ITAD Ruling No. 107-01

October 30, 2001 ITAD RULING NO. 107-01 Article 13, RP-US Article 12, RP-Netherlands BIR Ruling No. ITAD 151-00 Baxter Healthcare Philippines, Inc. 19/F Wynsum Corporate Plaza Emerald Avenue, Ortigas Center Pasig City Attention: Ms. Anabel T. Chan Asst. Finance Manager Gentlemen : This refers to your letter dated February 14, 2001 requesting to avail of the preferential tax rate of 15% final withholding tax on your royalty payments to Baxter International, Incorporated (BII) citing the "most favored nation" clause under Article 13 of the RP-US Tax Treaty in relation to the RP-Netherlands Tax Treaty. It is represented that BII is a non-resident foreign corporation organized and existing under the laws of the State of Delaware with principal office located in One Baxter Parkway, Deerfield, Illinois, 60015, USA; that it is not registered either as a corporation or as a partnership licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated September 12, 2000; that Baxter Healthcare Philippines, Inc. (BHPI) is a domestic corporation duly organized and existing under Philippine laws with principal office at 19/F Wynsum Corporate Plaza, Emerald Ave., Ortigas Center, Pasig City; that BHPI entered into an Intellectual Property License Agreement with BII dated January 2, 2001, which is duly registered with the Intellectual Property Office of the Department of Trade and Industry under a Certificate of Compliance No. 5-2001-00005 and valid for ten (10) years, i.e., from January 2, 2001 to January 1, 2011; that under the said Agreement, BII grants to BHPI (a) a nonexclusive license under Patent Rights to make and sell Licensed Products, (b) a nonexclusive license under Trademark Rights to make and to sell Licensed Products, (c) nonexclusive license to use the Know-How Rights and the Software Copyright Rights in the manufacture and supply of the Licensed Products, and (d) to promptly inform the Licensee of improvements in techniques and processes of Licensed Products; and that for and in consideration of the license granted, BHPI undertakes to pay BII royalty whichever the larger between Ten Thousand United States dollars ($10,000) per year and six percent (6%) of the Net Sales per year on quarterly basis. 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) . . . (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." The "most favored nation" clause under Article 13(2)(b)(iii) of the RP-US Tax Treaty calls for the application of a Philippine tax treaty which provides for the lowest rate of the 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) "xxx xxx xxx" 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. Hence, the "most favored nation" clause of the RP-US Tax Treaty must be interpreted not only in relation to Article 12 of the RP-Netherlands Tax Treaty but also in connection with the provisions on the elimination of double taxation of both the RP-US Tax Treaty and Netherlands Tax Treaty. A perusal of the RP-US and RP-Netherlands Tax Treaty provisions on the avoidance of double taxation shows a similarity on the manner of payment of taxes, that is, the allowable foreign tax credit on both treaties is the amount actually paid in the Philippines. Such being the case, this Office is of the opinion and so holds that the royalties paid by BHPI to BII are subject to Philippine tax at the rate of fifteen percent (15%) of the gross amount of royalties pursuant to the "most favored nation" clause of the RP-US Tax Treaty in relation to the RP-Netherlands Tax Treaty. (BIR Ruling No. ITAD-151-00 dated October 23, 2000) Moreover, under Section 108(A)(1) and (3) of the Tax Code of 1997, the payments to be remitted by BHPI to BII are subject to 10% value-added tax. Accordingly, BHPI shall, before making payment of royalties to BII, withhold and remit to this Bureau the said 10 percent VAT due thereon by filing a separate VAT return for and on behalf of BII using BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly validated VAT declaration/return is sufficient evidence in claiming input tax credit. (Section 4.110-3(b) of Revenue Regulations No. 7-95) In fine, BHPI shall be responsible for the withholding of income tax at the rate of 15% of the gross amount of royalties and the value-added tax 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 will be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) EDMUNDO P. GUEVARA Deputy Commissioner Legal and Inspection Group