ITAD Ruling No. 087-04

August 12, 2004 ITAD RULING NO. 087-04 Articles 5 & 12, Philippines-Netherlands tax treaty Sec. 28 (A) (i) & 108 (B) (2), Tax Code of 1997 BIR Ruling No. DA-ITAD 100-03 Lina Lavares Didulo Guiao & Leviste-Avellana Law Offices Unit 2202 Asia Tower Paseo de Roxas corner Benavidez Street Legaspi Village, Makati City Attention: Atty. Jose Leonilo V. Didulo Gentlemen : This refers to your application for relief from double taxation dated May 26, 2004, on behalf of United International Pictures B.V. (UIP BV), requesting confirmation that: (1) the execution of the License Agreement between UP BV and Solar Entertainment Corporation (Solar) will not create a permanent establishment under the Philippines-Netherlands tax treaty; (2) the income generated by UIP BV on the exhibition of motion pictures in the Philippines relative to the License Agreement with Solar is subject to a fifteen percent (15%) preferential tax rate on royalty payments; and (3) the execution of a Service Agreement between UIP BV and United International Pictures Aktiebolag-Philippine Branch (UIP AB Philippine Branch) in the areas of management, accounting and administration, data gathering, advisory and marketing services will not create a permanent establishment in the Philippines. It is represented that UIP BV is a corporation organized and existing under the laws of the Netherlands with principal address at Rijswijkstraat 175, 1062 EV Amsterdam, The Netherlands; that it 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 March 22, 2004; that Solar is a corporation organized and existing under the laws of the Philippines with principal address at No. 16, Jupiter corner Antares Sts.,Bel Air Village III, Makati City; that on March 18, 2004, UIP BV and Solar entered into a License Agreement whereby UIP BV granted Solar exclusive license under copyright to exploit the Theatrical Rights and the Non-Theatrical Rights in the Pictures in the Philippines during the License Period as specified in the License Agreement; that " Theatrical Rights " include the right to exploit a motion picture by exhibition in 35mm or larger gauge widths in cinemas or other places of viewing where the general public is admitted and where an admission price is charged, while " Non-Theatrical Rights " refers to the right to exploit a motion picture by exhibition in any gauge widths, video cassettes, video discs or any analogous means before an audience (a) by institutions or organisations not primarily engaged in the business of exhibiting motion pictures to the public including, without limitation, educational institutions, churches, restaurants, bars, clubs, trains, coaches, libraries, government or military installations, Red Cross facilities, oil fields and oil rigs, (b) by exhibition in hotels, motels, apartment complexes, condominiums and hospitals by means of closed-circuit television systems where the transmission originates within or in the immediate proximity of such place, or (c) by exhibition on ocean-going vessels, wherever located and having whatever destination, flying the flag of the Philippines or customarily supplied out of the Philippines; that in consideration thereof, UIP BV shall pay Solar Distribution Fee equal to 6 % of the gross receipts, and UIP BV shall receive the amount equal to the gross receipts for each picture after payments of (a) the Distribution Fee of Solar and (b) Distribution Costs. It is further represented that UIP BV entered into a Service Agreement with United International Pictures AB Philippine Branch (UIP AB Philippine Branch),a branch of United International Pictures AB (UIP AB),a foreign corporation organized under the laws of Sweden licensed to do business in the Philippines through a branch as certified by the Securities and Exchange Commission; that under the said Service Agreement, UIP AB Philippine Branch undertakes to provide UIP BV corporate support services in the areas of management, accounting and administration, data gathering, advisory and marketing services relative to the implementation of the License Agreement in the Philippines; that UIP AB Philippine Branch is not authorized to conclude contracts on behalf of UIP BV either with Solar or with any other third party in the Philippines, nor does it have any power legally or contractually to bind UIP BV in any manner; and that it is not an agent of UIP BV and the Service Agreement does not create a partnership or joint venture relationship between the two contracting parties; that in consideration for the provision of the services by UIP AB Philippine Branch, UIP BV shall reimburse to or cause to be reimbursed to UIP AB Philippine Branch all costs and operating expenses authorized in advance by UIP BV and incurred by UIP AB Philippine Branch in connection with the services; and pay to UIP AB Philippine Branch a fee equal to five percent (5%) of such costs and operating expenses. AEHTIC In reply, please be informed of this Office's opinion on the following issues as, follows: (1) The execution of the License Agreement between UIP BV and Solar Entertainment Corporation (Solar) will not create a permanent establishment of UIP BV under the Philippines-Netherlands tax treaty Article 5 of the Philippines-Netherlands tax treaty provides that: "Article 5 "PERMANENT ESTABLISHMENT "1. For the purposes of this Convention, 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 especially: "(a) a place of management; "(b) a branch; "(c) an office; "(d) a factory; "(e) a workshop; "(f) a mine, quarry or other place of exploration or extraction of natural resources; "(g) a building site or construction or assembly project or supervisory activities in connection therewith, where such site, project or activity continues for a period of more than 183 days; "(h) the furnishing of services including consultancy services by an enterprise through an employee or other personnel where activities of that nature continue (for the same or a connected project) for a period or periods exceeding in the aggregate 183 day within any twelve-month period. "xxx xxx xxx" The aforementioned provisions clearly enumerate what comprises a permanent establishment. Considering that UIP BV does not have a fixed place of business in the Philippines to which its business is carried on, UIP BV is considered as not having a permanent establishment in the Philippines. However, if in furtherance of the execution of the License Agreement, UIP BV will furnish services to Solar through the former's employees, in the Philippines for a period or periods exceeding in the aggregate 183 days, then such would constitute a permanent establishment of UIP BV. (2) The income generated by UIP BV on the payments made for the right to exploit a motion picture by exhibition in the Philippines relative to the License Agreement with Solar is subject to 15% preferential tax rate on royalty payments Article 12 of the same treaty provides: "Article 12 "ROYALTIES "1. Royalties arising in one of the States and paid to a resident of the other State may be taxed in that other State. "2. However, such royalties may also be taxed in the 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) 10 per cent of the gross amount of the royalties where the royalties are paid by an enterprise registered, and engaged in preferred areas of activities in that State; and "(b) 15 per cent of the gross amount of the royalties in all other cases. "3. The competent authorities of the States shall by mutual agreement settle the mode of application of paragraph 2. "4. 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 cinematograph films or tapes for radio or television broadcasting ,any patent, trademark, 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. .." (emphasis supplied) Based on the above, royalties arising in the Philippines and paid to a resident of Netherlands who is the beneficial owner thereof may be subject to the Philippine income tax at a rate not exceed ten percent (10%) where the royalties are paid by an enterprise registered, and engaged in preferred areas of activities, or 15% of the gross amount of royalties in all other cases. It is clear that Article 12(4) of the above treaty specifically defines royalties to include payments received as consideration for "artistic or scientific work including cinematograph films or tapes for radio or television broadcasting". Therefore, this Office is of the opinion and so holds that the income of UIP BV under the subject License Agreement including the right to exploit a motion picture by exhibition in the Philippines are royalties subject to the preferential tax rate of 15% of the gross amount of royalties pursuant to the Philippines-Netherlands tax treaty. ( BIR Ruling No. DA-ITAD-100-03 dated July 16, 2003 ) Moreover, the herein royalties are subject to the 10% value-added tax (VAT) pursuant to Section 108 of the Tax Code of 1997. Accordingly, Solar, being the resident withholding agent and payor in control of the payment, shall be responsible for the withholding of the 10% VAT on such license fees before paying them to UIP BV. In remitting the VAT withheld, Solar shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). If Solar is a VAT-registered taxpayer, the duly filed BIR Form No. 1600 and proof of payment thereof shall serve as documentary substantiation for the claim of input VAT by Solar upon filing its own VAT. If Solar 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 an " expense " or " asset " whichever is applicable. In addition, Solar is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate upon request of UIP BV, the first three copies thereof to be given to UIP BV and the fourth copy to be retained by Solar as its file copy. In view of all the foregoing, Solar shall be responsible for the withholding of the 10% VAT and income tax at the rate of 15% of the gross amount of royalties. (3) The execution of a Service Agreement between UIP BV and United International Pictures Aktiebolag-Philippine Branch (UIP AB Philippine Branch) in the areas of management, accounting and administration, data gathering, advisory and marketing services will not likewise create a permanent establishment in the Philippines . Considering that the services/activities in the Philippines under the Service Agreement shall be performed by UIP AB Philippine Branch, a Philippine entity which, as represented, is neither an agent authorized to conclude contracts for UIP BV nor does it have power to legally bind UIP BV in any manner, then this Office is of the opinion and so holds that the execution of the above Service Agreement will not create a permanent establishment of UIP BV in the Philippines. The fees in payment for the herein services rendered by UIP AB Philippine Branch under the Service Agreement shall be subject to tax at either the Minimum Corporate Income Tax (MCIT) of two percent (2%) of its gross income as defined in Section 28(2) or the thirty two (32%) of its taxable income under Section 28(1) both of the Tax Code of 1997, whichever is higher. For this purpose, the comparison between the normal income tax payable by the corporation and the MCIT shall be made at the end of the taxable year. On the other hand, payments received by UIP AB Philippine Branch in foreign currency inwardly remitted into its Philippine bank account qualifies as VAT zero-rated pursuant to Section 108(B)(2) of the Tax Code, as amended, provided that UIP AB Philippine Branch is a VAT registered entity. ( American Express International, Inc. Philippine Branch vs. Commissioner of Internal Revenue ,CTA Case No. 5813) 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. TEAcCD Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service