ITAD Ruling No. 112-03

July 29, 2003 ITAD RULING NO. 112-03 Art. 13, RP-US tax treaty Article 12, RP-Netherlands tax treaty Article 12, RP-China Tax Treaty Revenue Memorandum Circular No. 46-02 BIR Ruling No. DA-ITAD-100-03 BIR Ruling No. DA-ITAD-101-03 Punongbayan & Araullo Ernst & Young International 20th Floor, Tower I, The Enterprise Center 6766 Ayala Avenue, 1200 Makati City Attention: Mr. Romeo H. Duran Tax Director Gentlemen : This refers to your letter dated July 18, 2002 on behalf of your client, OTIS ELEVATOR COMPANY (PHILIPPINES), INC. (Otis-Phil), requesting confirmation that the royalty payments of Otis-Phils to OTIS ELEVATOR COMPANY (Otis-US) is subject to the preferential withholding tax rate of fifteen percent (15%) pursuant to Article 13(2)(b)[iii], otherwise known as the "most-favored-nation clause," of the RP-US tax treaty in relation to Article 12(2) of the RP-Denmark tax treaty. It is represented that Otis-US is a non-resident foreign corporation organized and existing under the laws of the State of New Jersey, U.S.A.; that the Certificate of Registration of Otis-US has been revoked per Order dated August 31, 1990 pursuant to Batas Pambansa Blg. 68 and Presidential Decree No. 902-A as amended per certification issued by the Securities and Exchange Commission dated June 07, 2002; that Otis-Phils, on the other hand, is a corporation duly organized and existing under Philippine laws; that it is registered primarily to import, buy and sell, at wholesale, install, maintain, repair, modernize, assemble and fabricate elevators, escalators, moving walkways and shuttle system and their parts; that on December 01, 1992, Otis-Phils and Otis-US entered into a Technical Assistance Agreement and License to Use Technical Data, Know-How and Patents whereby Otis-US will provide among others, technical data, know-how to improve the technical knowledge of OTIS-Phils' personnel, a non-exclusive; non-transferable right and license to make use of the technical data, know-how and rights under the patents to sell, install, use, copy, repair, modernize and service products in the territory, and a non-exclusive, non-transferable right and license to sell the products to Otis-Phil and the subsidiaries and affiliated companies throughout the world; that in consideration, Otis-Phils will pay Otis-US a royalty fee equivalent to three and one-half percent (3%) of the net billings of the former for the products; that the aforementioned Agreement complies with Sections 87 and 88 of the Intellectual Property Code (Republic Act No. 8293) on Voluntary Licensing per Certificate of Compliance No. 5-1999-00012 dated September 05, 2000 issued by the Intellectual Property Office. 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 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: cCTAIE (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 "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)(b) of the RP-Netherlands tax treaty, the tax charged shall not exceed 15% of the gross amount of royalties, while under Article 12(2)(b) 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.N. 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. 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 Otis-Phils to Otis-US under the Technical Assistance Agreement and License to Use Technical Data, Know-How and Patents for the years 1992 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-100-03 dated July 16, 2003; BIR Ruling No. DA-ITAD-101-03 dated July 24, 2003; RMC No. 46-02 dated September 2, 2002 ) It is worthy to note that the RP-Netherlands tax treaty, which took effect January 1, 1992, more appropriately applies to cover the period of the subject Technical Assistance and License Agreement, that is, from December 1, 1992 to December 31, 2001 than the RP-Denmark tax treaty as invoked in your request, which took effect only on January 1, 1998. Moreover, the said royalty payments are subject to 10% value-added tax (VAT) pursuant to Section 108 of the Tax Code of 1997. Accordingly, Otis-Phil being the payor in control of the payment shall, before making payments of royalties to Otis-US, 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 Otis-US 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 Otis-Phil if it is a VAT-registered taxpayer. In case Otis-Phil 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, Otis-Phil is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of Otis-US, the first three copies thereof to be given to Otis-US and the fourth copy to be retained by Otis-Phil as its file copy. ( Section 4 & 6, Revenue Regulation No. 4-2002 ) In fine, Otis-Phil shall be responsible for the withholding of income tax at the rate of 15% for the years 1992 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 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. CDTHSI Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service