ITAD Ruling No. 086-04

August 12, 2004 ITAD RULING NO. 086-04 Articles 13 (2) (b) (iii), Philippines-United States tax treaty; Article 12 (2) (b), Philippines-China tax treaty; Section 108, NIRC; RMC No. 46-2002 Quisumbing Torres Law Offices 12th floor, Net One Center 26th Street corner 3rd Avenue Crescent Park West Bonifacio Global City Taguig, Metro Manila Attention: Atty. Jose R. Sandejas Gentlemen : This refers to your letter dated May 5, 2004, on behalf * ITW International Holdings, Inc. (ITWIHI), requesting confirmation that the royalty payments by ITW Ampang Industries Phil., Inc. (ITWAIPI) to ITWIHI will be subject to the preferential tax rate of ten percent (10%) pursuant to the "most-favored-nation clause" (MFN) of the Philippines-United States tax treaty. It is represented that ITWIHI is a nonresident foreign corporation duly organized and existing under and by virtue of the laws of the State of Delaware, United States of America with principal place of business at 1300 Market St., Suite 504, Wilmington, Delaware 19801, USA; that ITWIHI is not registered either as a corporation or as a partnership licensed to do business in the Philippines per Certification of Non-Registration issued by the Securities and Exchange Commission dated April 27, 2004; that ITWIHI is the owner of the right, title and interest in and to the data, experience and know-how relating to the manufacture, assemble, sales and use of certain products (Products), including all designs, drawings, technical data, specifications, bills of materials and the like (Collectively referred to as Licensed Technology); that ITWIHI is also the owner of the right, title and interest in and to the patents and the trademarks applicable to the Products and it has substantial marketing expertise in connection with the Products and trademarks; that ITW Ampang Industries Philippines, Inc. (ITWAIPI) is a corporation duly organized and existing under and by virtue of the laws of the Philippines with principal place of business at G/F SFB#1, Baguio Ecozone, Loakan Road, Baguio City; that on September 17, 2003, ITWIHI and ITWAIPI entered into a License Agreement whereby ITWIHI grants to ITWAIPI a right and license to practice the former's patents, Licensed Technology and improvements thereto for the manufacture of the Products in the Philippines; that ITWAIPI is also granted the license for the use of the patents, trademarks and the marketing support on and in connection with the sale of the Products in and outside the Philippines throughout the rest of the world, and is allowed to affix ITWIHI trademarks to or on the Products, packaging, labeling, advertising, promotional and display material sold, used or distributed in connection with the Products; that in consideration for the use of the patents, trademarks, Licensed Technology and other intellectual property rights that will be provided by ITWIHI, ITWAIPI will pay ITWIHI a royalty equal to four percent (4%) of the net sales price of each of the Products and all other products manufactured or sold by ITWAIPI, except products sold to other subsidiaries and/or affiliates of ITWIHI. In reply, please be informed that Article 13 of the Philippines-United States tax treaty provides, viz. : AaSHED "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. (Emphasis supplied) "(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 film or films or tapes used for radio or television broadcasting, any patent, trademark, 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" and in relation thereto, Article 12 of the Philippines-China tax treaty provides, viz. : "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. ESTcIA "(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, 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, trademark, 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. "xxx xxx xxx" Based on the above-mentioned provisions, 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 is noteworthy that under Article 12 (2) (b) of the Philippines-China tax treaty, the tax charged shall not exceed 10% of the gross amount of royalties. 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. (BIR Ruling No. DA-ITAD-16-04 dated February 20, 2004) EICDSA A plain reading of Article 23 of the Philippines-United States tax treaty and Article 23 of the Philippine-China tax treaty, though differently worded, plainly reveal a similarity on the provisions on relief from or avoidance of double taxation to their respective residents. Thus, the tax on royalty payments to residents of United States and China are paid under similar circumstances, i.e. , the amount of royalty income tax paid and accrued to the Philippines under the respective tax treaties is available tax credit against the income tax payable in their respective countries. Such being the case, this Office is of the opinion and so holds that the royalty payments of ITWAIPI and ITWIHI under the said License Agreement are subject to final withholding tax at the rate of 10% pursuant to the "most-favored-nation" provision of the Philippine-United States tax treaty in relation to the Philippines-China tax treaty effective January 1, 2002. [Revenue Memorandum Circular (RMC) No. 46- * payment is paid or payable, or the income payment is accrued or recorded as an expense or asset, whichever is applicable, and whichever comes first. The term "payable" refers to the date the obligation become due, demandable, or legally enforceable. [Section 4-Time of Withholding, Revenue Regulations (RR) No. 12-2001] Moreover, under Section 108 of the National Internal Revenue Code (Tax Code) of 1997, the lease or the use of property or property rights is embraced within the definition of "sale or exchange of services" and is subject to VAT. Under current regulations, the sale of services to ECOZONE Enterprises may be considered effectively zero-rated for VAT purposes but subject to the limitation that the sales of service is made to persons or entities who enjoy indirect tax exception [Section 4.102 (c), Revenue Regulations No. 7-95]. Since there is no express provision under Republic Act (RA) No. 7916 or the PEZA law granting indirect tax exemption to ECOZONE Enterprises, the recognition of zero-rated sale of services is made to rest on the Cross Border Doctrine or Destination Principle of the VAT system, viz. : "the country taxes all value-added, at home and abroad, for goods that have as their destination the consumers of that country. Exports are exempt, imports are taxable. . . ." (VAT Ruling No. 009-99 dated January 21, 1999) The same principle is applicable to the case at hand. It should be noted that the transfer of technology is in connection with the manufacture of products for export. However, instead of zero-rating which the non-resident supplier cannot avail of, the provision for exempt transaction under Section 109 of the Tax Code which provides VAT exemptions for transactions which are exempt under special laws, e.g., RA 7916 or PEZA law, is particularly applicable to the instant case. In the case of payment for lease or royalties to a non-resident owner, the responsibility for withholding the VAT and paying the same rest on the payor. However, since PEZA-registered export enterprise may not be passed on with nor claim input VAT, then its payment of royalties to a non-resident lessor, such as ITWIHI should be, as it is hereby confirmed to be exempt from VAT. (VAT Ruling No. 095-99 dated September 14, 1999.) This ruling is issued based on the facts as represented. However, if upon investigation it shall be disclosed that the facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. EHScCA Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service