ITAD Ruling No. 139-05

November 15, 2005 ITAD RULING NO. 139-05 Articles 5 & 12, Philippines-Korea; Sec. 28 (B) (1), 42 (A) (3) of NIRC BIR Ruling DA-ITAD No. 156-04; ITAD No. 114-04 Sycip Gorres Velayo & Co . 6760 Ayala Avenue Makati City Attention: R.C. Vinzon Tax Services Gentlemen : This refers to your application for tax treaty relief dated March 2, 2005 on behalf of your client, Samsung Electronics Philippines Manufacturing Corporation (SEPHIL) requesting confirmation of your opinion that the fees paid by SEPHIL to Samsung SDS Co. Ltd. (SDS) are not subject to the Philippine income tax pursuant to Articles 5 & 7 of the Philippines-Korea tax treaty. It is represented that SDS is a nonresident foreign corporation duly organized and existing under the laws of Korea with business address at 707-19, Yeoksam-dong, Gangnam-gu, Seoul, Korea; that it is not registered either as a corporation or as a partnership licensed to do business in the Philippines per certification issued by the Securities and Exchange Commission dated February 16, 2005; that SEPHIL is a domestic corporation duly organized and existing under Philippines laws registered with the Philippine Economic Zone Authority (PEZA) under Certificate of Registration No. 01-11 dated July 31, 2002, with principal office address at Block 6, Calamba Premiere International Park, Batino, Calamba, Laguna; that SEPHIL is engaged in the design, manufacture and sale of electronics products including but not limited to, optical disk drive products, their components and parts; that SEPHIL entered into a Master mySingle Service Agreement (Agreement) with SDS on January 1, 2004; that the Agreement provides that SDS shall provide to SEPHIL Standard Services consisting of membership administration, mail, approval, business card, community, portal, messenger, internet access and helpdesk services; that the Agreement shall commence as of the Effective Date and continue for a period of four (4) years thereafter such initial four-year term, the term shall automatically renew unless SDS receives cancellation notice 30 days prior to the end of the term; and that per Certification issued on June 1, 2005 by Jeong Ho Park, Vice President of SEPHIL, SDS does not send employees to the Philippines to provide services under the Agreement. 06taxcdtai In reply, this Office is of the opinion and so holds that: 1. The service fees payable by SEPHIL to SDS under the Agreement are ordinary business profits and not royalties . Article 12 of the Philippines-Korea tax treaty defines the term "royalties" as follows: caIDSH "Article 12 ROYALTIES xxx xxx xxx (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, 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 equipment, or for information concerning industrial, commercial or scientific experience, and includes payments of any kind in respect of motion picture films and works on films or videotapes for use in connection with television or tapes for the use of radio broadcasting." 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 "know-how",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 examinations 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 ) Further, in the case of Philippine Refining Company vs. CIR , CTA Case No. 2872 dated January 15, 1986, the Court of Tax Appeals had an occasion to rule on the distinction of service fees from royalties, to wit: "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." Applying the above discussions to the instant case, there is nothing in the subject of the Agreement that would require transfer into the Philippines of technology, equipment or other property where SDS has proprietary interest or would otherwise permit SDS to impart to SEPHIL their special knowledge and experience which remain unrevealed to the public. Likewise, inasmuch as SDS shall render these services using their customary skills, then the compensation to be received therefor shall not constitute as consideration for the use of, or the right to use, any copyright, patent, trademark, design or model, plan, secret formula or process, or for the transfer of technology. Accordingly, the service fees to be paid by the SEPHIL to SDS are not within the definition of "royalties" under Article 12 of Philippines-Korea tax treaty. Thus, the service fees paid to SDS shall not be considered as royalties but shall constitute as business profits. ( BIR Ruling No. DA-ITAD 156-04 dated December 28, 2004 ) 2. The service fees which are considered as income of SDS derived from sources outside the Philippines shall be exempt from Philippine income tax . CHDTEA Inasmuch as it has been represented that the subject services are to be performed by SDS entirely in Korea, then the Philippines-Korea tax treaty does not apply as the herein transaction does not result in a case of double taxation of business profits for which a tax treaty relief may be sought. In this regard, Section 23(F), in relation to Section 42(A)(3), both of the National Internal Revenue Code of 1997, provide, viz: "SEC. 23. General Principles of Income Taxation in the Philippines. Except when otherwise provided in this Code: xxx xxx xxx (F) A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines. xxx xxx xxx" "SEC. 42. Income from Sources Within the Philippines. (A) Gross Income From Sources Within the Philippines. The following items of gross income shall be treated as gross income from sources within the Philippines: xxx xxx xxx" (3) Services Compensation for labor or personal services performed in the Philippines; xxx xxx xxx" It is clear from the aforequoted provisions that a nonresident foreign corporation is taxable only on income derived from sources within the Philippines. Since the design and support services to be rendered by SDS to SEPHIL shall be performed entirely in Korea, the fees to be remitted by SEPHIL are considered income derived from sources outside the Philippines and are therefore not subject to Philippine income tax and consequently to the withholding tax. ( BIR Ruling No. 036-90, BIR Ruling No. DA-ITAD 101-02 dated May 28, 2002 and DA-ITAD 207-02 dated November 26, 2002 ) This ruling is issued on the basis of the foregoing facts as represented However, if upon investigation it shall be disclosed or discovered 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