ITAD Ruling No. 116-02

June 4, 2002 ITAD RULING NO. 116-02 Article 13, RP-US Tax Treaty Article 12, RP-Russia Tax Treaty BIR Ruling No. ITAD-121-00 Joaquin Cunanan & Co. 14th Floor Multinational Bancorporation Centre 6805 Ayala Ave., 1226 Makati City Attention: Mary Assumption S. Bautista-Villareal Principal, Tax Services Department Gentlemen : This refers to your application for relief from double taxation dated January 29, 2001, on behalf of Unilever Philippines, Inc. (UPI), requesting confirmation of your opinion that the royalty payments to be made by UPI to Helene Curtis, Inc. (HCI) are subject to the preferential tax rate of 15% pursuant to Article 13 of the RP-US tax treaty in relation to Article 12 of the RP-Russia tax treaty, and to the 10% value-added tax under the National Internal Revenue Code (Tax Code) of 1997, and that the said payments are deductible business expense of UPI. It is represented that HCI is a corporation organized and existing under the laws of the State of Delaware, United States of America (USA), with office address at 501 Silverside Road, Wilmington, Delaware, USA 19809; that HCI is not registered as a corporation/partnership licensed to do business in the Philippines per Securities and Exchange Commission certification dated February 9, 2001; that UPI is a corporation organized and existing under the laws of the Philippines with office address at No. 1351 United Nations Avenue, Manila, Philippines; that both UPI and HCI are affiliate companies belonging to an international concern which carries on business all over the world in the manufacture and sale of various products; that to assist in the development of its business in the Philippines, UPI has requested HCI to secure the availability to it of HCI's international experience in the areas of research and development, provision of trademark, communication of patents and secret processes, general advisory services in the areas of production and technical, marketing, sales, logistics and legal; that in consideration for the aforementioned services, UPI and HCI entered into a Service Agreement whereby UPI agrees to pay HCI a service fee of five percent (5%) of the total net sales value of all the Agreement Products on a quarterly basis; that the Agreement Products refer to hair lotion, oils, essential oils, toilet and skin preparations and other cosmetics as are from time to time manufactured by or on behalf of UPI; that the Service Agreement shall take effect on Dec. 1, 1999 and shall continue in full force and effect until Nov. 30, 2009 unless terminated by mutual agreement between the parties or by either party giving to the other at anytime at least three (3) months written notice; that the Service Agreement complied with Sections 87 and 88 of the Intellectual Property Code on Voluntary Licensing as per Certificate of Compliance No. 5-2000-00090 dated Nov. 23, 2000 issued by the Intellectual Property Office of the Department of Trade and Industry; that the said fees shall be paid within one month from the end of each quarter to which the fees relate; that under the Service Agreement, it is stipulated that for and in consideration of the payments to be made by UPI, HCI shall, during the term and existence of the Agreement, render certain corporate or central services as set forth below: a. research and development b. trademark c. communication of patents d. secret processes e. general advisory services on production and technical f. marketing/sales/logistics g. legal that for the services on research and development, HCI shall make available to UPI the results of HCI's research in respect of the Agreement Products that will be of mutual benefit to both parties; that on trademarks, HCI shall secure to UPI the right during the continuance of the agreement to apply or to continue to apply to the Agreement Products the trademark of HCI's the parties may from time to time require; and that on Communication of Patents, Secret Processes, etc., HCI shall communicate and make available to UPI for the purposes of the manufacture of the Agreement Products such secret processes, inventions and improvements, now or hereafter directly or indirectly owned by HCI. In reply, please be informed that Article 13 of the RP-US tax treaty provides as follows, 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" The tax treaty defines "royalties" to include payments of any kind received as a consideration for the use of, or the right to use, any patent, trade marks, design or model, plan, secret formula or process. It also includes "payments of any kind received as a consideration for information concerning industrial, commercial or scientific experience." According to the Commentaries of the ORGANIZATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT (OECD) Committee on Fiscal Affairs on the Model Tax Convention [par. 11, Commentary on Article 12 (Royalties), 1998, p. 151], such information alludes to the concept of "know-how" . The definition of know-how, which has been adopted by the said Committee, is "all the undivulged technical information, whether capable of being patented or not, that is necessary for the industrial reproduction of a product or process, directly and under the same conditions; inasmuch as it is derived from experience, know-how represents what a manufacturer cannot know from mere examination of the product and mere knowledge of the progress of technique." In the know-how contract, one of the parties agrees to impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public. As thus stated in the Service Agreement by and between UPI and HCI, the information to be imparted by HCI falls under the purview of know-how. Hence, payments received by HCI in consideration for the said services are deemed royalties. The RP-US tax treaty also speaks of 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." This is known as the most-favored-nation clause of the RP-US tax treaty. The purpose of the most favored nation clause is to grant to the Contracting State treatment no less favorable than that which has been or may be granted to the "most favored" among other countries. Corollarily, the RP-US and RP-Russia tax treaties, particularly their provision on the avoidance of double taxation, show 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. Article 12 of the RP-Russia tax treaty provides as follows, 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, the royalties may also be taxed in the Contracting State in which they arise and according to the laws of the State, but the tax so charged shall not exceed 15 percent of the gross amount of royalties. "xxx xxx xxx" Such being the case, this Office confirms your opinion as it holds that the payments to be made by UPI to HCI are subject to the preferential tax rate of 15%, pursuant to the most favored nation clause [Article 13(2)(b)(iii)] of the RP-US tax treaty in relation to the RP-Russia tax treaty. (BIR Ruling No. ITAD 121-00) Moreover, under Section 108 of the Tax Code of 1997, the royalty payments to be remitted by UPI are subject to the 10% value-added tax. Accordingly, being the payor in control of the payment, UPI shall be responsible for the withholding of VAT on such royalties on behalf of HCI by filing a separate VAT return for and on behalf of HCI using BIR Form No. 1600 (Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld). The duly 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 UPI. In addition, UPI is required to issue the Certificate of Creditable Tax Withheld at Source (BIR Form 2307) in quadruplicate upon request of HCI, the first three (3) copies thereof to be given to HCI and the fourth copy to be retained by UPI as its file copy. In fine, UPI 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. As regards your query on whether the subject royalty payments are considered deductible business expense pursuant to Section 34(A)(1) of the Tax Code, please be advised that we decline to rule on the matter considering the factual nature of the issue raised. This ruling is issued on the basis of the foregoing facts as presented. However, if upon investigation it shall be disclosed that the facts are different, then this ruling shall be null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) MILAGROS V. REGALADO Assistant Commissioner Legal Service