ITAD Ruling No. 121-05

October 26, 2005 ITAD RULING NO. 121-05 Arts. 12, 5, & 7, Philippines-Netherlands tax treaty DA-ITAD 100-03; DA-ITAD 207-03; DA-ITAD 90-04 Joaquin Cunanan & Co . 29th Floor Philamlife Tower 8767 Paseo de Roxas 1226 Makati City Attention: Mary Assumption S. Bautista-Villareal Principal, Tax Services Gentlemen : This refers to your letter dated February 7, 2005, (received by this Office on May 7, 2005) on behalf of your client, Unilever Foods Philippines (CMC), Inc. (UFP, for brevity) (formerly, California Manufacturing Co., Inc.) seeking confirmation of the following: 1. Royalties paid by UFP to Unilever N.V. (UNV) under their Trademark License Agreement and Technology License Agreement are subject to the preferential tax rate of fifteen percent (15%) in accordance with Article 12(2)(b) of the Philippines-Netherlands tax treaty; and 2. Service fees paid by UFP to UNV under their Central Services Agreement are business profits and as such, are not subject to Philippine income tax and, consequently, to withholding tax on the ground that UNV does not have a permanent establishment in the Philippines under the Philippines-Netherlands tax treaty. It is represented that UNV is a nonresident foreign corporation with office address located at Weena 455, 3013 AL Rotterdam, Netherlands and is a resident of The Netherlands within the meaning of Article 4 of the Philippines Netherlands tax treaty per Certification issued by the Inspector of Tax Office, Rotterdam, The Netherlands on August 24, 2004; that it is not registered either as a corporation or as a partnership licensed to do business in the Philippines as shown by the Certification of Non-Registration dated January 27, 2005 issued by the Securities and Exchange Commission; that UFP is a corporation duly organized and existing under the Philippine laws with office address at 1351 UN Avenue, Manila; that UFP is primarily engaged in the manufacture of various consumer products; and that UNV and UFP (then California Manufacturing Co., Inc.) entered into the following Agreements: 1. Unilever Trademark License Agreement (June 2, 2004) whereby UNV grants UFP an exclusive license to use and apply the Intellectual Property Rights 1 including the Trade Marks 2 on or in relation to the Products 3 in the Philippines for the duration of the Agreement. In consideration-for the rights thereby granted, UFP shall pay to UNV a royalty fee of 2.5% of the Turnover determined in UFP's currency of the Products sold by UFP under the Trade Marks as specified in the Agreement. The Agreement shall be deemed to have come into effect from April 1, 2004 and shall remain in force for a period of ten (10) years from that date and that it shall be deemed to be renewed for subsequent periods of 10 years. but otherwise on the same terms, unless either party shall have given the other not less than three (3) months notice in writing of the party's intention to terminate the agreement at the end of the period of 10 years. A Certificate of Compliance has been issued by the Intellectual Property Office (IPO) for this Agreement. DEScaT 2. Unilever Technology License Agreement (April 1, 2004) whereby UNV will continue to grant UFP an exclusive license under the Intellectual Property Rights and/or the Technology, 4 to make, have made, use, keep (whether for disposal or otherwise), offer for sale, sell and import Products, and services embodying or utilizing the technology in the Philippines. In consideration of the rights granted under the Agreement, UFP shall pay UNV a royalty fee of 3.5% of the Turnover 5 determined in Philippine currency of the products sold by UFP. The Agreement shall be deemed to have come into effect from April 1, 2004 and. shall remain in force for a period of ten (10) years from that date and shall be deemed to be renewed for subsequent periods of 10 years each but otherwise on the same terms, unless, and until either party shall have given to the other not less than 3 months notice in writing of that party's intention to terminate the Agreement at the end of the period of 10 years. A Certificate of Compliance has been issued by the Intellectual Property Office for this Agreement. 3. Unilever Central Services Agreement (CSA) June 2, 2004 whereby UNV shall either by itself, or at its option through one or more of the Group Companies, provide or make available Central Services to UFP. Corporate services, 6 divisional services 7 and other services, 8 jointly referred to as "central services" shall be provided, or made available, in such manner and at such time as may be agreed between the parties and which are: a) necessary for UFP's activities in respect of the Products in the Philippines and in the countries authorized by Unilever; b) of mutual benefit to UFP and the Unilever Group; and c) necessary to ensure that the manufacture, marketing and/or sale of the Products is at the standard of quality and appearance required by Unilever of the Group Companies. In consideration for the corporate and central services rendered, UFP shall pay UNV a service fee of four percent (4%) of Turnover determined in Philippine currency of the products sold by UFP. The Agreement shall be deemed to have come into effect from April 1, 2004 and shall remain in force for an indefinite period unless terminated by mutual agreement between the parties or by either party giving notice to the other. In reply, please be informed that Article 12 of the Philippines-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. "3. . . . "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 experience. DIEACH "xxx xxx xxx" Based on the above, royalties arising in the Philippines and paid to a resident of The Netherlands who is the beneficial owner thereof may be subject to Philippine income tax at a rate not to exceed 10 percent of the gross amount of the royalties where such royalties ate paid by an enterprise registered and engaged in preferred areas of activities, or 15 percent of the gross amount of the royalties in all other cases. In view thereof, royalty fees paid by UFP to UNV under the Unilever Trademark License Agreement and the Unilever Technology License Agreement are subject to the preferential tax rate of 15 percent, based on the gross amount of royalties, pursuant to the Philippines-Netherlands tax treaty. (BIR Ruling No. DA-ITAD 100-03 dated July 16, 2003) Moreover, the subject royalty payments, by UFP to UNV are subject to the 10% value-added tax (VAT) pursuant to Section 106 of the Tax Code of 1997, as amended. Accordingly, UFP, being the resident withholding agent and payor in control of the payment, shall be responsible for the withholding of 10% final VAT before remitting any payment to UNV. In remitting the VAT withheld, UFP 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 proof of payment thereof shall serve as documentary substantiation for the claim of input tax by UFP upon filing its own VAT return, if it is a VAT-registered taxpayer. In case UFP 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 an "expense" or as an "asset", whichever is applicable. In addition, UFP is required to issue the Certificate of Final Tax Withheld at Source (BIR Form No. 2306) in quadruplicate, the first three copies thereof to be given to UNV upon its request and the fourth copy to be retained by UFP as its file copy. [Section 4 & 6, Revenue Regulations (RR) No. 4-2000; Section 3 of RR 8-2002; Section 7 of RR 14-2002] In sum, with respect to the subject royalty payments, UFP shall be responsible for the withholding of the 10% VAT and income tax at the rate of 15% of the gross amount of royalties. As regards the CSA, please be informed that in classifying as royalties payments received in consideration for information concerning industrial, commercial or scientific experience, paragraph 2 alludes to the concept of "know-how" which 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. This type of contract thus differs from contracts for the provision of services in which one of the parties undertakes to use customary skills of his calling to execute work himself for the other party. Thus, payments obtained as consideration for "after-sales service", for services rendered by a seller to the purchaser under a guarantee, for pure technical assistance, or for an opinion given by an engineer, an advocate or an accountant, do not constitute royalties within the meaning of paragraph 4 of Article 12 of the Philippines-Netherlands tax treaty. Such payments generally fall under Article 7 or Article 14. Furthermore, in the case of Philippine Refining Company (PRC) vs. CIR, CTA Case No. 2872 dated January 15, 1986, the Court of Appeals had an occasion to rule on the distinction of service fees from royalties, to wit: IaTSED "To distinguish between compensation for service and royalty payments, one must inquire on whether the payee has proprietary interest in the property giving rise to the income. If the payee has none, then the payment is a compensation for personal services, if the payee has proprietary interest then the payment is royalty." Based on the above, the subject payments under the CSA are not within the definition of royalties under Article 12(4) of the Philippines-Netherlands tax treaty. Nothing in the CSA would require transfer in the Philippines of "know-how" or any property of which the payee has a proprietary interest. Such being the case, the subject payments under the said CSA would fall under Article 7 of the Philippines-Netherlands tax treaty. Article 7 in relation to Article 5 of the Philippines-Netherlands tax treaty provide, viz.: "Article 7 Business Profits "1. The profits of an enterprise of one of the States shall be taxable only in that State unless the enterprise carries on business in the other State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment. "xxx xxx xxx" "Article 5 Permanent Establishment "1. For the purposes of this Convention, the term 'permanent establishment' means of a fixed place of business in which the business of the enterprise is wholly or partly carried on. "2. The term 'permanent establishment' includes especially: a) a place of management b) a branch; c) an office; d) a factory; e) a workshop; f) a mine, quarry or other place of exploration or extraction of natural resources; g) a building site or construction or assembly project or supervisory activities in connection therewith, where such site, project or activity continues for a period of more than 183 days; h) the furnishing of services including consultancy services by an enterprise through an employee or other personnel where activities of that nature continue (for the same or a connected project) for a period or periods exceeding in the aggregate 183 days within any twelve month period. "xxx xxx xxx" Based on the foregoing provisions, an enterprise which is a resident of the Netherlands is taxable only in the Netherlands unless it carries on business in the Philippines through a permanent establishment situated therein. The term "permanent establishment", as has been defined under Article 5 of the tax treaty, includes the furnishing of consultancy services by an enterprise through an employee or other personnel where activities of that nature continue (for the same or connected project) for a period or periods exceeding in the aggregate 183 days within any twelve-month period. Thus, technical or consultancy services rendered outside the Philippines, or when services are rendered within the Philippines but the rendition thereof is for an aggregate period or periods of 183 days or less during any twelve month period, shall not constitute a permanent establishment for the foreign enterprise. TSIDEa In view thereof, this Office is of the opinion and so holds that since the services covered by the CSA are rendered by UNV outside the Philippines as confirmed by the Certification issued by Nicolas J. Pauig in his capacity as SVP Finance of Unilever Foods Philippines, (CMC) Inc. on September 16, 2005, the same are considered as income from sources outside the Philippines and the payments made by UFP to UNV for said services shall not be subject to Philippine income tax and consequently to the withholding tax under Section 28(B)(I) of the Tax Code of 1997. (BIR Ruling No. DA-ITAD 201-02 dated November 26, 2002) Similarly, the subject fees are not subject to ten percent (10%) Value-Added Tax (VAT) imposed under Section 108(A) of the Tax Code below: "Section 108. Value-Added Tax on Sale of Services and use or Lease of Properties. (A) Rate and Base of Tax. There shall be levied, assessed and collected, a value-added tax equivalent to ten percent (10%) of gross receipts derived from the sale or exchange of services, including the use or lease of properties. The phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration . . ." Section 108(A) clearly states that the sale or exchange of services subject to VAT include only those services that are performed in the Philippines. Accordingly, since the subject services will not be performed in the Philippines, the service fees therefor to be paid by UFP to UNV are therefore exempt from VAT. (BIR Ruling No. DA-ITAD 90-04 dated August 24, 2004) 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, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. "Intellectual Property Rights" shall mean for the purpose of the agreement any proprietary right relating to the marketing and sale of Products bearing the global core brands of which Licensor is the owner, including rights relating to the Trade Marks, copyrights, designs (whether registered or not), utility models, business methods, and rights relating to the trade dress and/or get-up of the Product. Intellectual Property Rights shall further include rights relating to confidential information, marketing/sales know-how, corporate name and logo, and image efforts, and shall not include services provided by Licensor or a Group Company. 2. "Trade Marks" shall mean all trade marks, trade names and brand names used, registered or pending application in the Philippines. 3. "Products" shall mean any product or goods marketed and sold under the Trade Marks in the course of Licensee's ordinary activities during the term of this Agreement which are manufactured by and/or on behalf of Licensee or a Group Company and distributed by Licensee, which employs or utilizes, directly or indirectly the Intellectual Property Rights and/or the Trade Marks. 4. "Technology" shall mean all information, knowledge and/or experience, relating to the composition, formulation, production, manufacture, specification, distribution, quality standards, sale and/or use of Products and/or services currently at Licensor's disposal or developed or acquired by Licensor during the subsistence of this Agreement. Technology shall further include any invention, design, scheme, method or improvement relating thereto, and any information, knowledge, practice and/or experience arising from scientific, market, economic or other research or development relating to the same. 5. "Turnover" refers to the net amount receivable from the customers for goods and services supplied and services rendered in the course of UFP's ordinary activities during the relevant financial period. 6. "Corporate Services" are those services provided by Unilever's board of directors and supporting staff, which benefit the Group Companies. Such services include, but not limited to the following: a. providing corporate strategic leadership; b. assisting the management of the Divisions, Business Groups and/or Group Companies, to translate the corporate strategies into regional strategies; and c. the provision of expert and transactional support, assistance and advice by the corporate functional departments including but not limited to legal matters, taxation, finance, human resources and information technology. 7. "Divisional Services" are those services provided by the management and supporting staff of a Division and certain Group Companies as agreed by the management of such Division, which benefit the Group Companies within that Division. Such services include, but Are not limited to the following: a. developing global business strategies and providing strategic global leadership; b. assisting the management of Business Groups and/or Group Companies to translate Divisional strategies into regional strategies; and c. the provision of support, assistance and advice from staff departments of the Division including but not limited to supply chain activities. 8. "Other Services" are those services which benefit the Group Companies in one or more regions and which are not corporate services, divisional services or, and include, but are not limited to the activities of the Global Infrastructure Organization (GIO) which provides services in the area of information technology and communications including but not limited to infrastructure management services. "Infrastructure management services" includes but is not limited to the organization, management, procurement, operation and maintenance of computer servers and proprietary hardware, desktop and mobile computers, printers and scanners. Unilever networks (local, national and global), vice, data and video communications, facsimile equipment, platform software (operating system, database, standard desktop and), end-user, support (helpdesk) and training for the above.