ITAD Ruling No. 114-05

October 3, 2005 ITAD RULING NO. 114-05 Art. 13 & 23 of the Philippines-United States Tax Treaty; Art. 12 & 23 of the Philippines-Japan Tax Treaty ROHM LSI Design Philippines, Inc. 24/F Tower 1, The Enterprise Center 6766 Ayala Avenue corner Paseo de Roxas 1200 Makati City Attention: Mr. Yoshihiko Yamauchi Managing Director Gentlemen : This refers to your letter dated July 30, 2004, requesting confirmation that your royalty payments to Paragon IC Solutions, Inc. (PARAGON), a resident of the United States of America, are subject to the withholding tax rate of ten percent (10%) pursuant to the "most-favored-nation" clause of the Philippines-United States of America (Philippines-United States) tax treaty in relation to the Philippines-Japan tax treaty. It is represented that PARAGON is a nonresident foreign corporation organized and existing under the laws of the United States of America (USA) with principal address at 4060 Campus Drive, Suite 220 Newport Beach, California 92660 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 March 2, 2004; that ROHM is a corporation registered with the Philippine Board of Investments (BOI) on a pioneer status per Certificate of Registration No. 92-467 dated January 27, 1993, with principal address at 24/F, The Enterprise Ctr.,Tower 1, 6766 Ayala Ave. corner Paseo de Roxas, Makati City; and that on January 31, 2004, ROHM and PARAGON entered into a Software License Agreement wider which PARAGON grants ROHM a non-exclusive and non-transferable license to use licensed software only on computer(s) as designated in the PARAGON license file. In reply, please be informed that Article 13 of the Philippines-United States 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 DHATcE (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" Pursuant to the aforequoted "most-favored-nation" clause under Article 13(2)(b)(iii) of the Philippines-United States 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. The purpose of the "most-favored-nation" clause is to grant the Contracting State treatment no less favorable than that which has been or may be granted to the "most favored" among other countries. Therefore, the tax treatment of royalty payment to a US entity must be taken in relation with other Philippine tax treaties which provide for the lowest rate. In this connection, it is noteworthy that under Article 12(3) of the Philippines-Japan tax treaty, the preferential tax rate not exceeding 10% of the gross amount of the royalties may be availed of when the paying company is registered with the BOI and engaged in preferred pioneer areas of investment. It provides: "Article 12 1. Royalties arising in a Contracting State and paid to a residents of the other Contracting State may be taxed in that other Contracting State. 2. However, such royalties may also be taxed in the Contracting State in which they arise, and according to the laws of that Contracting 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 the royalties the royalties are paid in respect of the use of or the right to use cinematograph films and films or tapes for radio or television broadcasting; (b) 25 per cent of the gross amount of the royalties in all other cases. 3. Notwithstanding the provisions of paragraph (2),the amount of tax imposed by the Philippines on the royalties paid by a company, being a resident of the Philippines, registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives laws of the Philippines to a resident of Japan, who is the beneficial owner of the royalties, shall not exceed 10 per cent of the gross amount of the royalties .(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, June 25, 1999), the interpretation of the Court of Tax Appeals of the phrase "paid under similar circumstances" as found in the Philippines-United States tax treaty was not sustained by the Supreme Court, thus: EcAISC "We are unable to sustain the position of the Court of Tax Appeals, which was upheld by the Court of Appeals, that the phrase 'paid under similar circumstances' in Article 13(2)(b)(iii) of the Philippines-United States Tax Treaty should be interpreted to refer to payment of royalty, and not to the payment of the tax, for the reason that the phrase 'paid under similar circumstances' is followed by the phrase 'to a resident of a third state.' The respondent court held that 'Words are to be understood in the context in which they are used,' and since what is paid to a resident of a third state is not a tax but a royalty, 'logic instructs' that the treaty provision in question should refer to royalties of the same kind paid under similar circumstances. The above construction is based principally on syntax or sentence structure but fails to take into account the purpose animating the treaty provisions in point. To begin with, we are not aware of any law or rule pertinent to the payment of royalties, and none has been brought to our attention, which provides for the payment of royalties under dissimilar circumstances. The tax rates on royalties and the circumstances of payment thereof are the same for all the recipients of such royalties and there is no disparity based on nationality in the circumstances of such payment. On the other hand, a cursory reading of the various tax treaties will show that there is no similarity in the provisions on relief from or avoidance of double taxation as this is a matter of negotiation between the contracting parties. xxx xxx xxx The reason for construing the phrase 'paid under similar circumstances' as used in Article 13(2)(b)(iii) of the Philippines-United States treaty as referring to taxes is anchored upon a logical reading of the text in the light of the fundamental purpose of such treaty which is to grant an incentive to the foreign investor by lowering the tax and at the same time crediting against the domestic tax abroad a figure higher than what was collected in the Philippines." In fine, 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. ITAD 140-03 dated September 18, 2003) In relation thereto, Article 23 of the Philippines-Japan tax treaty and the Philippines-United States tax treaty provide, respectively: Philippines-Japan tax treaty : "Article 23 1. Subject to the laws of Japan regarding the allowance as a credit against Japanese tax of tax payable in any country other than Japan, Philippine tax payable in respect of income derived from the Philippines shall be allowed as a credit against Japanese tax payable in respect of that income. Where such income is a dividend paid by a company which is a resident of the Philippines to a company which is a resident of Japan and which owns not less than 25 per cent either of the voting shares of the company paying the dividend or of the total shares issued by that company, the credit shall take into account Philippine tax payable by the company paying the dividend in respect of its income. SaCIAE 2. Subject to the laws of the Philippines regarding the allowance as a credit against Philippine tax of tax payable in any country other than the Philippines, Japanese tax payable in respect of income derived from Japan shall be allowed as a credit against Philippine tax payable in respect of that income. Where such income is a dividend paid by a company which is a resident of Japan to a company which is a resident of the Philippines and which owns the majority of the voting shares of the company paying the dividend or of the total shares issued by that company, the credit shall take into account Japanese tax payable by the company paying the dividend in respect of its income. 3. For the purposes of the credit referred to in the first sentence of paragraph (1), Philippine tax shall always be considered as having been paid at the rate of 20 per cent in the case of dividends to which the provisions of paragraph (3) of Article 10 apply, and at the rate of 15 per cent in the case of interest to which the provisions of paragraph 2(a) or 3 of Article 11 apply, and in the case of royalties to which the provisions of paragraph 3 of Article 12 apply ." (Emphasis supplied) Philippines-United States tax treaty : "Article 23 Relief from Double Taxation Double taxation of income shall be avoided in the following manner: 1. In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof),the United States shall allow to a citizen or resident of the United States as a credit against the United States tax the appropriate amount of taxes paid or accrued to the Philippines and, in the case of a United States corporation owning at least 10 percent of the voting stock of a Philippine corporation from which it receives dividends in any taxable year, shall allow credit for the appropriate amount of taxes paid or accrued to the Philippines by the Philippine corporation paying such dividends with respect to the profits out of which such dividends are paid. Such appropriate amount shall be based upon the amount of tax paid or accrued to the Philippines, but the credit shall not exceed the limitations (for the purpose of limiting the credit to the United States tax on income from sources within the Philippines, or on income from sources outside the United States) provided by United States law for the taxable year. For the purpose of applying the United States credit in relation to taxes paid or accrued to the Philippines, the rules set forth in Article 4 (Sources of Income) shall be applied to determine the source of income. For purposes of applying the United States credit in relation to taxes paid or accrued to the Philippines, the taxes referred to in paragraphs 1(b) and 2 of Article 1 (Taxes Covered) shall be considered to be income taxes. DAcSIC 2. In accordance with the provisions and subject to the limitations of the law of the Philippines (as it may be amended from time to time without changing the general principle hereof), the Philippines shall allow to a citizen or resident of the Philippines as a credit against the Philippine tax the appropriate amount of taxes paid or accrued to the United States and, in the case of a Philippine corporation owning more than 50 percent of the voting stock of a United States corporation from which it receives dividends in any taxable year, shall allow credit for the appropriate amount of taxes paid or accrued as to the United States by the United States corporation paying dividends with respect to the profits out of which such dividends are paid. Such appropriate amount shall be based upon the amount of tax paid or accrued to the United States, but the credit shall not exceed the limitations (for the purpose of limiting the credit to the Philippine tax on income from sources within the United States, and on income from sources outside the Philippines) provided by Philippine law for the taxable year. For the purpose of applying the Philippine credit in relation to taxes paid or accrued to the United States, the rules set forth in Article 4 (Source of Income) shall be applied to determine the source of income. For purposes of applying the Philippine credit in relation to taxes paid or accrued to the United States, the taxes referred to in paragraphs 1(a) and 2 of Article 1 (Taxes Covered) shall be considered to be income taxes. xxx xxx xxx" It must be noted that unlike the Philippines-United States tax treaty, the Philippines-Japan tax treaty allows a tax credit of fifteen percent (15%) of the gross amount of royalties against Japanese income tax for the taxes payable in the Philippines on such royalties where the tax rate is reduced to ten percent (10%) or fifteen percent (15%) under the said treaty. To illustrate, the royalty income of a Japanese resident from sources within the Philippines is taxed at ten percent (10%),if the payor, being a resident of the Philippines, is a company registered with the Board of Investments and engaged in preferred pioneer areas of investment under the investment incentives law of the Philippines. But for purposes of eliminating double taxation, a 15% rate is credited in Japan in favor of the Japanese corporation who earned royalties in the Philippines. On the other hand, the Philippines-United States tax treaty provides that the United States shall allow to a United States resident "a credit against the United States tax the appropriate amount of taxes paid or accrued to the Philippines". Hence, the tax on royalties under the Philippines-United States tax treaty is not paid under similar circumstances as those obtaining in the Philippines-Japan tax treaty. Consequently, the royalty provisions in the Philippines-Japan tax treaty cannot be availed of in the interpretation of the 'most-favored-nation' clause provision of the Philippines-United States tax treaty. In view thereof, and considering that ROHM is a BOI-registered corporation engaged in preferred areas of activities, Article 13(2)(b)(ii) of the Philippines-United States tax treaty applies instead in the herein case. Therefore, the royalty payments by ROHM to PARAGON is subject to a preferential tax rate of 15 percent (15%) of the gross amount thereof pursuant to Article 13(2)(b)(ii) of the Philippines-United States tax treaty. TSEHcA Lastly, the said royalty payments to be paid by ROHM to PARAGON are subject to the 10% value-added tax (VAT) pursuant to Sec. 108 of the Tax Code of 1997. Accordingly, ROHM, being the resident withholding agent and payor in control of the payment shall be responsible for the withholding of the 10% VAT on such royalty before making any payment to PARAGON. In remitting the VAT withheld, ROHM shall use BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly filed BIR Form No. 1600 and the proof of payment thereof shall serve as documentary substantiation for the claim of input tax by ROHM upon filing its own VAT return, if it is a VAT-registered taxpayer. In case ROHM 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, ROHM is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate upon the request of PARAGON, the first three copies thereof to be given to PARAGON and the fourth copy to be retained by ROHM as its file copy. [Sections 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 of RR No. 8-2002; Section 7 of RR No. 14-2002] 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. Very truly yours, (SGD.) JOSE MARIO C. BUAG OIC-Commissioner of Internal Revenue