ITAD Ruling No. 075-04

July 28, 2004 ITAD RULING NO. 075-04 Article 7 (1) & 5 (6) Philippines-Germany tax treaty BIR Ruling No. DA-ITAD 49-03 BIR Ruling No. DA-ITAD 134-00 Schering Philippine Corporation 36th Floor, PBCom Tower 6597 Ayala Avenue, cor. Herrera St. Makati City Attention: Gerry D . Bibit Director, Financial & Administrative Gentlemen : This refers to your application for relief from double taxation dated February 3, 2003, on behalf of Infonet Network Services Deutschland GmbH (Infonet), requesting, in effect, for a tax refund on the income tax withheld, and a ruling on the proper income tax rate to be applied, by Schering Philippine Corporation (Schering Phils), pursuant to the Philippines-Germany tax treaty. It is represented that Infonet is a corporation organized and existing under the laws of the Federal Republic of Germany with business address at (Lyoner Str. 14) 60494 Frankfurt am Main, Germany; that Infonet is not registered either as a corporation or as a partnership licensed to do business in the Philippines per certification dated February 11, 2003 issued by the Securities and Exchange Commission (SEC); that Infonet concluded a Master Agreement dated January 2002 with Schering AG, Berlin (the Head Office of Schering Phils), under which it will provide Schering AG and its affiliates and partners a worldwide intranet to enable Schering AG, its affiliates and partners to exchange data quickly, safely and with reliability; that specifically, the services to be performed by Infonet are electronic messaging services, electronic data interchange services, data communication services and enterprise define network services; that under said Agreement, Infonet has concluded with Schering Phils individual contracts by means of Order Forms which include: a) a port to the Infonet Worldwide Frame Relay Network, b) the capacity of the PVC (private virtual circuit) between Manila and Hongkong, and c) the necessary items to link Schering Phils with the Infonet Worldwide Net, in this case a local line and a customer premise router; that the said services are to be performed in Germany; that Schering Phils is a corporation organized and existing under the laws of the Philippines with office address at 36th Floor, PBCom Tower, Ayala Avenue cor. Herrera St., Salcedo Village, Makati City; that Schering Phils paid Infonet certain service fees and a monthly charge for the billing services; that Schering Phils remitted directly to Infonet net of 32% withholding tax; and that said payments are to be considered as business profits and not royalties. In reply, please be informed of this Office's ruling on the following issues as follows: 1. The service fees are not in the nature of royalties . Article 12(3) of the Philippines-Germany tax treaty provides that: "Article 12 "Royalties "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 tapes for television or broadcasting, any patent, trade mark, 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." The tax treaty defines " royalties " to include " payments of any kind received as a consideration for information concerning industrial, commercial or scientific experience ." According to the commentaries of the ORGANIZATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT (OECD) Committee on Fiscal Affairs on the Model Tax Convention [par. 11, Commentary on Article 12 (royalties), 1998, p. 151], such information alludes to the concept of " know-how ". The definition of know-how, which has been adopted by the said Committee, 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 agree 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. ( BIR Ruling No. DA-ITAD-49-02 dated April 15, 2002 ) Furthermore, in the case of Philippine Refining Company (PRC) vs . CIR , CTA Case No. 2872 dated January 15, 1986, the Court of Tax Appeals had an occasion to rule on the distinction of service fees from royalties, to wit: "To distinguish between compensation for service and royalty payments, one must inquire on whether the payee has proprietary interest in the property giving rise to the income. If the payee has none, then the payment is a compensation for personal services, if the payee has proprietary interest then the payment is royalty." Based on the above, the subject payments under the Master Agreement and/or the individual contracts by means of Order Forms are not within the definition of royalties under Article 12(3) of the Philippines-Germany tax treaty. Nothing in the said agreements would require transfer in the Philippines of " know-how " or any property of which the payee has proprietary interest. CaASIc 2. The service fees are business profits not subject to Philippine taxation . Article 5 of the Philippines-Germany tax treaty provides: "Article 5 "Permanent Establishment "1. For the purposes of this Agreement, the term 'permanent establishment' means a fixed place of business in which the business of the enterprise is wholly or partly carried on. "2. The term 'permanent establishment' includes specially but is not limited to: a) A place of management; b) A branch; c) An office; d) A factory; e) A workshop; f) A warehouse, in relation to a person providing storage facilities for others; g) A mine, quarry, or other place of extraction of natural resources; i) A building site or construction or assembly project or supervisory activities in connection therewith, where such site, project or activity continues for a period more than six months. "xxx xxx xxx" In relation thereto, Article 7 of Philippines-Germany tax treaty also provides: "Article 7 "Business Profits "1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment. "xxx xxx xxx" The aforequoted Article 7 of the Philippines-Germany tax treaty allows the Philippines to tax the business profits of an enterprise which is a resident of Germany if such enterprise has a permanent establishment located in the Philippines. Inasmuch as Infonet does not have a permanent establishment in the Philippines to which its business profits or income may be attributed, income derived by Infonet, arising from the above-stated individual contracts by means of Order Forms it entered into with Schering Phils, is not subject to Philippine income tax. ( BIR Ruling No. DA-ITAD-134-00 dated September 19, 2000 ) This ruling is issued based on the foregoing facts as represented and is rendered only for the purpose of determining whether Infonet is entitled to the benefits of the Philippines-Germany 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. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service