ITAD Ruling No. 105-03

July 28, 2003 ITAD RULING NO. 105-03 Article 13, RP-US, Article 12, RP-China BIR Ruling No. DA-ITAD 101-03 BIR Ruling No. ITAD-18-01 Revenue Memorandum Circular 46-2002 Sycip Gorres & Velayo 6760 Ayala Avenue 1226 Makati City Attention: Mr. Joel L. Tan Torres Partner, Tax Division Gentlemen : This refers to your tax treaty relief application dated October 21, 2002, on behalf of your client, McGeorge Food Industries, Inc. (McGeorge), requesting confirmation of your opinion that the royalty payment of McGeorge to McDonald's Corporation (McDonald's) is subject to preferential tax rate of 10% pursuant to the most favored nation clause of the RP-US tax treaty in relation to the RP-China tax treaty. It is represented that McDonald's is a foreign corporation duly organized and existing under the laws of the United States of America (USA), with principal office at 1013 Centre Road, Wilmington, New Castle, County Delaware, USA, 19805; 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 dated October 17, 2002; that McDonald's entered into a "License Agreement" with McGeorge, a corporation duly organized and existing under the laws of the Philippines with office address at 17/F Citibank Bldg. 8741 Paseo de Roxas, Makati City; that under the agreement, McDonald's granted the McGeorge a non-exclusive license and privilege to adopt and use the McDonald's system in restaurants constructed at location all over the Philippines, including the right to use trade names, trademarks and service marks relating to the McDonald's system; that the original License Agreement, valid from September 1993 to April 2001, was amended on April 1, 2001 extending its validity to December 31, 2010; that in consideration for the license granted, McGeorge pays McDonald's royalty at the rate of 5% of net sales with an additional bonus royalty of 1% Net Foreign Exchange Earnings, payable only upon proof of such Net Foreign Exchange Earnings as provided under Article 9 of the License Agreement; that for some restaurants identified in Schedule A of the License Agreement, the royalty rate is 3% of the Net Sales; and that the aforementioned Agreement is registered with the Intellectual Property Code (Republic Act No. 8293) with Certificate of Registration No. 1630 dated October 9, 2000. 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. "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 .(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. TcSAaH "xxx xxx xxx" and, in relation thereto, Article 12 of the RP-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. "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. (Emphasis supplied) Based on the aforequoted 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(b) of the RP-China tax treaty, the tax charged shall not exceed 10% of the gross amount of royalties. Such being the case, this Office is of the opinion and so holds that the royalty payments of McGeorge to McDonald's under the License Agreement effective January 01, 2002, the date of effectivity of the RP-China tax treaty, shall be subject to tax rate of ten percent (10%), pursuant to the RP-US tax treaty in relation to Article 12(2)(b) of the RP-China tax treaty. ( Revenue Memorandum Circular No . 46-2002 dated September 2, 2002 ) ( BIR Ruling No . DA-ITAD 101-03 dated July 24, 2003 ) Moreover, the said royalty payments to be paid by McGeorge to McDonald's in the Philippines are subject to the 10% value-added tax pursuant to Sec. 108 of the Tax Code. Accordingly, McGeorge, being the resident withholding agent and payor in control of the payment shall be responsible for the withholding of the 10% final VAT on such royalty before making any payment to McDonald's. In remitting the VAT withheld, McGeorge shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form 1600 and proof of payment thereof shall serve as documentary substantiation for the claim of input tax by McGeorge upon filing its own VAT return, if it is a VAT-registered taxpayer. In case McGeorge 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 "expense" or "asset" whichever is applicable. In addition, McGeorge, is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of McDonald's, the first three copies thereof to be given to McDonald's and the fourth copy to be retained by McGeorge as its file copy. [ Sections 4 & 6, Revenue Regulations (RR) No. 4-2000; Section 3 of RR 8-2002; Section 7 of RR 14-2002 ] 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. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service