ITAD Ruling No. 134-03

August 29, 2003 ITAD RULING NO. 134-03 Article 13, RP-US tax treaty Article 12, RP-China tax treaty Revenue Memorandum Circular No. 46-02 BIR Ruling No. DA-ITAD 101-03 Colgate-Palmolive Philippines, Inc. 1049 Jose P. Rizal St., Guadalupe Viejo 0701 Makati City Attention: Aniceto Y. Dideles Legal Director & Corporate Secretary Gentlemen : This refers to your letter dated September 24, 2002 requesting confirmation of your opinion that the royalty payments by your company to Colgate-Palmolive Company (Colgate USA) are subject to the preferential tax rate of 10 percent pursuant to the "most-favored-nation" clause of the RP-US tax treaty in relation to the RP-China tax treaty. It is represented that Colgate USA is a non-resident foreign corporation duly organized and existing under the laws of the United States of America with principal office at 300 Park Avenue, New York, NY 10022; that it is not registered either as a corporation or as a partnership and has not been licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated October 14, 2002; that Colgate-Palmolive Philippines, Inc. (Colgate Phil) is a corporation duly organized and existing under the laws of the Philippines; that on several dates, Colgate USA and Colgate Phil executed the following royalty agreements, all with a uniform ten-year term and duly registered with the Intellectual Property Office (IPO): Certificate of Registration (COR) No./ Certificate of Compliance (COC) No. Date Executed Effective Until COR No. 1472 March 15, 1993 March 15, 2003 COR No. 1593 May 15, 1994 May 14, 2004 COR No. 1813 April 02, 1996 April 01, 2006 COR No. 1919 December 12, 1996 December 31, 2006 COR No. 1962 May 01, 1997 April 30, 2007 COC: No. 5-1999-00010 January 01, 1999 December 31, 2008 COC No. 5-2000-00021 January 01, 2000 December 31, 2009 COC No. 5-2000-00042 January 01, 2001 May 31, 2010 Under the above royalty agreements, Colgate Phil agreed to pay Colgate USA a running royalty calculated at the rate of five percent (5%) of the total net sales of the licensed products during the terms of said agreements. In reply, please be informed that Article 13 of the RP-US tax treaty provides as follows: "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 same 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 for property, or for information concerning industrial, or 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" Under the "most favored nation," clause found in Article 13(2)(b)(iii) of the RP-US 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 the Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State. In this light, Article 12 of the RP-China tax treaty, which became effective on January 1, 2002, provides: "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 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" 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. Hence, the "most favored nation clause of the RP-US tax treaty must be interpreted not only in relation to Article 12 of the RP-China tax treaty but also in connection with the provisions on the elimination of double taxation of both the RP-US and RP-China tax treaties. A perusal of the RP-US and RP-China tax treaties, particularly their provision on the avoidance of double taxation, shows 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. Such being the case, this Office is of the opinion and so holds that royalty payments by Colgate Phil to Colgate USA beginning January 1, 2002 are subject to the preferential tax rate not exceeding 10 percent of the gross amount of royalties pursuant to the "most favored nation" provision of the RP-US tax treaty in relation to RP-China tax treaty. (BIR Ruling No. DA-ITAD 101-03 dated July 24, 2003) Moreover, the said royalty payments are subject to 10% value-added tax (VAT) pursuant to Section 108 of the Tax Code of 1997. Accordingly, Colgate Phil being the resident withholding agent and payor in control of the payment, shall be responsible for the withholding of the 10% final VAT before making any payment to Colgate USA. In remitting the VAT withheld, Colgate Phil shall use 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 documentary substantiation for the claim of input tax by Colgate Phil upon filing its own VAT, if it is a VAT-registered taxpayer. In case Colgate 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" or "asset" whichever is applicable. In addition, Colgate Phil is required to issue the Certificate of Final Tax Withheld at Source (BIR Form 2306) in quadruplicate upon request of Colgate USA, the first three copies thereof to be given to Colgate USA and the fourth copy to be retained by Colgate Phil as its file copy. [Sections 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 of RR 8-2002; Section 7 of RR 14-2002] In fine, Colgate-Palmolive Philippines, Inc. shall be responsible for the withholding of income tax at the rate of 10% of the gross amount of royalties beginning January 1, 2002, and to the value-added tax at the rate of 10% of the contract amount. 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.) MILAGROS V. REGALADO Assistant Commissioner Legal Service