ITAD Ruling No. 101-03

July 24, 2003 ITAD RULING NO. 101-03 RP-US Tax Treaty, Article 13 RP-Netherlands Tax Treaty, Article 12 RP-China Tax Treaty, Article 12 Revenue Memorandum Circular 46-02 DA-ITAD-52-03 dated April 8, 2003 DA-ITAD 102-002 dated May 28, 2002 Romulo Mabanta Buenaventura Sayoc & De los Angeles 30th Floor Citibank Tower 8741 Paseo de Roxas Makati City Attention: Atty. Priscilla B. Valer Gentlemen : This refers to your application for tax treaty relief on behalf of Avon Products, Inc. (Avon) requesting confirmation of your opinion that the royalties paid by Avon Cosmetics, Inc. (ACI) to Avon are subject to withholding tax at the following rates: 1) 15% with respect to royalties derived by, or which accrued, to Avon beginning January 1, 2001 to December 31, 2001; and 2) 10% with respect to royalties derived by, or which accrued to, Avon beginning January 1, 2002 and onwards, pursuant to the "most favored nation" clause of the RP-US tax treaty in relation to the Philippine tax treaties with the Netherlands and the People's Republic of China (PROC). It is represented that Avon is a non-resident foreign corporation duly organized and existing under the laws of the State of New York, U.S.A. with offices at 1345 Avenue of the Americas, New York, New York; that it is not registered either as a corporation or as a partnership and has not been licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission (SEC) dated October 16, 2001; that ACI is a corporation duly organized and existing under Philippine laws with principal office at the Avon Corporate Center, 144 Legaspi corner Herrera Sts.,Legaspi Village, Makati City; that on January 1, 2001, Avon and ACI entered into a License and Trademark Agreement whereby Avon granted ACI an exclusive license in the Philippines to use Avon's proprietary information and know-how in its business operations in the field of marketing, research, distribution and administration and a non-exclusive license to use Avon's trademarks and tradename; that in consideration for the licensed rights, ACI shall pay Avon a royalty of 6% of Net Sales; that on January 1, 2001, Avon and ACI entered into a License and Trademark Agreement which was amended on December 4, 2001; that on December 7, 2001, the Agreement and Its Amendment were registered with the Intellectual Property Office under Certificate of Compliance No. 5-2001-00098. In reply, please be informed that Article 13 of the RP-US tax 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. IEaHSD "(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 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 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 (Royalties) of the RP-Netherlands tax treaty provides, viz : "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 .(Emphasis supplied) "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. IcESDA "xxx xxx xxx" Moreover, Article 12 (Royalties) of the RP-PROC 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. 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. 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-52-03, April 8, 2003 ) A perusal of the RP-US, RP-Netherlands and the RP-China tax treaty provision on the avoidance of double taxation shows a similarity on the manner of payment of taxes, that is, the allowable foreign tax credit on the three treaties is the amount actually paid in the Philippines. Such being the case, and since ACI is not registered and engaged in preferred areas of activities in the Philippines, royalties arising in the Philippines and payable to Avon for the year 2001 are subject to tax at the rate of 15 per cent (15%) pursuant to Article 13(2)(b)(iii) of the RP-US tax treaty in relation to Article 12(2)(b) of the RP-Netherlands tax treaty. On the other hand, royalty payments beginning January 1, 2002 shall be subject to 10 per cent (10%) pursuant to Article 13(2)(b)(iii) of the RP-US tax treaty in relation to Article 12(2)(b) of the RP-PROC tax treaty. ( BIR Ruling DA-ITAD 102-02 dated May 28, 2002; RMC 46-02 dated September 2, 2002 ). ACI shall deduct and withhold the tax at the time the royalty income 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 becomes due, demandable, or legally enforceable. (Section 4-Time of Withholding, Revenue Regulations No. 12-2001) HDCAaS Moreover, the said royalty payments are subject to 10% value-added tax (VAT) pursuant to Section 108 of the Tax Code of 1997. Accordingly, ACI being the payor in control of the payment, shall, upon making payments of royalties to Avon, be responsible for withholding and remitting to this Bureau the 10% VAT due thereon using BIR Form 1600 Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld (Sec. 7 Withholding of VAT, Revenue Regulations No. 14-2002). The duly filed BIR Form 1600 and proof of payment thereof shall serve as sufficient basis for the claim of input tax to be applied against the output tax that may be due from ACI if it is a VAT-registered taxpayer. In case ACI is a non-VAT registered taxpayer, the passed-on VAT withheld shall form part of the cost of the service purchased or treated as expense, whichever is applicable. In addition, ACI is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of Avon, the first three copies thereof to be given to Avon and the fourth copy to be retained by ACI as its file copy. In fine, ACI shall be responsible for the withholding of income tax at the rate of 15% for the year 2001 of the gross amount of royalties and 10% for the succeeding years and VAT at the rate of 10% of the contract amount. 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 without force and effect insofar as the herein parties are concerned. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service