ITAD Ruling No. 076-05

July 28, 2005 ITAD RULING NO. 076-05 Article 13 (2) (B) (iii) of RP-US Article 12 (2) (b) of RP-China Sec. 108 of the Tax Code of 1997 BIR Ruling Nos. DA-ITAD 134-03; 21-05 Joaquin Cunanan & Co . 29th Floor, Philamlife Tower 8767 Paseo de Roxas Avenue Makati City 1200 Attention: Mary Assumption S. Bautista-Villareal Principal, Tax Services Department Gentlemen : This refers to your letter dated February 21, 2005, on behalf of your client, Unilever Foods Philippines (CMC) Inc. (UFP), formerly California Manufacturing Co., Inc., requesting confirmation of your opinion that the service fees paid by UFP to Conopco, Inc. (Conopco) under their Trademark License Agreement are subject to the preferential tax rate of 10% in accordance with Article 13(2)(b)(iii) of the Philippines-United States of America (RP-US) tax treaty, or the so called "most-favored-nation" clause, in relation to 12(2)(b) of the Philippines-China (RP-China) tax treaty. It is represented that Conopco is a nonresident foreign corporation duly organized and existing under the laws of the State of New York, USA, with principal place of business at 390 Park Avenue, New York, New York USA 10022; that it is not registered either as a corporation or as a partnership licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated January 31, 2005; that UFP is a domestic corporation organized and existing under the laws of the Philippines and is primarily engaged in the manufacture and selling of various consumer products; that in 2005, UFP and Conopco entered into a "Trademark License Agreement" (Agreement) whereby Conopco, as Licensor, grants to UFP, as Licensee, an exclusive license to use certain trademarks in the Philippines in order to identify, present and sell products which have been reviewed and accepted by Conopco, or Conopco's authorized nominee, as products suitable to be distributed under the trademarks; that the trademarks shall not be deemed to include any other type of intellectual property rights such as, but not limited to, the use of know-how, designs and patents; that in consideration of the rights granted under the Agreement, UFP shall pay Conopco a royalty fee of two and a half percent (2.5%) of the Turnover determined in Philippine currency of the products sold under the trademarks; that "Turnover" refers to the net amount receivable from customers for goods and services supplied and services rendered in the course of UFP's ordinary activities during the relevant financial period; that the Agreement shall be deemed to have come to effect from July 1, 2004 and shall remain in force until December 31, 2011; that it shall be deemed to be renewed for subsequent period of five (5) years, unless either party shall have given the other not less than three (3) months notice in writing of the party's intention to terminate the Agreement at the end of the initial term; and that the Agreement complies with the relevant provisions of the Intellectual Property Code per Intellectual Property Office's Certificate of Compliance No. 5-2005-00012 dated March 29, 2005, valid from July 1, 2004 until December 31, 2011. aHDTAI In reply, please be informed that Article 13 of the RP-US treaty provides, viz: "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" Under the "most-favored-nation" clause found in 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 the Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State. In this light, Article 12 of the RP-China tax treaty, which became effective on January 1, 2002, provides: "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, such royalties may also be taxed in the Contracting 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) 15 per cent of the gross amount of royalties arising from the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films or tapes for television or broadcasting, or b) 10 per cent of the gross amount of royalties arising from the use of, or the right to use, any patent, trade mark, design or model, plan, secret formula or process, or from the use of, or the right to use, industrial, commercial, or scientific equipment, or for information concerning industrial, commercial or scientific experience . (Emphasis supplied) ICAcHE For as long as the transfer, of technology, under Philippine law, is subject to approval, the limitation of the tax rate mentioned under (b) shall, in the case of royalties arising in the Republic of the Philippines, only apply if the contract giving rise to such royalties has been approved by the Philippine competent authorities. "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 cinematography films, or films or tapes for radio or television 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. "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 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-China tax treaty but also in connection with the provisions on the elimination of double taxation of both the RP-US and RP-China tax treaties. A perusal of the RP-US and RP-China tax treaties, particularly their provisions on the avoidance of double taxation, shows 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, this Office is of the opinion and so holds that the royalty payments of UFP to Conopco are subject to the preferential tax rate of ten percent (10%) of the gross amount of royalties pursuant to the "most-favored-nation" provision of the RP-US in relation to RP-China tax treaty. (BIR Ruling ITAD No. 134-03 dated August 29, 2003 and BIR Ruling ITAD No. 21-05 dated March 11, 2005) Finally, said royalty payments are subject to the 10% value-added tax (VAT) under Section 108 of the Tax Code of 1997. Accordingly, UFP, being the resident withholding agent and payor in control of the payment shall be responsible for the withholding of the 10% VAT on such payments before making any payment to Conopco. In remitting the VAT withheld, UFP shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld) for and on behalf of Conopco. The duly validated VAT declaration/return shall serve as documentary substantiation for the claim of input tax by UFP upon filing its own VAT return, if it is a VAT-registered taxpayer. In case, UFP is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased which may be treated as "expense" or "asset" whichever is applicable. In addition, UFP is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies thereof to be given to Conopco upon its request and the fourth copy to be retained by UFP as its file copy. [Sections 4 and 6 of Revenue Regulations (RR) No. 4-2002; Section 3 of RR No. 8-2002; Section 7 of RR No. 14-2002] In fine, UFP shall be responsible for the withholding of income tax at the rate of 10% of the gross amount of royalties and to the 10% VAT of the contract amount. DaIACS This ruling is issued on the basis of the foregoing facts as represented. However, if upon investigation, it shall be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service