ITAD Ruling No. 128-01

December 21, 2001 ITAD RULING NO. 128-01 RP-US Art. 13 RP-Russia Art. 12 BIR Ruling No. ITAD-121-00 BIR Ruling No. 163-99 Poblador Bautista & Reyes 5th Floor SEDCCO 1 Bldg. 120 Rada cor Legaspi St., Legaspi Village, Makati City Attention: Mr. Gilbert Raymund T. Reyes Mr. Raymund Martin C. Rodriguez Ms. Susan Bustos-Jacinto Gentlemen : This refers to your letter dated August 14, 2001 requesting confirmation that royalty payments made by Drake Beam Morin (Philippines), Inc. ("DBM Phil.") to Drake Beam Morin, Inc. ("DBM") pursuant to their Affiliate License Agreement shall be subject to the preferential tax rate of fifteen percent (15%) pursuant to the "most favored nation clause" [Article 13(2)(b)(iii)] of the RP-US tax treaty in relation to Article 12(2) of the RP- Russia tax treaty. Documents submitted show that DBM is a non-resident foreign corporation duly organized and existing under the laws of the State of Delaware, USA; that it is not licensed to engage in business in the Philippines per certification dated July 27, 2001 issued by the Securities and Exchange Commission (SEC); that DBM is engaged in the business of providing individual outplacement consulting programs and group outplacement consulting workshops; that it has access to, has developed and uses sophisticated technology and know-how in executive career continuation programs, spouse relocation counseling, retirement counseling, entrepreneurial programs, career decision workshops, selection interviews and other outplacement programs; on the other hand, DBM Phil. is a 100% Filipino-owned corporation duly organized and existing under Philippine laws, engaged in the business of providing individual and group outplacement consultancy services; that DBM Phil., desirous of obtaining sophisticated technology and know-how in the field of outplacement consulting services, entered into an Affiliate License Agreement with DBM effective for three (3) years commencing on June 01, 2001, whereby DBM has agreed to provide technology and know-how to DBM Phil. through the licensing of the trade names, trademarks and technology transfer of the software, manuals, modules and other materials developed by DBM; that in consideration thereof, DBM Phil. shall pay royalty fees consisting of an initial royalty fee of US$25,000.00 upon the execution of the Agreement, and a monthly license fee being a percentage of DBM Phil.'s annual gross revenues as follows: (i) a fee of 7% for annual gross revenue of up to US$1,500,000.00, and (ii) a fee of 4.5% for annual gross revenues in excess of US$1,500,000.00; that the Affiliate License Agreement is registered with the Intellectual Property Office (IPO) under Certificate of Registration No. 5-2001-00055, dated July 30, 2001. Based on the foregoing, it is now your opinion that pursuant to Article 13(2)[b](iii) of the RP-US tax treaty, which 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) . . . (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, considering that the lowest rate given to a third State is 15% as provided in Article 12(2) of the RP-Russia tax treaty, 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 per cent of the gross amount of royalties. (Emphasis supplied) "xxx xxx xxx" the royalties arising as a consequence of the Affiliate License Agreement between DBM and DBM Phil., are subject to 15% final withholding tax. In reply, please be informed that under the "most favored nation" clause provision of the RP-US tax treaty [Article 13, (2)(b)(iii)], 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. Article 12(2) of the RP-Russia tax treaty provides that royalties arising from the Philippines and paid to a resident of Russia may also be taxed in the Philippines but the tax so charged shall not exceed 15 per cent of the gross amount of royalties. The term "royalties" as used in this Article means any payment 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 and films and tapes for television or radio broadcasting, any patent, trademark, design or model, 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. 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 to the subject matter of the tax which is royalties. Thus, anent the most favored nation clause, U.S. recipients of royalty income are not entitled to the lower rate of 10 percent enjoyed by the German recipients under the RP-West Germany tax treaty as it was declared that the payment of taxes was made under different circumstances. Moreover, the aforementioned decision and its doctrine are applied prospectively. (BIR Ruling No. 163-99 dated October 20, 1999) A perusal of the RP-US and RP-Russia tax treaties, particularly their provisions on the avoidance of double taxation, shows 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. Such being the case, this Office is of the opinion and so holds that the royalties paid by DBM Phil. to DBM under the Affiliate License Agreement are subject to tax at the rate of 15% pursuant to the "most favored nation" provision of the RP-US tax treaty in relation to RP-Russia tax treaty. (BIR Ruling No. ITAD-121-00 dated August 29, 2000) Moreover, the said royalty payments shall be subject to 10% value-added tax (VAT) under Section 108(A)(1) and (3) of the Tax Code. Section 4.102-1(b) of Revenue Regulation No. 7-95 provides that: "The VAT on rental and/or royalties payable to non-resident foreign corporations or owners for the sale of services and use or lease of properties in the Philippines shall be based on the contract price agreed upon by the licensor and the licensee. The licensee shall be responsible for the payment of VAT on such rentals and/or royalties in behalf of the non-resident foreign corporation or owner by filing a separate VAT declaration/return (BIR Form No. 1600 Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld) for this purpose. The duly validated VAT declaration/return is sufficient evidence in claiming input tax credit by the licensee." Accordingly, DBM Phil. shall, before making payment of royalties to DBM, withhold and remit to this Bureau the value-added tax at the rate of 10% of the contract amount and the income tax at the rate of 15% of the gross amount of royalties. 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 considered null and void. Very truly yours, Commissioner of Internal Revenue By: (SGD.) EDMUNDO P. GUEVARA Deputy Commissioner Legal and Inspection Group