ITAD Ruling No. 092-04

August 31, 2004 ITAD RULING NO. 092-04 Articles 5, 7, 12 & 14 Philippines-Singapore tax treaty Section 23 (F); 28 (B); 108 (A) NIRC BIR Ruling No. DA-ITAD-59-03 BIR Ruling No. DA-ITAD-26-03 BIR Ruling No. DA-ITAD-293-00 Sycip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Attention: Atty. E.C. Alcantara Tax Division Gentlemen : This refers to your letter dated March 10, 2004 requesting confirmation on behalf of your client, Hyatt International SEA (Pte) Limited (Hyatt) that: (1) the sales and marketing fees to be paid by New Coast Hotel, Inc. (NCHI) under the Sales and Marketing Agreement between NCHI and Hyatt are in the nature of service income and are not to be considered as royalties; (2) the sales and marketing fees constitute compensation for labor or personal services to be rendered outside of the Philippines and are not subject to Philippine income tax/final withholding tax; and (3) the sales and marketing fees which constitute compensation for labor or personal services to be rendered outside of the Philippines are not subject to the 10% value-added tax (VAT). CTEaDc It is represented that Hyatt, a wholly-owned subsidiary of Hyatt International Corporation (H.I.) is a nonresident foreign corporation duly organized and existing under and by virtue of the laws of Singapore with principal place of business at 10-12 Scotts Road Singapore; that Hyatt 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 9, 2004; that NCHI is a corporation duly organized and existing under and by virtue of the laws of the Philippines with registered office and principal place of business at 12th Floor, Net One Center, 26th Street Corner 3rd Avenue, Crescent Park West, Bonifacio Global City, Taguig, Metro Manila; that on December 12, 2003, Hyatt and NCHI entered into a Sales and Marketing Agreement (Agreement); that pursuant to such Agreement, NCHI is prepared to finance, plan, build, furnish and equip, in Manila, a modern and outstanding hotel (Hyatt Hotel and Casino Manila) to be constructed as indicated in the agreement, to be operated under standards comparable to those prevailing in H.I. hotels throughout the world; that under the said Agreement NCHI retained Hyatt to provide, among others, appropriate worldwide sales and marketing for the Hotel; that the sales and marketing services shall consist in: (a) appropriate worldwide sales and marketing services for the Hotel, including the definition of policies, and the determination of annual and long-term objectives for occupancy, rates, revenues, clientele structure, sales terms and methods; and (b) appropriate consultation, worldwide advertising and promotional services for the Hotel, including the definition of policies and the preparation of advertising and promotional brochures (folders, leaflets, tariffs and fact sheets, guide books, maps, etc.) to be distributed worldwide in H.I. hotels and sales offices; that, furthermore, Hyatt shall provide (or cause to be provided) Hyatt's, H.I.'s or their affiliates' chain-wide sales and marketing services, such as, Chain Marketing Services and centralized reservation services, and shall coordinate the participation of the Hyatt Gold Passport program and any new sales and marketing or promotional programs organized by Hyatt, H.I. or their affiliates or be implemented in H.I. hotels worldwide; that as part of the worldwide marketing services to be provided for the Hotel, Hyatt shall provide (or cause to be provided) from outside the Philippines, convention, business and sales promotion services (including the maintenance and staffing of H.I.'s home office sales force and regional sales offices in various parts of the world), publicity, public relations, and all other group benefits, services and facilities including institutional advertising programs (which exclude advertising in which one or more other H.I. hotels participate by mutual agreement and shares the cost thereof), comparable to or to the same extent as furnished to other hotels operated by Hyatt and its affiliates; that these services shall be provided by Hyatt from outside the Philippines; and that in consideration therefor, Hyatt shall be entitled to receive monthly, as a preliminary installment of its sales and marketing fee, an amount equal to two percent (2%) of the revenue of the Hotel. In reply, please be informed of this Office's opinion on the following issues as follows: 1) The sales and marketing fees to be paid by NCHI to Hyatt under the Sales and Marketing Agreement are in the nature of service income and are not to be considered as royalties . Article 12(3) of the Philippines-Singapore tax treaty provides that: "Article 12 "Royalties "xxx xxx xxx (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. "xxx xxx xxx The treaty defines " royalties " to include " payment 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), (C) 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 No. 59-03 dated April 21, 2003 ) TcEAIH 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 compensate for personal services, if the payee has proprietary interest then the payment is royalty." Applying the above discussions to the case at hand, it is clear in the Sales and Marketing Agreement that the service fees do not fall within the definition of "royalties" under Article 12 of the Philippines-Singapore tax treaty. Specifically, nothing in the Agreement, as represented herein, would require transfer into the Philippines of technology, equipment or other property where the payee has proprietary interest or would otherwise permit Hyatt to impart to NCHI their special knowledge and experience, which remain unrevealed to the public. Inasmuch as Hyatt shall render these services using their customary skills, then the compensation to be received therefor shall not constitute as consideration for the use of, or the right to use, any copyright, patent, trademark, design or model, plan, secret formula or process, or for the transfer of technology. Thus, the subject sales and marketing fees to be paid by NCHI to Hyatt shall not be considered as royalties but shall constitute as business profits. ( BIR Ruling No. DA-ITAD-59-03 dated April 21, 2003 ) 2) Sales and marketing fees for services to be rendered outside the Philippines are not subject to Philippine income tax/final tax. In view of the representation that the services to be rendered by Hyatt in favor of NCHI shall be provided from outside the Philippines, the fees to be paid by NCHI are to be considered income derived from sources outside the Philippines which shall be governed by Section 23 (F) in relation to Section 28(B)(1), all of the 1997 Tax Code, to wit: "Sec. 23. General Principles of Income Taxation in the Philippines . (F) A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines. "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 interests, 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): 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) "xxx xxx xxx It is clear from the aforequoted provisions that a nonresident foreign corporation is taxable only on income derived from sources within the Philippines. However, since the services to be rendered by Hyatt to NCHI shall be provided outside the Philippines, fees to be remitted by NCHI to Hyatt in consideration for said services shall not be subject to Philippine income tax and consequently to withholding tax. ( BIR Ruling No. DA-ITAD-26-03 dated January 30, 2003 ) 3) The sales and marketing fees for services to be rendered outside Philippines are not subject to the 10% value-added tax . Section 108(A) of the said Tax Code of 1997 imposes a VAT equivalent to ten percent (10%) of the gross receipts derived from the sale, or exchange of services, including the use or lease of properties. The phrase "sale or exchange of services" means "the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration . . ." Inasmuch as it is represented that the sales and marketing services are to be performed by Hyatt outside of the Philippines, then, the service fees to be paid by NCHI are considered as income derived from services rendered outside the Philippines and shall not be subject to the 10% value-added tax. ( BIR Ruling [DA-293-00] dated July 28, 2000 ) 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. HIEAcC Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service