing under and by virtue of the laws of the Philippines and is primarily engaged in the design, development, manufacture, production, localization, duplication, promotion, licensing, distribution and support of software products; that on March 12, 1996, Sybase-Phils and Sybase-US entered into an Inter-company Distribution Agreement whereby Sybase-US granted Sybase Phils the right to market, sub-license, distribute and sell certain commercial software of the former; and that in consideration of the license, Sybase-Phils agreed to pay Sybase-US on a quarterly basis an amount equal to forty percent (40%) of the actual price charged by Sybase-Phils to its consumers and resellers for the software. In reply, please be informed that Article 13 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" The RP-US tax treaty also speaks of 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 ." This is known as the most-favored-nation clause of the RP-US tax treaty. The purpose of a most favored nation clause is to grant the Contracting State treatment no less favorable than that which has been or may be granted to the "most favored" among other countries. Therefore, the tax treatment of royalty payment to a US entity must be taken in relation with other Philippine tax treaties which provide for the lowest rate. Article 12 of the RP-Denmark tax treaty provides as follows: "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 in which they arise and according to the laws of that State, but if the recipient is the owner of the royalties, the tax so charged shall not exceed 15 percent of the gross amount the royalties. "The competent authorities of the Contracting State may by mutual agreement settle the mode of application of this limitation. "xxx xxx xxx" In the case of Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc., and Court of Appeals (G.R. No. 127105, June 25, 1999), the interpretation of the Court of Tax Appeals of the phrase "paid under similar circumstances" was not sustained, thus: "We are unable to sustain the position of the Court of Tax Appeals, which was upheld by the Court of Appeals, that the phrase 'paid under similar circumstances' in Article 13 (2) (b) (iii) of the RP-US Tax Treaty should be interpreted to refer to payment of royalty, and not to the payment of the tax, for the reason that the phrase 'paid under similar circumstances' is followed by the phrase 'to a resident of a third state.' The respondent court held that `Words are to be understood in the context in which they are used,' and since what is paid to a resident of a third state is not a tax but a royalty `logic instructs' that the treaty provision in question should refer to royalties of the same kind paid under similar circumstances. "The above construction is based principally on syntax or sentence structure but fails to take into account the purpose animating the treaty provisions in point. To begin with, we are not aware of any law or rule pertinent to the payment of royalties, and none has been brought to our attention, which provides for the payment of royalties under dissimilar circumstances. The tax rates on royalties and the circumstances of payment thereof are the same for all the recipients of such royalties and there is no disparity based on nationality in the circumstances of such payment. On the other hand, a cursory reading of the various tax treaties will show that there is no similarity in the provisions on relief from or avoidance of double taxation as this is a matter of negotiation between the contracting parties. "xxx xxx xxx." "The reason for construing the phrase 'paid under similar circumstances' as used in Article 13 (2) (b) (iii) of the RP-US Tax Treaty as referring to taxes is anchored upon a logical reading of the text in the light of the fundamental purpose of such treaty which is to grant an incentive to the foreign investor by lowering the tax and at the same time crediting against the domestic tax abroad a figure higher than what was collected in the Philippines. DEICTS Article 23 of RP-US tax treaty reads: "Article 23 "RELIEF FROM DOUBLE TAXATION "Double taxation of income shall be avoided in the following manner: "1. In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof), the United States shall allow to a citizen or resident of the United States as a credit against the United States tax the appropriate amount of taxes paid or accrued to the Philippines and, in the case of a United States corporation owning at least 10 percent of the voting stock of a Philippine corporation from which it receives dividends in any taxable year, shall allow credit for the appropriate amount of taxes paid or accrued to the Philippines by the Philippine corporation paying such dividends with respect to the profits out of which such dividends are paid. Such appropriate amount shall be based upon the amount of tax paid or accrued to the Philippines, but the credit shall not exceed the limitations (for the purpose of limiting the credit to the United States tax on income from sources within the Philippines or on income from sources outside the United States) provided by United States law for the taxable year. . ." On the other hand, Article 23 of the RP-Denmark tax treaty provides, viz :" "Article 23 "ELIMINATION OF DOUBLE TAXATION "xxx xxx xxx. "2. In Denmark, in accordance with the provisions and subject to the limitations of the laws of Denmark, as may be amended from time to time without changing the general principle hereof, double taxation shall be eliminated as follows: a) Subject to the provisions of sub-paragraph (c), where a resident of Denmark derives income which, in accordance with the provisions of this Convention, may be taxed in the Philippines, Denmark shall allow as a deduction from the tax on the income of that resident, an amount equal to the income tax paid in the Philippines; b) Such deduction shall not, however, exceed that part of the income tax, as computed before the deduction is given, which is attributable to the income which may be taxed in the Philippines; c) Where a resident of Denmark derives income which, in accordance with the provisions of this Convention shall be taxable only in the Philippines, Denmark may include this income in the tax base, but shall allow as a deduction from the income tax that part of the income tax, which is attributable to the income derived from the Philippines; "xxx xxx xxx." A cursory reading of the above-quoted Article 23 of the RP-US tax treaty and Article 23 of the RP-Denmark tax treaty, though differently worded, will reveal that they grant the same relief from double taxation to their respective residents who are covered thereby. Thus, the tax on royalties by Danish residents and US residents are paid under similar circumstances. US residents may, therefore, invoke the preferential tax rate of 15% under the RP-Denmark tax treaty pursuant to the most favored nation clause of the RP-US tax treaty. Such being the case, this Office confirms your opinion that the payments made by Sybase-Phils to Sybase-US as stipulated in their Intercompany Distribution Agreement are deemed royalties and, thus, subject to the preferential rate of 15%, pursuant to the most favored nation clause [Article 13 (2) (b) (iii)] of the RP-US Tax Treaty in relation to Article 12 (2) of the RP-Denmark Tax Treaty. ( BIR Ruling No. ITAD 46-01 dated May 11, 2001 ) Furthermore, under Section 108 of the said Code, the royalty payments remitted by Sybase-Phils are subject to the 10% value-added tax. Section 4.102-1(b) of the 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, Sybase-Phils 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 such amount. This ruling is issued based on the foregoing facts as represented. If upon investigation, it will 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