ITAD Ruling No. 135-05

November 15, 2005 ITAD RULING NO. 135-05 Article 12 & 14, Philippine-Singapore ITAD Ruling No. 108-03; DA-127-02; DA-139-03 Bernaldo Mirador & Director Law Office Unit 1807 Cityland Condominium 10-Tower 1 6815 Ayala Avenue cor. H.V. dela Costa St Makati City Attention: Mr. Rosario S. Bernaldo Managing Partner Gentlemen : This refers to your application for tax treaty relief dated January 3, 2005, on behalf of your client, Gardenia Bakeries (Philippines) (Gardenia-Phils), requesting confirmation of your opinion that the royalty payments made by Gardenia-Phils to QAF Limited (QAF) are subject to the twenty-five percent (25%) preferential tax rate under Article 12 of the Philippines-Singapore tax treaty. It is represented that QAF is a nonresident foreign corporation duly organized and existing under the laws of Singapore with business address at 150 South Bridge Road, #09-04 Fook Hai Building, Singapore; that QAF is not registered either as a corporation or as a partnership licensed to do business in the Philippines per certification dated November 11, 2004 issued by the Securities and Exchange Commission; that Gardenia-Phils is a domestic corporation duly organized and existing under Philippines laws with office address at Block 9, Lots 4 & 5, Star Avenue, Laguna International Industrial Park, Bo. Mamplasan, Bian, Laguna, Philippines; that on November 1, 1999, Gardenia-Phils and QAF entered into and executed a Royalty and Technical Assistance Agreement (Agreement) which was amended on November 10, 2004 to comply with the requirements of the Intellectual Property Code of the Philippines; that the Agreement is registered with the Intellectual Property Office per Certificate of Compliance No. 5-2004-00071 dated December 8, 2004; that the Agreement shall be valid for one (1) calendar year from the date of said Agreement and shall be deemed as having been renewed by the parties for a further year at the expiry of every subsequent calendar year; that under the Agreement, QAF grants Gardenia-Phils the right to operate in the Philippines bakery plants utilizing the Gardenia Bakery System and to use certain Trademarks on bakery products; that QAF shall make available to Gardenia-Phils certain "know-how" formulations and technical informations; that QAF shall provide technical assistance, marketing sales advertising promotions services and assistance in training the management staff; that in rendering the services mentioned, QAF may provide such number of qualified personnel as it deems reasonably necessary and shall bear the salaries of said personnel; that in consideration for the use of said formulations, technical information, provisions of technical and management services, Gardenia-Phils shall pay QAF royalties commencing from the financial year immediately after the financial year in which QAF, the Licensor, first achieved an audited profit before tax (the "Accruing Financial Year") of a minimum sum of Six Million Pesos (P6,000,000.00) since the set-up of the Approved Gardenia Bakeries by Gardenia Phils; and that Gardenia Phils shall be liable to pay QAF: a) 4.5% for the first 5 calendar years from the first day of the Accruing Financial Year; and b) an increase thereafter of 0.25% for every subsequent 5 calendar years provided the maximum percentage shall not exceed 7% of the Gross Sales. TEHDIA In reply, please be informed that Article 12 of the Philippines-Singapore tax treaty states that: "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 in which they arise, and according to the law of that State, but, if the recipient is the beneficial owner of the royalties, the tax so charged shall not exceed: a) in the case of the Philippines, 15 per cent of the gross amount of the royalties, where the royalties are paid by an enterprise registered with the Philippine Board of Investments and engaged in preferred areas of activities and also royalties in respect of cinematographic films or tapes for television or broadcasting; b) in the case of Singapore, where the royalties are approved under the Economic Expansion Incentives (Relief from Income Tax) Act of Singapore, the royalties shall be exempt; c) in all other cases, 25 per cent of the gross amount of the royalties. 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 tapes for television or 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. 4. The provisions of paragraphs 1 and 2 of this Article shall not apply if the recipient of the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties arise through a permanent establishment situated therein, or performs in that other State professional services from a fixed base situated therein, and the right or property in respect of which the royalties are paid is effectively connected with such permanent establishment or fixed base. In such a case, the provisions of Article 7 or Article 14 of this Agreement, as the case may be, shall apply. "xxx xxx xxx" The treaty defines "royalties" to include "payment of any kind received as a consideration for information concerning industrial, commercial or scientific experience ." According to the commentaries of the ORGANISATION FOR ECONOMIC COOPERATION AND DEVELOPMENT (OECD) Committee on Fiscal Affairs on the Model Tax Convention [par. 11 and 12, Commentary on Article 12 (Royalties), 2003, p. 175),such information alludes to the concept of " know-how ".The definition 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 a 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 can remain unrevealed to the public. ( BIR Ruling DA-ITAD No. 57-05 dated June 17, 2005 ) SEHTAC Based on the above, the herein payment by Gardenia Phils to QAF fall under the definition of "royalties" under Article 12 of the. Philippines-Singapore tax treaty. Inasmuch as Gardenia Phils is not an enterprise registered with the Philippine Board of Investments (BOI) which is engaged in preferred areas of activities, and that the herein royalty payments are not in respect of cinematographic films and tapes for television or broadcasting, this Office is of the opinion and so holds that the royalty payments by Gardenia Phils to QAF are subject to the preferential withholding tax rate of 25% of the gross amount of royalties pursuant to Article 12(2)(c) of the Philippines-Singapore tax treaty. (BIR Ruling DA-ITAD No. 99-02 dated May 22, 2002). Moreover, remuneration of QAF personnel who will render services to Gardenia under the provisions of the Agreement will be generally subject to Philippine income tax, unless the following conditions set forth in paragraph 2, Article 14 (Personal Services) of the Philippines-Singapore tax treaty below are all complied with: "Article 14 PERSONAL SERVICES "1. Subject to the provisions of Articles 15, 17, 18, and 19, salaries, wages and other similar remuneration or income for personal (including professional) services derived by a resident of a Contracting State, shall be taxable only in that Contracting State, unless the services are performed in the other Contracting State. If the services are so performed, such remuneration or income as is derived therefrom may be taxed in that other Contracting State. "2. Notwithstanding the provisions of paragraph 1, remuneration or income derived by a resident of a Contracting State for personal (including professional) services performed in the other Contracting State shall be taxable only in the first-mentioned Contracting State if: a) the recipient is present in the other Contracting State for a period or periods not exceeding in the aggregate 90 days in the case of professional services and 183 days in other cases, in the calendar year concerned; and b) the remuneration or income is paid by, or on behalf of, a person who is a resident of the first-mentioned Contracting State; and c) the remuneration or income is not borne directly by a permanent establishment which that person has in the other Contracting State. "xxx xxx xxx" Paragraph 2 states that the subject remuneration will be exempt from tax if: (a) the personnel are present in the Philippines for an aggregate period or periods not exceeding 90 days in the case of professional services and 183 days in other cases, in the calendar year concerned; (b) the remuneration is paid by an employer who is not a resident of the Philippines; and (c) the remuneration is not borne by a permanent establishment which the employer has in the Philippines. In the instant case, the second and third conditions are satisfied by reason that the employer, QAF, is not a resident of the Philippines and it does not have a permanent establishment or a fixed place of business in the Philippines. Thus, remuneration of personnel involved in rendering the services mentioned herein shall be taxable based on whether or not the first condition under Article 14, paragraph 2 of the Philippines-Singapore tax treaty is fulfilled. ( BIR Ruling No. DA-ITAD 139-03 dated September 26, 2002 ) aEAcHI Finally, Section 108(A)[(1) and (5)] of the Tax Code, states that "the use of certain 'know-how' formulations and technical informations" and "the supply of services by a nonresident person or his employee in connection with the use of property or rights belonging to the nonresident person" both fall within the definition of sale or exchange of services subject to ten percent (10%) value-added tax (VAT). Accordingly, the subject royalties by Gardenia to QAF are subject to the 10% value-added tax (VAT) pursuant to Section 108 of the Tax Code of 1997. Gardenia Phils, 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 fees before remitting any payment to QAF. In remitting the VAT withheld, Gardenia Phils 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 Gardenia Phils upon filing its own VAT return, if it is a VAT-registered taxpayer. In case Gardenia Phils 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, Gardenia Phils 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 QAF upon its request, and the fourth copy to be retained by Gardenia Phils as its file copy. [Section 4 & 6, Revenue Regulations (RR) No. 4-2002; Section 3 of RR No. 8-2002; Section 7 of RR No. 14-2002] (BIR Ruling Nos. DA-ITAD 28-04 dated March 29, 2004 and DA-ITAD 67-04 dated July 9, 2004) 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 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