ITAD Ruling No. 086-05

August 26, 2005 ITAD RULING NO. 086-05 Secs. 28 & 42, NIRC BIR Ruling No. ITAD-166-02 SGV & Co . 6760 Ayala Avenue 1226 Makati City Attention: R . M . C . Vinzon Tax Division This refers to your letter dated August 14, 2001 on behalf of your client AMKOR TECHNOLOGY PHILIPPINES (P1/P2),INC. (hereinafter P1/P2),requesting for a ruling that payments to be made by P1/P2 and AMKOR TECHNOLOGY PHILIPPINES (P3/P4),INC. (hereinafter P3/P4) to AMKOR TECHNOLOGY, INC. (ATI-US) for research and development cost pursuant to the Research and Development Cost Sharing Agreement (Agreement) are in the nature of reimbursements and not royalties subject to Philippine withholding tax. ICDcEA It is represented that ATI-US (formerly AMKOR ELECTRONICS, INC.) is a corporation organized and existing under the laws of the State of Pennsylvania, U.S.A. with principal office address at 1345 Enterprise Drive, West Chester PA 19380; that ATI-US was licensed to establish a regional or area headquarters in the Philippines with Securities and Exchange Commission (SEC) License No. BSFM-064 dated May 8, 1992 per certification issued by the SEC dated August 29, 2002; that the activities of the regional or area headquarters shall be limited to acting as supervisory, communications and coordinating center for its affiliates, subsidiaries or branches in the region, and that it will not derive any income from sources within the Philippines and will not participate in any manner in the management of any subsidiary or branch of the foreign entity in the Philippines; that P1/P2 and P3/P4 are corporations organized and existing under and by virtue of Philippine laws; that both companies are wholly-owned subsidiaries of P-Four, Inc. (PFI) and C.I.L. Ltd. (CIL),with a respective sixty-forty percent (60-40%) ownership distribution in both subsidiaries; that PFI is a corporation organized and existing under Philippine laws whereas CIL is a non-resident foreign corporation duly organized and existing under and by virtue of the laws of the Cayman Islands; that both PFI and CIL are in turn owned by ATI-US. It is further represented that on January 01, 2000, an Agreement was executed and entered into between ATI-US and its affiliates, which include P1/P2 and P3/P4, to provide mechanisms for the sharing of costs, risks and rights among the participants therein with respect to certain research and development activities; that under the said Agreement, a Research Program, wherein research and development activities which are to be performed predominantly within the United States, will be undertaken by ATI-US to develop new intellectual property rights or "developed technology" 1 as the term is defined in the Agreement; that the participants shall retain all beneficial and economic title and interest to all "developed technology" under the Agreement while the bare legal title thereto shall be in the name of any participant identified under any subsequent agreement as one which is best able to protect the intellectual property rights associated with the "developed technology",holding said bare legal title on behalf of the other participants; that each participant is granted full rights to utilize any and all "developed technology" or other intangibles resulting from the efforts and expenditures covered by the Agreement; that this interest in "developed technology" may be relinquished, abandoned or transferred to another participant where actual benefit therefrom is identified; that such benefited participant shall make an arm's length consideration to the relinquishing participant; that the parties shall share among themselves the cost and risk of research and development using a reasonable allocation formula based on the benefits anticipated to be derived by each party in exploiting the "developed technology;" that the cost which may be identified as potentially benefiting only one participant shall be allocated solely to that participant and removed from the pool of costs to be shared by all participants; that such cost allocation shall be subject to adjustments to account for changes in economic conditions and the business operations and practices of the parties so that the allocations shall continue to reflect a reasonable effort to share costs in proportion to benefits over time; that the research and development costs ("R&D Costs") which are to be allocated among the participants shall consist mainly of the following: (i) All cost for the conduct by ATI-US of the Research Program and the development of intangibles thereunder as determined under U.S. generally accepted accounting principles, including the costs and risk of unsuccessful related development, support costs and corporate overhead costs, and any legal costs, court costs, and other costs incurred in defense of any intangibles developed in the course of the Research Program; (ii) Amounts paid or incurred by ATI-US for the acquisition, by purchase, license, or otherwise, of technology relating to a Product which is, or thereafter becomes covered by the Agreement; (iii) Costs for product design and development services in support of the products manufactured by Participant, performed exclusively outside of the participant's country of organization; that the cost advanced by ATI-US with respect to the Research Program shall be reimbursed by each participant identified to derive benefit therefrom within sixty (60) days following the close of an R&D Calendar Year as defined in the Agreement; that following the close of each calendar quarter, or at such other times as agreed by the parties, each party shall make interim payments of the estimated cost sharing amount to ATI-US with respect to the cost incurred by ATI-US during such period; that such interim payments shall be an advance payment of the amount ultimately determined to be payable by the respective parties under the Agreement for the R&D Calendar Year; that the parties shall likewise share in the risks of failure and financial loss associated with the Research Program and risk arising directly as a result of the development and/or exploitation of intangibles including the risk of loss as a result of product liability, patent infringement and other claims which may arise in connection with the development, manufacture or sale of products utilizing the intangible. ESHcTD In the light of the above representations, you now request for a ruling that: (1) the cost-sharing payments to be made by P1/P2 and P3/P4 to ATI-US for the cost of the research and development activities pursuant to the Agreement are not considered as royalties subject to Philippine tax under the RP-US tax treaty; and (2) that the said payments being mere reimbursements of cost or that the same constitute gross income not attributable to a permanent establishment of ATI-US in addition to being foreign-source income, shall not be subject to Philippine withholding tax. In reply, please be informed of the following: 1. Whether the cost-sharing payments of P1/P2 and P3/P4 to ATI-US for the cost of the research and development activities are not considered royalties under Article 13 of the RP-US tax treaty . Article 13(3) of the RP-US tax treaty provides, viz : "(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." The definition of "royalties" includes "payments of any kind received as a consideration for information concerning industrial, commercial or scientific experience." According to the commentaries of the ORGANISATION 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 agrees 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. This type of contract thus differs from contracts for the provisions of the services, in which one of the parties undertakes to use the customary skills of his calling to execute work himself for the other party. Thus, payments obtained as consideration for after-sales service, for services rendered by a seller to the purchaser under a guarantee, for pure technical assistance, or for an opinion given by an engineer, an advocate or an accountant do not constitute royalties within the meaning of paragraph 4. In the instant case, no transfer of technology of which ATI-US has proprietary interest or know-how or any undivulged technical information will take place but rather a development thereof, with the corresponding rights or interest being retained by all participants in the venture. Article VI of the Agreement provides that the participating corporations will own all beneficial and economic title and interest to all Developed Technology. Thus, if as a result of the venture, ATI-US develops new intellectual property right/technology, the contributing corporations, which includes P1/P2 and P3/P4 shall have the beneficial and economic title and interest to such newly developed technology. As beneficial and economic title holders, each participating corporation has full rights to utilize, relinquish, abandon or transfer said technology in the concept of an owner and not as a mere user or recipient of all undivulged technical information concerning industrial, commercial, or scientific experience for a consideration. Such being the case, the said cost-sharing payments by P1/P2 and P3/P4 cannot be considered "royalties" under the RP-US tax treaty. CHTcSE 2. Whether the said cost-sharing payments are reimbursement of cost or gross income not attributable to a permanent establishment of ATI-US in addition to being foreign-source income, not subject to Philippine income tax . Based on the representation, the research and development activities by ATI-US are to be performed predominantly within the United States, then the RP-US tax treaty finds no application inasmuch as the herein transaction does not result in a case of double taxation for which a tax treaty relief is sought. (BIR Ruling No. ITAD-166-02 dated September 23, 2002) Hence, the instant case is clearly governed by Section 28(B)(1) in relation to Section 42(A)(3) of the National Internal Revenue Code which provides, viz : "SEC. 28. Rates of Income Tax on Foreign Corporations . xxx xxx xxx "(B) Tax on Nonresident Foreign Corporation . "(1) In General . Except as otherwise provided in this Code, a foreign corporation not engaged in trade or business in the Philippines shall pay a tax equal to thirty-five percent (35%) of the gross income received during each taxable year from all sources within the Philippines ,such as interest, dividends, rents, royalties, salaries, premiums (except reinsurance premiums),annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and capital gains, except capital gains subject to tax under subparagraphs 5(c) and (d): Provided, That effective January 1, 1998, the rate of income tax shall be thirty-four percent (34%);effective January 1, 1999, the rate shall be thirty-three percent (33%);and, effective January 1, 2000 and thereafter, the rate shall be thirty-two percent (32%).(Emphasis supplied) aCcHEI "SEC. 42. Income from Sources Within the Philippines . "(A) Gross Income From Sources Within the Philippines . The following items of gross income shall be treated as gross income from sources within the Philippines: xxx xxx xxx "(3) Services . Compensation for labor or personal services performed in the Philippines; Under the afore-cited provisions, a nonresident foreign corporation is taxable only on income derived from sources within the Philippines so that if a nonresident foreign corporation furnishes and performs services in the Philippines, the service fees therefrom are taxable in the Philippines. Considering that the services of ATI-US to P1/P2 and P3/P4 under the said Service Agreement are rendered outside the Philippines, the payments by P1/P2 and P3/P4 to ATI-US are considered income derived from sources outside the Philippines. In view thereof, this Office is of the opinion and so holds that the subject amounts paid by P1/P2 and P3/P4 to ATI-US are in consideration for services performed in the US and, as such, are considered income derived from sources outside the Philippines and therefore, are not subject to Philippine income tax and consequently to withholding tax. (BIR Ruling No. DA-ITAD-166-02 dated September 23, 2002) However, while the above subject payments are considered as reimbursements by P1/P2 and P3/P4 of costs advanced by ATI-US with respect to the Research Program not subject to tax in the Philippines, the matter of identifying the said expense of P1/P2 and P3/P4 as accurately pertaining to the said Research and Development Cost Sharing Agreement is a question of fact subject to confirmation through audit or investigation, as the case may be. This ruling is issued on the basis of 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. Very truly yours, (SGD.) JOSE MARIO C. BUAG OIC-Commissioner of Internal Revenue Footnotes 1. Developed Technology means and includes any and all patents, copyrights, inventions, designs, know-how, trade secrets, manufacturing information and techniques, process technology, secret and/or confidential information, data, specifications, blueprints, functional and detailed design specifications, current and all prior versions of computer software or programs (in any form, however fixed), source code, object code, firmware, functional and detailed design specifications and flowcharts for computer software, enhancements, updates, translations, adaptations, and all other intangible property, arising from or developed as a result of the Research Program. [Article II (B) of the Agreement]