ITAD Ruling No. 111-03

July 29, 2003 ITAD RULING NO. 111-03 Article 13, RP-US tax treaty Article 12, RP-Netherlands tax treaty Article 12, RP-China tax treaty Revenue Memorandum Circular 46-02 BIR Ruling No. DA-ITAD-101-03 Nippon Paint Philippines, Inc . Hologram St., Light Industry and Science Park of the Philippines Cabuyao, Laguna Attention: Ms. Aileen Regina B. Lomotan Finance and Accounting Manager Gentlemen : This refers to your letter dated November 22, 2001, requesting relief from double taxation on your royalty payments to The Valspar Corporation (Valspar), pursuant to the "most-favored-nation" clause of the RP-US tax treaty in relation to the RP-Netherlands and the RP-China tax treaties. It is represented that Valspar is a non-resident foreign corporation duly organized and existing under the laws of the State of Delaware, U.S.A.; 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 February 14, 2002; that Nippon Paint Philippines, Inc. (NPP), on the other hand, is a corporation duly organized and existing under the laws of the Philippines; that on July 20, 1998, NPP and Valspar entered into a Licensing Agreement whereby Valspar granted NPP a license to manufacture and sell consumer paints in the Philippines under Valspar labels, trademarks and tradenames; that in consideration therefor, NPP shall pay royalty fees to Valspar; that the Licensing Agreement and its Amendment comply with the provisions of the intellectual Property Code per Certificate of Compliance No. 5-1998-00066 issued by the Intellectual Property Office dated April 21, 1999. 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, CAaSED "(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" and, in relation thereto, Article 12 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. "xxx xxx xxx" Moreover, Article 12 of 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 TaDSCA "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) 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." "xxx xxx xxx" 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(2) of the RP-Netherlands tax treaty, the tax charged shall not exceed 15% of the gross amount of royalties, while under Article 12(2) of the RP-China tax treaty, the tax charged shall not exceed 10% of the gross amount of royalties. 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 the subject matter of the tax which is royalties. A perusal of the RP-US, RP-Netherlands and the RP-China 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 treaties is the amount actually paid in the Philippines. Such being the case, this Office is of the opinion and so holds that the royalty payments of NPP to Valspar under their Licensing Agreement for the years 1998 up to 2001 are subject to Philippine tax at the rate of fifteen percent (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, while the royalty payments from January 01, 2002, the date of effectivity of the RP-China tax treaty, shall be subject to tax at the 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. ( BIR Ruling No. DA-ITAD-101-03 dated July 24, 2003; RMC 46-02 dated September 2, 2002 ) Moreover, the said royalty payments are subject to 10% value-added tax (VAT) pursuant to Section 108 of the Tax Code of 1997. Accordingly, NPP being the payor in control of the payment shall, before making payments of royalties to Valspar, be responsible for withholding and remitting to this Bureau the 10% VAT due thereon by filing a separate VAT return for and on behalf of Valspar using BIR Form 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 sufficient basis for the claim of input tax to be applied against the output tax that may be due from NPP if it is a VAT-registered taxpayer. In case NPP 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, NPP is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of Valspar, the first three copies thereof to be given to Valspar and the fourth copy to be retained by NPP as its file copy. [ Section 4 & 6, Revenue Regulation No. 4-2002 ) In fine, NPP shall be responsible for the withholding of income tax at the rate of 15% for the years 1998 up to 2001 and 10% beginning 2002 of the gross amount of royalties paid and the value-added tax at the rate of 10% of the contract amount. 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. cAHIST Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service