ITAD Ruling No. 067-01

August 15, 2001 ITAD RULING NO. 067-01 Article 13 Philippines United States Tax Treaty BIR Ruling No. ITAD-151-00; DA-ITAD 067-00 Punongbayan & Araullo 20th Floor Tower I, The Enterprise Center 6766 Ayala Avenue 1200 Makati City Attention: Atty . Vic C . Mamalateo Tax Partner Gentlemen : This refers to your letter dated April 30, 2001 requesting confirmation of your opinion that royalties paid under a Franchise Agreement by Warner Bros. (F.E.), Inc . Philippine Branch (WB (FE)-Philippines) to Warner Bros. (WB-USA) are subject to a preferential tax rate of 15 percent pursuant to Article 13(2)(b)(iii) of the Philippines-United States Tax Treaty in relation to the Royalties article of the existing Philippine tax treaties with Denmark, Finland, Malaysia, and the United Kingdom. It is represented that WB-USA , a division of Time Warner Entertainment, L.P. (U.S.A.) , is a corporation organized and existing under the laws of the United States of America with principal office at 4000 Warner Boulevard, Burbank, California, United States of America; that WB-USA is not registered as a corporation or partnership licensed to do business in the Philippines as per certification issued by the Securities and Exchange Commission dated March 22, 2001; that WB(FE) - Philippines is a corporation organized and existing under the laws of the Philippines with principal office at Room 3111, PPL Building, 1000 United Nations Avenue, Manila, Philippines; that, on December 1, 1996, a Franchise Agreement was entered into by and between WB-USA and WB(FE)-Philippines wherein WB-USA grants WB(FE)-Philippines the following rights which use are limited solely within the territory of the Philippines and during the term of the Agreement: (A) the sole and exclusive right to distribute, advertise, promote and publicize WB-USA theatrical pictures and trailers in theatrical and non-theatrical distributions, and to use and perform simultaneously, and in synchronization with such theatrical pictures, any and all music and lyrics contained in such theatrical pictures and or recorded in its soundtrack; ("Theatrical and Non-Theatrical Rights"); TaDAHE (B) the sole and exclusive right to manufacture and sell devices containing copies of WB-USA homevideo pictures, and to exploit such devices for the intended purpose of homevideo use by consumers in their places of dwelling in such manner that viewing frequency may be freely controlled by such consumers; ("Homevideo Rights") (C) the non-exclusive right to distribute, sell, advertise, merchandise, manufacture, publish, and retail WB-USA properties, and to engage in any form of exploitation or use of such properties, including the granting of any or all such rights to third parties under license agreements; ("Rights to Properties") that, in consideration of the aforementioned rights, WB(FE)-Philippines shall pay to W B-USA a royalty equal to the percentage of combined gross receipts accrued in each year of the term of the Agreement from and after December 1, 1996, and reduced by 100 percent of the combined allowable distribution expenses, as defined in the Agreement . In reply, please be informed that paragraphs 1, 2, and 3, Article 13 (Royalties) of the Philippines-United States Tax Treaty provide: "Article 13 ROYALTIES 1. Royalties delivered 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 Applying paragraph 3 of the foregoing Article, royalties in respect of theatrical and non-theatrical rights, homevideo rights, and rights to properties, granted by WB-USA to WB (FE)-Philippines ar e 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, and, are, therefore, royalties within the scope of the Article. Rather than imposing a tax which shall not exceed 25 percent of the gross amount of the royalties under paragraph 2(b)(ii) of the Article, its paragraph 2(b)(iii) provides that such royalties may be subject to 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 (otherwise known as the most favored nation treatment). The Supreme Court, in the case of Commissioner of Internal Revenue vs. S.C. Johnson and Son Inc. and Court of Appeals (G.R. No. 127105 dated June 25, 1999), had interpreted the most favored nation clause , in particular, the phrase paid under similar circumstances , as referring both to the income in which the tax is paid (i.e., royalties) and to the manner in which the tax is paid, and further declared: EDHTAI "The purpose of a most favored nation clause is to grant to the contracting party treatment not less favorable than that which has been or may be granted to the 'most favored' among other countries. The most favored nation clause is intended to establish the principle of equality of international treatment by providing that the citizens or subject of the contracting nations may enjoy the privileges accorded by either party to those of the most favored nation. The essence of the principle is to allow the taxpayer in one State to avail of more liberal provisions granted in another tax treaty to which the country of residence of such taxpayer is also a party provided that the subject matter of taxation, in this case royalty income, is the same as that in the tax treaty under which the taxpayer is liable. Both Article 13 of the RP-US Tax Treaty and Article 12(2)(b)of the RP-West Germany Tax Treaty, above quoted, speaks of tax on royalties for the use of trademark, patent and technology. The entitlement of the 10% rate by U.S. firms despite the absence of a matching credit (20% for royalties) would derogate from the design behind the most favored clause to grant equality of international treatment since the tax burden laid upon the income of the investor is not the same in the two countries. The similarity in the circumstances of payment of taxes is a condition for the enjoyment of most favored nation treatment precisely to underscore the need for equality of treatment." cHaICD Hence, the most favored nation clause in Article 13 of the Philippines-United States Tax Treaty must be interpreted in relation both to the Royalties article of the tax treaty of the relevant third State with the Philippines, and to its Relief from Double Taxation article, vis-a-vis that of the Philippines-United States Tax Treaty. In connection therewith, the Royalties article of the existing Philippine tax treaties with Denmark, Finland, Malaysia, and the United Kingdom, included in their definition of royalties, "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 . . ." and provide that such royalties shall be taxed at a rate not to exceed 15 percent of the gross amount thereof. Further, a perusal of the Relief from Double Taxation article of these treaties vis-a-vis that of the Philippines-United States Tax Treaty reveals that a similarity on the manner of payment of taxes does, in fact, exist, that is, the foreign tax credit allowed on these treaties are those which are actually paid in the Philippines. Hence, your opinion that royalties in respect of theatrical and non-theatrical rights, homevideo rights, and rights to properties, paid by WB(FE)-Philippines to WB-USA are subject to a preferential tax rate of 15 percent pursuant to Article 13(2)(b)(iii) of the Philippines-United States Tax Treaty in relation to the Royalties article of the existing Philippine tax treaties with Denmark, Finland, Malaysia, and the United Kingdom, is hereby confirmed. (BIR Ruling No. ITAD 151-00 dated October 23, 2000) Finally, such royalties shall be subject to 10 percent value added tax (VAT) imposed under Section 108(A)(3) of the National Internal Revenue Code of 1997. Section 4.102-1(b) of Revenue Regulations No. 7-95 provides: "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 on 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 &e licensee." In fine, royalties in respect of theatrical and non-theatrical rights, homevideo rights, and rights to properties, paid by WB(EE)-Philippines to WB-USA are subject to a final withholding income tax of 15 percent of the gross amount thereof, and to a value-added tax of 10 percent based on the contract price of such royalties. This ruling is issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are materially different, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) EDMUNDO P. GUEVARA Deputy Commissioner Legal and Inspection Group